‘Navigating’ Through The Time – Charter Agreements: Impact Of ‘The Great Eastern Shipping’Judgment

This blog is inscribed by Aditya Anand.

Chartering is an important activity with respect to the shipping industry, contributing significantly to the tax revenue that is generated from the industry. However, there exist certain grey areas pertaining to the same, making the levying of taxes, a difficult or rather, a tricky affair. Contextually speaking, it refers to the activity wherein the shipowner provides the vessel, for use to the charterer by having an agreement for the same in place (known as ‘Charter-Party’ Agreement). There exists a variety of nomenclature with respect to the categorization of the same, in the form of ‘Demise Charter’, ‘Voyage Charter’, ‘Bareboat Charter’, ‘Time Charter’ etc.

Talking specifically about the ‘Time Charter’ agreement, the charterer takes the vessel for a fixed period of time but however the “ownership” and “possession” of the vessel remains with the original owner. This is in contradiction to the system of ‘Bareboat Charter’ wherein the owner leases the ship to the charterer for an agreed period, in return of periodic payments usually and the charterer ends up occupying the position of the owner of the vessel, for the time being of the agreement. The original owner of the vessel is also free from all third – party liabilities in this form of arrangement.

‘Right to Use’ & ‘Transfer of Right to Use’ Dichotomy

The contention however arises because of the ‘right to use’ vis-a-vis ‘transfer of right to use’ dichotomy. The Bareboat charter falls into the latter category, thereby attracting the imposition of sales tax but however there exists certain ambiguity with respect to the treatment of time charter agreements. There has been a lot of disputes on whether erstwhile State Value Added Tax along with Article 366 (29-A) (d) could be imposed on the same or not.

However, in December 2019, a three-judge bench of the Supreme Court in the case of Great Eastern Shipping Co. Ltd[1]dealt with the question as to whether time charter agreement could be considered a transaction involving ‘transfer of right to use’ the goods and thereby attracting the imposition of sales tax under the relevant provisions of the Karnataka Sales Tax Act, 1967 (Section 5C)[2] & Article 366 (29-A) (d) of the Constitution of India. It was the first time that any court discussed and explored the various types of charter – hire agreements and chalked out the distinction between different forms of charter arrangements, thereby filling up the precedential void.

The Great Eastern Shipping Company Ltd v State of Karnataka – Case Analysis

The facts involved the Appellant i.e. the Great Eastern Shipping Company Limited entering into a Charter Party Agreement with the New Mangalore Port Trust. As per the terms of the agreement, it provided a tug or vessel along with the master and the personnel for achieving the specific purposes of the Port Trust, for a specific period of time, thus making it a time charter agreement. 

The revenue authorities considered the same as a transaction involving the transfer of right to use, thereby attracting sales tax. But however, the Appellants contended otherwise i.e. the transaction was just a mere ‘right to use’ the goods and therefore Sales Tax cannot be imposed on the transaction. In addition, the following contentions were also raised by the Appellants – 

  1. The delivery to the port trust is merely a symbolic delivery, as the legal and physical possession of the vessel continues with the appellant
  2. In any time – charter agreement, the master and the crew as well as the complete control, ownership as well as possession of the vessel remains with the owner – which was the Appellant in this case
  3. Even though the clause 7 of the agreement uses the words ‘at the disposal of port’, it does not signify the transfer of legal possession and is a standard term that is used in such agreements
  4. The agreement also provided that certain liabilities like insurance charges, bank guarantee, indemnity as well as damages were to be borne by the appellant itself, thereby indicating that the control over the vessel was not transferred in the course of the transaction

The clarification issued by the Ministry of Finance, Department of Revenue dated 18 June 2008 was also cited by the Appellants which clarified that chartering of vessels is liable to be charged under service tax under the category of ‘supply of tangible goods for use by way of service without possession and control’, in an attempt to free themselves from the liability of Sales Tax. 

Another part of the dispute was regarding the ambit of the territorial jurisdiction of the state of Karnataka, to levy taxes on the territorial waters of Union of India, as only the Parliament has the power to make laws related to levy and collection of taxes on transactions carried out in the territorial waters. 

The Court after careful perusal of the agreement came to the conclusion that the usage of words like “let”, “delivery”, “disposal” etc. and the fact that the charterer was given the right to use all outfits, equipment, etc. The court observed – 

“…When we peruse the various terms and conditions of the Charter Party Agreement (Annexure I), Clause 1 provides that the contractors “let” and the charterer “hire” the goods vessel for six months. The expression ‘let’ has been used, and the vessel most significantly during the charter period has been placed at the “disposal” of the charterers and under their control in every respect. The charterers have been given the right to use all outfits, equipment, and appliances on board the vessel at the time of the delivery, including the whole reach, burthen, and deck capacity…”

Reliance was placed on judgments like BSNL v UOI[3] & several tests like the ‘dominant – nature’ test propounded by State of Madras v Gannon Dunkerley[4] and the ‘employee’ test, given by the British India Steam Navigation Co. Ltd[5], for the purpose of determining whether the transaction qualified as ‘transfer of right to use the goods’ or a ‘mere right to use’ and it was observed that the essential criteria of the good being available for delivery & subsequent delivery have also been fulfilled. The restriction was also imposed on the charterer to not give the vessel to anybody else during the contract period.

With respect to the situs of the sale, the court relying on 20th Century Finance Corporation[6] observed that the location of the delivery of the vessel could not be the basis for a levy on the transfer of right to use in goods and the situs would, in fact, be the place, where the contract for the delivery has been entered into, which was the state of Karnataka in the given case. So, therefore, the question of jurisdiction with respect to territorial waters does not arise in the given case.

The Service Tax Question

The Supreme Court skipped going into any discussion with respect to the applicability of service tax on the transaction, as the introduction of the category ‘supply of tangible goods for use by way of service without possession and control’, under the erstwhile service tax regime, happened in the year 2008, whereas the material year for the dispute was 1998. 

However, it should have ideally commented on whether this agreement would qualify as a service otherwise if the material facts are different. It should have been done keeping in mind the fact that a lot of disputes and litigations are pending before different judicial bodies, with some of them having the contention of treating the time – charter agreement as a contract for service, leading to the imposition of service tax on the same.

Present Position According to GST Act & Rules

Talking from the viewpoint of GST, the classification with respect to leasing or rental services has been modified into two categories now, namely– ‘leasing or rental services without an operator’ and ‘leasing or rental services with an operator’, wherein the former falls into the category of a bareboat charter and the latter falls into the category of a time charter. This distinction was created by a notification[7] dated 30 September 2019, that modified the transaction item by removing the term ‘with operator’ which earlier was ‘Leasing or rental services with or without operators.’ 

Thus, there is no distinction on the grounds of “control” and “possession”, which are the major grounds for distinction between the two kinds of agreements in the Great Eastern Shipping judgment, which is something that could become a contention in the future for the taxing authorities because of its contradictory nature with the classification.

This also makes time charter agreement attract GST at 18% as they would now fall under the head of ‘residual entry’, as they have not been specified anywhere else (SAC 9997)[8], which otherwise would have been 5% prior to the amendment (SAC 9973). This would have a direct bearing on the transactions and would also have a significant impact on the shipping industry.

[1] Great Eastern Shipping Co. Ltd v State of Karnataka 2019 SCCOnline SC 1547

[2] Karnataka Sales Tax Act, 1967 <can be accessed at http://ctax.kar.nic.in/acts/kst/kst.pdf>

[3] BSNL v UOI 2006 3 SCC 1

[4] State of Madras v Gannon Dunkerley Ltd. AIR 1958 SC 560

[5] British India Steam Navigation Co. Ltd v Shanmughavilas Cashew Industries (1990) 3 SCC 481

[6] 20th Century Finnace Corporation Ltd v State of Maharashtra (2000) 6 SCC 12

[7] Ministry of Finance (Department of Revenue) Notification No. 20/2019 – Central Tax (Rate) (30th September 2019) <can be accessed at http://www.cbic.gov.in/resources//htdocs-cbec/gst/notfctn-20-2019-cgst-rate-english.pdf>

[8] Good & Services Rate List, Central Board of Indirect Taxes & Customs <can be accessed at https://cbic-gst.gov.in/gst-goods-services-rates.html>

Leave a Reply

Your email address will not be published. Required fields are marked *