Taxation Powers of Union and States in India

Indian constitution has divided the taxing powers as well as the spending powers (and responsibilities) between the Union and the state governments. The subjects on which Union or State or both can levy taxes are defined in the 7th schedule of the constitution. Further, limited financial powers have been given to the local governments also as per 73rd and 74th amendments of the constitution and enshrined in Part IX and IX-A of the constitution.

Since the taxing abilities of the states are not necessarily commensurate with their spending responsibilities, some of the centre’s revenues need to be assigned to the state governments.  On what basis this assignment should be made and on what guidelines the government should act – the Constitution provides for the formation of a Finance Commission (FC) by President of India, every five years, or any such earlier period which the President deems necessary via Article 280. Based on the report of the Finance Commission, the central taxes are devolved to the state governments.

Separation of Powers

The Union government is responsible for issues that usually concern the country as a whole, for example national defence, foreign policy, railways, national highways, shipping, airways, post and telegraphs, foreign trade and banking. The state governments are responsible for other items including, law and order, agriculture, fisheries, water supply and irrigation, and public health.

Some items for which responsibility vests in both the Centre and the states include forests, economic and social planning, education, trade unions and industrial disputes, price control and electricity. Then, there is devolution of some powers to local governments at the city, town and village levels.

The taxing powers of the central government encompass taxes on income (except agricultural income), excise on goods produced (other than alcohol), customs duties, and inter-state sale of goods. The state governments are vested with the power to tax agricultural income, land and buildings, sale of goods (other than inter-state), and excise on alcohol. Local authorities such as Panchayat and Municipality also have power to levy some minor taxes.

The authority to levy a tax is comes from the Constitution which allocates the power to levy various taxes between the Centre and the State. An important restriction on this power is Article 265 of the Constitution which states that “No tax shall be levied or collected except by the authority of law.” This means that no tax can be levied if it is not backed by a legislation passed by either Parliament or the State Legislature.

Sources of Revenue for Union Government

The sources of Revenue of the Union Government are as follows:

• Income (except tax on agricultural income), Corporation Tax & Service Tax
• Currency, Coinage, legal tender, Foreign Exchange
• Custom duties (except export duties)
• Excise on tobacco and other goods.
• Estate Duty (except on agricultural goods) (Kindly note that its mentioned in the constitution but Estate duty was abolished in India in 1985 by Rajiv Gandhi Government)
• Fees related to any matter in Union list except Court Fee
• Foreign Loans
• Lotteries by Union as well as State Governments.
• Post Office Savings bank, Posts, Telegraphs, Telephones, Wireless Broadcasting, other forms of communication
• Property of the Union
• Public Debt of the Union
• Railways
• Stamp duty on negotiable instruments such as Bills of Exchange, Cheques, Promissory notes etc.
• Reserve Bank of India
• Capital gains taxes, Taxes on capital value of assets except farm land
• Taxes other than stamp duties on transactions in stock exchanges and future markets
• Taxes on the sale and purchase of newspapers and advertisements published therein.
• Terminal Taxes on Goods and passengers, carried by Railways and sea or air.

Sources of revenue for State Governments

The following are sources of revenue for State Governments.

• Taxes and duties related to agricultural lands
• Capitation Taxes
• Excise on liquors, opium etc.
• Fees on matters related to state list except court fee
• Land Revenue, Land and buildings related taxes
• Rates of Stamp duties in respect of documents other than those specified in the Union List
• Taxes on mineral rights subject to limitations imposed by the parliament related to mineral development
• Taxes on the consumption or sale of electricity
• Sales tax on goods (other than newspapers) for consumption and use within state.
• Taxes on advertisements except newspaper ads.
• Taxes on goods and passengers carried by road or on inland waterways
• Taxes on vehicles, animals and boats, professions, trades, callings, employments, luxuries, including the taxes on entertainments, amusements, betting and gambling.
• Toll Taxes.

 Certain Taxes levied as Concurrent Powers

Please note that the Union and the State Governments have the concurrent powers to fix the principles on which taxes on motor vehicles shall be levied and to impose stamp duties on non-judicial stamps. The property of the Union is exempted from State Taxation; and the property of the states is exempted from the Union Taxation. But the parliament of India can pass legislation for taxation by Union Government of any business activities / trade of the state which are not the ordinary functions of the state.

Residuary Power of Taxation

Union Government has exclusive powers to impose taxes which are not specifically mentioned in the state or concurrent lists. Some taxes imposed using these powers include Gift tax, wealth tax and expenditure tax.

State’s power Regarding Sales Tax

The sales tax on consumer goods such as toothpastes, soaps, daily use items, electronic items etc. are imposed, collected and appropriated by state governments. However, newspapers and newspaper ads are exception to this. Further, there are four restrictions to this power of the state. These include:

• A state cannot impose sales tax if a good is produced there but is sold outside the state.
• A state cannot impose sales tax if the sale and purchase is taking place for items due for export.
• A state cannot impose tax on interstate trade and commerce of goods
• State cannot impose a tax on a good that has been declared of special importance by parliament.

Other facts about levying and appropriation of Taxes

• Sales tax is imposed, levied, collected, appropriated by states as mentioned above
• Income tax, Corporation Tax, Service tax are levied and collected by Centre but are appropriated by both states and centres as per distribution formula recommended by Finance Commission. This formula is NOT binding upon the parliament.
• However states have no share in surcharges, cesses on these taxes.
• Stamp duties on negotiable instruments and excise duties on medicinal and toilet preparations that have use of alcohol and narcotics are levied by Centre. But these taxes don’t make a part of consolidated fund of India. They are assigned to respective states only, which appropriate these taxes.
• Sales tax in case of Inter-state trade of goods (except newspapers) is levied and collected by the centre but such proceeds are assigned to states. (This is known as Central Sales Tax)