Unit 3 – Finance Relations

3.1. Distribution of Fiscal Power

3.1.1. Scheme of Allocation of Taxing Power

3.1.2. Extent of Union power of Taxation

3.1.3. Residuary power

• inclusion of Fiscal Power

3.2. Restriction of Fiscal Power

3.2.1. Fundamental Rights

3.2.2. Inter

-Government Tax immunities

3.2.3. Difference between Tax and fee

3.3. Distribution of Tax Revenues

3.3.1. Tax

• Sharing under the Construction

3.3.2. Finance Commission

• Specific Purpose

grants (Article 282)

3.3.3.

6th Amendment Act

3.3.4. 22nd Amendment Act

3.3.5. 101th Amendment Act

3.4. Borrowing Power of States

3.4.1. Borrowing by the Government of India

3.4.2. Borrowing by the States

 

Unit 3: Finance Relations (Constitutional Law II)

3.1. Distribution of Fiscal Power

(3.1.1 Scheme of Allocation, 3.1.2 Union Power, 3.1.3 Residuary Power)

Introduction & Definition

The Indian Constitution adopts a federal structure with a strong unitary bias, especially in financial matters. To ensure administrative efficiency, fiscal power (the power to tax) is clearly divided between the Centre (Union) and the States. The general rule is “No tax shall be levied or collected except by authority of law” (Article 265). There is no “Concurrent List” for taxation (except for the special case of GST introduced later). A tax must either belong to the Union or the State.

Statutory Provisions

• Article 265: Prohibition of tax without legal authority.
• Article 246: Division of subject matter laws (referencing 7th Schedule).
• Article 248: Residuary Powers.
• 7th Schedule:
  • List I (Union List): Entries 82 to 92B (e.g., Income Tax, Customs, Corp Tax).
  • List II (State List): Entries 45 to 63 (e.g., Land Revenue, Tax on Agriculture Income, Liquor).
  • List III (Concurrent List): Entry 47 (Fees, but not Taxes).

Essential Ingredients (Allocation of Power)

• Distinctness: Taxing entries are distinct from general legislative entries. A power to legislate on a subject (e.g., “Industry”) does not automatically include the power to tax it.
• Exclusivity: Generally, items taxed by the Union cannot be taxed by the State, and vice versa.
• Residuary Power: If a subject of taxation is not mentioned in either List II or III, the power belongs to the Union (Parliament).

Landmark Case Laws

1. Union of India v. H.S. Dhillon (1972)

• Facts: The Union imposed a “Wealth Tax” which included the value of agricultural land. The States argued that “Agriculture” is a State subject (List II), so the Union cannot tax it.
• Issue: Whether the Wealth Tax Act fell under the Residuary Power of the Union?
• Judgment: The Supreme Court upheld the Act. It ruled that the test for Union power is simple: Is the subject mentioned in List II? If no, the Parliament has the power under Article 248 (Residuary Power) combined with Entry 97 of List I.

2. M.P.V. Sundararamier & Co. v. State of A.P. (1958)

• Facts: A dispute arose regarding sales tax on inter-state trade.
• Issue: Interpretation of legislative entries regarding taxation.
• Judgment: The Court held that the power to levy a tax is not incidental to the power to legislate. Tax entries are separate and specific. Parliament and State Legislatures have exclusive powers in their respective lists.

Exam-Style Conclusion

The scheme of fiscal power in India ensures that while States have autonomy over local revenues (like agriculture and alcohol), the Union retains major revenue sources (Income Tax, Customs) and Residuary powers. This centralization ensures financial stability for the nation.

3.2. Restriction of Fiscal Power

(3.2.1 Fundamental Rights, 3.2.2 Inter-Govt Tax Immunities, 3.2.3 Tax vs. Fee)

Introduction & Definition

The power to tax is a sovereign power, but it is not absolute. It is subject to constitutional limitations. The State cannot tax arbitrarily, nor can the Union and State tax each other’s property (Doctrine of Immunity of Instrumentalities). Furthermore, the government cannot disguise a “Tax” as a “Fee” to bypass legislative competence.

Statutory Provisions

• Article 13: Laws inconsistent with Fundamental Rights are void.
• Article 14: Right to Equality (Tax cannot be arbitrary).
• Article 19(1)(g): Right to Trade/Profession (Tax cannot be confiscatory).
• Article 285: Exemption of Union property from State taxation.
• Article 289: Exemption of State property/income from Union taxation.

Essential Ingredients

• Constitutional Limitation: A tax law must not violate Part III (Fundamental Rights).
• Non-Confiscatory: A tax should not be so heavy that it destroys the right to carry on trade.
• Quid Pro Quo (for Fees): For a levy to be a “Fee,” there must be a service rendered in return.

Comparison: Tax vs. Fee

Feature	Tax	Fee
Nature	Compulsory contribution to the State.	Voluntary/Compulsory payment for a specific service.
Benefit	No direct benefit to the payer (General Revenue).	Direct benefit/service rendered to the payer (Quid Pro Quo).
Object	To raise revenue for public welfare.	To cover the cost of administration/service.
Assent	Payment is not optional.	Can be optional (mostly).
Case Law	H.S. Dhillon Case	Shirur Mutt Case

Landmark Case Laws

1. The Commissioner, Hindu Religious Endowments v. Sri Lakshmindra Thirtha Swamiar of Sri Shirur Mutt (1954) (The Shirur Mutt Case)

• Facts: The Madras Govt imposed a heavy contribution on Mutts.
• Issue: Was this contribution a Tax or a Fee?
• Judgment: The SC defined a “Tax” as a compulsory exaction of money for public purposes without reference to special benefits. A “Fee” involves a Quid Pro Quo (something in return). Since no specific service was rendered to the Mutt, it was a Tax.

2. In Re Sea Customs Act (1963)

• Facts: A Presidential reference on whether States can tax goods imported by the Union.
• Issue: Scope of Article 285 (Immunity).
• Judgment: The immunity under Article 285 is for “Property,” not for indirect taxes like Customs or Excise. Therefore, the Union is liable to pay indirect taxes regulated by law, but its physical property is immune from State property tax.

3. New Delhi Municipal Council (NDMC) v. State of Punjab (1997)

• Judgment: The SC clarified that the property owned by State Governments situated in Union Territories (like Delhi) can be taxed by the Union (via Municipalities) because Article 289 gives immunity only from Union taxes, not Municipal taxes if authorized by Parliament.

Exam-Style Conclusion

While the State has broad powers to tax, it is restricted by Fundamental Rights (it cannot be confiscatory) and the doctrine of Inter-Governmental Immunity (Articles 285 & 289). The distinction between ‘Tax’ and ‘Fee’ remains crucial, relying heavily on the principle of Quid Pro Quo.

3.3. Distribution of Tax Revenues

(Sharing, Finance Commission, Grants, Amendments)

Introduction & Definition

While the power to levy taxes is separated, the revenue generated is often shared to correct the “Vertical Imbalance” (Centre has more money, States have more responsibilities). The Constitution provides a mechanism where the Union collects certain taxes but distributes the proceeds to States based on the Finance Commission’s recommendations.

Statutory Provisions

• Article 268: Duties levied by Union but collected/appropriated by States.
• Article 269: Taxes levied/collected by Union but assigned to States (Inter-state trade).
• Article 270: Taxes levied/collected by Union and distributed between Union and States.
• Article 275: Statutory Grants.
• Article 282: Discretionary/Specific Purpose Grants.
• Article 280: Finance Commission.

3.3.2 The Finance Commission (Article 280)

• Composition: Chairman + 4 Members appointed by the President every 5 years.
• Function: It is a quasi-judicial body that recommends:
  1. The distribution of net tax proceeds between Center and States.
  2. The principles governing Grants-in-Aid (Art 275).
  3. Measures to augment the Consolidated Fund of a State.

3.3.2 Specific Purpose Grants (Article 282)

• Concept: Allows the Union or a State to make grants for any public purpose, even if the purpose is outside their legislative competence.
• Usage: Often used by the Centre to influence State subjects (e.g., Central Schemes for Health or Education).
• Criticism: Unlike Art 275 (Statutory Grants recommended by Finance Commission), Art 282 is discretionary and often political.

Constitutional Amendments in Finance

1. The 6th Amendment Act, 1956

• Purpose: Amended the Union List to add taxes on the sale or purchase of goods in the course of inter-State trade or commerce.
• Impact: It validated the Central Sales Tax (CST). It ensured States couldn’t tax sales taking place outside their borders or in the course of import/export.

2. The 80th Amendment Act, 2000 (Note: Syllabus likely has a typo saying “22nd”)

• Note to Student: Your syllabus mentions “22nd Amendment”. The 22nd Amendment (1969) relates to the autonomous state of Meghalaya and has no direct relevance to “Distribution of Tax Revenues.” It is highly probable the syllabus meant the 80th Amendment, which is the most critical amendment for tax sharing. I have covered the 80th below.
• Context: Based on the 10th Finance Commission.
• Change: Prior to this, only specific taxes (like Income Tax) were shared. The 80th Amendment introduced the “Alternative Scheme of Devolution” where all Union taxes (except Cesses/Surcharges) are pooled and shared with States (approx 29% then, now 41%). It amended Article 270.

3. The 101st Amendment Act, 2016 (GST)

• Introduction: Introduced the Goods and Services Tax (GST).
• Key Changes:
  • Article 246A: Special provision giving simultaneous power to Parliament and State Legislatures to tax goods and services.
  • Article 269A: GST on Inter-State trade (IGST) is levied by the Union but shared.
  • Article 279A: Establishment of the GST Council (Union Finance Minister + State Ministers) to decide rates.

Landmark Case Laws

1. Bhim Singh v. Union of India (2010)

• Issue: Validity of the Scheme of MP Local Area Development (MPLADS) under Article 282.
• Judgment: The SC upheld the MPLADS scheme, stating that Article 282 gives very wide powers to the Parliament to spend money on “public purposes,” even if the subject (like local water or roads) is in the State List.

Exam-Style Conclusion

The distribution of revenue has evolved from a selective sharing model to a general pooling model (80th Amendment) and finally to a cooperative federalism model under GST (101st Amendment). The Finance Commission (Art 280) acts as the balancing wheel to ensure fiscal equity between the Center and States.

3.4. Borrowing Power of States

(3.4.1 Govt of India, 3.4.2 States)

Introduction & Definition

Governments need to borrow money when expenditure exceeds revenue (deficit). The Constitution places strict geographical and consent-based limits on borrowing to ensure the nation’s creditworthiness is not compromised.

Statutory Provisions

• Article 292: Borrowing by the Government of India.
• Article 293: Borrowing by States.

Essential Ingredients (Comparison)

Feature	Government of India (Art 292)	State Governments (Art 293)
Source	Can borrow within India and from abroad.	Can borrow only within the territory of India.
Security	Security of the Consolidated Fund of India.	Security of the Consolidated Fund of the State.
Limits	Parliament may fix limits by law (FRBM Act).	State Legislature may fix limits by law.
Restrictions	No consent needed from States.	Crucial Restriction: If the State owes a debt to the Centre, it cannot borrow more without the Centre’s consent (Art 293(3)).

Legal Exceptions/Provisos

• Article 293(3): This is the most litigated area. A State cannot raise a new loan without the consent of the Government of India if there is still an outstanding loan which the State has borrowed from the Government of India. Since almost all States owe money to the Centre, the Centre effectively controls State borrowing.

Landmark Case Laws

1. State of Kerala v. Union of India (2024 – Pending/Recent Context)

• Note: This is a very current constitutional debate relevant to exams.
• Context: Kerala filed a suit against the Union because the Union imposed a “Net Borrowing Ceiling,” restricting the State from borrowing even from open markets.
• Legal Point: The Union argued that under Article 293(3), it has the absolute right to impose conditions when granting consent for borrowing, to protect national macroeconomic stability.

Exam-Style Conclusion

While the Union has unrestricted borrowing powers (subject to Parliament), States are restricted territorially (cannot borrow abroad) and structurally (require Union consent if they have existing Central debts). Article 293(3) serves as a financial leash held by the Center to ensure States do not fall into a debt trap.