Restitution Against Public Authorities: The Status of ‘Passing On’ Defence in Indian Law

Anirud Raghav S U |

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Introduction

Assume I run a manufacturing business. I pay excise tax pursuant to a provision in a (hypothetical) Excise Tax Act mandating that I pay tax in respect of certain articles manufactured. I dutifully pay tax on the strength of this provision. But, as is common business practice, I externalize the tax costs by including it in the overall price of my transactions with parties. A week later, this provision is challenged as being ultra vires the Constitution on the ground that the collecting authority is not authorized by the Parliament to tax, violating Art.265 of the Constitution. The Court finds that the provision was actually ultra vires for violating Art.265. I come to know of this judgment. I wonder if I have actually made a payment under a provision that was never constitutional to begin with—and approach the Court demanding a refund of my ultra vires payments from the authority. The Court says: you ask for a refund, but you have yourself passed on the costs of the tax to the ultimate consumer. Thus, you should not be entitled to recover the ultra vires payments.

In unjust enrichment jurisprudence, this is recognized as the defence of ‘passing on’, or in Birksian parlance, ‘disimpoverishment’.[1] It is a defence, in the above case, claimed by the public authority. What is the principled basis of this defence? Typically, claims of restitution against public authorities rely on unjust enrichment as a cause of action. In making out unjust enrichment, one of the elements to be shown is enrichment at the claimant’s expense. Where the claimant has passed on the costs to a third party, the enrichment would cease to be at their expense. Moreover, awarding recovery to the claimant would constitute a windfall, which is an inequitable result. These are the principled reasons for the passing on defence that the public authority can take in response to an action of unjust enrichment. When I went to Court claiming a refund grounded on unjust enrichment, the public authority would argue—you have passed on your costs, and thus, the enrichment is no more at your expense. The expense, more appropriately put, is now that of ultimate consumer.

In this background, we will examine the status of passing on defence in Indian law. As context,  we will examine the Canadian jurisprudence on the subject, which has featured extensive discourse on the passing on defence. This post argues that Mafatlal Industries, the controlling judgment in India on the subject, uses s.72 to do indirectly what it could not do directly—deny the claimant recovery.

The Canadian Saga: Air Canada to Kingstreet Investments

Air Canada

In Air Canada v. British Columbia, a Supreme Court majority ruled on two important aspects. First, the Court endorsed a rule against recovery based on ultra vires. The reasoning was the threat of fiscal chaos and the potential disruption of public finances (as per La Forest J). If a decision that a certain provision of tax, on which taxes have been collected for years, is ultra vires, this would in principle permit every single taxpayer to recover subject to laches and limitation. Saying so, he rejected the claim for recovery. Yet, for good measure he also proposes an additional reason to reject recovery—the passing on defence:

[t]he evidence supports that the airlines had passed on to their customers the burden of the tax imposed upon them. The law of restitution is not intended to provide windfalls to plaintiffs who have suffered no loss. Its function is to ensure that where a plaintiff has been deprived of wealth that is either in his possession or would have accrued for his benefit, it is restored to him. The measure of restitutionary recovery is the gain the province made at the airlines' expense. If the airlines have not shown that they bore the burden of the tax, then they have not made out their claim. What the province received is relevant only in so far as it was received at the airlines' expense. [pp. 1202-3] 

It could be argued that the passing on defence came as obiter, since it followed the decision that permitting recovery would open up an unenviable can of worms. The life of passing on defence in Canada, however, was ephemeral.

Kingstreet Investments v. New Brunswick

This case involved a similar fact situation: a tax provision was declared ultra vires because the provincial government had levied indirect tax, which was without constitutional authority. Thus, taxpayers claimed refund of the taxes so paid. Thus, after nearly two decades, the Canadian Supreme Court had the opportunity to re-examine the validity of the passing on defence. The Supreme Court gives two main reasons to expunge the passing-on defence from the judicial books. First, it was contrary to basic principles of restitution law. The idea is that restitution being a gain-based remedy seeks only to reverse the unjust enrichment that the defendant enjoys. Here, the restitutionary analysis will only be concerned with reversing the government’s unjust enrichment at the claimant’s expense. Regardless of whether the claimant has recouped his losses, it is a fact that the government was enriched (by receiving taxes) at the claimant’s expense (it came from his coffers, irrespective of whether it was later passed on through price increases). The analysis must end there; for the purposes of restitutionary remedies do not extend to preventing the claimant from receiving a windfall. This reasoning finds approval in Australian jurisprudence as well. Second, a pragmatic argument against passing on is that any business that suffers a loss will pass it on through price increases—it is sound commercial practice. One would hardly suggest that despite Y’s enrichment at X’s expense, if X had managed to pass it on to its consumers, X could not sue for unjust enrichment. To put it in LeBel J’s words:

“[t]he passing on defence would, in effect, result in an argument that no damages are ever recoverable in commercial litigation because anyone who claimed to have suffered damages but was still solvent had obviously found a way to pass the loss on

This sounded the death-knell for the passing on defence in Canadian law. Remarkably, Kingstreet Investments expressly rejects the unjust enrichment framework in assessing such recovery actions. The discomfort with the framework was felt earlier as well, but was reconciled by subsequent judgments where the public policy considerations were assimilated within the unjust enrichment framework by incorporating ‘ultra vires’ as an unjust factor. However, the Kingstreet Courts considers this test diffuse, and with potential to dilute restitution jurisprudence. It notes that the underlying purposes between public actions and unjust enrichment actions are different:

Actions for recovery of taxes collected without legal authority and actions of unjust enrichment both address concerns of restitutionary justice, but these remedies developed in our legal system along separate paths for distinct purposes. The action for recovery of taxes is firmly grounded, as a public law remedy in a constitutional principle stemming from democracy’s earliest attempts to - 28 - circumscribe government’s power within the rule of law. Unjust enrichment, on the other hand, originally evolved from the common law action ofindebitatus assumpsit as a means of granting plaintiffs relief for quasi-contractual damages.

Based on this analysis, they consider unjust enrichment an inappropriate framework for assessing actions for recovery of taxes collected without public authority. This obviates the need to go into the argument on mistake of law (by this time, Air Canada had already recognized mistake of law as an unjust factor grounding restitution). The position emerging is that the claim for recovery can only be made under the constitutional provision pertaining to the authority to collect taxes, rendering it a broadly public law claim. In this context, we may examine the Indian Supreme Court decision in Mafatlal.

Supreme Courts’ judicial acrobatics: Mafatlal Industries and Passing on in Indian law

Mafatlal Industries v. Union of India, being a 9J bench decision, holds the field on various aspects of restitution against public authorities, passing on being one of them. The court in great detail considered the various bases of which restitutionary liability can be fastened against public authorities. Prominently, it considered the private law claim of mistake of law under s.72, and the public law claim of ultra vires under Art.265 of the Constitution. It would be in order to briefly canvass these distinct bases of liability, since they are important to understanding Mafatlal’s acrobatics.

A)   S.72 – mistaken payments as a ground for recovery

Section 72 of the Contract Act allows for recovery of payments made under a mistake. It has for a while now been settled that mistake in s.72 includes both mistakes of law and fact. Thus, a textbook s.72 claim for recovery would go: I made the payment under a mistake of law; I discovered the mistake pursuant to the subsequent decision declaring the taxation provision ultra vires; thus, I must be entitled to recovery under s.72. Notably, s.72 is silent on defences; it simply provides that: “A person to whom money has been paid, or anything delivered, by mistake or under coercion, must repay or return it.” This will go on to be an important factor in Indian judicial decisons on whether defences are available. In this background, we may examine the evolution of case law on this subject, with respect to defences under s.72.

Before Mafatlal, STO v. Kanhaiya Lal Mukundsaraf, a 7J SC decision, held the law on restitutionary defences to s.72. The government in that case raised the defence that the taxes they were paid (ultra vires) were already spent elsewhere, and thus, it would be inequitable to require them to return the money. This is the change of position defence. The Kanhaiya Lal court rejected the defence because it had no statutory basis; the terms of s.72 were clear: they do not refer to any equitable considerations or defences, and thus no such defences may be imported. Thus, the position emerging here was that there would be no defences to a claim for recovery under a mistake. Naturally, this would also mean that the defence of passing on was not available. Curiously, the Kanhaiya Court itself elsewhere makes reference to factor such as estoppel or waiver, which are undoubtedly equitable principles, in deciding the claim of whether recovery can be permitted. This would be noted in Mafatlal.

Mafatlal overrules Kanhaiya Lal in this respect. They suggest that s.72 itself being an equitable principle, cannot be divorced from its equitable origins. Thus, in assessing a claim under s.72, the whole palette of equitable considerations would be have to be considered. For our purposes, this is crucial, because it now means that restitutionary defences, including the defence of passing on would be available to the defendant.

B)   The judicial acrobatics?

Mafatlal need never have invoked s.72 of the Contract Act. They began with the simple premise that ultra vires payments are recoverable. One would suppose that this would dispose of the matter entirely. In fact, Lord Goff in Woolwich Equitable Building Society v. IRC (the landmark case in England, eponymous of the Woolwich ground) did not invoke the language of restitution of unjust enrichment—he simply permitted recovery on the ground that ultra vires payments, are essentially payments made to authorities who did not have parliamentary sanction to collect said payments. In other words, the result of an Art.265 analysis would be that the recovery should have been allowed without question. Yet, the Supreme Court in Mafatlal entered into the restitution analysis under s.72.

It is my argument that this is an exercise in judicial acrobatics. The reason the Court undertook the restitution analysis is to do indirectly what they could not directly: deny a refund. The Court evidently opined that the only equitable response where the claimant had recouped their losses (and have been disimpoverished) is to deny them the refund. However, Art.265 is concise and unambiguous in its stricture: no taxes can be levied without parliamentary sanction. How could the Court deny recovery under such situations? The Court acknowledges that a right to refund would prima facie arise from Art.265 subject to the finding of a violation thereof. The Court, in a strained manner, attempts to first find constitutional grounds for denying a refund. They vaguely reference “economic justice” enshrined under Art.38 of the Constitution, and suggest that allowing an unburdened claimant to benefit from a recovery would be the antithesis of economic justice. It is respectfully submitted that this is an incongruent use of Art.38, which by design is a general guiding principle that the State must implement in its welfare policies. The strained nature of this interpretation is evident on its very face; it shows an attempt to get around not being able to deny recovery.

However, there was a very simple way to resolve this conundrum, which the Court adopted. This was to enter into the restitutionary analysis under s.72, which might give way to the passing on defence. A prior question had to however be asked—what about the Kanhaiya Lal ratio that s.72 is exhaustive and does not permit of any defences? At this juncture, the Court overrules Kanhaiya Lal, as noted above. Alternatively, it held that s.72 of the Contract Act enacts an equitable rule. This means that in applying the rule, other equitable considerations (including equitable defences) must be taken into account. Hence, it becomes clear that passing on—an equitable defence—could be claimed as a defence to the claim of recovery based on a mistaken payment. Now, then, the Court has a far more tenable ground to justify the denial of recovery. The claimant was effectively disimpoverished,[2] and thus, in equity,  would not be entitled to recovery since the principles of unjust enrichment requires that he be suffer injustice or detriment.

The broader implications of this decision are twofold. First, the traditional defences to unjust enrichment might in principle be available. This would include change of position (which, interestingly was argued but rejected in Kanhaiya Lal) as well as passing on. The passing on defence has since featured in Indian decisions, some succeeding and others failing. It would be interesting to see if other defences like change of position, or disruption of public finances gathers traction. A potential counterargument, however, could be that the Court’s discussion is merely obiter. This is because the Court ultimately held [para 78] that rule 11-B of the Central Excise and Salt Act governs recovery. Nonetheless, this has not stopped subsequent courts (here, here) from relying on Mafatlal’s rulings on unjust enrichment or the ultra vires ground. Second, a critical implication is that now we do not know if recovery actions against public authorities are to be assessed as private unjust enrichment claims, or public ultra vires claims. Practical aspects like the limitation period, the nature of the suit (civil suit or writ petition) and broader precepts of interpretation turn on the answer. There are broader policy discussions that animate this question—some argue that the private unjust enrichment framework would suffice, and the ultra vires ground will act as the unjust factor, while others argue inter alia that flexibility is important in decisions concerning the public exchequer, and thus, it must be dealt with as a public claim. Mafatlal strictly does not bar concurrent claims under both s.72 and well as Art.265, and some scholars positively advocate a concurrency approach.[3] While Mafatlal has fomented more questions than answers, it has kindled important questions on restitutionary defences and broader questions of a public-private approach to restitution actions against public authorities. It will be interesting to see how the law evolves on these questions.

[1] Peter Birks, Unjust Enrichment, 2nd edn, (Oxford, OUP, 2005) 219-221.

[2] Michael Rush, The Defence of Passing On (Hart 2006).

[3] Duncan Sheehan, ‘Mistaken Overpayments of Tax’ in Steven Elliott, Birke Hacker et al (eds.), Restitution of Overpaid Tax (Hart 2013)