Kiran Raj

The Supreme Court of India has delivered its verdict on a set of appeals concerning the levy of service tax on lottery distributors, ruling that the imposition of service tax on their activities was unconstitutional. The case, which involved multiple appeals filed by the Union of India against decisions of the High Court of Sikkim, questioned whether lottery distributors were liable to pay service tax under the Finance Act, 1994. The respondents, private companies engaged in selling lottery tickets for the Government of Sikkim, challenged the applicability of service tax, arguing that they were engaged in a principal-to-principal transaction rather than rendering a taxable service. The Court examined statutory provisions, contractual relationships, and constitutional limitations to determine the legality of the tax imposed.

The dispute arose from amendments to the Finance Act, 1994, that sought to include lottery distribution under taxable services. The Finance Act, 2010, introduced clause (zzzzn) to Section 65(105), defining a taxable service as any service related to the promotion, marketing, or organization of lotteries. Subsequent amendments in 2012, 2015, and 2016 attempted to reinforce the taxability of lottery distribution by refining the definitions of taxable services and explicitly including lottery distributors as service providers. The High Court of Sikkim struck down these provisions, holding that they exceeded the legislative competence of Parliament. The Union of India appealed to the Supreme Court, arguing that lottery distributors were acting as agents of the State and were therefore liable to pay service tax.

The respondents contended that their business involved the outright purchase of lottery tickets from the State at a fixed price, allowing them to sell the tickets independently. They submitted that there was no agency relationship with the State, as they bore the financial risk of unsold tickets and determined resale pricing strategies. The respondents asserted that the tax sought to be imposed effectively encroached upon the exclusive power of State Legislatures under Entry 62 of List II of the Constitution, which governs taxation on betting and gambling.

The Union of India argued that the Lotteries (Regulation) Act, 1998, mandated that the State government oversee all aspects of lottery sales, inherently establishing an agency relationship between the State and the respondents. The appellants submitted that under Section 4 of the Lotteries Act, lottery tickets could only be sold by the State or through its appointed agents, and that the respondents were merely facilitating sales on behalf of the State. It was contended that the amendments to the Finance Act were a legitimate exercise of Parliament’s power to impose service tax and that they targeted the service aspect of lottery distribution rather than the lottery ticket itself.

The Supreme Court examined the agreements between the Government of Sikkim and the respondents to determine whether the relationship was one of agency or a principal-to-principal arrangement. It observed that while earlier agreements required the respondents to purchase tickets outright, subsequent amendments allowed them to return unsold tickets, shifting the financial risk back to the State. The Court analyzed the structure of online lottery agreements, where tickets were sold directly by the State through computer terminals managed by the respondents. The Court recorded that while some contractual provisions indicated elements of control by the State, others suggested that the respondents operated independently.

The Court examined the constitutional validity of the service tax provisions in light of the Seventh Schedule of the Constitution, which divides legislative powers between Parliament and State Legislatures. It recorded that Entry 62 of List II grants States exclusive authority to tax betting and gambling, which includes lotteries. It considered whether Parliament could impose service tax on lottery distribution under its residuary power in Entry 97 of List I. The Court observed that taxation is a distinct legislative subject and that the power to tax must be explicitly provided in the Constitution. It considered whether the aspect theory could be applied to justify the imposition of service tax on certain components of lottery distribution while leaving the core activity of lotteries within the State’s taxation domain.

The Supreme Court examined previous decisions, including Sunrise Associates vs. Government of NCT of Delhi, which held that lottery tickets constitute actionable claims rather than goods or services. It recorded that actionable claims are excluded from the scope of service tax under the Finance Act, 1994. The Court also referred to its decision in K. Arumugam vs. Union of India, which held that the purchase and resale of lottery tickets did not constitute a taxable service. The Court examined whether the amendments to the Finance Act effectively changed the nature of the transaction or whether they attempted to impose service tax on an activity already within the exclusive taxation domain of the States.

The Supreme Court, in its judgment, stated: "Taxation is a distinct matter for the purposes of legislative competence, and the power to tax cannot be deduced from a general legislative entry as an ancillary power."

On the issue of the nature of the relationship between the respondents and the Government of Sikkim, the Court observed: "The agreements between the State and the distributors indicate that the respondents are purchasing lottery tickets outright and reselling them at their own risk, which does not establish an agency relationship."

Regarding the constitutional validity of the amendments, the Court held: "The impugned provisions of the Finance Act, 1994, insofar as they seek to impose service tax on lottery distribution, encroach upon the exclusive taxation domain of the States under Entry 62 of List II and are therefore unconstitutional."

The Supreme Court dismissed the appeals filed by the Union of India and upheld the decisions of the High Court of Sikkim, declaring the service tax provisions in question as ultra vires the Constitution. It held that the respondents were engaged in transactions on a principal-to-principal basis and were not rendering a taxable service. The Court stated that its judgment would apply prospectively and that no refunds would be issued for service tax already paid under the impugned provisions.

Case Title: Union of India & Others vs. Future Gaming Solutions Pvt. Ltd. & Another

Case Number: Civil Appeal Nos. 4289-4290 of 2013 & connected matters

Bench: Justice B.V. Nagarathna and Justice N Kotiswar Singh

[Read/Download order]