Section 7(1)(aa) & 2(17)(e) Of The Kerala GST Act, Insofar As They Introduce A Levy On Activities Or Transactions Between Members And Their Constituents Or Vice Versa, Have Been Held To Be Ultra Vires

BRIEF FACTS OF THE CASE

• The Petitioner operates various mutual benefit schemes for its member doctors, such as the Social Security Scheme, Professional Disability Support Scheme, Professional Protection Scheme, Kerala Health Scheme, among others. Under these schemes, member doctors contribute admission and/or annual fees and make fraternity contributions upon the death or disability of fellow members. The pooled contributions are disbursed to the widows of deceased doctors, to disabled doctors, or to doctors suffering from specified diseases. Each scheme is managed by a separate, earmarked committee, maintains a separate bank account, and has independently drawn and audited financial statements.
• The Petitioner was under a bona fide belief that it was not liable to pay GST on services rendered to its members under the aforesaid schemes relying on judicial precedents affirming the principles of mutuality, which holds that services provided by a club or association to its members do not constitute a taxable supply, as there is no distinction between the provider and recipient of services. The Petitioner claimed that such services were effectively rendered by the members to themselves.
• The insertion of section 7(1)(aa) in the Central Goods and Services Tax Act, 2017 [CGST Act] and KGST Act along with section 2(17)(e), introduced a deeming fiction whereby supplies made by a club or association to its members were treated as taxable supplies for the purpose of GST. These amendments were made retrospectively effective from 1 July 2017, pursuant to the Finance Act, 2021.
• A Writ petition was filed challenging the constitutional validity of the aforesaid provisions, whereby, the Single Bench of Kerala High Court upheld the said provisions. However, the retroactive operation given to the said amendment was held to be legally unsustainable and was accordingly set aside.
• The present writ appeals were filed before the Division Bench of Kerala High Court by the Petitioner as well as the GST Department against the aforesaid order¹ of the Single Bench. The writ appeal filed by the Petitioner was for declaring the aforesaid inserted provisions as unconstitutional and void, being ultra vires Articles 246A, 366(12A) and violative of Articles 14, 19(1)(g) and 300A of the Constitution of India. Concurrently, the GST officials of the Union and Kerala State filed the writ appeals against the order of the Single Bench to the extent it set aside the retrospective effect given to the said amendment.

KEY OBSERVATIONS OF THE HON'BLE HIGH COURT

• The division bench of the Hon'ble High Court held that insertion of section 7(1)(aa) and section 2(17)(e) of the KGST Act, which deemed transactions between a club/ association and its members to be taxable supplies, is unconstitutional and void being ultra vires Article 246A and 366(12A) and Article 265 of the Constitution of India, as it overrides the foundational legal doctrine through a statutory deeming fiction which was beyond the constitutional powers. The Court further noted that the doctrine of mutuality, as reaffirmed by the Supreme Court in Calcutta Club Ltd. vs. State of Bengal² , remained good law even after the 46th Constitutional Amendment. It held that the Parliament cannot by a statutory deeming fiction, override a settled constitutional interpretation of the term 'supply' under Article 366(12A) [supply presupposes two distinct persons, and mutuality negates the duality]. Furthermore, the Court reiterated the principle from Gannon Dunkerley & Co.³ that legislative powers under the Constitution need to be interpreted in line with established legal connotations, and statutory provisions cannot broaden constitutional concepts through artificial definitions.
• Further, while rejecting the appeal of the revenue, the division bench concurred with the Single bench's view that the retrospective application of the amendment from 1 July 2017 was manifestly arbitrary, disproportionate, and violative of Articles 14 and 19(1)(g). It agreed that retrospective levies, especially those upsetting long-settled legal positions without adequate justification are impermissible and violate the principles of fairness and legal certainty. Reliance was placed on Jayam & Co. v. Assistant Commissioner⁴ , among others, where retrospective amendments creating new tax liabilities were held to be unconstitutional.

AURTUS COMMENTS

• The principle of mutuality, long debated under the erstwhile VAT regime, found finality by the Supreme Court's landmark decision in Calcutta Club Ltd. (supra), which held that transactions between members and their associations were not liable to indirect tax. In a move that changed this settled position, the Finance Act, 2021 introduced a deeming fiction in GST law through Section 7(1)(aa) and Section 2(17)(e), seeking to tax such transactions. This legislative amendment clearly brought various associations and societies (real estate associations, residential welfare societies, clubs, etc.), within the ambit of GST, which had been earlier arguing non-taxability based on the principles of mutuality.
• Albeit, the Kerala High Court has now struck down these provisions as unconstitutional, reiterating the limits of legislative competence and the constitutional sanctity of the mutuality doctrine. This ruling has again reopened Pandora's box, prompting taxpayers— particularly entities working under a member-based structure model—to revisit and reassess their GST positions. A view of non-payment of GST will also make such entities ineligible to take credits that they may have been taking earlier.
• The Kerala High Court's decision also highlights a critical tenet of tax jurisprudence—that retroactive legislation must strike a careful balance between the State's revenue objectives and the taxpayer's right to predictability, stability and legitimate expectation.
• The road ahead is likely to be litigation-heavy, as this decision will likely be appealed to the Supreme Court. What becomes important is ascertaining the way forward position, one amongst which could be to pay GST under protest and take eligible credits. Once the Supreme Court confirms non-taxability, a refund claim can be filed. Another view could be to stop discharging GST, however, that could saddle such entities with protective show cause notices and if the judgement is reversed, it could result in significant interest costs.

Footnotes

1 W.P. (C). No. 21297 of 2023 dated 23 July 2024

2 [(2019) 19 SCC 107]

3 [AIR 1958 SC 560]

4 [2016) 15 SCC 125]

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