Intergovernmental financial relationship in a federal state is an important matter. It is considered as the heart of whole federal polity as it affects the very working of the polity. To maintain a balanced financial relationship between centre and units of federation i.e. states is a difficult exercise. Finance being an essential pre-requisite of good government gets to play a more vital role in the governance.
In federal polity, there are two levels of governments having their own various functions therefore it becomes essential for effective working of each government that each of them be conferred with such powers that enable them to raise financial resources of its own. As a result of this, there is need of a distribution of taxing powers between centre and states. Therefore, in a federation along with division of functions there is division of taxing powers between central and the state governments. But however, only allocating taxing powers between state and centre could not result in effectively functioning of the government. The next requirement for proper functioning of a government is a balance ought to exist between the financial resources of the government and its allotted responsibilities and functions. For example, if a government has very less resource to finance, then its power and autonomy will be of no use as it will be unable to carry out its allotted responsibility. A sound federal system would, therefore ensure that financial resources between centre and states are allocated in such a way that there exists a balance, an equilibrium, between the functions and resources equation at every level of government. Also, absence of such balance may lead to bad government and create stress within the federal structure of a nation, resulting to unstable and jeopardize its functions.
A strong scheme of centre-state financial relationship is the sine qua non for the smooth and apt functioning of federalism as a whole. But it is very difficult objective to achieve as there always are some economic disparities among the states. It is the universal experience of functioning of a federal polity that no scheme of allocation of taxing power in creating finance balance at each level of government is successful. It is extremely complex task to create a balance between needs and resources at each level of government. The most common situation that arises is, the centre instead of its own commitments on defence and other important services, does appear with a much stronger financial capacity than the units of federation which always find themselves inadequate in their resources to match up to their responsibilities. Therefore to overcome such problem the centre transfers some revenue to the states so that the required balanced is maintained. The Constitution of India provides a much elaborated scheme of centre-state financial relationship. The two most prominent features of this scheme are[i]:
- A complete separation of Central-State taxing powers,
- Transfer of funds from the Centre to the States.
2.1 ALLOCATION OF TAXING POWERS
As per the federal polity, the legislative powers are divided between the Centre and the States. This division is in both, territorial and topics of legislation. Article 245[ii] of the Indian Constitution, defines the ambit or territorial limit of the legislative power vested in Parliament and the Legislatures of States. Clause (2) of 245 makes it clear that a law passed by the Parliament cannot deem to be invalid on the ground that it has extra-territorial operation i.e. is effective outside the territory of India. The power to make a law having extra-territorial operation is conferred only on parliament and not on state legislatures. Therefore, if an act of state legislature gives extra territorial operation, can be challenged in the court, unless the extra-territorial operation can be sustained on the ground of territorial nexus[iii]. Territorial nexus provides that the state law is not invalid if there is a sufficient nexus or connection between the state and the subject matter of the law. In Tata Iron & Steel Co. Ltd. v. State of Bihar[iv], it was observed that the nexus theory does not impose the tax, it only indicates the circumstances in which a tax imposed by the legislature may be enforced in the particular case. In a sale of goods, the goods must be of necessity play an important part, for it is the goods in which as result of the sale, the property will pass. The presence of the goods at the date of the agreement for sale in the taxing state or production or manufacture in that state of goods, the property wherein eventually passed as a result of the sale wherever that might have taken place, constituted a sufficient nexus between taxing state and the sale.
Taxing powers are divided between the Centre and the States. The Constitution of India allots separate legislative heads of taxation to the Centre and the States. The list of taxes enumerated in Union List i.e. List I are leviable by the Centre exclusively while those mentioned in the State List i.e. List II are leviable by the States exclusively. However, not much tax entries are enumerated in the Concurrent List i.e. the list III this is done to avoid the overlapping and multiple taxation between the Centre and the State. The principle of allocating the taxing powers between centre and the states is based on the common principle that the taxes of local nature have been allotted to the states whereas the taxes which have a tax base extending over more than one state, or which should be levied on a uniform basis throughout the country and not vary from the state to state, or which can be collected more conveniently by the Centre than that of state have been allotted to the Centre.
The rules which apply to the interpretation of the non-tax entries apply mutatis mutandis[v] to the interpretation of the tax entries as well. A tax entry, like a non tax entry, has to be interpreted broadly and literally. The entries in the lists give outline of the subject matter of legislation and should, therefore be given widest amplitude[vi]. The Supreme Court has enunciated the principle of interpretation of the entries as[vii], “the cardinal rule of interpretation is that the entries in the legislative lists are not to be read in a narrow or restricted sense and that each general word should be held to the extend to all ancillary or subsidiary matters which can be fairly and reasonably be said to be comprehended in it.”
Applying the broad principle of interpretation of the tax entries, it has been held that under a tax entry, it is possible for a legislature to levy a tax not only prospectively but even retrospectively[viii]. Also, the validation of a tax declared illegal may be done only by removing the grounds of illegality or invalidity, the legislature cannot reverse, or disobey or disregard a court decision but can remove the basis on which the court decision was based[ix]. When a challenge is made to levy of a tax, its validity may have to be adjudged mainly by reference to the legislative competence or power to levy the same. In adjudging this issue, the nature and character of the tax has to be determined at the threshold. It was observed by Supreme Court that[x], “the objects to be taxed so long as they happen to be within the legislative competence of the legislature can be taxed by the legislature according to the exigencies of its needs. Once it is found that there is nexus between the legislative competence and the subject of taxation, the levy will be justified and valid”. While levying a tax, it is competent to the legislature to devise machinery for effective collection of tax, to determine procedure for assessing the tax liability and devise and make necessary provisions for preventing its evasion[xi].
The Constitution of India does not contain any prohibition against double taxation. There is no rule against double taxation, as such, i.e. the same tax being levied twice on the same tax base either under the same name or under different name. A subject can be taxed twice over if the legislature evinces a clear intension to do so. There is nothing in Art. 265[xii] from which one can spin the constitution vice called double taxation[xiii].
A notice under s. 22(2) of the Income Tax Act, 1922, was served on the appellant, a registered firm, calling upon it to submit a return of the income for the assessment year 1960-61. A return was filed, but not within time. The assessment was completed in November 1964. In view of the amendment made by the Finance Act of 1956 in s. 23(5) of the Act of 1922, the tax payable by the firm as also the amount to be included in the income of each partner was determined. The Income Tax Officer also passed an order under Cl. (a) of s. 271 (i) of the Act of 1961 imposing a penalty for non-compliance with the notice under s. 22(2) of the 1922 Act. The appellants challenged in a writ petition the validity and constitutionality of s. 23 (5) of the Act of 1922 and s. 297 (2) (g) and s. 271(2) of the Act of 1961. The High Court dismissed the petition. In the appeal to this Court it was contended (i) section 23(5) was invalid for the reason that the same income in the hands of both the firm and the partners could not be simultaneously subjected to tax; (ii) cl. (g) of s. 297(2) was violative of Article 14 inasmuch as in the matter of imposition of penalty it- discriminated between two sets of assesses with reference to a particular date, namely completion of assessment proceedings on or after the first day of April 1962, the date of commencement of the Act of 1961, the classification thus being arbitrary depending on the accident of the date of completion of the assessment and (iii) s. 271(2) contravened Article 14, because, in the case of assessees other than registered firms the maximum penalty imposable under s. 271(l)(i) could not exceed fifty per cent of the tax payable by the assessee; whereas in the case of a registered firm the maximum penalty was not made to depend upon the tax assessed on or payable by such firm.
There can be double taxation if the legislature has distinctly enacted it. It is only when there are general words of taxation and they have to be interpreted they cannot be so interpreted as to tax the subject twice over to the same tax. The Constitution does not contain any prohibition against double taxation even if it be assumed that such taxation is involved in the case of a firm and its partners after the amendment of Section 23(5) by the Finance Act of 1956; nor is there any other enactment which interdicts such taxation[xiv].
Also, in B. Krishna Bhatt v. State o Karnataka[xv]the high court specifically ruled that the power to levy under the law in question could be legal only if the concerned authority collecting the tax rendered services to the tax payers and as no services had been rendered, the collection of the tax was illegal.
2.2.1 CENTRAL TAXES
Entries 1 to 81 in the List I, the Union List confer general legislative powers on Parliament, while entries 82 to 92B enumerate the taxes which, Parliament is entitled to levy exclusively. The power to levy the income tax is divided between the centre and the states. The centre can levy a tax on non-agricultural income, whereas tax on agricultural income is assigned to the states. In accordance to the rules of interpretation of legislative entries, as said by the judicial policy, must be broadly and liberally, the courts have interpreted the term income in entry 82[xvi] in a very liberal manner. Thus the Supreme Court has ruled that the word income in that entry is of elastic import as it is used in a wide and comprehensive connotation.
The existence of two groups of entries in this list (i.e. legislative entries 1-81; taxing entries 82-97) indicate that while the main subject of legislation falls in the first group, a tax in relation thereto is separately mentioned in the second group. This means that if the general entry were to be interpreted so broadly as to include the taxing power as well, then the taxing entry would become superfluous. Thus, for legislative purposes, a general legislative entry does not comprise taxing powers. Taxation is created as a separate and distinct matter for the purposes of legislative competence.[xvii]
2.2.2 STATE TAX
Entries 1 to 44 in List II confer general legislative power on the state legislature while entries 45 to 63 confer taxing power on them, to be leviable exclusively by the state. Sales tax constitutes a major source of revenue for the states. With a view to enhance their taxing capacity under the entry 54[xviii], the Constitution (Forty-Sixth Amendment) Act, 1982, has been enacted. Clause 29A has been added to the Art.366 so as to clarify the position in certain respects, to remove certain judicially imposed restrictions and to include the many transactions within the expression, ‘a tax on sale or purchase of goods’.
However, the provisions to check the evasion of sales tax are within the legislative competence of the States under entry 54, List II. This being so, the provisions to make imposition of tax efficacious, or to prevent evasion of tax, are within the legislative competence of the state legislature[xix].
Art. 277[xx] permits continuance of a tax being levied by a state, or a local body, at the commencement of the Constitution in spite of the fact that such a tax falls in Union List.
2.2.3 CONCURRENT TAXES
The Concurrent list, List III has only few tax entries, such as:
Entry 35. Principles on which taxes on mechanically propelled vehicles are to be levied. Under this entry, parliament as well as the state legislature can legislate to lay down principles of taxation in respect of only the mechanically propelled vehicles. Under this entry only principles for taxation can be laid down; no tax as such can be levied[xxi].
2.2.4 RESIDUARY TAXES
The entry 97 in Union List states- ‘any other matter not enumerated in List II or List III including nay tax not mentioned in either of those Lists.’ This entry is further reinforced by Art. 248 which vests in Parliament ‘exclusive power to make law with respect to any matter not enumerated in List II or List III’. Therefore this is the power to levy residuary taxes along with residuary powers of legislation. Several taxes have been enacted by the Parliament under the residuary entry. Ex, the gift tax falls under the residuary entry.
- RESTRICTIONS ON THE POWER TO LEVY TAXES
The Constitution imposes few restrictions on the taxing powers of the centre and the state. As, states’ power to levy tax on profession and trade is restricted by Art. 276[xxii], and their power to levy taxes on electricity is restricted by art. 287[xxiii] and 288[xxiv]. Besides, some restrictions have been imposed on the states’ power to levy sales taxes.
- RESTRICTIONS ON THE STATES’ POWER TO LEVY SALES TAX
The states’ power to levy sales tax has been subjected to a few restrictions with a view to keep inter-state and international trade and commerce, and trade in goods of special importance free from the haphazard state taxation.
- A state is debarred from levying tax on inter-state sale or purchase.
A federation although is divided into several states, there is need to promote freedom of trade and commerce within the country to strengthen it into one economic unit. It therefore becomes necessary to regulate taxation of inter-state sale or purchase as restricted because it will hamper free flow of trade and commerce from one state to another and thus would hit the economy of the country.
- No state can tax a sale or purchase taking place outside the state.
Parliament levied a tax on interstate sale or purchase by the Central Sales Tax Act, 1956. The object of the act is to formulate principles for determining when a sale or purchase of goods takes place in the course of inter-state trade or commerce or outside a state[xxv]. The tax is levied by the centre but the power to collect and assess the same has been delegated to the exporting state which retains the proceeds of its own use.
- A state is debarred from levying a tax on sale or purchase taking place in course of import and export.
Foreign trade being of great importance to the national economy, it becomes necessary to protect it from the indiscriminate taxation.
Sale of coffee by the coffee board to the registered exporters who were under an obligation to export the same was a sale for export but not ‘in the course of export’ and so was not exempt from sales taxation[xxvi].
- Parliament is empowered to impose restrictions on state taxation of sale or purchase of goods of special importance.
Art. 286 (3) lays down that a state law imposing a tax on the sale or purchase of goods declared by the Parliament by law to be of special importance in inter-state trade or commerce, is the subject to such restriction and condition in regard to tax so levied as parliament may specify[xxvii].
- INTER- GOVERNMENT TAX IMMUNITIES
The scope of the inter-governmental tax immunities in India is very restricted. Arts. 287, 288, 285 and 289.
- Article 285: Exemption of Union Property from State Taxation
Art. 285 debars a state from taxing the union property. It imposes a ban on state taxation of central governmental property, and there is no way in which a state legislature can impose a tax on the property of the central government. The proscription relates to tax and does not affect the liability of the railways to pay fees levied by the local authorities for supply of water and maintaining sewerage systems[xxviii]. Certain government companies incorporated under the Companies Act, the entire share capital of which was held by the government of India, claimed the exemption of state taxation under 285 (1). The Supreme Court rejected the plea holding that merely because the share capitals are owned by the government of India, it cannot be held that the company is owned by the government of India[xxix].
- Article 289: Property and Income of the States and the Union Taxing powers:
Art. 289(1) limits the taxing power of the Union by exempting from its purview state property and income. Thus the income derived by a state both from the governmental and non-governmental or commercial activities would be immune from the Central taxation. The term central taxation means all taxes which the Centre is empowered to impose.
The centre can impose a tax on income or property of state owned companies or corporations because they have an entity separate from its share holders and accordingly, their property and income cannot be regarded as that of the concerned state. Exemption from the central tax under 289 (1) extends only to the states and not to their instrumentalities[xxx]
The scheme of allocation of taxing powers of Union and States, though is created with many considerations in view like economy, simplicity, convenience, uniformity, yet fails to create an equilibrium between responsibilities and resources at the state level. However the most expansive and lucrative sources of taxation lie with the Centre like the income-tax, corporation tax, customs and excises. Centre has whole country to take care and can tax the taxing capacity anywhere in India. Whereas on other hand, the fiscal needs of the states are large, because of their responsibility to provide for development, welfare and social service activities like education, housing, health etc.. for which there is insatiable demand in our country, their revenue raising capacity is restricted due to many reasons like-
- The economic conditions prevailing within the boundaries
- Also states have to share their revenue with the local authority of its state.
- Limited taxing power.
However, the framers of Constitution did not intend that all taxes assigned to the Centre should be solely spent by the Centre for its own purposes. They desired that a part of the central revenue arising from the taxation be used for subsidising the state activities. Till the year 2000, only a few central taxes were shareable between centre and states but the Tenth Finance Commission suggested and changed by the new scheme in which the states shared the total tax revenue of the centre. This scheme is designed to enable the states to share the aggregate buoyancy of the central taxes. Also, the Constitution of India provides for several types of grant-in-aid from the centre to the states
[i] Jain, M.P., Indian Constitutional Law, 6th Edition, page- 627.
[ii] Extent of laws made by Parliament and by the Legislatures of States.
[iii] K. K. Kochuni v. State of Madras & Kerala, AIR 1960 SC 1080.
[iv] AIR 1958 SC 452.
[v] Things being changed which are to be changed (meaning)
[vi] Hindustan Lever v. State of Maharashtra, AIR 2004 SC 326.
[vii] The Elel Hotels and Investment Ltd. v. Union of India, AIR 1990 SC 1664.
[viii] Chhotabhai Jethabhai Patel v. Union of India, AIR 1962 SC 1006.
[ix] Rai Ram Krishna v. State of Bihar, AIR 1963 SC 1967.
[x] Ibid at p. 1968.
[xi] Orient Paper Mills. V. State of Orissa, AIR 1961 SC 1438.
[xii] Taxes not to be imposed save by the authority of law.
[xiii] Avinder Singh v. State of Punjab, AIR 1979 SC 321.
[xiv] Jain Bros. v. Union of India, AIR 1970 SC 778.
[xv] AIR 2001 SC 1885.
[xvi] Taxes on income other than agricultural income.
[xvii] All India Federation of Tax Practicers v. Union of India, AIR 2007 SC 2990.
[xviii] Taxes on the sale or purchase of goods other than newspaper, subject to the provisions of entry 92A of list I.
[xix] State of Rajasthan v. D.P. Metals, AIR 2001 SC 3076.
[xx] Savings.- any taxes, duties, cesses or fees which, immediately before the commencement of this constitution, were being lawfully levied by the government of any state or by any municipality or other local authority or body for the purposes of the states, municipality, district or other local area may, notwithstanding that those taxes, duties, cesses or fees are mentioned in Union List, continue to be levied and to be applied to the same purposes until provision to the contrary is made by parliament by law.
[xxi] State of Assam v. Labanya Probha Debi, AIR 1967 SC 1575.
[xxii] Taxes on professions, trades, callings and employments.
[xxiii] Exemption from taxes on electricity.
[xxiv] Exemption from taxation by the states in respect of water or electricity in certain cases.
[xxv] Ashok Leyland Ltd. v. State of Tamil Nadu, AIR 2004 SC 2836.
[xxvi] Coffee Board v. Jt. C. T. O., AIR 1966 SC 870.
[xxvii] Satnam Overseas v. State of Haryana, AIR 2003 SC 66.
[xxviii] Union of India v. Sahibganj Municipality, AIR 1973 SC 1185.
[xxix] Western Coalfields Ltd. v. Spl. Area Development Authority, AIR 1982 SC 697.
[xxx] Andhra Pradesh State Civil Supplies Corp. Ltd. v. I.T. Commr. Hyd., 1983 Tax L.R. 1564.