Royalty is not a tax: SC ruling deals a financial blow to mining firms

In the 25 July ruling, an eight-to-one decision by Chief Justice of India (CJI) D.Y. Chandrachud-led nine-judge constitutional bench upheld that state legislatures have the power to tax mining lands and quarries, independent of the Mines and Minerals (Development and Regulation) Act of 1957.

The judgement gives states the authority to impose additional taxes on top of existing royalties, thereby increasing the financial burden on companies operating in the mining sector, experts said.

Cash outflow

"The judgment may lead to a heavy cash outflow for mine operators, creating a disturbance in working capital. In the future, there may be instances of overlapping financial obligations, leading to double taxation scenarios that can burden mining companies," said S.R. Patnaik, partner (head-taxation), law firm Cyril Amarchand Mangaldas. “The compliance burden may increase as this would require more detailed accounting and reporting practices to meet the distinct requirements for taxes and royalties."

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Patnaik said with potentially higher tax revenues from mining, states may also demand more from companies in terms of CSR (corporate social responsibility) activities, including investments in local communities and environmental sustainability initiatives.

Moreover, industries like gas, oil and construction, which use mineral resources, may pass on these costs to their products, thereby increasing the cost of such products and services, added Patnaik.

In 2023, Odisha’s former chief secretary, P.K. Jena, said in a statement that the state earned ₹50,000 crore in revenue from the mining sector in 2021-22, compared to about ₹4,900 crore in 2016-17.

“This (citing Odisha’s revenue from tax) could become a benchmark for states, making it financially challenging for mining-sector companies to operate," said a person from the industry on the condition of anonymity. “The order has empowered states to exert more control over corporations, potentially demanding investments like new plant setups in exchange for reduced tax obligations."

The Supreme Court ruling concluded that royalty rates cannot be classified as a tax for three main reasons: First, the obligation to pay royalty stems from the mining lease agreement rather than a legal requirement. Second, the demand for payment comes from the lessor, which can either be the state government or a private party and not a public authority. Third, the payment of royalty serves as a consideration to the lessor for permitting access to mineral reserves and is not intended for public purposes.

However, whether the judgement will apply retrospectively or prospectively is yet to be clarified. The Union government has requested the court to make it prospective, and the court will hear this aspect on Wednesday.

Fiscal federalism

The Supreme Court also highlighted the importance of maintaining fiscal federalism in taxing natural resources like minerals. “Fiscal federalism in the context of mineral resources requires us to be mindful that not all states are equally endowed with mineral resources. States such as Chhattisgarh, Jharkhand and Orissa have greater reserves of mineral resources. Despite this abundance, many of these states lag economically and suffer from a ‘resource curse’," the judgment noted.

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“Taxation is a crucial revenue source for these states, impacting their ability to deliver welfare schemes and services. Fiscal federalism entails that the states' power to levy taxes within their legislative domain must be secured from unconstitutional interference by Parliament," the judgement said.

According to Gopal Mundhra, partner at Economic Laws Practice, the ruling alters the fiscal relationship between the Union and mineral-rich states. “Until now, the central government was periodically determining royalty rates based on states' fiscal requirements, assuming states had no right to levy taxes on minerals beyond royalties. The central government may need to revisit royalty rate determination formulas for the future."

Tax competition 

Mundhra also pointed out the risk of tax competition between states. Some might introduce more favourable tax regimes to attract mining investments, while others might impose higher taxes to maximize revenue. This could lead to uneven development of the mining sector across different states.

"This Supreme Court judgement is poised to have significant economic repercussions, with companies potentially facing higher costs as states may impose additional taxes on top of existing royalties. This could impact profitability and influence investment decisions," said another person closely associated with the industry on the condition of anonymity. “The variation in new taxes on mineral rights from state to state could lead to a complex and higher tax liability for companies. Additionally, this will introduce regulatory challenges, straining the government's 'ease of doing business' initiative and potentially deterring future investments."

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The majority decision was given by a bench led by CJI D.Y. Chandrachud, comprising Justices Hrishikesh Roy, Abhay Oka, B.V. Nagarathna, J.B. Pardiwala, Manoj Misra, Ujjal Bhuyan, S.C. Sharma and A.G. Masih.

Justice B.V. Nagarathna was the lone dissenter. Justice Nagarathna held that royalty is a tax and that states have no right to levy it, endorsing a 1989 verdict by a seven-judge bench in the India Cements vs Tamil Nadu case.

Justice Nagarathna stated that non-extracting states starting to import minerals could affect foreign exchange reserves, potentially leading to a breakdown of the federal system envisaged under the Constitution in the context of mineral development. This could lead to unhealthy competition for mining licences in mineral-rich states that do not want to impose any levy beyond royalty.

Long-standing issue

More than 80 petitions have been filed over the years challenging the interpretation of royalties under the MMDR Act. In February, the Supreme Court commenced hearings to decide upon these conflicting interpretations and determine the rightful authority—the Union or states—for imposing taxes on mineral rights.

The dispute originated from the enactment of the MMDR Act by the Union government in 1957, which brought the control of mines and minerals under the Union government's jurisdiction. Section 9 of this Act mandated that mining leaseholders should pay royalties for minerals extracted.

In 1963, the Tamil Nadu government granted a mining lease to India Cements Ltd for extracting limestone and kankar. Under the Act, royalty payments were fixed. Concurrently, under Section 115(1) of the Madras Panchayat Act, a local cess was levied on land revenue paid to the government in each panchayat development block.

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India Cements contested the imposition of this cess in the Madras High Court, arguing that the Tamil Nadu government lacked the legislative competence to levy cess on royalty. The high court ruled in favour of the state, stating that the cess was a charge on land under its legislative authority.

India Cements appealed to the Supreme Court, which in 1989 ruled that royalty payments were indirectly related to minerals extracted and classified them as taxable under the MMDR Act. The Supreme Court held that royalty was a tax, and any cess on royalty exceeded the state's legislative competence, as the Act comprehensively covered the domain. Over the years, subsequent cases and interpretations challenged the ruling in the India Cements case.

In the 2004 case of the State of West Bengal vs Kesoram Industries Ltd, the Supreme Court acknowledged a clerical error in the India Cements judgment, clarifying that royalties were not taxes but contractual payments between lessors and lessees.

Conflicting interpretations and subsequent litigations resulted in over 80 related cases being consolidated and referred to the Supreme Court.

UltraTech Cement, which in November 2023 acquired the cement business of Kesoram and in June 2024 acquired a 23% stake in India Cements, didn’t respond to Mint's queries.