UPSC NCERT Notes – Indian Economy – Indian Tax System

The tax system in India is designed with both the Central Government and State Governments imposing taxes. Local authorities, such as Municipalities and Local Governments, also impose minor taxes.

To sustain the operations of the government and handle state affairs, finances are essential. Consequently, the government imposes various forms of taxes on the incomes of individuals and companies.

Tax

• Tax is a mandatory contribution to state revenue levied by the Indian Government on workers’ income, and corporate gains, and added to the cost of specific transactions, commodities, and services.
• The government collects taxes to generate revenue for initiatives that enhance the country’s economy and elevate citizens’ living standards.
• In India, the authority to levy taxes is derived from the Indian Constitution, granting equal jurisdiction to the State and Central Governments for imposing taxes.
• Every tax imposed in the country must be accompanied by an accompanying law passed by the State Legislature or the Parliament.

Features of Tax

• Tax is a compulsory payment imposed on citizens, and failure to pay it is a punishable offense.
• There is no direct quid-pro-quo between taxpayers and public authorities.
• Taxes are levied to meet public expenditure incurred by the government for the general interest of the nation.
• A tax is a recurring and periodic payment established by the taxing authority.
• A tax is a legally mandated collection.

Objectives of Taxation

The objectives and significance of taxation are outlined as follows:

• Economic Development: Taxation serves as a resource mobilization tool for economic development. Governments use tax revenues to boost both public and private investment, contributing to increased savings in the national income.
• Income Redistribution: Taxation aims to reduce inequalities in income and wealth distribution.
• Employment Boost: Effective demand for employment depends on the country’s ability to achieve full employment, which may be facilitated by reducing tax rates. Lower taxes result in increased disposable income, leading to a rise in demand for goods and services. This heightened demand stimulates investment, thereby fostering income and employment growth through the multiplier effect.
• Price Stability: Taxes serve as an effective tool for controlling inflation. By increasing direct taxes, private spending can be regulated, reducing pressure on the commodity market. However, indirect taxes on commodities can fuel inflationary tendencies, with high commodity prices discouraging consumption and encouraging saving. Conversely, lowering taxes during deflation can have the opposite effect.

Difference between Cess and Surcharge	Cess	Surcharge
Definition	An additional tax is levied on the tax base.	Other tax levied on the rate of tax is tax surcharge.
Purpose	Imposed for a particular purpose.	Particular purpose is not necessary for this tax.
Applicability	Levied on both direct tax and indirect tax.	Levied on income tax and some other taxes.
Link to Amount	The amount is linked to a certain item.	N/A
Destination of Revenue	The revenue from the cess is allocated to a specific fund for the designated purpose.	The revenue from the surcharge goes to the Consolidated Fund of India.

Different Types of Tax Systems

• Progressive Taxation Progressive tax is the authem taxing mechanism in which the taxing a charges more taxes as the income of the tax increases. 
• A higher tax is collected from the taxpayers w earn more and lower taxes from taxpayers eas less. The government uses a mechanism
• Regressive Taxation Under this system of taxation, the tax rate diminishes as the taxable amount increases. In other words, there is an inverse relationship between the tax rate and taxable income.
• The rate of taxation decreases as the income ur taxpayers increases. This system of taxation gerterally benefits the higher sections of the society having higher incomes as they need to pe tax at lesser rates.
• On the other hand, people with lesser incomes are burdened with higher rate of taxation.
• Proportional Taxation Proportional tax is the taxing mechanism in which the taxing authori charges the same rate of tax from each taxpaye irrespective of income.

Terms Related to Tax System

• Tax Impact : The impact of a tax is the initial point where the tax is imposed. For example, when a tax is levied on production (excise duty) of a commodity, the manufacturer bears the impact, but the tax burden is later shifted to the ultimate consumer through the commodity’s price. Here, the impact is on the manufacturer, while the incidence is on the consumer.
• Tax Shifting : Tax shifting refers to the process of transferring the burden (payment) of a tax from one entity to another. For instance, in the case of GST, the tax burden is ultimately shifted from the producer to the consumer. The manufacturer shifts the tax burden to the ultimate consumer.
• Tax Incidence: Incidence is the ultimate point where the burden of a tax settles. It indicates who ultimately bears the tax burden. In the case of direct taxes like personal income tax, the impact and incidence are on the income earner. Nobody else bears the burden of the tax on their behalf. In contrast, with indirect taxes, some business firms may bear a portion of the tax to enhance sales by providing concessions to consumers. This results in a backward shifting of tax, which is not possible with personal income tax.

Laffer Curve

• The Laffer curve illustrates the relationship between tax rates and government revenue levels. Introduced by economist Arthur Laffer in 1979, the curve suggests that tax revenue increases with higher tax rates, up to a certain point. It is based on the principle that lowering tax rates stimulates economic growth, leading to increased spending, business activity, and employment opportunities, ultimately offsetting revenue losses caused by tax cuts.

Types of Tax

• Taxes can be categorized as Direct or Indirect. Examples of direct taxes include income tax, wealth tax, gift tax, etc., while sales taxes, excise duty, customs duty, etc., are examples of indirect taxes.

Classification of Direct and Indirect Taxes

Central Government Taxes

• Direct Tax: Income tax, Corporate tax, Expenditure tax, Wealth tax, Capital Gains tax, Dividend Distribution tax, Interest tax, Gift tax, Estate tax duty, FBT, Banking cash transaction tax, Securities transaction tax, Commodity transaction tax, etc.
• Indirect Tax: Custom duty, Central Excise duty, Goods and Services tax, Union Sales tax, etc.

State Government Taxes

• Direct Tax: Business tax/sales tax, stamp and registration fee, state excise duty, Sales tax on Diesel/Petrol, tax on the vehicle, tax on transport, entry tax, advertising tax, taxes and duties on electricity, education cess, tax on betting.
• Indirect Tax: Land revenue tax, tax on agricultural income, tax on hotel receipts, business tax, tax on fixed assets, tax on employment, toll tax, etc.

Direct Tax

• A direct tax is one that is borne by the person on whom it is levied and cannot be shifted to another person.
• The impact and incidence of a direct tax are on the same person, resulting in a direct financial burden.
• Direct taxes have accounted for over half of total tax revenue since 2007 to 2008, with examples including Income Tax, levied directly on the income of individuals by the Central Government, where income sources are considered for taxation.

Corporate Tax

• Levied on the profit of companies or corporations, with a rate of 25% for turnover up to 250 crores and 30% for turnover above 250 crores as of June 2021.
• To prevent tax avoidance, Minimum Alternate Tax (MAT) at 15% of book profit is imposed.
• A significant revenue source for the Central Government, contributing approximately 18% of the total revenue.
• The Budget 2022-2023 proposes a 15% Corporate tax rate available until March 2024 for newly incorporated manufacturing units.

Wealth Tax

• Primarily imposed to reduce wealth concentration in society, wealth tax was levied on the net wealth of individuals, Hindu Undivided Family, and joint-stock companies.
• Calculated based on net wealth, where liabilities are deducted from the market value.
• Abolished by former Finance Minister Arun Jaitley in Budget 2015.

Gift Tax

• Imposed by the Central Government on donations and gifts exceeding prescribed limits to family members.
• Exempts donations from charitable institutions and companies.
• Aims to prevent evasion of estate duty and wealth tax.

Interest Tax

• Imposed on the interest income of commercial banks on their gross loans and advances.
• Currently not in force in India.

Recent Initiatives for Direct Taxes

• Minimum Alternate Tax (MAT) extended to non-company assets to broaden the tax base.
• Introduction of the Advance Pricing Agreement (APA) scheme to enhance certainty and reduce litigation in transfer pricing and international taxation matters.

Equalisation Levy

• A direct tax targeting digital transactions and income accruing to foreign e-commerce companies from India.
• Covers online advertisements and provisions for digital advertising space or facilities. Introduced in India in 2016.

Indirect Tax

• Taxes with their primary impact on one person but with the ability to shift the burden to others.
• Indirect taxes, also known as consumption taxes, are those where the impact is on one person, but the incidence is borne by a third party. In India, examples of indirect taxes include sales tax, excise duty, and custom duty.

Central Excise Duties:

• Imposed by the Central Government on goods produced within the country, excluding certain items under State Government jurisdiction like liquor and drugs.

Value Added Tax (VAT):

• A multi-point sales tax with set-off for tax paid on input purchases, eliminating the cascading effect.
• Levied on the value of the product and consumption, with the total burden borne by the consumer.
• VAT replaces the sales tax in states, merging several indirect taxes.

Central Value Added Tax (CENVAT):

• Aims to eliminate cascading effects through a Tax Credit System.
• Allows manufacturers and service providers to take credit for excise duty and service tax paid on inputs.

Custom Duties:

• Imposed on commodities imported or exported from India, contributing significantly to government revenue.

Service Tax:

• Introduced in India in 1994-1995, levied on individuals availing specified services.
• An increasingly important revenue source, with the service tax net expanding over the years.
• Reforms in Budget 2014-2015 expanded the scope of services covered under the service tax.

Surplus Budget:

• Occurs when the revenue for the financial year exceeds anticipated expenditures.

Ways and Means Advances (WMA):

• Provided by the Reserve Bank of India (RBI) to states banking with it to address temporary mismatches in their cash flow.
• Governed by the RBI Act, 1934, with repayments due within three months.

Includes normal and special types of WMA.

Applicable Year	Specific Facts
1953	Property Taxes
1957	Income Tax
1960	Corporation Tax
1960-61	Custom Duty
1962	Agriculture Income Tax
1972	Expense Tax
1957	Service Tax
1994-95	Securities Trading Tax
1985	Abolished (Year not specified)
2004-05	Re-implemented
2004-05	Implemented on the recommendation of N Nichols
Not specified	Recommendation of KR Raj Committee (Not yet implemented)
Not specified	لله
Not specified	Implemented on the recommendation of N Nichols
Not specified	Implemented on the recommendation of Chelliah Committee
2004-05	Implemented by P Chidambaram in 2004-05

Goods and Services Tax (GST)

• Goods and Services Tax (GST) is an indirect tax applicable in India on the supply of goods and services.
• It serves as a comprehensive, multistage, destination-based tax, encompassing almost all indirect taxes, with a few exceptions for state and local taxes. 
• Implemented by the Government of India from July 1, 2017, GST aims to create a unified market by replacing multiple indirect taxes with a single tax, applicable to both goods and services. The tax rates for GST were categorized into four brackets: 5%, 12%, 18%, and 28%.

Key Features of GST:

• Dual Components: It comprises Central GST (CGST) and State GST (SGST) levied by the Centre and States, respectively.
• Applicability: GST is applicable to all transactions involving goods and services, excluding exempted items and those of basic importance.
• Rates: Different rates are prescribed, including a standard rate for most goods and services, a special rate for precious metals, and a list of exempted items.
• Import: GST is levied on the import of goods and services into the country.
• Administration: Central GST is administered by the Centre, and State GST is administered by the States.

Taxes Replaced by GST:

• Central Taxes: Central Excise Duty, Additional Duties of Excise and Customs, Special Additional Duty of Customs (SAD), Service Tax, and various Cesses and Surcharges.
• State Taxes: VAT, Central Sales Tax, Purchase Tax, Luxury Tax, Entry Tax, Entertainment Tax, Taxes on advertisements, lotteries, betting, gambling, and State Cesses and Surcharges.

Types of GST:

• Central GST (CGST): Imposed by the Central Government on the supply of goods and services.
• State GST (SGST): SGST refers to the taxes imposed and collected by the State Government on goods and services. Previously, State Governments levied taxes such as VAT, purchase tax, entry tax, entertainment tax, advertisement tax, State excise, and related surcharges. All these taxes are now subsumed under SGST.
• Integrated GST (IGST): The proposed Goods and Services Tax includes an Integrated GST (IGST), levied on international commodities and services. IGST is imposed and collected by the Central Government. The taxes collected under IGST are distributed to the states to compensate for the revenue loss incurred.
• Union Territory GST (UTGST): UTGST is applicable in Union Territories without Legislative Assemblies, such as Andaman and Nicobar Islands, Dadra and Nagar Haveli and Daman and Diu (DNHDD), and Ladakh. In these Union Territories, the Central Government has the authority to levy and collect taxes.

Taxes Excluded from GST

• Certain items, such as alcohol, real estate, crude oil, petrol, natural gas, and turbine fuel, are not included in the provisions of GST. These items continue to be governed by the existing taxation system.

Advantages of GST:

• Easy Compliance: GST introduces a robust IT system, making taxpayer services, such as registrations and returns, available online for easy and transparent compliance.
• Uniformity of Tax Rates: GST ensures common indirect tax rates and structures across the country, promoting certainty and ease of doing business.
• Removal of Cascading: The seamless transfer of input tax credits minimizes cascading of taxes, reducing hidden business costs.
• Improved Competitiveness: Lower transaction costs enhance competitiveness, and the dismantling of inter-state check-posts is a crucial reform for India’s manufacturing sector.
• Gain to Manufacturers and Exporters: Subsuming major Central and State taxes in GST, comprehensive set-off of input goods and services, and phasing out of Central Sales Tax (CST) reduce the cost of locally manufactured goods and services.
• Simple and Easy to Administer: With multiple indirect taxes replaced by GST, backed by a robust IT system, administration becomes simpler.
• Better Controls on Leakage: GST’s design incentivizes tax compliance by traders, resulting in better tax compliance.
• Higher Revenue Efficiency: GST is expected to decrease the cost of tax revenue collection, leading to higher revenue efficiency.

GST Council:

• The GST regime was implemented after the Constitutional (122nd Amendment) Bill was passed by both Houses of Parliament in 2016, ratified by more than 15 Indian states, and received the President’s assent. The GST Council oversees the implementation and functioning of the GST system.
• The GST Council is a collaborative platform comprising representatives from both the Centre and the States, established by the President under Article 279(A) (1) of the amended Constitution.

Members:

• The council includes the Union Finance Minister (as Chairperson), and the Union Minister of State (Finance) from the Centre. Additionally, each state has the authority to nominate a Minister responsible for finance, taxation, or any other relevant Minister as a member.

Functions:

• According to Article 279, the Council is tasked with providing recommendations to both the Union and the States on crucial GST-related matters.
• This encompasses decisions on the inclusion or exemption of goods and services from GST, formulation of model GST Laws, and determining various GST rate slabs.

Tax Reform Committees:

• Several committees have played pivotal roles in shaping tax reforms in India:

1. Taxation Enquiry Commission (1953-54):

• Emphasized the need to broaden the base of excise duties for a stable tax structure.
• Chaired by John Mathai, it addressed issues related to taxation at the Centre, State, and Local levels.

2. Tax Reform Committee (1956):

• Headed by Nicolas Fedor, it focused on direct taxation matters.

3. Mahavir Tyagi Committee (1968):

• Under the Chairmanship of Mahavir Tyagi, it aimed to address evasion issues and enhance fiscal structure effectiveness.
• Recommended the introduction of a Permanent Account Number (PAN) for taxpayers, implemented in 1972.

4. KN Wanchoo Committee (1970):

• Formed to rationalize and simplify the tax structure.
• Recommended the establishment of the Income-Tax Settlement Commission as an alternative dispute resolution body.
• Focused on bringing out black money, reviewing concessions under corporation tax, and reforming tax administration.
• Presented its report in 1972, critiquing the prevailing control and licensing system.
• These committees have played crucial roles in shaping India’s tax policies and administration over the years.

Committee on Taxation of Agricultural Property Income:

The Central Government, recognizing the complexity surrounding agricultural taxation, established the committee under the leadership of Dr. KN Raj in February 1972. Tasked with examining the taxation of agricultural wealth and income comprehensively, the Raj Committee presented its findings in October 1972.

Major Recommendations:

• Introduction of Agricultural Holdings Tax (AHT) on agriculturists.
• Inclusion of income from agriculture in the total income for non-agricultural tax-paying assessees.
• Taxation of income from livestock, poultry, dairy farming, etc.
• Implementation of integrated taxation on agricultural property through wealth tax.
• Imposition of capital gains tax on land transfers.
• Direct Taxation Reform Committee (1978):
  • Under the leadership of CC Choksey, the committee was formed in 1978, focusing on filing returns and suggesting reforms in direct taxation.

Parthasarathi Shome Committee (2014):

• In 2014, the committee, chaired by Partha Sarathi Som, was established for administration reform and direct tax reform.

RV Easwar Committee (2015):

• An expert committee led by Justice (retired) RV Easwar submitted a report to the Union Finance Ministry in 2015. Recommendations aimed at simplifying income tax laws, especially provisions related to Tax Deduction at Source (TDS), tax refunds, and expenditure claims.
• Raja J Chelliah Committee (1991-1992):

Appointed in 1991, the Chelliah Committee focused on making the tax system more elastic and broad-based, simplifying existing laws, and ensuring easier enforcement and compliance.

Main Recommendations:

• Acceptable tax system and burden for taxpayers.
• Maximum income tax rate not exceeding 40% of total income.
• More income-elastic tax system.
• Reduced tax rates for foreign companies.
• Concessions for Special Economic Zones (SEZs) and tax exemptions for export projects.
• Dr Vijay L Kelkar Committee (2002):

Tasked with simplifying and rationalizing direct and indirect taxes, the Kelkar Committee submitted its final report in December 2002.

Major Recommendations:

• Increase the exemption limit to 1 lakh for general taxpayers.
• Raise the exemption limit to 1,50,000 for women and senior citizens.
• Abolish surcharge on personal income tax.
• Propose two rates of personal income tax (20% for income up to 4 lakh, and 30% for income exceeding 4 lakh).
• Advocate uniformity in all State Legislations relating to VAT.

MK Gupta Committee (2012):

• Established in 2012 under the leadership of MK Gupta, the former Vice-chairman of the Customs and Central Excise Settlement Commission. The government tasked this committee with developing a uniform Common Tax Code to streamline and coordinate excise duty and service tax with GST.
• High Level Committee for Direct Tax (2015):

In response to the complexities surrounding direct taxes, the Ministry of Finance formed a High Level Committee chaired by Mr. A P Shah on May 20, 2015. Mr. Shah, the Chairman of the 20th Law Commission, played a pivotal role in addressing issues related to direct taxes.

Recommendation: The committee suggested resolving disputes related to Minimum Alternative Tax (MAT) on Foreign Institutional Investors (FIIs).

Important Terms Related to Taxation

Terms	Description
Tax Haven	A country or territory with low or no taxes, leading to revenue loss for governments and potential issues like money laundering. Examples include Cayman Islands, Gibraltar, and Liechtenstein.
Pigouvian Tax	Imposed on activities with negative externalities, such as carbon tax to address pollution.
Tobin Tax	A tax on foreign exchange transactions to control speculative flows, applied when capital enters or leaves a country.
Transfer Pricing	The price at which divisions of a company transact with each other, often used when treating individual entities as separate entities.
Specific Duty	Tax levied based on weight or quantity of a product.
Ad Valorem	Tax levied based on the value of a product, not its weight or quantity.
Withholding Tax	Withholding a portion of certain payments (e.g., salary, contractor payments) at the source, similar to Tax Deducted at Source (TDS).
Capital Gains Tax	Tax on gains from buying and selling assets like land or shares, with a distinction between short-term and long-term capital gains.
Base Erosion and Profit Shifting (BEPS)	Strategies that exploit gaps in tax rules to artificially shift profits to low-tax locations, impacting developing countries relying heavily on corporate income tax.

Tax-Related Primary Concepts

Tax Evasion 

• Definition: The illegal act of evading taxes by individuals, corporations, and trusts, involving deliberate misrepresentation of their financial state to tax authorities.
• Activities: Deliberate underreporting of income, profits, or gains, as well as overstating deductions to reduce tax liability.
• Definition: Transferring some or all of the tax burden of an entity (e.g., a subsidiary) to another entity (e.g., the parent firm).
• Tax Shift or Tax Swap: A change in taxation that eliminates or reduces certain taxes while establishing or increasing others, with the overall revenue remaining unchanged.

Tax Avoidance

• Definition: The legal use of the tax regime to one’s advantage, within the bounds of the law, to minimize the amount of payable tax.
• Related Terms: Tax mitigation (used as an alternative to the pejorative term tax avoidance), tax havens (jurisdictions facilitating reduced taxes).
• Definition: A term denoting the flexibility of a government in its spending choices and financial well-being.
• Explanation: Refers to the room in a government’s budget that allows it to allocate resources for desired purposes without compromising financial sustainability or economic stability.
• Example: India’s debt to GDP ratio and the appointment of a committee by Dr. Vijay Kelkar to outline a roadmap for fiscal consolidation.

Other Concepts Related to Tax

Direct Tax Code (DTC) 

• Definition: A significant reform proposed by the UPA Government to consolidate laws related to direct taxes, aiming to simplify tax laws into a single legislation.
• Purpose: Replace the Income Tax Act, 1961, Wealth Tax Act, 1957, and Gift Tax Act, 1958.
• Changes Introduced in 2012-2013 Budget: General Anti-Avoidance Rule (GAAR), Advance Pricing Agreement (APA), revised income tax exemption limit, altered tax slabs, reduced Securities Transaction Tax (STT), establishment of the National Bench of GST Appellate Tribunal (GSTAT).

National Anti-Profiteering Authority

• Definition: A statutory body established under Section 171 of the Central GST Act, 2017, responsible for ensuring that trade and industry pass on rate reductions under the Goods and Services Tax (GST).
• Role: Resolving disputes between the Centre and the States, maintaining uniformity in dispute resolution, possessing the powers of a civil court.
• Key functions of the National Anti-profiteering Authority include:
  • Ensuring that traders do not unfairly profit by overcharging consumers in the name of GST.
  • Investigating and scrutinizing instances of profiteering, with the authority to recommend punitive actions, such as license cancellations.
  • Examining whether registered individuals have passed on the benefits of additional input tax credits or tax rate reductions to consumers through corresponding price reductions.

General Anti-Avoidance Rule (GAAR):

• Proposed in mid-March as part of the Fiscal Year 2013 budget, GAAR was originally slated to be effective from April 1, 2013. However, a modified version was announced to come into effect from April 2016 in the 2013-2014 budget.
• GAAR’s primary goal is to combat tax evasion, particularly by preventing Indian companies and investors from routing investments through tax havens like Mauritius solely to avoid taxes.
• One major advantage of GAAR is its potential to significantly reduce tax avoidance and curb the misuse of Double Taxation Avoidance Agreements (DTAA).
• GAAR investigates arrangements primarily aimed at securing a tax benefit or those lacking commercial substance, and it can be invoked when good business principles are not followed for tax avoidance purposes.
• GAAR applies to foreign investors who have not utilized benefits under Double Taxation Avoidance Agreements (DTAA).

Non-Tax Revenue:

• Non-tax revenue comprises receipts obtained from sources other than taxes, such as fees, fines, etc.
• Fee, License, and Permit: A significant contributor to the government’s non-tax revenue is derived from fees, licenses, and permits. Fees are payments made to the government for the services it provides to the public, such as land registration fees, birth and death registration fees, passport fees, court fees, etc.
• License and Permit Fees: The fee charged by the government for granting permission to individuals for specific activities is known as a license or permit fee. License fees are levied when the government grants permission for certain activities, such as obtaining a driving license or import license. It’s important to note that license fees differ from general fees as they are paid for permission rather than for specific services rendered.
• Escheat: Escheat refers to the income received by the state from property that lacks a legal heir. In cases where there is no claimant for the property, the state holds the sole legal right over it.
• Special Assessment: Another source of non-tax revenue for the government is special assessment. This payment is made by property owners whose property values have increased due to government-led developmental activities.
• Fines and Penalties: Fines and penalties serve as payments made by those who violate the law, providing economic consequences for unlawful behavior. The primary goal is not revenue generation but rather to encourage adherence to laws and regulations. The determination of fines and penalties is arbitrary and not based on administrative costs.

Sources of Revenue

Union Sources	State Sources
Corporation tax	Capitation tax
Duties of excise on tobacco and certain goods	Duties of excise on certain goods produced or
manufactured or produced in India.	manufactured in the state (e.g., alcoholic
	liquids, opium, etc.)
Estate duty in respect of property other than	Duties in respect of succession to agricultural
agricultural land.	land.
Fees in respect of any matters in the Union	Fees in respect of any matters in the State
list, excluding any fees taken in any court.	List, excluding fees taken in any court.
Foreign loans	Lotteries organized by the Government of India
	or the Government of the State.
Post office savings bank	Fees in respect of bills of exchange, cheques,
	promissory notes, etc. (excluding those
	specified in the Union List).
Post and telegraphs, telephones, wireless,	Taxes on agricultural income
broadcasting, and other forms of communication.	Taxes on land and buildings
Property of the Union	Taxes on mineral rights (subject to limitations
	imposed by Parliament relating to mineral
	development).
The public debt of the Union	Taxes on the consumption or sale of electricity
Railways	Taxes on the entry of goods into a local area
	for consumption, use, or sale therein.
Rates of stamp duty in respect of documents	Taxes on the sale and purchase of goods other
other than those specified in the Union List.	than newspapers.
Reserve Bank of India	Taxes on advertisements (excluding those
	published in newspapers).
Taxes on income other than agricultural income	Taxes on goods and passengers carried by road
	or on inland waterways.
Taxes on the capital value of assets, exclusive	Taxes on vehicles
of agricultural land of individuals and	Taxes on animals and boats
companies.
Taxes other than stamp duties on transactions	Taxes on professions, trades, callings, and
in stock exchanges and future markets.	employments.
Terminal taxes on goods or passengers carried	Taxes on luxuries, including taxes on
by railways, sea, or air.	entertainments, amusements, betting, and
	gambling.

Revenue from Public Enterprises:

• The government owns various public enterprises, including Indian Railways, Nangal Fertiliser Factory, Indian Oil, Bhilai Steel Plant, and more. The income generated from the sale of products produced by these enterprises contributes to the government’s overall revenue.

Finance Commission:

• As per Article 280 of the Constitution, the President appoints a Finance Commission every five years, making this provision a distinctive feature of the Indian Constitution not found in others.
• The Finance Commission was established two years post the Constitution’s implementation and subsequently every five years.
• The President holds the authority to appoint a new Finance Commission even before the completion of five years if deemed necessary. Thus, the appointment of the Finance Commission is an ongoing process per our Constitution.
• The Finance Commission typically provides recommendations on the allocation of funds.

Objectives of the Finance Commission

• To determine the basis for the allocation of funds collected from the taxes, which are divisible between the Centre and the States. To formulate the principles regarding the grants to the States from the Centre.
• To continue the agreements made between the Government of India and the States or to recommend changes in them. To consider any other financial matter in the interest of the country, on being notified by the President 

Finance Commission	Chairman
1st (1951)	Mr. KC Neogy
2nd (1956)	Mr. K Santhanam
3rd (1960)	Mr. AK Chanda
4th (1964)	Mr. RV Rajamannar
5th (1968)	Mr. Mahavir Tyagi
6th (1972)	Mr. YB Chavan
7th (1977)	Mr. Brahmananda Reddy
8th (1983)	Mr. NKP Salve
9th (1987)	Mr. JM Shelat
10th (1992)	Shri KC Pant
11th (1998)	Prof AM Khusrau
12th (2002)	Dr. C Rangarajan
13th (2007)	Dr. Vijay L Kelkar
14th (2013)	YV Reddy
15th (2017)	NK Singh

15th Finance Commission:

• The Chairman of the 15th Finance Commission, NK Singh, a former member of the Planning Commission, led a team tasked with examining the impact of the Goods and Services Tax (GST) on the finances of both the Centre and the States.
• Other members included former Economic Affairs Secretary Shaktikanta Das, former Chief Economic Advisor Ashok Lahiri, NITI Aayog member Ramesh Chand, and Georgetown Professor Anoop Singh.
• The commission, initially set to submit its report by October 2019, had its term extended  by the Union Government until October 30, 2020, for a total duration of 11 months.
• The recommendations of the 15th Finance Commission, originally intended for the period from April 1, 2020, to March 31, 2025, were extended for the fiscal years 2021-2026.

Recommendations of the 15th Finance Commission:

• The commission reduced the vertical devolution, decreasing the share of tax revenues allocated from 42% to 41%. This 1% decrease aimed to accommodate the newly formed Union Territories of Jammu and Kashmir and Ladakh using resources from the Central Government.
• Unlike the previous Finance Commission, which considered both the 1971 and 2011 populations, the 15th Finance Commission emphasized the 2011 population more (10% weight compared to 17.5% for the 1971 population).
• Tax effort was introduced as a criterion to reward states with higher tax collection efficiency, calculated as the ratio of the average per capita own tax revenue to the average per capita state GDP during the period between 2014-2015 and 2016-2017.

14th Finance Commission:

• Headed by former RBI Governor YV Reddy, the 14th Finance Commission endorsed the compensation roadmap for the Goods and Services Tax finalized by the Centre. It emphasized the need for an autonomous and independent GST compensation fund.
• Members of the 14th Finance Commission included YV Reddy, Abhijit Sen, M Govinda Rao, Sushama Nath, and Sudipto Mundle.

Recommendations of the 14th Finance Commission:

• The 14th Finance Commission advocates that horizontal devolution should serve as the primary channel for transferring resources to the states, disregarding distinctions between plan and non-plan allocations. In addressing the states’ needs, it employs comprehensive criteria such as population from 1971, changes in population since then, income distance, forest cover, and area, among other factors.
• For the distribution of grants to states for local bodies, the commission relies on 2011 population data with a weight of 90% and area with a weight of 10%. These grants are further categorized into basic and performance grants for Gram Panchayats and Municipal bodies. The ratio of basic to performance grants is set at 90:10 for Panchayats and 80:20 for Municipalities.
• In the fiscal years 2021-2026, the criteria established for the states’ share may influence the allocation of the pool of Central taxes.

Criteria	14th Finance Commission (2015-2020)	15th Finance Commission (2021-26) (Same for 2020-21)
Population (2011)	10.5	15.0
Population (1971)	17.5	45.0
Income Gap	50.0	10.0
Forest and Ecology	7.5	12.5
Forest Cover	–	15.0
Demographic Performance	–	15.0
Area	–	–
Tax and Fiscal Efforts	100	2.5
Total	2.5	100

Committees About Finance:

• Various committees have been established to address government expenditure and financial discipline:

Rangarajan Committee 2011:

• In 2011, an expert committee led by C. Rangarajan proposed the elimination of the distinction between plan and non-plan expenditure for both the Centre and the States.
• Constituted by the Planning Commission, this committee aimed to provide recommendations for the effective management of government expenditure.
• Key recommendations include abolishing the difference between planning and non-planning in public expenditure, fundamentally transforming the approach to government expenditure management by aligning the budget system with production and results.
• The introduction of a new multidimensional budgeting and accounting system with uniform taxes for Central programs, sub-programs, and schemes implemented in the states.
• A transition from the 12th plan to a full fiscal mode for all new schemes.

Kelkar Committee:

• The government established an audit committee, chaired by Vijay Kelkar, with the objective of instilling financial discipline. The committee produced its report in less than a month.
• Fiscal discipline pertains to achieving the ideal balance between government income and expenditures in an economy.

Prelims Facts

• Income tax in India was introduced by – James Wilson [UP RO/ARO (Pre) 2014]
• Which tax is levied by the Union and shared by the Union and the States? – Corporation tax (IAS (Pre) 1995]
• Direct tax code in India is related to which tax? -Income tax /UPPSC (Pre) 2018)
• Agriculture income tax can be levied in India by -State Government [UPPSC (Mains) 2009]
• Who assigns agricultural income tax to the State Governments? -Constitution of India [IAS (Pre) 1995]
• Which tax is levied by Gram Panchayats?- Tax on local fairs (UPPSC (Pre) 2018]
• By which department was the ‘e-Sahyog’ project launched in October 2015? -Income Tax Department [MPPSC (Pre) 2016]
• Which tax does not directly increase the price of a commodity to buyers? -Income tax [UPPSC (Pre) 1995]
• In which year, service tax was introduced in India? -1994 to 1995 [BPSC (Pre) 2015]
• CENVAT is related with -Value Added Tax [UPPSC (Mains) 2004, 2008]
• When was the wealth tax first introduced in India? -1957 [MPPSC (Pre) 2006]
• The tax levied on imports and exports is known as -Custom duty [UPPSC (Mains) 2005]
• The sales tax you pay while purchasing a toothpaste is a tax imposed and collected by the -State Government [IAS (Pre) 2014]
• In which budget, the Commodities Transaction Tax (CTT) was introduced in the Budget of India? -2013 to 2014 [BPSC (Pre)2020

UPSC NCERT Practice Questions

1. Which of the following statements are true for the income tax in India?

1. It is a progressive tax.

2. It is a direct tax.

3. It is collected by the State Governments.

4. It is a proportional tax.

Codes

(a) Only 1

(b) 1 and 2

(c) 1,2 and 3

(d) 2, 3 and 4

2. Corporation tax

(a) is levied and appropriated by the states.

(b) is levied by the Union and collected and appropriated by the States

(c) is levied by the Union and shared by the Union and the States.

(d) is levied by the Union and belongs to it exclusively.

3. Which of the following is not a direct tax in India? UKPSC (Pre) 2021

(a) Income tax

(b) Wealth tax

(c) Estate duty

(d) Sales tax

4. CENVAT is related with

(a) Custom duties

(b) Union excise duties

(c) Value Added Tax

(d) Central sales tax

5. Which of the following Union Government? taxes is not levied by the Union Government?

(a) Gift tax

(b) Entertainment tax

(c) Personal income tax

(d) Corporation tax

6. Consider the following important sources of tax revenue for the Central Government in India. RAS/RTS (Pre) 2016

1. Union excise duty

2. Corporation tax

3. Income tax

4. Service tax

Which one of the following is the correct descending order in terms of Gross Tax Revenue?

(a) 1, 2, 4, 3

(c) 2, 3, 1, 4

(b) 2, 4, 1, 3

(d) 4, 1, 2, 3

7. Which one of the following is not related with income from corporate sector in India?

(a) Fringe benefit tax

(b) Minimum alternate tax

(d) Tax on company profit

(c) Capital gains tax

8. Which one of the following taxes is the largest source of revenue in India?

(a) Income tax

(b) Corporate tax

(c) Union excise duties

(d) Custom duties

9. Which one of the following is not related to the income of the corporate sector in India?

(a) Collective additional profit tax

(b) Minimum alternative tax

(c) Capital gains tax

(d) Tax on profit of companies

10. Which among the following taxes is not shared by the Central Government with Uttar Pradesh Government under the Finance Commission Award?

(a) Income tax

(b) Custom duty

(c) Excise duty

(d) Agriculture income tax

11. Consider the following taxes.

1. Company tax

2. Customs tax

3. Wealth tax

4. Excise duty

Which of the above statement(s) is/are indirect tax?

(a) Only 1

(b) 2 and 4

(c) 1 and 3

(d) 2 and 3

12. Which of the following tax is not included in the Goods and Services Tax (GST)? CGPSC (Pre) 2020

(a) Excise duty

(b) Custom duty

(c) Value Added Tax

(d) Service tax

13. Which of the following statement(s) given below is/are correct?

1. The provisions of the General Anti-Avoidance Rule (GAAR) in India will come into force from 1st April. 2015.

2. The purpose of the provision of GAAR was to prevent tax avoidance by overseas investors.

Code 

(a) Only 1

(b) Only 2

(c) Both 1 and 2

(d) Neither 1 nor 2

14. The non-plan grants to the states by the Central Government are made on the recommendations of UPPSC (Mains) 2017

(a) Finance Commission

(b) Reserve Bank of India

(c) Ministry of Finance 

(d) State Bank of India

15. Who among the following was the Chairman of the First Finance Commission of India? UPPSC (Pre) 2021

(a) Shri Santhanam

(b) Shri KC Neogy

(c) Dr Rajamannar

(d) Shri AK Chanda

16. Consider the following statements IAS (Pre) 2023

Statement I Interest income from the deposits in Infrastructure Investment Trusts (InvITs) distributed to their investors is exempted from tax, but the dividend is taxable.

Statement II lnvITs are recognised as borrowers under the ‘Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002’.

Which one of the following is correct in respect of the above statements?

(a) Both Statement I and Statement II are correct and Statement II is the correct explanation for Statement 1.

(b) Both Statement-I and Statement Il are correct and Statement II is not the correct explanation for Statement 1.

(c) Statement I is correct but Statement II is incorrect.

(d) Statement I is incorrect but Statement II is correct.

17. Consider the following:

1. Demographic performance

2. Forest and ecology

3. Governance reforms

4. Stable government

5. Tax and fiscal efforts

For the horizontal tax devolution, the 15th Finance Commission used how many of the above as criteria other than population area and income distance?

(a) Only 2

(b) Only 3

(c) Only 4

(d) All of the above

18. With reference to Union Finance Commission, which of the following statement(s) is/are correct?

1. Finance Commission has a Chairman and six members.

2. It submits its report to the NITI Aayog.

Select the correct answer by using the codes given below.

(a) Both 1 and 2

(b) Only 2

(c) Neither 1 nor 2

(d) Only 1

Know Right Answer

1. (b)

2. (c)

3. (d)

4. (c)

5. (b)

6. (c)

7. (c)

8. (a)

9. (c)

10. (c)

11. (b)

12. (b)

13. (d)

14. (a)

15. (b)

16. (a)

17. (b)

18. (c)

Frequently Asked Questions (FAQs)

Q1: What is the role of taxation in the Indian economy?

A1: Taxation plays a crucial role in the Indian economy as it serves multiple purposes. It is the primary source of revenue for the government, enabling it to fund public infrastructure, social welfare programs, and other essential services. Additionally, taxes are used as a tool to redistribute wealth, promote economic stability, and control inflation. The Indian tax system comprises direct taxes (income tax, corporate tax) and indirect taxes (GST, excise duty), each serving specific economic objectives.

Q2: How does the Goods and Services Tax (GST) impact the Indian economy?

A2: GST, introduced in India in 2017, is a comprehensive indirect tax reform that has streamlined the taxation system. It has replaced multiple indirect taxes at the central and state levels, creating a unified tax structure. GST aims to eliminate tax cascading, enhance compliance, and boost economic efficiency. By simplifying the tax structure, GST promotes ease of doing business and facilitates seamless movement of goods and services across states, contributing to the overall growth of the Indian economy.

Q3: What is the significance of fiscal policy in the context of the Indian tax system?

A3: Fiscal policy, which includes taxation and government spending, plays a vital role in influencing the economic activities of a country. In the Indian context, the government uses fiscal policy to achieve various macroeconomic objectives such as economic growth, employment generation, and price stability. Through tax policies, the government can influence consumer spending, investment, and overall economic behavior. Understanding the impact of fiscal measures on the Indian tax system is crucial for policymakers in formulating strategies to address economic challenges and promote sustainable development.

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