Post-MADA v. SAIL: GST's Effect on Mineral Royalty

[Rajnandan and Joshua are students at National University of Advanced Legal Studies.]

The Mines and Minerals (Development and Regulation) Act 1957 (Act) was enacted to provide for the regulation of mines and the development of minerals. It inter alia provided for the issuance of mineral concessions, including but not limited to mining leases that could be granted by landowners (especially state governments) and mandated considerations to be paid by the lessee. In the 1989 case of India Cement Limited v. State of Tamil Nadu (India Cements), the Hon’ble Supreme Court of India (SC) initially ruled that royalty under Section 9 of the Act (royalty) was a tax. 

However, in State of West Bengal v. Kesoram Industries Limited, an SC bench of lesser strength declared that royalty was not a tax. These positions led to conflicting decisions by various lower courts, and a reference to a 9-judge bench of the SC was made in 2011 to clarify the nature of royalty. The reference was finally addressed by the SC ruling in Mineral Area Development Authority v. Steel Authority of India Limited (MADA v. SAIL), which clarified the position that royalty was not a tax but rather a consideration, settling decades of differing positions on the matter. However, the bench left the treatment of royalty under the current goods and services tax (GST) regime unaddressed. 

In this article, the authors argue that the GST Council’s practice of treating royalty as consideration paid for ‘services’ as opposed to ‘goods’ is erroneous, particularly considering MADA v. SAIL, and suggest appropriate rectifications. Section I contends that royalty is a consideration for goods rather than services. Section II evaluates its treatment under the GST regime and the flaws in such treatment. Towards the conclusion, Section III suggests potential solutions and amendments that could be mutually beneficial to the governments and mining sector.

Royalty is Consideration Paid for ‘Goods’ Not ‘Services’ 

Prior to 1 January 2019, there was confusion among adjudicatory authorities such as Authorities for Advance Ruling and Appellate Authorities for Advance Ruling (AAAR) of various states on the GST rate applicable on the granting of mineral exploration and mining rights; clarity was needed on whether the rate applicable was 5% or 18%. However, the GST Council vide circular number 164/20/2021-GST, using a priori reasoning, clarified the position by affirming the reasoning employed by the AAAR Odisha, vide its 2019 ruling in M/s Penguin Trading and Agencies Limited (Penguin). 

The ruling stated that 18% was the applicable GST rate as royalty is paid for a service, which is the right of the lessee to extract minerals from leased land. It further buttressed the point, stating that royalties have no underlying goods in leasing mining areas, unlike leasing or renting goods. Another reason for the clarification may have been pressure from the state governments, particularly lobbyists from mineral-rich states, to increase their GST collection considering the revenue lost following India Cements.

Although the supra position is the prevailing law, this characterisation of royalty as payment for a service is incorrect in light of the reasoning employed by the SC in MADA v. SAIL, where it went on to characterise ‘royalty’ and its object. It stated in paragraph 96 of the judgement that royalty is understood as the consideration paid not just for the right to extract minerals but also “to compensate the lessor for the degradation of the value of the mine because of the extraction of minerals”, implying value for the minerals. Hence, the reasoning in Penguin is incorrect when it states that payment of royalties has no underlying goods. 

The reasoning employed in MADA v. SAIL is not a sui generis characterisation of royalty. Instead, it affirms an observation made by the same court in 1989 vis-à-vis India Cements.  Here, royalty was treated as a consideration for minerals determined by their intrinsic economic value, influenced by the interaction of land, capital, and labour. The sale of the mineral by the lessee ultimately realises the value. Moreover, the calculation of royalty is made on the basis of the value of minerals extracted, again implying that royalty is in lieu of the mineral, which is movable property and thereby, a good.

Existing GST Treatment and its Pitfalls

Under the reverse charge mechanism (RCM), the GST payable on the royalty is 18% (9% Central GST + 9% State GST). RCM is a process of GST remittance where the responsibility to pay tax falls on the recipient of goods or services rather than the supplier in specified categories of supply. In this situation, the state government, which issues a mining lease, acts as the supplier of services, making the lessee (the miner) the recipient and responsible for paying the GST under the RCM. Additionally, the lessee is liable to pay output GST on the sale of minerals mined, usually at the rate of 5%. Thus, not only is the miner forced to pay taxes as the recipient of goods at the input stage but also at the output stage, when it is selling the minerals.

It may be contended that the miner could offset the burden of these cascading taxes by availing input tax credit (ITC) and set-off the input tax against the output tax. However, although miners are allowed to claim this credit, their output tax liability sometimes exceeds the amount of the input tax credit they can claim. This means that miners still owe additional taxes to the government beyond the credit they claim, ensuring minimal revenue loss for the government. Even in the case of an inverted duty structure, where the input tax exceeds the output tax, taxpayers often find themselves with excess ITC in their GST electronic credit ledger, even after clearing their output tax liability. This situation ties up their working capital, as the funds remain locked in the electronic credit ledger. While the GST law allows taxpayers to claim a refund for the unutilised ITC, the process is cumbersome.

Rather than navigating the complex web of GST law and compliance, the apt simplification would be to consider royalty as a consideration for a good and levy tax on it accordingly.

Proposed Pathways

The authors recommend that, ideally, the GST levied on royalty should be nil-rated, i.e. 0% payable. This is in line with the Lafferian idea of supply-side economics, which argues that reducing high tax rates could increase total tax revenue by encouraging more economic activity. Furthermore, this would reduce the cost of materials and, thereby the overall selling price of the minerals. Thus, it would incentivise other state governments to buy minerals through inter-state trade instead of importing foreign minerals. This internal trade would prevent foreign reserves from depleting and potentially widening the current account deficit.

A more amenable alternative may be for the Department of Revenue to reclassify the royalty as a remittance for goods but retain their previous practice of setting the rate of GST on the royalty, as per the sixth entry of HSN code 9973 of their June 2017 notification, at the “same rate of central tax as applicable on supply of like goods involving transfer of title in goods” This would mean that instead of a flat 9% CGST rate for all mineral extracted, the rate would generally be 2.5% on mineral products. When the corresponding 2.5% SGST is added, the entire GST levied is 5%, which is still much lower than the current 18% slab. This amendment would significantly alleviate the burden on the mining lessees without completely removing a revenue stream for the central and state governments.

Conclusion and Way Forward

In conclusion, the treatment of mineral royalty under the GST regime as consideration for services rather than goods is deeply problematic. Categorising this transaction as one involving services provided by the government is a misclassification that results in a heavy financial burden on the lessees who are already liable to pay the auction bid, environmental cess, corporate tax, surface rent, contributions to District Mineral Foundations and National Mineral Exploration Trust — both of which are subject to GST — along with other state-specific cesses and high operating costs. 

The SC’s ruling in MADA v. SAIL established that royalty is a consideration for the minerals themselves, reflecting their intrinsic economic value. However, the issue is compounded by the fact that royalty is not treated as a tax, which already contributes to the heavy taxation burden on the mining sector. The GST Council’s classification of royalty as payment for licensing services further exacerbates this burden, adding another layer of financial strain on lessees. This dual challenge—royalty not being recognized as a tax and its misclassification under GST— creates a significant deterrent to private investment in India, hindering economic growth in a period when increased private sector participation is crucial for job creation, among other things.