Author: Ashwarya Sharma, Advocate, Co-Founder & Legal Head, RB LawCorp
Published on: 30/07/2026
Introduction
The constitutional validity of a taxing statute often turns not on whether the legislature possesses the power to tax, but how that taxing power is exercised.
The recent judgment of the Hon’ble Karnataka High Court in Dhariwal Industries Pvt. Ltd. & Ors. v. Union of India & Ors. [TS-229-HC-2026(KAR)-NT] provides an important illustration of this principle.
The challenge before the Court concerned the Health Security & National Security Cess Act, 2025 (HSNS Act) and the Health Security & National Security Cess Rules, 2026, which introduced a new capacity-based cess on the manufacture of pan masala.
While the petitioners questioned Parliament’s legislative competence to enact the levy itself, they also challenged the formula adopted for computing the cess—one based not on actual production, but on the deemed production capacity of pouch-packing machines.
The High Court delivered a balanced verdict.
It upheld Parliament’s competence to levy the cess, but struck down the capacity-based computation mechanism as arbitrary and violative of Article 14 of the Constitution, holding that administrative convenience cannot justify an irrational taxing formula.
Background of the Dispute
The petitioners were manufacturers of pan masala falling under HSN 2106 90 20.
Before the introduction of the HSNS Act, pan masala attracted GST at the highest applicable rate together with GST Compensation Cess.
With effect from 1 February 2026, however, the HSNS Act fundamentally altered the taxation model.
Instead of taxing actual production or actual clearances, the legislation imposed cess based upon the production capacity of pouch-packing machines, irrespective of the quantity actually manufactured.
The challenge before the Court therefore extended beyond the levy itself to the constitutional validity of the entire capacity-based taxation mechanism.
The Petitioners’ Challenge
The petitioners advanced two principal constitutional arguments.
First, they contended that once pan masala was already taxed under the constitutional framework governing GST, Parliament could not impose what was, in substance, an additional indirect levy through the HSNS Act in the manner adopted.
Secondly, and more significantly, they argued that the cess computation mechanism itself was unconstitutional.
The levy was not linked to actual manufacture or actual production.
Instead, it proceeded on the assumption that every machine would operate at its theoretical production capacity, regardless of the quantity actually produced.
According to the petitioners, such a fiction bore no rational nexus with the taxable activity and resulted in arbitrary taxation.
The Union’s Defence
The Union defended the legislation as a valid exercise of Parliament’s residuary legislative powers.
It argued that pan masala has historically been one of the most tax-evasion-prone sectors and that the conventional transaction-based taxation model had consistently failed to capture actual production.
The HSNS Act, according to the respondents, addressed this problem by shifting the levy from reported production to machine capacity—a parameter that could not easily be manipulated.
The Government further maintained that the cess was neither GST nor a surcharge, but an independent levy enacted under Parliament’s plenary legislative competence.
The High Court’s Analysis
Parliament’s Legislative Competence Was Upheld
The Court rejected the challenge to Parliament’s legislative competence.
It held that Parliament possessed the constitutional authority to enact the HSNS Act and impose the cess.
The existence of legislative competence, however, did not automatically validate every mechanism adopted for calculating the levy.
The constitutional enquiry therefore shifted from whether Parliament could levy the cess to whether the formula adopted satisfied the requirements of Article 14.
Capacity-Based Computation Was Found Arbitrary
The Court closely examined the statutory scheme and observed that the cess was effectively imposed on machines and their deemed capacity, rather than on actual production.
This resulted in situations where manufacturers paid tax on production that had never taken place.
The Court held that such a mechanism departed from rational taxation and introduced arbitrariness into the levy.
The Arithmetic Exposed the Disproportion
One of the most striking features of the judgment is the Court’s numerical analysis of the statutory formula.
Using illustrations placed on record, the Court demonstrated that the cess payable on a machine could exceed the total commercial value that the goods manufactured from that machine could reasonably generate.
The Court observed that taxation producing such disproportionate outcomes could not be defended merely as a matter of legislative policy.
When the computation formula itself produces manifestly irrational results, constitutional scrutiny under Article 14 becomes inevitable.
The Fifteen-Day Abatement Rule Failed the Test of Reasonableness
The Court also examined the Rules governing abatement of cess.
Under the impugned framework, relief was available only if manufacturing remained suspended for fifteen continuous days or more.
Shorter interruptions caused by machinery breakdown, labour shortages, maintenance, or non-availability of raw material received no relief whatsoever.
The Revenue justified this threshold as an anti-evasion measure.
The Court, however, found that the Rule proceeded on an assumption that taxpayers were likely to misuse the provision and held that administrative convenience could not justify such an inflexible standard.
The fifteen-day requirement was therefore declared arbitrary and inconsistent with Article 14.
Equal Tax for Unequal Machines
Perhaps the most significant constitutional defect identified by the Court lay in the slab-based structure itself.
Machines capable of producing 100 pouches per minute and those capable of producing 500 pouches per minute were placed within the same slab and subjected to identical cess.
The Court held that manufacturers possessing substantially different production capacities were treated identically without any rational basis.
Such uniform taxation of inherently unequal situations amounted to hostile discrimination and violated the equality clause under Article 14.
Reliance on Established Constitutional Principles
In reaching this conclusion, the High Court relied upon settled constitutional jurisprudence, including the decisions of the Supreme Court in Kunnathat Thathunni Moopil Nair v. State of Kerala, State of Kerala v. Haji K. Kutty Naha, and the Constitution Bench judgment in Jindal Stainless Steel Ltd. v. State of Haryana.
These authorities reaffirm the principle that fiscal legislation is not immune from Article 14 and that arbitrary classification or irrational methods of taxation remain subject to constitutional review.
Why the Judgment Matters
The significance of Dhariwal Industries extends beyond the pan masala industry.
The judgment reiterates several important constitutional principles:
- Legislative competence alone does not validate every method of taxation.
- Administrative convenience cannot replace constitutional reasonableness.
- Fiscal legislation remains subject to judicial review under Article 14.
- Capacity-based taxation must bear a rational relationship with the realities it seeks to measure.
- Anti-evasion measures cannot justify arbitrary classifications or disproportionate tax burdens.
The ruling therefore represents an important reminder that while legislatures possess wide latitude in designing tax policy, the method adopted must still satisfy constitutional standards of fairness and equality.
Conclusion
The Karnataka High Court has drawn a clear distinction between the power to tax and the manner in which that power is exercised.
While Parliament’s competence to enact the HSNS Act remained unquestioned, the formula chosen to compute the cess failed constitutional scrutiny because it treated unequal manufacturers alike, ignored actual production, and imposed burdens that could become manifestly disproportionate.
The judgment reinforces an enduring constitutional principle: administrative efficiency can never become a substitute for constitutional validity.
As governments increasingly experiment with innovative methods of capacity-based and presumptive taxation, Dhariwal Industries is likely to serve as an important precedent on the constitutional limits of such fiscal models.
📎 Attached Article for Detailed Reading
📎 Full Published Version: https://www.taxsutra.com/gst/experts-corner/power-upheld-formula-struck-down-karnataka-high-court-limits-capacity-based
(The author is a practicing advocate, Co-Founder and Legal Head of RB LawCorp.
He specializes in GST law. Suggestions or queries can be directed to
ashsharma@rblawcorp.in. The views expressed in this article are strictly
personal.)