When Incentives Become Barriers: Supreme Court on Discriminatory Tax Notifications

 

Ashwarya Sharma, Advocate, Co-Founder & Legal Head, RB LawCorp

 

A. Opening

The Hon'ble Supreme Court in U.P. Asbestos Limited vs. State of Rajasthan and Ors. [2025-VIL-75-SC] has recently delivered a significant judgment quashing the levy of entry tax imposed in Rajasthan. The Court held the levy to be discriminatory and violative of Article 304(a) of the Constitution of India, thereby reaffirming the constitutional guarantee of non-discriminatory taxation on inter-State trade and commerce.

 

B. Issue Before the Court

The central issue arose from Notification No. S.O.377 dated 09.03.2007 ("Notification") issued under Section 8(3) of the Rajasthan Value Added Tax Act, 2003. The Notification granted exemption from VAT on sale of asbestos cement sheets and bricks manufactured within Rajasthan. The question was whether this exemption, which excluded goods imported from outside the State, was discriminatory and thus violative of Article 304(a).

 

The appellants, engaged in the manufacture and sale of asbestos cement products but without manufacturing facilities in Rajasthan, challenged the Notification. Their grievance was that by favouring local manufacturers, the Notification erected a fiscal barrier against goods imported from other States, directly offending Articles 301-304 of the Constitution.

 

The challenge was particularly notable because the Supreme Court, in its landmark nine-Judge Bench decision in Jindal Stainless Ltd. v. State of Haryana [2016-VIL-66-SC-CB], had generally upheld States' powers to levy entry tax, subject to non-discrimination under Article 304(a).

 

C. Petitioners' Arguments

The petitioners contended that:

 

1. The Notification was discriminatory, granting a blanket exemption to locally manufactured goods without any rational justification, thereby violating Article 304(a).
2. Relying on Jindal Stainless Ltd., it was argued that any differentiation imbued with "intentional and unfavourable bias" constitutes discrimination.
3. The High Court [2007-VIL-192-RAJ] erred in relying upon Video Electronics, as that case involved exemptions granted to a limited class of industries for a specified period, unlike the present Notification which was open-ended and across-the-board.
4. The absence of a challenge to earlier notifications could not estopp the petitioners from contesting constitutional rights.
5. The rationale of promoting local industry could not stretch Article 301 to justify discriminatory treatment against imported goods.

 

D. Respondent State's Arguments

The State of Rajasthan argued that:

 

1. Its plenary taxation power under Articles 245 and 246 is curtailed only if it violates Article 304(a).
2. Differentiation in favour of local industries is permissible if non-hostile, limited in duration, and intended to promote economic development.
3. Incentives or exemptions aimed at utilising local fly ash resources and attracting asbestos manufacturing units were legitimate policy measures.
4. Reliance was placed on Shree Digvijay Cement Co. Ltd. and Ors. v. State of Rajasthan and Ors. (1999-VIL-17-SC) and Video Electronics Pvt. Ltd. and Ors. v. State of Punjab and Ors. (1989-VIL-18-SC) to argue that tax exemptions to incentivise industries for a limited period are constitutionally valid.

 

E. Supreme Court's Findings & Discussion

The Court undertook an extensive analysis of Articles 301-304 and relevant precedents. Drawing from Atiabari Tea Co., Ltd. v. The State of Assam and Ors. (1960-VIL-02-SC-LB), The Automobile Transport (Rajasthan) Ltd. v. The State of Rajasthan and Ors. (1962-VIL-07-SC), Video Electronics, State of U.P. and Ors. v. Jaiprakash Associates Ltd. and Ors. (2013-VIL-04-SC) and Jindal Stainless, the Court reiterated that:

 

• Taxation per se is not barred under Part XIII; what is barred is discriminatory taxation under Article 304(a).
• Every differentiation is not discrimination. However, exemptions favouring local goods must satisfy the test of being non-hostile, for a limited period, and aimed at genuine economic development with reasons forthcoming from the notification itself.
• Notifications must contain reasons at the time of issuance. Post facto justifications in affidavits cannot cure inherent defects.

 

Applying these principles, the Court held that the Rajasthan Notification was discriminatory. Unlike Video Electronics, it was neither confined to a particular class of industries nor limited in duration. Moreover, no rationale was provided within the Notification itself; explanations advanced later in affidavits could not substitute the requirement of contemporaneous reasoning.

 

It was further noted that the State's contention-that fly ash was abundantly available in Rajasthan and that the objective of granting sales tax exemption was to encourage its utilisation in the manufacture of asbestos cement sheets and bricks-did not find support in the record. The justification that no manufacturing plant existed in the State, and that the exemption sought to incentivise such industries, was neither borne out from the Notification itself nor from the surrounding factual matrix discussed before the Court.

 

F. Conclusion of the Court

The Supreme Court crystallised the position of law as follows:

 

1. Articles 304(a) and 304(b) operate disjunctively-non-discrimination is a standalone requirement.
2. A tax on imported goods is not discriminatory if no similar goods are manufactured in the taxing State.
3. States may design fiscal statutes to ensure equal tax burdens on local and imported goods; such measures are permissible.
4. Exemptions/incentives granted to a specified class of dealers, for a limited period, and in a non-hostile manner to develop backward areas, would not offend Article 304(a).

 

On applying these tests, the Court concluded that the impugned Notification violated Article 304(a) as it was discriminatory, unlimited in scope, and unsupported by stated reasons.

 

G. Concluding Remarks

This judgment assumes significance in the evolving jurisprudence on Part XIII of the Constitution. While Jindal Stainless case upheld States' powers to impose entry tax, it emphasised the prohibition on discriminatory taxation. U.P. Asbestos reaffirms this principle by striking down a notification that extended blanket exemptions to local industries without justification.

 

By holding that reasons cannot be retrofitted through affidavits, the Court has also underscored the importance of transparency, contemporaneity, and constitutional discipline in fiscal policymaking. The decision serves as a cautionary reminder to States that while industrial incentives are permissible, they must be narrowly tailored, time-bound, and non-discriminatory.

 

From a GST perspective, the ruling resonates strongly. Though GST subsumes VAT and entry tax, disputes on discriminatory exemptions and fiscal incentives continue under GST (for instance, area-based exemptions, concessional rates, or State-specific incentives). The principle that exemptions must be non-discriminatory, contemporaneously reasoned, and consistent with the constitutional mandate of free trade remains equally applicable. Going forward, this judgment could guide courts in scrutinising GST notifications and circulars that attempt to confer preferential treatment on local industries at the expense of inter-State trade.

 

H. Food for thought

Before parting, a thought worth reflecting on: in Union of India v. Mohit Minerals Pvt. Ltd. (2022-VIL-30-SC), the Supreme Court held that the recommendations of the GST Council are not binding on the plenary legislative powers of the Union and the States, thereby recognising the States' autonomy to chart a course different from that suggested by the Council. This was celebrated as a significant assertion of fiscal federalism. Yet, in light of the present ruling, one must ask-if a State were to exercise such autonomy by prescribing a different rate of tax on State-specific considerations, would such differentiation withstand the scrutiny of Part XIII of the Constitution, especially when GST has been conceived as a unifying reform to establish a common national market?

 

The answer is far from settled. The delicate balance between the plenary power to legislate under Article 246A and the constitutional fetters imposed by Part XIII remains an open constitutional frontier. How the Courts reconcile these competing forces in the years ahead will shape not only the future of GST but also the larger contours of fiscal federalism in India.

 

[Date: 30/09/2025]

 

(The author is a practicing advocate, Co-Founder and Legal Head of RB LawCorp. He specializes in GST law. Suggestions or queries can be directed to ashsharma@rblawcorp.in. The views expressed in this article are strictly personal.)