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IN THE SUPREME COURT OF INDIA  

CIVIL APPEALLATE JURISDICTION

CIVIL APPEAL NO.9344 OF 2010 (Arising out of S.L.P. (C) No.23149 of 2009)

Association of Leasing &  Financial Service Companies       …  Appellant (s)

Versus

Union of India and others …  Respondent(s)

WITH  

Civil Appeal No.9345 of 2010 (arising out of S.L.P. (C) No.23805 of 2009)  Civil Appeal No.9346 of 2010 (arising out of S.L.P. (C) No.24704 of 2009)  Civil Appeal No.9347 of 2010 (arising out of S.L.P. (C) No.11672 of 2009)  Civil Appeal No.9348  of 2010 (arising out of S.L.P. (C) No.23161 of 2009))  Civil  Appeal Nos.9350-9351 of  2010 (arising out of  S.L.P.  (C)  Nos.27989- 27990 of 2009

J U D G M E N T

S.H. KAPADIA, CJI  

1. Leave granted.

2. In this batch of Civil  Appeals,  the controversy pertains to  

validity of Sections 65(12)  and 65(105)(zm) of  the Finance Act,  

1994 (as amended)  insofar  as the  said provisions seek to levy  

service tax on leasing and hire purchase.  The appellants contend  

that service tax imposed by Section 66 of the Finance Act, 1994

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on the value of taxable services referred to in Section 65(105)(zm)  

read with Section 65(12) of the Finance Act, 1994 (as amended),  

insofar  as  it  relates  to  financial  leasing  services  including  

equipment  leasing  and hire  purchase  is  beyond the  legislative  

competence  of  Parliament  by  virtue  of  Article  366(29A)  of  the  

Constitution.

Facts in Civil Appeal @ SLP (C) No. 24704 of 2009

3. Appellant  is  an  Association  of  leasing  and  financial  

companies.  Finance Act sought to levy service tax on “banking  

and other financial  services”.   Section 137 of  the Finance Act,  

2001 substituted Section 65 of the Finance Act, 1994 by a new  

Section 65 which defined “banking and other financial services”.  

Subsequently,  this  definition also  underwent  some changes by  

way of Section 90 of the Finance Act, 2004 and Section 135 of the  

Finance Act, 2007.  The relevant part of the definition as on date  

contained in Section 65(12) of the Finance Act, 1994 is as follows:

“65. In this Chapter, unless the context otherwise requires –  (12) “banking and other financial services” means –  

(a) the following services provided by a banking company  or  financial  institution  including  a  non-banking  financial  company  or  any  other  body  corporate  or  commercial  concern  namely: -  

(i) financial  leasing services including equipment leasing  and hire-purchase;”   

4. Appellant had filed a writ petition under Article 226 of the

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Constitution before the High Court challenging the levy of service  

tax imposed by Section 65(12)(a)(i).  During the pendency of the  

writ  petition,  Union  of  India  issued  a  Notification  ST  dated  

1.3.2006 exempting  90% of  the  amount  repayable  under  hire-

purchase/  equipment  leasing  agreement(s)  from service  tax on  

the ground that the said 90% represented interest income earned  

by the service provider.  According to the appellant, the concept  

of  “service  tax”  was first  introduced by the Finance Act,  1994  

which  came  into  force  w.e.f.  1.7.1994  under  Chapter  V.   No  

service  tax  was  levied  by  the  said  Act  or  by  its  subsequent  

amendment till 2001.  However, vide Finance Act, 2001 service  

tax was imposed on “banking and other financial services”.  Vide  

Section  137(a)  of  the  Finance  Act,  2001,  Section  65  of  the  

Finance  Act,  1994  was  replaced  by  a  new  Section  65  which  

defined “banking and other financial services” vide clause (10).  

By virtue of the said definition under Section 65(10)(i), Parliament  

has sought to bring within the service tax net, transactions in the  

nature of financial leasing, equipment leasing and hire-purchase.  

By  Section  65(72),  the  expression  “taxable  service”  has  been  

defined to mean any service provided to a customer, by a banking  

company or a financial institution including NBFC, in relation to  

banking  and  other  financial  services  [See  Section  65(72)(zm)].  

Being  aggrieved  by  the  inclusion  of  hire-purchase  and  leasing

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services  within  the  service  tax  net,  the  appellant  herein  

challenged the amendment of 2001 as ultra vires the legislative  

competence of the Parliament.  By the impugned judgment, the  

Madras High Court has dismissed the writ petition, hence, this  

civil appeal.

Submissions

5. Mr. Arvind P. Datar, learned senior counsel appearing on  

behalf  of  the  appellant(s),  submitted  that  the  effect  of  Article  

366(29A) is to treat six types of transactions as deemed sales so  

as to enable state legislatures to levy sales tax under Entry 54,  

List  II;  that,  the  Statement  of  Objects  and  Reasons  to  the  

Constitution (Forty-sixth Amendment) Act makes it clear that all  

six transactions could have been taxed under Entry 97, List I by  

Parliament.   However,  based  on  the  61st Report  of  the  Law  

Commission, the Constitution has now conferred exclusive power  

to the States to levy sales tax by expanding Entry 54, List II by  

insertion  of  Article  366(29A).   Thus,  having  characterized  

constitutionally the subject matter of hire-purchase and leasing  

as a sale (deemed sale), it is not open to Parliament to tax the  

same subject matter under Entry 97, List I.  Thus, by reason of  

the  Constitution  (Forty-sixth  Amendment)  Act,  there  exist  six  

transactions as “sales”.  That, inevitable corollary is that power of  

taxation of hire-purchase/ leasing, being sales, is exclusively with

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the state legislatures.   The purpose of  the Constitution (Forty-

sixth Amendment) Act was to reserve the exclusive competence to  

tax  hire-purchase/  leasing  transactions  with  state  legislatures  

which is clearly seen from the 61st Report of the Law Commission  

which  recommended  constitutional  amendment.   In  this  

connection, learned counsel has placed reliance on the principles  

laid down by this Court in  Bharat Sanchar Nigam Limited v.  

Union  of  India  [(2006)  3  SCC 1].   According  to  the  learned  

counsel,  once  by  reason  of  the  Constitution  (Forty-sixth  

Amendment)  Act the hire-purchase/ leasing is deemed to be a  

sale, any attempt to levy service tax on the same transaction will  

amount  to  a  colourable  exercise  of  power.   According  to  the  

learned counsel, when sales tax is already paid for the transfer of  

the right to use the goods particularly when such transfer is a  

deemed sale under Article 366(29A), it is not open to Parliament  

to  impose  service  tax  on  the  same  transaction  once  again.  

According to the learned counsel, the impugned judgment of the  

High  Court  assumes  erroneously  that  hire-purchase/  leasing  

transactions include the concept of rendition of service and, thus,  

the impugned judgment needs to be set aside.

6. Mr. T.R. Andhyarujina, learned senior counsel appearing  

on behalf  of one of the appellants, submitted that prior to the  

Constitution  (Forty-sixth  Amendment)  Act,  the  Parliament  had

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the legislative competence to levy service tax on a hire-purchase  

transaction or leasing transaction; except on the sale part in such  

transaction,  which  lay  in  the  competence  of  the  States  under  

Entry  54,  List  II.   In  this  connection,  learned  counsel  placed  

reliance on the judgment of this Court in K.L. Johar and Co. v.  

Deputy Commercial Tax Officer [(1965) 2 SCR 112].  That, by  

the  Constitution  (Forty-sixth  Amendment)  Act  in  Article  

366(29A)(c)  and  (d),  hire-purchase/  leasing  transactions  were  

deemed to be sales and, consequently, the legislative competence  

in respect of hire part of the transaction was made over to the  

States.  That, the Law Commission in its 61st Report stated that  

“the other alternative would be to transfer the entire power to the  

States.  This will achieve a merger of the existing power of the  

States to tax the sale part and the new power to tax the hire part,  

which will enable state legislatures to provide for a tax on hire  

purchase price without demarcation”.  As a consequence of the  

Constitution  (Forty-sixth  Amendment)  Act,  the  Parliament’s  

competence  to  levy  a  tax  on  an  activity  relating  to  financial  

leasing services including equipment leasing and hire-purchase is  

constitutionally  truncated  by  the  newly  conferred  exclusive  

legislative competence of States over the deemed sales in Article  

366(29A)(c) and (d).  According to the appellant(s), when Section  

65 of the Finance Act imposes a service tax on “value of taxable

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services”, the value cannot include the elements of transaction of  

hire-purchase and leasing, which have now been transferred to  

the exclusive legislative competence of the States.  That, although  

Parliament can levy service tax on the providing of  services of  

hire-purchase  and leasing  of  equipment  if  the  service  provider  

levies  a  charge  by  way  of  management  fee,  processing  fee,  

documentation  charges  or  administrative  fees,  the  Parliament  

cannot  levy  a  service  tax  in  respect  of  the  hire  part  in  such  

transactions in view of the Constitution (Forty-sixth Amendment)  

Act  and,  consequently,  the  Parliament  has  no  legislative  

competence  to  levy  service  tax  on  the  hiring  charges  in  the  

transaction.   The  said  hiring  charges  are  nothing but  interest  

charges on the finance provided in hiring and leasing and hence  

the impugned tax cannot extend to tax the interest charged in the  

transactions.  According to the learned counsel,  various States  

have been imposing sales tax/ VAT on the entire transaction of  

hire-purchase/ leasing including the component of hire charges,  

interest  and  other  charges.   This  is  done  in  view  of  the  

Constitution  (Forty-sixth  Amendment)  Act.   Thus,  when  sales  

tax/ VAT is  charged by the States on the entire  consideration  

including interest received under the hire-purchase and leasing  

transactions any tax by Parliament on the same is beyond the  

competence and residuary power under Entry 97 of List I.  Thus,

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according to the learned counsel, levy of service tax in respect of  

the hire part in hire-purchase/ leasing transactions is beyond the  

competence of the Parliament.   

7. Mr. Goolam E. Vahanvati,  learned Attorney General for  

India, submitted that the basic contention advanced on behalf of  

the  appellant(s)  is  that  by  reason  of  introduction  of  Article  

366(29A) by the Constitution (Forty-sixth Amendment)  Act,  the  

entire power of taxation in respect of hire-purchase transactions  

is now vested only in the States under Entry 54 of List II and that  

the Parliament has no power at all including the power to levy a  

service  tax.   According  to  the  Attorney  General,  the  said  

argument is based on the contents of the 61st Report of the Law  

Commission, particularly, in relation to the background in which  

clauses (c) and (d) of Article 366(29A) were recommended.  The  

learned Attorney General invited our attention to the historical  

background of Article 366(29A) and the 61st Report of the Law  

Commission in support of his submission that a legal fiction was  

sought to be inserted in Article 366 in order to give an artificial  

extension to the definition of sale so as to include the power to  

levy sales tax even on the hiring part, and this is all that Article  

366(29A)  intended  to  do.   From  that,  according  to  learned  

Attorney General, one cannot infer that Parliament has divested  

itself  of  the  power  to  levy  service  tax.   According  to  learned

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Attorney  General,  the  question  of  service  tax  was  not  even  

present in the mind of Parliament when the Constitution (Forty-

sixth Amendment) Act was enacted and, therefore, reliance on the  

61st Report of the Law Commission was completely misconceived.  

According  to  learned  Attorney  General,  the  reliance  placed  on  

Para 44 of the  Bharat Sanchar Nigam Limited (supra) by the  

appellant(s)  is  completely  misconceived  because  that  judgment  

read in entirety recognizes the power of Union of India to levy  

service tax.  The learned Attorney General placed heavy reliance  

on the judgment of this Court in  All-India Federation of Tax  

Practitioners  v.  Union  of  India  [(2007)  7  SCC  527].   The  

learned Attorney General  drew our attention to the conceptual  

distinction between a service tax and a tax on hiring transaction.  

According to him, the business of banking or organizing financial  

services is an organized activity and service tax is imposed on  

that activity of financial leasing services provided by a banking  

company,  a  non-banking  financial  company,  a  body  corporate  

engaged in the business of financial leasing, etc.  That, service  

tax  is  not  imposed  on  the  hiring  part  of  a  hire-purchase  

transaction.   According  to  the  learned  Attorney  General,  it  is  

wrong to suggest that the whole “field” is covered by Entry 54 of  

List II as is sought to be contended on behalf of the appellant(s)  

because Article 366(29A), by way of a legal fiction, deems a tax on

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the delivery of goods on hire purchase to be a sale.  To interpret  

this fiction to mean that even a tax on financial leasing services is  

a tax on delivery of goods amounts to creating a fiction within a  

fiction, which is impermissible in law.  Therefore, according to the  

learned Attorney General, there is no question of the impugned  

levy being a levy of service tax on a hire-purchase transaction.  

Relying on the doctrine of pith and substance, it was submitted  

that the substance of the impugned law must be looked at in  

order to determine whether it is in pith and substance within a  

particular entry whatever its ancillary effect may be.  Applying  

the said test, it was submitted that imposition of service tax on  

financial  leasing services including equipment leasing and hire  

purchase does not, in pith and substance, fall within the scope of  

Entry 54 of List II as extended by Article 366(29A).  On the other  

hand,  according  to  the  learned  Attorney  General,  in  three  

decisions of this Court in the case of T.N. Kalayana Mandapam  

Association  v.  Union  of  India  [(2004)  5  SCC 632],  Gujarat  

Ambuja Cements Ltd. v. Union of India [(2005) 4 SCC 214]  

and All-India Federation of Tax Practitioners (supra),  it  has  

been held that levy of service tax falls within Entry 97 of List I.  

For the afore-stated reasons, it was submitted that the impugned  

levy  is  within  the  legislative  competence  of  Parliament  with  

reference  to  Entry  97  of  List  I  of  Seventh  Schedule  of  the

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Constitution and, thus, the same is constitutionally valid.

Relevant provisions of the Finance Act, 2001 (as amended)

8. By the Finance Act, 2001, Section 65 of the Finance Act,  

1994 stood substituted.  For deciding this batch of cases, we are  

concerned  with  Section  65(10)  read  with  Section  65(72)(zm),  

relevant parts whereof are quoted hereinbelow:

“65. Definitions- In this Chapter, unless the context  otherwise requires,-

(10) "banking and other financial services"  means,  the following services provided by a banking company  or  a  financial  institution  including  a  non-banking  financial company, namely:-

(i)  financial  leasing  services  including  equipment  leasing and hire-purchase by a body corporate;

(72) "taxable service" means any service provided,-

(zm) to  a  customer,  by  a  banking  company  or  a  financial institution including a non-banking financial  company,  in  relation  to  banking and other  financial  services;”

9. The  point  to  be  noted  is  that  whereas  Section  

65(10)/Section  65(12)  defines  what  is  “banking  and  other  

financial  services”,  Section  65(72)(zm)/Section  65(105)(zm)  

indicates  what  is  “taxable  service”.  Section  65(12)  read  with  

Section 65(105)(zm), as amended, read as under:

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“65. Definitions.-- In this Chapter, unless the context  otherwise requires,--

(12) "banking and other financial service" means--

(a) the following services provided by a banking company  or  a  financial  institution  including  a  non-banking  financial company or any other body corporate, namely:-

(i) financial leasing services including equipment leasing  and hire-purchase by a body corporate;

(105) "taxable service" means any service provided,--

(zm) to a customer, by a banking company or a financial  institution including a non-banking financial company,  in relation to banking and other financial services;”

    10. We  also  quote  hereinbelow Section  66  of  Finance  Act,  

2001  which  deals  with  charge  of  service  tax  and  the  relevant  

portion whereof reads as under:

“66. Charge of service tax- (1) On and from the date of  commencement of this Chapter, there shall  be levied a  tax (hereinafter referred to as the service tax), at the rate  of  five  per  cent.  of  the  value  of  the  taxable  services  referred to in sub-clauses (a), (b) and (d) of clause (72) of  section  65  and  collected  in  such  manner  as  may  be  prescribed.”

11. We  also  quote  hereinbelow Section  67  of  Finance  Act,  

2001 which deals with valuation of taxable services for charging  

service  tax.   The  relevant  portion  of  Section  67  is  quoted  

herebelow:

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“67. Valuation of taxable services for charging service  tax- For the purposes of this Chapter, the value of any  taxable service shall be the gross amount charged by the  service provider for such service rendered by him.”

12. Since in this batch of cases there is a challenge to the  

Constitutional  validity of the imposition of service tax on hire-

purchase/  lease  transactions,  we  are  also  required  to  quote  

hereinbelow Article 366(29A) of the Constitution:

“(29A)  "tax  on  the  sale  or  purchase  of  goods"  includes--

(a) a tax on the transfer, otherwise than in pursuance of  a contract,  of  property in any goods for cash, deferred  payment or other valuable consideration;

(b) a tax on the transfer of property in goods (whether as  goods or in some other form) involved in the execution of  a works contract;

(c) a tax on the delivery of goods on hire-purchase or any  system of payment by installments;

(d) a tax on the transfer of the right to use any goods for  any purpose (whether or not for a specified period) for  cash, deferred payment or other valuable consideration;

(e) a tax on the supply of goods by any unincorporated  association or body of persons to a member thereof for  cash, deferred payment or other valuable consideration;

(f) a tax on the supply, by way of or as part of any service  or in any other manner whatsoever, of goods, being food

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or any other article for human consumption or any drink  (whether  or  not  intoxicating),  where  such  supply  or  service, is for cash, deferred payment or other valuable  consideration,

and such transfer, delivery or supply of any goods shall  be  deemed to  be  a  sale  of  those  goods by  the  person  making the transfer, delivery or supply and a purchase of  those  goods  by  the  person  to  whom  such  transfer,  delivery or supply is made;”

13. We also quote hereinbelow Articles 246 and 248 of the  

Constitution, which read as follows:

“246  -  Subject-matter  of  laws  made  by  Parliament  and by the Legislatures of States     

(1)  Notwithstanding  anything  in  clauses  (2)  and  (3),  Parliament  has  exclusive  power  to  make  laws  with  respect to any of the matters enumerated in List 1 in the  Seventh Schedule (in this Constitution referred to as the  "Union List").

(2)  Notwithstanding  anything  in  clause  (3),  Parliament  and subject  to clause (1),  the  Legislature of  any State  also, have power to make laws with respect to any of the  matters enumerated in List III in the Seventh Schedule  (in this Constitution referred to as the "Concurrent List").

(3) Subject to clauses (1) and (2), the Legislature of any  State has exclusive power to make laws for such State or  any  part  thereof  with  respect  to  any  of  the  matters  enumerated in List II  in the Seventh Schedule (in this  Constitution referred to as the 'State List').

(4) Parliament has power to make laws with respect to  any  matter  for  any  part  of  the  territory  of  India  not  included in a State notwithstanding that such matter is  a matter enumerated in the State List.

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248 - Residuary powers of legislation  

(1) Parliament has exclusive power to make any law with  respect to any matter not enumerated in the Concurrent  List or State List.  

(2)  Such power shall  include the power of making any  law  imposing  a  tax  not  mentioned  in  either  of  those  Lists.”

14. We are also required to quote Entry 97 of List I, which  

reads as under:

“97. Any other matter not enumerated in List II or List III  including any tax not mentioned in either of those Lists.”

15. We quote hereinbelow Entry 54 of List II, which reads as  

under:

“54. Taxes on the sale or purchase of goods other than  newspapers, subject to the provisions of entry 92A of List  I.”

Meaning of the words “banking and other financial services”  in Section 65(12) of Finance Act, 1994

16. Before dealing with the submissions we need to clarify  

the  concept  of  “banking  and  other  financial  services”  which  

expression finds place in Section 65(12)(a)(i) of the Finance Act,

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1994 (as amended).

17. At the outset, it may be noted that the Appellant(s) is a  

non-banking financial company [“NBFC”, for short].  The RBI was  

constituted under the RBI Act, 1934 (“1934 Act”, for short) inter  

alia to regulate the country’s monetary system. It is appointed as  

a regulator to secure the monetary stability and to operate the  

credit system of the country.  Chapter III-B of the 1934 Act deals  

with  provisions  relating  to  NBFCs  and  financial  institutions.  

Under  Section  45-I(a),  “the  business  of  a  NBFC”  is  defined  to  

mean carrying on the business of a financial institution referred  

to in clause (c) of Section 45-I and includes business of a NBFC.  

The  expression  “financial  institution”  means  any  non-banking  

institution which carries on as its business an activity inter alia  

of  financing,  whether  by  way of  making  loans  or  advances  or  

otherwise.  Thus, Section 45-I(c) treats financing as an activity.  

Under  Section 45-I(f),  an NBFC is defined to mean a financial  

institution which is a company; a non-banking institution which  

is a company and which as a matter of business receives deposits  

or which lends in any manner.  These activities are regulated by  

RBI under the 1934 Act.  Thus, all NBFCs which carry on these  

activities as part  of  their  business come within the purview of  

being financial institutions. Under Section 45-IA, no NBFC shall  

carry  on  the  business  of  a  non-banking  financial  institution

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without obtaining a certificate of registration from RBI.  Under  

Section 45-JA the RBI is authorized in public interest to issue  

directions to NBFCs relating to income recognition,  accounting  

standards,  deployment of  funds etc.  and such NBFCs shall  be  

bound to  follow the policy  so determined.   Accordingly,  under  

notification dated 2.1.1998 bearing No. 114, the deposit taking  

activities of NBFCs was sought to be regulated.  Under the said  

notification, there is classification of NBFCs.  Vide Clause 5 it has  

been clarified that several instances have come to the notice of  

RBI where NBFCs conducting their business as loan companies  

claim themselves to be equipment leasing/hire-purchase finance  

companies with the intention to avail of higher borrowing limits  

and thus an NBFC having not less than 60% of its assets and  

deriving not less than 60% of its income from equipment leasing  

and hire-purchase activities taken together will only be eligible for  

being  classified  as  equipment  leasing  company/hire-purchase  

finance company.   The  said notification is  relied upon only to  

demonstrate  that  the  classification  of  loan  or  investment  

companies  is  not  only  asset  and  income  based  but  also  that  

certain  NBFCs  undertake  activities  of  equipment  leasing  and  

hire-purchase  financing  in  addition  to  giving  of  loans.   Under  

clause (a) of the said Direction, RBI has categorized NBFCs on the  

basis  of  the  businesses  in  which  they  are  engaged  including

18

giving  of  loans,  hire-purchase  finance  and  equipment  leasing  

activities [See Taxmann’s Statutory Guide to NBFCs page 224].

18. The Institute of Chartered Accountants of India (ICAI) has  

also issued AS-19 “Accounting for Leases”.  It  is mandatory in  

respect of financial leases executed on or after April,  2001.  It  

inter alia provides for capitalization of finance lease assets in the  

books  of  the  lessee  instead  of  lessor.   The  lessor  [NBFC]  is  

required  to  show  the  assets  leased  only  as  receivables  in  its  

balance sheet instead of as fixed assets.  The implication of the  

above AS-19 for the NBFC prescribed by RBI vide amendments to  

the  1998  Directions  is  that  all  financial  leases  would  now be  

accounted like hire-purchase transactions [See Manual of NBFCs  

9th Edition  Page  268].   Similarly,  under  the  RBI  Guidelines  

dealing with accounting for investments, NBFCs having not less  

than  60% of  the  total  assets  in  lease  and  hire  purchase  and  

deriving  not  less  than  60%  of  their  total  income  from  such  

activities can be classified as hire purchase/ equipment leasing  

companies.  All these circulars and guidelines issued by RBI are  

relied  upon  only  to  show  that  equipment  leasing  and  hire-

purchase are activities undertaken as business by NBFCs which  

are regulated  as para banking activities  by the RBI  under  the  

provisions of the 1934 Act.  They are regulated not only to protect  

depositors  but  also customers [See Section 45-I(c)(iii)(i)].    The

19

above  activities  are  financing  activities  encompassed  under  

Section 45-I(c)(i) which in turn constitutes “rendition of services  

to  its  customer(s)”  which  is  the  taxable  event  under  Section  

65(105)(zm) of the Finance Act, 1994 (as amended).  Apart from  

NBFCs, even banks through their subsidiaries with the approval  

of RBI can undertake equipment leasing, hire-purchase business  

and financial  services.   These are  not direct  lending activities.  

However, RBI treats them as services or facilities.  The financial  

facilities  are  extended  by  way  of  equipment  leasing  or  hire-

purchase finance subject to approval of RBI [See Taxmann’s RBI  

Instructions for Banking Operations 7th Edition page 224].

19. The significance of the above circulars and guidelines is  

to show that the activities undertaken by NBFCs of equipment  

leasing  and  hire-purchase  finance  are  facilities  extended  by  

NBFCs  to  their  customers;  that,  they  are  financial  services  

rendered by NBFCs to their customers and that they fall within  

the meaning of the words “banking and other financial services”  

which is sought to be brought within the service tax net under  

Section 66 of the Finance Act, 1994.  One more aspect needs to  

be highlighted.  With the application of AS-19, the leased assets  

are required to be shown as “receivables” and not as fixed assets  

which further shows that equipment leasing and hire-purchase  

finance  are  financial  facilities  which  thereby  funds  projects

20

presented  by  the  customers  to  banks  and  other  financial  

institutions including NBFCs.  Thus, the impugned tax is levied  

on these services as taxable services.  It is not a tax on material  

or sale.   The taxable event is rendition of  service.   Hence, the  

impugned tax is different and distinct from tax on sale of goods  

under Entry 54 List II of the VIIth Schedule to the Constitution.

20. According to Sale of Goods Act by Mulla [6th Edition] a  

common method of selling goods is by means of an agreement  

commonly known as a hire-purchase agreement which is more  

aptly described as a hiring agreement coupled with an option to  

purchase, i.e., to say that the owner lets out the chattel on hire  

and  undertakes  to  sell  it  to  the  hirer  on  his  making  certain  

number of payments.  If that is the real effect of the agreement  

there is no contract of sale until the hirer has made the required  

number of payments and he remains a bailee till then.  But some  

so-called  hire-purchase  agreements  are  in  reality  contracts  to  

purchase, the price to be paid by instalments and in those cases  

the contract is a contract of sale and not of hiring.  It depends on  

the  terms  of  the  contract  whether  it  is  to  be  regarded  as  a  

contract  of  hiring  or  a  contract  of  sale.   A  hire-purchase  

agreement partakes of the nature of a contract of bailment with  

an element of sale added to it.  However, if the intention of the  

financing  party  in  obtaining  the  hire-purchase  and  the  allied

21

agreements is to secure the return of the loan advanced to its  

customer  the  transaction  would  be  merely  a  financing  

transaction. [See page 75].  The point which needs to be re-stated  

is  that  the  funding activity  undertaken by the  financing party  

which could be in the form of loan or equipment leasing or hire-

purchase  financing,  would  be  exigible  to  service  tax  if  such  

activity  falls  in  the  category  of  “banking  and  other  financial  

services”  under  Section 65(12)  of  the  Finance Act,  1994.   The  

financial  transaction  was  earlier  out  of  the  tax  net.   In  the  

process there are two different and distinct transactions, viz., the  

financing transaction and the equipment leasing/hire-purchase  

transaction.  The former is exigible to service tax under Section  

66 of Finance Act, 1994 (as amended) whereas the latter would  

be  exigible  to  local  sales  tax/VAT.   Funding  or  financing  the  

transaction of equipment leasing and hire-purchase covers two  

different  and  distinct  transactions.  The  activity  of  funding  or  

financing by NBFC who is in the business of financing by giving  

loans, or equipment leasing or hire-purchase finance falls in the  

category  of  financial  services  rendered  by  NBFCs  to  their  

customers.  It is an activity in relation to the hire-purchase or  

lease  transaction.   In  this  connection,  as  and  by  way  of  

illustration we need to give an illustration which brings out the  

distinction between a “finance lease” and “operating  lease”.   A

22

finance  lease  transfers  all  the  risks  and rewards  incidental  to  

ownership, even though the title may or may not be eventually  

transferred to the lessee.  In the case of “finance lease” the lessee  

could  use  the  asset  for  its  entire  economic  life  and  thereby  

acquires risks and rewards incidental to the ownership of such  

assets.  In substance, finance lease is a financial loan from the  

lessor to the lessee.  On the other hand an operating lease is a  

lease  other  than  the  finance  lease.   Accounting  of  a  “finance  

lease” is under AS-19, which as stated above, is mandatory for  

NBFCs.  It is a completely different regime.  According to Chitty  

on Contract, a hire-purchase agreement is a vehicle of instalment  

credit.  It is an agreement under which an owner lets chattels out  

on hire and further agrees that the hirer may either return the  

goods and terminate the hiring or elect to purchase the goods  

when the  payments for  hire  have reached a sum equal  to the  

amount of the purchase price stated in the agreement or upon  

payment  of  a  stated  sum.   The  essence  of  the  transaction  is  

bailment of goods by the owner to the hirer and the agreement by  

which the hirer has the option to return the goods at some time  

or the other [See para 36.242, 36.243].  Further, in the bailment  

termed “hire” the bailee receives both possession of the chattel  

and the right to use it  in return for remuneration to be paid to  

the  bailor  [See  para  32.045].   Further,  under  the  head

23

“equipment leasing”, it is explained that it is a form of long-term  

financing.   In a finance  lease,  it  is  the  lessee who selects  the  

equipment to be supplied by the dealer or the manufacturer, but  

the lessor [finance company] provides the funds, acquires the title  

to the equipment and allows the lessee to use it for its expected  

life.   During  the  period  of  the  lease  the  risk  and  rewards  of  

ownership are transferred to the lessee who bears the risks of  

loss,  destruction  and  depreciation  or  malfunctioning.   The  

bailment  which  underlies  finance  leasing  is  only  a  device to  

provide  the  finance  company  with  a  security  interest  [its  

reversionary right].   If the lease is terminated prematurely, the  

lessor  is  entitled  to  recoup  its  capital  investment  [less  the  

realizable value of the equipment at the time] and its expected  

finance charges [less  an allowance  to  reflect  the  return of  the  

capital]  [para 32.057].  In the case of hire-purchase agreement  

the periodical payments made by the hirer is made up of :

(a) consideration for hire

(b) payment on account of purchase

21. To sum up, NBFCs essentially are loan companies.  They  

basically conduct their business as loan companies.  They could  

be in addition thereto in the business of equipment leasing, hire  

purchase finance and investment.  Because NBFCs are basically  

loan companies, they are required to show the assets leased as

24

“receivables” in their balance sheets.  That, the activities of hire-

purchase finance/equipment leasing undertaken by NBFCs come  

under  the  category  of  “para  banking”.   That,  in  substance  a  

finance  lease,  unlike  an  operating  lease,  is  a  financial  loan  

(assistance/facility)  by  the  lessor  to  the  lessee.   That,  in  the  

bailment termed “hire” the bailee receives both possession of the  

chattel and the right to use it in return for remuneration.  On the  

other hand, equipment leasing is long term financing which helps  

the borrower to raise funds without outright payment in the first  

instance.   Here  the  “interest”  element  cannot  be  compared  to  

consideration  for  lease/hire  which  is  in  the  nature  of  

remuneration  (consideration)  for  hire.   Thus,  financing  as  an  

activity  or  business  of  NBFCs  is  different  and  distinct  from  

operating lease/hire-purchase agreements in the classical sense.  

The elements of the finance lease or loan transaction are quite  

different  from  those  in  equipment  leasing/hire-purchase  

agreements between owner (lessor) and the hirer (lessee).  There  

are  two independent  transactions  and what  the  impugned tax  

seeks  to  do  is  to  tax  the  financial  facilities  extended  to  its  

customers by the NBFCs under Section 66 of the 1994 Act (as  

amended)  as  they  come  under  “banking  and  other  financial  

services”  under  Section  65(12)  of  the  said  Act.   “The  finance  

lease” and “the hire-purchase finance” thus squarely come under

25

the expression “financial leasing services” in Section 65(12) of the  

Finance Act, 1994 (as amended).

Nature and character of service-tax

22. In  All  India  Federation  of  Tax  Practitioners’  case  

(supra), this Court explained the concept of service tax and held  

that service tax is a Value Added Tax (‘VAT’ for short)  which in  

turn is a destination based consumption tax in the sense that it  

is levied on commercial activities and it is not a charge on the  

business but on the consumer.  That, service tax is an economic  

concept  based  on  the  principle  of  equivalence in  a  sense  that  

consumption of goods and consumption of services are similar as  

they  both satisfy  human needs.   Today with the  technological  

advancement there is a very thin line which divides a “sale” from  

“service”.  That, applying the principle of equivalence, there is no  

difference between production or manufacture of saleable goods  

and production of marketable/saleable services in the form of an  

activity  undertaken  by  the  service  provider  for  consideration,  

which correspondingly stands consumed by the service receiver.  

It is this principle of equivalence which is inbuilt into the concept  

of service tax under the Finance Act, 1994.  That service tax is,  

therefore, a tax on an activity.  That, service tax is a value added  

tax.   The  value  addition  is  on  account  of  the  activity  which  

provides value addition, for example, an activity undertaken by a

26

chartered accountant or a broker is  an activity  undertaken by  

him based on his performance and skill.  This is from the point of  

view of the professional.  However, from the point of view of his  

client, the chartered accountant/broker is his service provider.  

The  value  addition  comes  in  on  account  of  the  activity  

undertaken  by  the  professional  like  tax  planning,  advising,  

consultation  etc.   It  gives  value  addition  to  the  goods  

manufactured or produced or sold.  Thus, service tax is imposed  

every time service  is  rendered to the  customer/client.   This  is  

clear from the provisions of Section 65(105)(zm) of the Finance  

Act,  1994  (as  amended).   Thus,  the  taxable  event  is  each  

exercise/ activity  undertaken by the service provider and each  

time  service  tax  gets  attracted.   The  same  view  is  reiterated  

broadly in the earlier judgment of this Court in Godfrey Phillips  

India  Ltd.  v.  State  of  U.P.  [(2005 (2)  SCC 515] in  which  a  

Constitution Bench observed that in the classical sense a tax is  

composed of two elements : the person, thing or activity on which  

tax is imposed.  Thus, every tax may be levied on an object or on  

the event  of  taxation.    Service  tax  is,  thus,  a  tax  on activity  

whereas sales tax is a tax on sale of a thing or goods.   

Law  as  it  stood  before  the  Constitution  (Forty-sixth  Amendment) Act, 1982:

23. The principle  that legislative  entries must be given the

27

widest interpretation is subject to the exception that where the  

entries use legal terms, they must be given their legal meaning.  

This  principle  was  established  in  The  State  of  Madras  v.  

Gannon Dunkerley & Co., (Madras) Ltd. [(1959) SCR 379] where  

it  was held  that  in  Entry  48 List  II,  Seventh  Schedule  of  the  

Government of India Act, 1935, the words “sale of goods” had the  

same meaning which those words have in the Sale of Goods Act,  

1930 (“1930 Act” for short). Thus, a  legislature cannot extend its  

taxing  power  by  defining  the  words  “sale  of  goods”  to  cover  

transactions which did not constitute “sale of goods” within the  

1930 Act. Accordingly, it was held in Gannon Dunkerley’s case  

that in a building contract there was neither a contract to sell  

materials used in the construction nor did the property in the  

materials pass as movables.  Accordingly,  it was held that the  

provisions  of  the  Madras  General  Sales  Tax  (Amendment)  Act,  

1947 defining  a  sale  to  include  “a  works  contract”  were  ultra  

vires.  It  was held  that  the  exercise  of  legislative  power  by the  

State  legislature  was  an  exercise  to  enlarge  that  power  which  

would amount to amending Entry 54 of List II by an ordinary law  

which was impermissible because under that Entry the subject of  

the legislative power was tax on sale of goods.  

24. The word “sale”  is  a  nomen juris.  It  is  the name of  a  

consensual contract.  The law with regard to chattels is embodied

28

in the Sale of Goods Act.  A contract of sale is different from an  

agreement to sell  and unlike other contracts, operates by itself  

and  without delivery to transfer the property in the goods sold.  

The word “sale” connotes both a contract and a conveyance or  

transfer of property.   The law relating to building contracts was  

well-known when  Gannon Dunkerley’s  case was  decided  and  

under that law the supply of goods as part of the works contract  

was not a sale.  Thus, the essential ingredients of the “sale” are  

agreement  to  sell  movables  for  a  price  and  property  passing  

therein  pursuant  to  an  agreement.   Therefore,  to  allow  

subsequent exercise of  legislative power to enlarge that power,  

would  be  to  amend  the  entry  relating  to  that  power  in  the  

Constitution by an ordinary law, which is not permissible.  The  

principle  of  Gannon  Dunkerley’s  case,  however,  has  no  

application to a law enacted by the Parliament imposing sales tax  

on supply of materials in building contracts since Parliament has  

power to legislate in respect of Part C States under Article 246(4).  

It is important to note that such power in the Parliament on the  

above matter could also be found in Entry 97, List I read with  

Article  248(2).   Entry  97  gives  effect  to  Article  248.   Thus,  

although  a  sales  tax  on  materials  supplied  under  a  building  

contract  is  outside  Entry  54,  List  II,  as  held  in  Gannon  

Dunkerley’s case, Parliament has power to impose such a tax.

29

[See Constitutional Law of India by H.M. Seervai, pp. 2437]

25. In  K.L.  Johar  and  Co.  v.  Deputy  Commercial  Tax  

Officer [(1965) 2 SCR 112], this Court held that a hire-purchase  

agreement had two elements, an element of bail and an element  

of sale. When all the terms of the said agreement stood satisfied  

and the option to purchase was exercised, only at that stage sales  

tax would be exigible; but the legislature would have no power to  

tax such agreements till that stage was reached.  Till that stage, a  

hire-purchase agreement is not a sale.  It is important to note  

that  under  K.L.  Johar’s  case,  bailment  termed  as  “hire”  fell  

within the competence of the Parliament, the tax on sale of goods  

came within the competence of the State Legislature.  Further,  

delivery which is the essence of bailment was not treated as an  

essential  element  of  sale  as  a  taxable  event  and  as  a  result  

certain consequences as enumerated in the Statement of Objects  

and  Reasons  to  the  Constitution  (Forty-sixth  Amendment)  Act  

ensued, as highlighted hereinbelow.

26. It is in view of the above problems, that the Constitution  

(Forty-sixth Amendment) Act, 1982 came to be enacted.  The 61st  

Report of the Law Commission begins with the genesis.  One of  

the points referred to in the Law Commission’s Report related to  

the restricted scope for the levy of sales tax by State Governments

30

in respect of works-contract and hire-purchase transactions.  In  

the report it  has been stated vide paras 1.6 & 1.7 at page 10  

“since the expression ‘sale of goods’ in Entry 54 of State List has  

the  same  meaning  as  in  Sale  of  Goods  Act,  a  hire-purchase  

agreement  is  not  a  sale,  as  no  property  passes  in  such  a  

transaction  until  the  option  to  purchase  is  exercised  and  the  

other terms of the agreement are fulfilled.  Similarly, in a building  

contract,  which is  indivisible,  there  is  no sale  of  goods.   It  is  

contract of works.  Similarly, a transaction between an hotelier  

and a resident customer is one of ‘service’ and is not taxable as  

‘sale of goods’; if there is a consolidated charge for boarding and  

lodging”.   That,  Gannon  Dunkerley’s  case  is  an  example  of  

composite contracts, involving supply of goods and services.  It is  

in this background that we have considered the question whether  

the  power  to  tax  indivisible  contracts  of  works  should  be  

conferred on the States.  It is in the above background that the  

Law Commission in fact observes “Supreme Court with respect  

appears to have adopted an unusually restricted interpretation of  

the word “sale””.  It is true that the word “sale” is not defined in  

the Constitution but is well recognized canon of construction that  

the words used in the three legislative Lists should receive the  

widest interpretation and not to the narrow definition of the word  

“sale”  contained  in  the  Sale  of  Goods  Act  for  the  purpose  of

31

interpreting  that  expression  in  Entry  54,  List  II.   That  is  the  

principal  juridical  ground  on  which  we  have  expressed  our  

preference for the transfer of power to tax such contracts to the  

State  Legislatures.   That,  the  Commission  would  prefer  

restoration of the power to State legislature [See pages 19 and  

20].   Thus,  to  restore  the  power  to  levy  sales  tax  on  such  

contracts, the Commission suggested the third out of the three  

below-mentioned alternatives:

(i) amending State List Entry 54;

(ii) adding a fresh Entry in the State List;

(iii) inserting in Article 366 a wide definition of “sale” so as to  

include works contract.

27. It is the third alternative that brought in Article 366(29A)  

vide the Constitution (Forty-sixth Amendment)  Act,  1982 (page  

21).   Even in the context  of  hire-purchase contracts the same  

alternative  is  opted  for  by  the  Commission.   However,  two  

observations of the Commission may be noticed.  The first is in  

para 25, page 32.  It reads as follows:

“The effect of  the judgment in K.L.  Johar’s case is  to  reduce the tax base on which sales tax is payable.  A tax  on hire-purchase  without sale can be levied  on the full  value of  the  hire-purchase  transaction  by  the  Union  under the residuary power – entry 97 of Union List.”

28. To the same effect is the observation of the Commission

32

at page 37:

“The  power  to  tax  hire-purchase  within  the  State  also  vests in the Union under Union List, entry 97.”

29. Thus,  before  the  Constitution  (Forty-sixth  Amendment)  

Act, hire-purchase transaction could have been taxed by Union  

under  Entry  97,  List  I  but  as  a  matter  of  policy  Parliament  

brought in Article 366 (29A) as recommended by the Commission.  

The point to be noted is that reliance on the report [though it  

helps our above reasoning on some of the aspects] placed by the  

appellant (s) only shows that service tax was not in the mind of  

Parliament when the Constitution (Forty-sixth Amendment)  Act  

stood  enacted.   It  was  not  even  in  the  mind  of  the  Law  

Commission.   That,  as  stated  above,  only  on  the  principal  

juridical ground that the word “sale” in Entry 54, List II should  

have been read widely,  the  Commission  suggested  that  Article  

366 be amended so that power to tax such contracts remains  

with the State Legislature as originally intended.  In fact at page  

20, the Commission states “before the judgment of the Supreme  

Court in Gannon Dunkerley’s case, the word “sale” was usually  

regarded  as  including  works  contract  and works  contract  was  

regarded as falling in Entry 54, List II and that taxes were in fact  

being levied and recovered by the States”.

Scope of Article 366(29A)

33

30. If one examines Article 366(29A) carefully, one finds that  

clause  (29A)  provides  for  an  inclusive  definition  and  has  two  

limbs.  The first limb says that the tax on sale or purchase of  

goods includes a tax on transactions specified in sub-clauses (a)  

to (f).  The second limb provides that such transfer, delivery or  

supply of goods referred to in the first limb shall be deemed to be  

a sale of those goods by the person making the transfer, delivery  

or supply and purchase of those goods by the person to whom  

such transfer, delivery or supply is made.  Now, in K.L. Johar’s  

case,  this  Court  held  that  the  States  can  tax  hire-purchase  

transactions resulting in sale but only to the extent to which tax  

is levied on the sale price.  This led the Parliament to say, in the  

Statement  of  Objects  and  Reasons  to  the  Constitution  (Forty-

sixth  Amendment)  Act,  “though  practically  the  purchaser  in  a  

hire-purchase transaction gets the goods on the date of entering  

into the hire-purchase contract, it has been held by the Supreme  

Court in  K.L. Johar’s case that there is a sale only when the  

purchaser exercises the option to purchase which is at a later  

date  and  therefore  only  the  depreciated  value  of  the  goods  

involved in such transaction at the time the option is exercised  

becomes assessable to sales tax which position has resulted in  

avoidance  of  tax  in  various  ways.”   Thus,  we  find  from  the  

Statement of Objects and Reasons that the concept of “deemed

34

sale” is brought in by the Constitution (Forty-sixth Amendment)  

Act only in the context of imposition of sales tax and that the  

words “transfer, delivery or supply” of goods is referred to in the  

second limb of Article 366(29A) to broaden the tax base and that  

as  indicated  in  the  Report  of  Law  Commission  prior  to  the  

judgment  of  this  Court  in  Gannon  Dunkerley’s  case,  works  

contract was always taxed by the States as part of the word “sale”  

in Entry 48/54 of List II.  The object behind enactment of Article  

366(29A) is to tax the composite price so that the full value of the  

hire-purchase price is taxed and to avoid the judgment in  K.L.  

Johar’s  case whose  implication  was  to  narrow  the  tax  base  

resulting  in  seepage  of  sales  tax  revenue.   It  is  in  that  sense  

“splitting”  of  the  contract  needs  to  be  understood.   Thus,  it  

cannot be said that Parliament divested itself of the power to levy  

service  tax  vide  enactment  of  the  Constitution  (Forty-sixth  

Amendment) Act.  Even in the Report of the Law Commission, it  

has been observed that “if a hire-purchase transaction results in  

a sale, sales-tax is undoubtedly leviable by the States.  No doubt,  

it is difficult to determine the “sale price” for the purpose of the  

sales tax law but this has no bearing on the question of legislative  

competence” (page 26).  Thus, reliance placed by the appellant(s)  

on  the  expression  “splitting  up”  in  K.L.  Johar’s  case is  

misconceived  because  the  “splitting  up”  referred  to  in  K.L.

35

Johar’s case was, as stated above, in regard to valuation and not  

in regard to legislative competence.  

Whether the State Legislature has the exclusive competence  to levy tax on “financial  leasing services” under Entry 54,  List II?

31. On behalf  of the appellant(s)  it  was submitted that the  

State Legislature has the exclusive competence to levy a tax on  

hire-purchase and financial leasing by reason of Entry 54, List II  

read with Article 366(29A).  It was submitted that, as held by this  

Court in the case of Bharat Sanchar Nigam Limited (supra) [vide  

para 44], splitting was permissible under Article 366(29A) only in  

two cases indicated in sub-clauses (b) and (f) and that in no other  

service (including hire-purchase).

32. For answering the above, we need to keep in mind the  

doctrine of “pith and substance” and the rule of interpretation of  

legislative entries.   These have to be applied to what is stated  

hereinabove in the earlier part of our judgment in which we have  

dealt with the concept of “banking and other financial services”  

and  the  nature  and  character  of  “service  tax”  as  a  tax  on  

activities.  We may reiterate that Equipment Leasing and Hire-

Purchase Finance are activities of long term financing and they  

fall within the ambit of “banking and other financial services”.  As  

stated  above,  a  financial  lease  is  a  lease  that  transfers

36

substantially all risks and rewards incident to ownership.  In the  

said  lease,  the  lessor  (NBFC)  merely  finances the  equipment/  

asset which the lessee is free to select, order, take delivery and  

maintain.  The lessor (NBFC) arranges the funding.  It accepts the  

invoice from the vendor (supplier)  and pays him.   The income  

which the lessor earns is by way of finance/ interest charges in  

addition to the management fees or documentation charges, etc.  

It  is  this  income which constitutes the measure of  tax for  the  

purposes  of  calculating  the  value  of  taxable  services  under  

Section 67 of  the  Finance  Act,  1994.   Thus,  a  financial  lease  

would come within “financial leasing services” in terms of Section  

65(12)(a)(i).  There are different types of financial leases, namely,  

a  tax-based  financial  lease,  a  leverage  lease  and an operating  

lease.  In the present case, there is no adjudication of the matter.  

The  appellant(s)  approached  the  High  Court  directly  without  

proper  adjudication  by  the  competent  authority  under  the  

Finance Act, 1994.  Even in the matter of allocation between the  

principal and finance/ interest charges, adjudication under the  

Act was warranted which has not been done.  One must also bear  

in mind that Article 366(29A) is essentially sales tax specific.  It  

was brought  in to expand the  tax base which stood narrowed  

down because of certain judgments of this Court.   That is the  

reason for bringing in the concept of “deemed sale” under which

37

tax could be imposed on mere “delivery” on hire-purchase [See  

clause (c)] which expression is also there in the second limb of  

the said article.

33. To begin we would  like  to  quote  hereinbelow from the  

judgment of this Court the relevant observations in the case of  

The Second Gift Tax Officer, Mangalore v. D.H. Hazareth [AIR  

1970 SC 999] on the doctrine of pith and substance:

"The sovereignty of Parliament and the Legislatures is a  sovereignty of enumerated entries, but within the ambit  of an entry, the exercise of power is as plenary as any  Legislature  can  possess,  subject,  of  course,  to  the  limitations  arising  from  the  fundamental  rights.  The  entries themselves do not follow any logical classification  or dichotomy. As was said in State of Rajasthan v. S.  Chawla (1959) Supp 1 SCR 904 = (AIR 1959 SC 544) the  entries  in  the  Lists  must  be  regarded  as  enumeratio  simplex  of  broad  categories.  Since  they  are  likely  to  overlap occasionally, it is usual to examine the pith and  substance  of  legislation with a view to determining to  which entry they can be substantially related, a slight  connection  with  another  entry  in  another  List  notwithstanding. Therefore, to find out whether a piece  of legislation falls within any entry, its true nature and  character  must  be in respect  to that  particular  entry.  The entries must of  course receive a large and liberal  interpretation  because the  few words  of  the  entry  are  intended to confer vast and plenary powers. If, however,  no entry in any of the three Lists covers it, then it must  be regarded as a matter not enumerated in any of the  three  Lists.  Then  it  belongs  exclusively  to  Parliament  under  entry  97  of  the  Union  List  as  a  topic  of  legislation.”  

34. We also quote hereinbelow the relevant observations in  

the case of  M/s Ujagar Prints (II) v. Union of India [(1989) 3

38

SCC 488]:

“Entries to the legislative lists, it must be recalled, are  not sources of the legislative power but are merely topics  or  fields  of  legislation  and  must  receive  a  liberal  construction  inspired  by  a  broad  and  generous  spirit  and not  in  a  narrow pedantic  sense.   The  expression  “with respect to” in Article 246 brings in the doctrine of  “Pith  and  Substance”  in  the  understanding  of  the  exertion  of  the  legislative  power  and  wherever  the  question of  legislative competence is  raised the test  is  whether  the  legislation,  looked  at  as  a  whole,  is  substantially  ‘with  respect  to’  the  particular  topic  of  legislation.  If the legislation has a substantial and not  merely a remote connection with the entry, the matter  may well be taken to be legislation on the topic.”

35. On the interpretation of legislative entries the law is well-

settled  by  the  judgment  of  this  Court  in  the  case  of  M/s.  

International  Tourist  Corporation v.  State  of  Haryana [AIR  

1981 SC 774] in the following terms:

“…Before  exclusive  legislative  competence  can  be  claimed for Parliament by resort to the residuary power,  the legislative incompetence of the State legislative must  be clearly established. Entry 97 itself is specific that a  matter can be brought under that entry only if it is not  enumerated in List II or List III and in the case of a tax if  it is not mentioned in either of those Lists. In a Federal  Constitution  like  ours  where  there  is  a  division  of  legislative subjects but the residuary power is vested in  Parliament,  such  residuary  power  cannot  be  so  expansively interpreted as to whittle down the power of  the State Legislature. That might affect and jeopardise  the  very  federal  principle.  The  federal  nature  of  the  Constitution  demands  that  an  interpretation  which  would  allow  the  exercise  of  legislative  power  by  Parliament pursuant to the residuary powers vested in it  to  trench  upon  State  legislation  and  which  would  thereby  destroy  or  belittle  State  autonomy  must  be  rejected . . .”

39

36. Now coming to the main point whether the whole field is  

covered  by  Entry  54  and  that  the  levy  of  service  tax  is  

incompetent, it is important to note the language of Entry 97, List  

I and Article 248 except for the word “other” in Entry 97.  This is  

because when one reads Entry 97 of List I with Article 246(1) it  

confers exclusive power first, to make laws in respect of matters  

specified in Entries 1 to 96 in List I and, secondly, it confers the  

residuary power of making laws by Entry 97.  Article 248 does  

not provide for any express powers of Parliament but only for its  

residuary power.  Article 248 adds nothing to the power conferred  

by Article 246(1) read with Entry 97, List I.  In the context of an  

exhaustive enumeration of subjects of legislation what does the  

conferment  of  residuary  power  mean?  Entry  97,  List  I  which  

confers  residuary  powers  on  Parliament  provides  “any  other  

matter not enumerated in List II and List III including any tax not  

mentioned in either of those lists”.  The word “other” is important.  

It  means  “any  subject  of  legislation  other  than  the  subject  

mentioned in Entries 1-96”.  Lastly, we must keep in mind a clear  

distinction  between  the  subject  and  measure  of  tax.  [See  

Goodricke Group Ltd. v. State of West Bengal, (1995) Suppl 1  

SCC 707]

37. Applying  the  above  decisions  to  the  present  case,  on  

examination of the impugned legislation in its entirety, we are of

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the view that the impugned levy relates to or is with respect to  

the  particular  topic  of  “banking  and  other  financial  services”  

which includes within it one of the several enumerated services,  

viz., financial leasing services.  These include long time financing  

by  banks  and  other  financial  institutions  (including  NBFCs).  

These  are  services  rendered  to  their  customers  which  comes  

within the meaning of the expression “taxable services” as defined  

in Section 65(105)(zm).  The taxable event under the impugned  

law  is  the  rendition  of  service.   The  impugned  tax  is  not  on  

material or sale.  It is on activity/ service rendered by the service  

provider  to  its  customer.   Equipment  Leasing/  Hire-Purchase  

finance  are  long  term financing  activities  undertaken  as  their  

business  by  NBFCs.  As  far  as  the  taxable  value  in  case  of  

financial leasing including equipment leasing and hire-purchase  

is  concerned,  the  amount  received  as  principal  is  not  the  

consideration for services rendered.  Such amount is credited to  

the capital account of the lessor/ hire-purchase service provider.  

It is the interest/ finance charge which is treated as income or  

revenue and which is  credited  to  the  revenue account.   Such  

interest or finance charges together with the lease management  

fee/  processing  fee/  documentation  charges  are  treated  as  

considerations  for  the  services  rendered  and  accordingly  they  

constitute the value of taxable services on which service tax is

41

made payable.  In fact, the Government has given exemption from  

payment  of  service  tax  to  financial  leasing  services  including  

equipment leasing and hire-purchase on that portion of taxable  

value comprising of 90% of the amount representing as interest,  

i.e.,  the  difference  between  the  instalment  paid  towards  

repayment of the lease amount and the principal amount in such  

instalments paid (See Notification No. 4/2006 – Service Tax dated  

1.3.2006).  In other words, service tax is leviable only on 10% of  

the interest portion.  (See also Circular F.No. B.11/1/2001-TRU  

dated 9.7.2001 in which it has been clarified that service tax, in  

the  case  of  financial  leasing  including  equipment  leasing  and  

hire-purchase,  will  be  leviable  only  on  the  lease  management  

fees/ processing fees/ documentation charges recovered at the  

time of entering into the agreement and on the finance/ interest  

charges recovered in equated monthly instalments and not on the  

principal amount).  Merely because for valuation purposes inter  

alia  “finance/  interest  charges”  are  taken  into  account  and  

merely because service tax is imposed on financial services with  

reference to “hiring/ interest” charges, the impugned tax does not  

cease  to  be  service  tax  and  nor  does  it  become  tax  on  hire-

purchase/ leasing transactions under Article 366(29A) read with  

Entry 54, List II.  Thus, while State Legislature is competent to  

impose tax on “sale” by legislation relatable to Entry 54 of List II

42

of Seventh Schedule, tax on the aspect of the “services”, vendor  

not being relatable to any entry in the State List, would be within  

the legislative  competence of  the  Parliament  under  Article  248  

read  with  Entry  97  of  List  I  of  Seventh  Schedule  to  the  

Constitution.

38. According  to  Mr.  Arvind  Datar  and  Mr.  K.  Parasaran,  

learned counsel appearing on behalf of some of the appellants,  

once  the  subject  matter  of  hire-purchase  and  leasing  is  

constitutionally  characterized  as  a  sale  (deemed  sale)  by  the  

Constitution  (Forty-sixth  Amendment)  Act,  the  said  subject  

matter can be taxed only under Entry 54, List II and it cannot be  

taxed under Entry 97, List I.  According to the learned counsel,  

the  object  behind  enactment  of  the  Constitution  (Forty-sixth  

Amendment) Act was to reserve the exclusive competence to tax  

hire-purchase  transactions  with  the  State  Legislature  and  

exclude the Parliament from the legislative sphere.  In support of  

the above contentions, learned counsel placed reliance on para  

44 of the judgment of this Court in the case of  Bharat Sanchar  

Nigam Limited (supra), the relevant portion of which is quoted  

hereinbelow:

“44. Of  all  the  different  kinds  of  composite  transactions, the drafters of the Forty-Sixth Amendment  chose  three  specifications,  a  works  contract,  a  hire- purchase contract and a catering contract to bring them  within the fiction of a deemed sale.  Of these three, the

43

first and third involve a kind of service and sale at the  same time.”

39. Emphasizing the underlined words, the learned counsel  

contended  that  a  hire-purchase  does  not  involve  a  sale  and  

service at  the same time and, therefore,  service tax cannot be  

levied on the interest/ finance charges which is sought to be done  

in  the  present  case.   In  our  view,  the  judgment  in  Bharat  

Sanchar Nigam Limited’s case has no application to the present  

case.   As stated above,  what  is  challenged in this  case  is  the  

service tax imposed by Section 66 of the Finance Act, 1994 (as  

amended) on the value of taxable services referred to in Section  

65(105)(zm) read with Section 65(12) of the said Act, insofar as it  

relates to  financial  leasing services including equipment leasing  

and  hire-purchase  as  beyond  the  legislative  competence  of  

Parliament by virtue of Article 366(29A) of the Constitution.  In  

short, legislative competence of the Parliament to impose service  

tax on financial leasing services including equipment leasing and  

hire-purchase  is  the  subject  matter  of  challenge.   Legislative  

competence was not the issue before this Court in the  Bharat  

Sanchar  Nigam  Limited’s  case.   In  that  case,  the  principal  

question  which  arose  for  determination  was  in  respect  of  the  

nature of the transaction by which mobile phone connections are  

enjoyed.  The question was whether such connections constituted

44

a sale or a service or both.  If it was a sale then the States were  

legislatively competent to levy sales tax on the transaction under  

Entry 54, List II of the Seventh Schedule to the Constitution.  If it  

was  service  then  the  Central  Government  alone  had  the  

legislative competence to levy service tax under Entry 97, List I  

and if the nature of the transaction partook of the character of  

both sale and service, then the moot question would be whether  

both  the  legislative  authorities  could  levy  their  separate  taxes  

together  or  only  one  of  them.   It  was  held  that  the  subject  

transaction  was  a  service  and,  thus,  the  Parliament  had  

legislative competence to levy service tax under Entry 97, List I.  

In para 88 of the said judgment, this Court observed that “No one  

denies the legislative competence of the States to levy sales tax on  

sales  provided  that  the  necessary  concomitants  of  a  sale  are  

present in the transaction and the sale is distinctly discernible in  

the  transaction.   This  does  not  however  allow  the  State  to  

entrench upon the Union List and tax services by including the  

cost of such service in the value of the goods”.  The principle of  

law in para 88 squarely applies to the present case.  As stated  

above, we are concerned with “financial leasing services” which  

are sought to be taxed under Section 65(12)(a)(i).   The taxable  

event is indicated in Section 65(105)(zm).  As stated above, the  

impugned  provision  operates  qua  an  activity  of  funding/

45

financing  of  equipment/  asset  under  equipment  leasing  under  

which a lessee is free to select, order, take delivery and maintain  

the asset.  The lessor (NBFC) arranges the finances.  It accepts  

the invoice from the vendor (supplier) and pays him.  Thus, the  

lessor  (NBFC)  renders  financial  services  to  its  customer(s)  and  

what is taxed under the impugned provision is the income, by  

way of finance/ interest charges in addition to management fees/  

documentation charges, which is earned by the financier (lessor).  

The taxable event is the service which is rendered by the finance  

company to its customer(s).  The value of taxable service under  

Section 67 is income by way of interest/finance charges (measure  

of tax)  which is not determinative of the character  of  the levy.  

Thus, Section 67 of the Finance Act, 1994 seeks to tax financial  

services rendered by the appellant(s) with reference to the income  

which the appellant(s) earns by way of interest/ finance charges.  

In the circumstances and for the reasons given hereinabove, the  

question of splitting up of transactions, as contended on behalf of  

the appellant(s), does not arise.  As held hereinabove, equipment  

leasing and hire-purchase finance constitute long term financing  

activity.   Such  an  activity  was  not  the  subject  matter  of  the  

discussion in the  Bharat Sanchar Nigam Limited’s case.  The  

service tax in the present case is neither on the material nor on  

sale.   It  is  on the  activity  of  financing/funding of  equipment/

46

asset within the meaning of the words “financial leasing services”  

in Section 65(12)(a)(i).  Lastly, we may state that this Court has  

on  three  different  occasions  upheld  the  levy  of  service  with  

reference to Entry 97 of List  I  in the face of  challenges to the  

competence of the Parliament based on the entries in List II and  

on all the three occasions, this Court has held that the levy of  

service tax falls within Entry 97 of List I.  The decisions are in the  

case of T.N. Kalayana Mandapam Association (supra), Gujarat  

Ambuja Cements Ltd. (supra) and All-India Federation of Tax  

Practitioners (supra).

Conclusion

40.  As stated above,  the appellant(s)  had moved the High  

Court in the writ petition challenging the validity of Section 66 of  

the Finance Act, 1994 on the value of taxable services referred to  

in  Section  65(105)(zm)  read  with  Section  65(12)(a)(i)  without  

exhausting the statutory remedy.  The contracts entered into by  

the appellant(s) with its customers were not vetted.  There has  

been no adjudication under the Act in most of these cases and,  

therefore,  we  hereby  direct  the  competent  authority  under  the  

Finance Act, 1994 to decide the matter in accordance with the  

law laid down.  Subject to above, for the afore-stated reasons, we  

hold that the service tax imposed by Section 66 of the Finance  

Act, 1994 (as amended) on the value of taxable services referred

47

to in Section 65(105)(zm) read with Section 65(12) of the said Act,  

insofar  as  it  relates  to  financial  leasing  services  including  

equipment  leasing  and  hire-purchase  is  within  the  legislative  

competence  of  the  Parliament  under  Entry  97,  List  I  of  the  

Seventh Schedule to the Constitution.  Accordingly, the appeals  

are dismissed with no order as to costs.      

…..……………………….CJI (S. H. Kapadia)

……………………………..J. (K.S. Radhakrishnan)

……………………………..J. (Swatanter Kumar)

New Delhi;  October 26, 2010