The Customs, Excise and Service Tax Appellate Tribunal (CESTAT), New Delhi, has set aside a service tax demand of approximately ₹7.30 crore holding that its agreement with the State Government for drawing water was a transaction involving the sale of water, rather than an assignment of the right to use natural resources.

The Bench of Dr. Rachna Gupta (Officiating President) and P.V. Subba Rao (Technical Member) has observed that the availability of CENVAT credit made the proposed tax liability revenue neutral.

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The appellant/assessee manufactures aluminium ingots, rods, billets, rolled sheets and coils. For its manufacturing operations, it established a captive power plant at BALCO Nagar in Korba, Chhattisgarh, which required substantial quantities of water.

The company entered into an agreement with the Chhattisgarh Water Resources Department to obtain water from a barrage. Under the agreement, it was responsible for constructing the civil and mechanical infrastructure required to carry water to its plant.

Water charges were payable at rates prescribed by the department from time to time. The agreement also required the company to pay for at least 90% of the quantity permitted to be drawn, even where its actual consumption was lower. The Government did not guarantee uninterrupted supply in the event of force majeure.

The Directorate General of GST Intelligence, Raipur, examined the arrangement and treated it as an assignment by the State Government of the right to use a natural resource. According to the department, the arrangement attracted service tax from April 1, 2016, with the entire liability payable by the company under the reverse charge mechanism.

A show cause notice demanded service tax for April 2016 to June 2017. The Commissioner subsequently confirmed a demand of ₹7,29,52,576 and imposed a penalty under Section 78 of the Finance Act, 1994, through an order dated April 25, 2023.

The central issue before the Tribunal was whether permission to draw water against prescribed charges constituted a taxable assignment of the right to use natural resources or was, in substance, an agreement for the sale of water.

The company argued that water was goods and that the transaction involved its supply, taking it outside the scope of taxable services. It relied principally on the Tribunal’s decision in Sasan Power Limited v. Commissioner, Central Excise & CGST, Jabalpur, which had treated a comparable arrangement as water supply.

It also cited the subsequent decision in National Aluminum Company Limited v. Commissioner of GST, Excise & Customs, Bhubaneswar, which followed Sasan Power.

As an alternative argument, the company invoked Entry 39 of Notification No. 25/2012-ST concerning government services relating to municipal functions. It submitted that the Twelfth Schedule to the Constitution expressly includes water supply for domestic, industrial and commercial purposes.

The company separately challenged the extended limitation period, arguing that the dispute concerned interpretation and that any service tax paid under reverse charge would have been available as CENVAT credit.

The department argued that the agreement conferred a right to draw a specified quantity of water rather than providing for an ordinary sale.

It emphasised that the company had to pay charges for at least 90% of its allotted quantity irrespective of actual consumption. According to the department, this showed that payment was not entirely linked to the quantity of water supplied.

The department also relied on a communication dated November 2, 2017, from the Engineer-in-Chief stating that industrial water allotment could not be treated as a sale because the Chhattisgarh Irrigation Act contained no provision for the sale of water.

To support the extended limitation period, the Revenue referred to non-payment of service tax and alleged failure to respond to departmental summons.

The Tribunal observed that power plants and other large industries often require quantities of water that ordinary supply systems cannot meet. Such industries consequently enter into agreements with State authorities to draw water directly from water bodies.

It found that the distinction between water supply and assignment of access to a natural resource had already been addressed in Sasan Power. In that case, too, the industry had been required to draw the water and arrange its transportation to the plant.

Finding no reason to depart from that precedent, the Bench held that the assessee’s agreement was for the sale of water and not for assignment of the right to use natural resources. The service tax demand therefore failed on merits.

The Tribunal further held that, even if the company had paid service tax under reverse charge, it could have immediately taken CENVAT credit and used it to discharge central excise duty on its final products.

On that basis, the Bench considered the entire exercise revenue neutral.

It additionally observed that, if the demand were confirmed, the company would be entitled to credit and, in the circumstances discussed in the order, a cash refund under Section 142 of the CGST Act, 2017.

The Tribunal consequently held that the demand could not survive on limitation either. It allowed the appeal on both grounds and set aside the Commissioner’s order with consequential relief. The decision rests on the nature of the water supply arrangement and revenue neutrality; the Bench did not separately determine the alternative municipal-function exemption argument.

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