Karnataka's 2% cess on OTT subscriptions: Do states have the power to impose such a tax?

The Karnataka government's recent proposal to impose a 2% cess on Over-The-Top (OTT) subscriptions and movie tickets has initiated important discussions regarding its legal implications and potential effects on consumers and the broader entertainment industry.

On September 23, Karnataka Governor Thawarchand Gehlot approved the Karnataka Cine and Cultural Activists (Welfare) Bill, 2024, which introduces a cess of up to 2% on movie tickets and OTT subscription fees, aiming to support cinema and cultural artists in the state.

Passed by the State Assembly in July, the bill has raised several concerns among industry experts and stakeholders.

A senior industry expert, who wished to remain anonymous, articulated concerns regarding the bill's scope. While it may be straightforward to apply this cess to traditional cinema halls, extending it to OTT services poses significant challenges.

These platforms operate on a nationwide basis, leading to questions about how the state could effectively enforce the cess exclusively for Karnataka residents, especially given the borderless nature of digital services, the industry observer said.

Another expert from the OTT space said that this bill was not valid as OTT services fall under the ambit of the Centre.

“OTT services are pan-India. How can this be implemented? It will be contested if implementated. This can also make other states want to follow suit and cause chaos in the industry as subscription costs will go up,” the expert noted.

In light of these complexities, exchange4media consulted various legal experts to clarify whether this new cess falls under the Centre’s jurisdiction or if a state can legitimately impose such a tax on broadcasting and entertainment-related services.

Legal experts point out that, according to the Seventh Schedule of the Indian Constitution, states do possess the authority to impose taxes on entertainment activities, including movie tickets and amusement.

However, t hey argue that the new cess may conflict with the principles established by the Goods and Services Tax (GST), which seeks to prevent tax cascading by creating a unified taxation framework.

Advocate Ankit Jain, a Partner at Ved Jain and Associates, noted that the primary argument against the Bill would hinge on the introduction of GST in 2017.

“When GST was implemented, it subsumed numerous indirect taxes, including those on entertainment. It was generally understood that states would not impose additional levies on the same subject, as GST aimed to foster a more uniform tax regime. Therefore, one could argue that the new cess violates the spirit of GST, which strives to eliminate tax cascading.

“However, courts may allow it if viewed as the state exercising its power to raise revenue under special circumstances,” he added.

He emphasized that the implementation of the Bill would undoubtedly carry legal and financial ramifications.

“Consumers in Karnataka could see a 2% increase in the cost of OTT subscriptions and movie tickets, potentially impacting both consumption patterns and overall industry revenue,” he warned.

Advocate Alay Razvi, Partner at Accord Juris, echoed these concerns, stating that the immediate effect of this 2% cess would likely translate into higher costs for consumers.

Razvi cautioned that if Karnataka successfully implements this cess, other states may follow suit.

“While this could generate revenue, it may also lead to increased costs in the long term. Legal challenges are inevitable, as it will be essential to define a clear line between state and central legislative powers,” Razvi noted.

Another legal expert pointed out that while Karnataka has the authority to impose entertainment taxes, the digital nature of OTT platforms, which serve customers across state boundaries, may give rise to constitutional debates over whether the state can levy such charges on services regulated by central laws. Advocate Aslam Ahmed, Partner at Singhania & Co, observed, “Critics may argue that OTT platforms fall under the Union List, thereby granting the central government exclusive control over broadcasting and telecommunications. Furthermore, the cess could disrupt the uniform taxation of digital services under GST, potentially violating the constitutional principle of free trade and commerce across state lines.”

Despite these concerns, legal experts agree that broadcasting and telecommunications fall primarily under the purview of the central government, which has the exclusive authority to legislate on these matters. However, states do retain the right to tax services provided within their borders, including those in the entertainment sector.

The distribution of power between the Centre and the States in India is outlined in the Seventh Schedule of the Constitution, which includes three lists: the Union List, the State List, and the Concurrent List. These lists delineate the subjects where the Centre, State, or both can legislate. Broadcasting is categorized as a Central subject under Entry 31 of the Union List, which encompasses various forms of electronic communication, such as radio and television. Conversely, Entry 62 of the State List empowers states to impose taxes on entertainment and amusements.

As this situation unfolds, it remains to be seen how the legal and regulatory landscape will adapt, as well as the implications for consumers and the entertainment industry in Karnataka.