The ministry of finance has proposed a new interpretation of the service tax on advertising agencies by issuing a tentative circular (draft circular No.341/43/2005-TRU). This proposes to increase the value of the taxable services by such a big amount that it will completely destroy the viability of newspapers.

Since this particular service tax came in 1996, the practice as approved by the ministry (previous circular namely, No. 341 issued on October 31, 1996) was that the payment made by the advertising agency to the newspaper was not to be included in the taxable value for calculating the service tax. Value-wise, this is the substantial part.

The tax was being levied only on the payment by the advertiser to the advertising agency for the service rendered by it for arranging for the advertisement.

Now if the payment to the newspaper is included, the tax will be at least four to five times more. This extra burden will certainly be passed on by the advertising agencies to the newspapers, which will make the newspapers unviable.

According to a study by PricewaterhouseCoopers (Presidential Address at the 66th annual meeting on September 29, 2005, of the Indian Newspaper Society. Page 1), the circulation component of revenues of newspapers is growing at 2.5 per cent per year and the advertising revenue component is growing at 8.5 per cent per year.

On the basis of the above data, we can say that if the service tax to be paid by the advertising agency is increased by about 8.5 per cent, the burden will be passed on to the newspapers and the growth component will become zero. And with an inflation rate of about 5 per cent per year, the net growth will be negative.

That will make newspapers unviable unless the price of newspapers is increased, which in turn will reduce circulation. This economic impact will have an effect on readers as well. If they cannot afford newspapers, they will not be able to form informed opinion, which is a fundamental requirement for the functioning of a democracy.

This will lead to compromising on the right to freedom of speech, guaranteed under Article 19(1)(a) of the Constitution. This view has already been upheld by the Supreme Court in the case of Indian Express Newspaper v. U.O.I. - AIR 1986 (SC)515.

In this case, several newspapers approached the Supreme Court challenging the impost of heavy and exorbitant import duty on newsprint by withdrawing the existing exemption, on the grounds that the action was against freedom of the Press as enshrined in Article 19(1)(a) of the Constitution, which guarantees freedom of speech and expression.

The Supreme Court held that there is "intimate connection of newsprint with freedom of the Press" because "newsprint constitutes the body if expression happens to be the soul".

In view of this, the Supreme Court held that a high levy on newsprint needed to be tested on stricter grounds. The government had not taken relevant circumstances into consideration and, therefore, once the burdensome nature of the levy was proved, the notification withdrawing the exemption was set aside.

We may quote another case here to show that advertising has a special place in newspapers. Any curtailment or restriction directly or indirectly has been held to be an unconstitutional act.

The Supreme Court in the case of Tata Press Ltd v. MTNL [Get Quote] held that advertising is a "commercial speech" and has two facets: advertising, which is no more than a commercial transaction, is nonetheless of information regarding the product advertised.

The economic system in a democracy would be handicapped without there being freedom of "commercial speech". It is therefore clear from the judgments of the Supreme Court that any attempt to curtail the financial viability of the newspapers either directly or indirectly has been held as unconstitutional.

In the present case though it is not directly a tax on newspapers, it is certainly a burden. And one of the principles of legal jurisprudence is that what cannot be done directly cannot be done indirectly either.

The proposed circular giving the new interpretation has serious legal flaws also. It considers the activity on the part of the advertising agency to buy space for display or exhibition in the newspaper as buying a service from the newspaper.

Here exactly is the mistake in the position taken in the circular. For the buying of space for display or exhibition by the newspaper is like renting the space from the newspaper.

If indeed it is a service, then the newspaper becomes an advertising agency for the purpose of service tax, under the definition of advertising agency given in Section 65(3), in which case the revenue department should have imposed the tax on the newspapers under the heading "advertising agency" right from 1996.

In a large number of cases, the clients directly pay the newspapers and get their advertisements published. Even there, the service tax should have been charged under the same heading, i.e. advertising agency. The fact that the department does not charge the service tax right from 1996 up to now only proves that the department does not consider this service.

In the Constitution there is an explicit protection for newspapers from sales tax in Entry 54 of the State List. For central excise the rate of duty is nil for newspapers under Item 49021010. The same is for journals and periodicals. Even for newsprint the rate is nil under 4801.

For customs duty the rate is just 5 per cent, which is actually a protective duty for domestic industry. So the constitutional and other statutory protections for newspapers from tax are transparent, which allows one to conclude that the idea of the founding fathers of the Constitution, and of the government has been always to make newspapers viable only to supply cheap newspapers to the public.

Whenever the government wavered on that issue, the Supreme Court intervened. So now the move to disturb the viability by imposing an indirect burden on them through the proposed circular would go totally against the basic structure of tax in regard to newspapers.

For all the arguments discussed above, the draft circular proposed to be issued should be withdrawn rather than making it final.