Supreme Court’s Landmark Ruling; Imposing Service Tax on Lottery Distributor is Unconstitutional [Read Judgement]

In a landmark ruling, the Supreme Court dismissed the Union Government’s appeal, affirming that lottery distributors are not liable to pay service tax under the Finance Act, 1994. The Court held that being no agency and no service rendered, service tax is not leviable on the transactions between the purchaser of the lottery tickets and the Government of Sikkim. 

A bench of Justice B.V. Nagarathna and Justice NK Singh observed that “ The amendments made to the Finance Act, 1994, in order to impose service tax on the sole distributor/purchaser of the lottery tickets (respondents-assessees herein) have been unsuccessful. We have reasoned that the amendment to the said definition would in no way detract from the substance of the relationship between the State Government and the sole distributor or purchaser of the lottery tickets which is one of principal to principal and not of principal-agent.”

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The petitioners before the High Court (respondents-assessees) are companies incorporated as private limited companies under the Companies Act, 1956. The respondents-assessees herein are engaged in the business of the sale of paper and online lottery tickets organised by the Government of Sikkim. They entered into respective agreements with the State of Sikkim. 

Since these cases assail the amendments made to the provisions of the Finance Act, 1994 from time to time commencing from the year 2012, the factual backdrop of these cases shall be in accordance with the amendments made to the Act and shall be stated chronologically.

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The Parliament introduced service tax through the Finance Act, 1994 under Chapter V, which took effect on 01.07.1994. Later, through the Finance Act, 2003, the Finance Act,1994 was amended to include a new category of taxable services, namely "Business Auxiliary Service," under sub-section (19) of Section 65, effective from 01.07.2003. Pursuant to this amendment, the Service Tax Department issued notices to the respondents-assessees herein, under the amended Finance Act in 2007, requiring them to register under the said Act for payment of service tax.  

Being aggrieved, the respondents-assessees herein approached the High Court in Martin Lottery Agencies Ltd. vs. Union of India, challenging the levy of service tax upon the sale of lottery tickets. Vide judgement dated 18.09.2007, the High Court allowed the writ petition filed by the respondents-assessees herein declaring that service tax was not payable on the activity undertaken by the respondentsassessees. The aforesaid judgment came to be challenged before this Court in Civil Appeal No.3239 of 2009. During the pendency of the Civil Appeal, the Finance Act, 1994 was further amended with the introduction of an “Explanation” to Section 65(19)(ii) of the Finance Act, 1994.

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During the pendency of the above appeal, the Finance Act, 1994 again came to be amended with the deletion of the Explanation to Section 65(19)(ii) and the introduction of a new category of “taxable service” vide clause (zzzzn) to sub-section (105) of Section 65 vide the Finance Act, 2010 with effect from 01.07.2010. Clause (zzzzn) to sub-section (105) of Section 65 .

The High Court noted that betting and gambling itself is an activity though the lottery ticket is a tangible thing that carries with it the right to participate in the game of chance. Thus, all activities right from the publishing of the lottery tickets to participation in the game of chance, declaration of draw and even distribution of prize to the winner fall within the purview of the expression ‘betting and gambling’. Thus the power to levy tax on the organisation, promotion and marketing of lottery being an act of betting and gambling comes within the exclusive domain of Entry 62 - List II of the Seventh Schedule of the Constitution.

The High Court applied the test of the principle of pith and substance and observed that the power to levy tax on lotteries, which are considered games of chance and fall under "betting and gambling" in Entry 62 - List II, lies exclusively with the State Legislature. Consequently, Parliament's authority to impose such a tax under its residuary power in Entry 97 - List I, read with Article 248 of the Constitution, is excluded.

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The High Court held that while Parliament is competent to levy service tax under Entry 97 – List I, this does not imply that it can impose such a tax on lotteries, as the power to levy taxes on this subject has been conferred on the State Legislature in List II. That the residuary powers of Parliament can only be exercised when no Entry in any of the Lists provide a legislative field. Hence, it is the exclusive legislative domain of the State Legislature to levy tax of any nature on lotteries by virtue of Entry 62 - List II. 

The parliamentary amendments made to the Finance Act, 1994, for the purpose of imposing service tax on the respondentsassessees herein as ‘business auxiliary service’ under sub-section 19 of Section 65 of the said Act effective from 01.07.2003 and by way of the insertion of the Explanation to Section 65(19)(ii) of the

Finance Act, 1994 culminated in the judgment of this Court in K. Arumugam. In the said case, this Court held that the relationship between the Government of Sikkim and the assessees therein was not that of principal and agent but one of principal and principal. 

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The High Court further held that when a sole purchaser/distributor/promoter purchases the lottery tickets from the State Government for the purpose of onward sales through stockists etc., it was not acting as an agent of the State Government but in its own right as a principal.  Thus, the relationship between the State Government and the sole distributor was one between a principal and principal and not one between principal and agent. 

Ther court viewed that since “betting, gambling or lottery” was included in the Negative List, an Explanation was inserted to Section 66D(i) to say that the said expression “betting, gambling or lottery” shall not include the activity specified in Explanation 2 to clause (44) of Section 65B.  Thus, the intent of the Parliament was that any transaction in an actionable claim (lottery being an actionable claim) would not include an activity carried out for the distribution of lottery by the distributor.  In other words, such activity of the distributor would not amount to the activity of betting, gambling or lottery.  

 The bench held that being no agency and no service rendered by the respondents-assessees as an agent to the Government of Sikkim, service tax is not leviable on the transactions between the purchaser of the lottery tickets (respondents-assessees) and the Government of Sikkim.  Gurmeet Singh appeared for the petitioner and Arjun Garg appeared for the respondent.

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