Financial relations between Union and the States

In Indian Constitution Articles 268 to 293 relate to the provisions of financial relations between Union and the States.

The Indian Constitution has made elaborate provisions relating to the distribution of taxes as well as non-tax revenue.

Article 268: – Duties imposed by the Union but collected and appropriated by the state

Article 268 refers to the stamp duties imposed by the Union but collected and appropriated by the States. This includes stamp duty for exchange, checks and promissory notes levied by the Government of India.

Article 268 (A): – Service tax levied by the Union and appropriated by the Union and the States.

This Article was introduced by the Nineteenth Amendment Bill, 2003, which was passed by both the Houses of Parliament- Lok Sabha on 6-5-2003 and Rajya Sabha on 8-5-2003. The Article states that the services will be taxed by the Government of India which will be collected by the states. Such tax will be appropriated by the Government of India and the States.

Article 269: – This article is imposed and collected by the Union but assigned to the States

1. Article 269 (1) covers all taxes on “sale or purchase of goods” and “tax on consignment of goods”, except those included in Article 269A. These taxes are handed over to the states as provided by law but are collected and levied by the Government of India.
   • The expression “tax on the sale or purchase of goods” does not apply to all types of trade, but essentially refers to taxes that are levied on the sale or purchase of all types of goods except newspapers.
   • The expression “tax on consignment” refers to the tax duty levied on consignment of goods occurring during inter-state trade. It also includes both cases even to the person who is making it or any other person.

2. Article 269(2) provides that the revenue derived from such tax is distributed among the states (except in the case of union territories where it goes to the central government), it is not part of the Consolidated Fund of India (an amount of revenue that government of India receive through income tax, customs, central excise and non-tax revenue. The mode of distribution is to be determined by the Parliament.

3. Article 269(3) further states that Parliament has the power to define the scope of the sale, purchase or composition of goods during inter-state trade or commerce.

Article 270: – Taxes levied and collected by the Union and distributed between the Union and the States

Some taxes are collected by the Union, but their income is divided between the Union and the States in a fixed proportion. To affect the equitable distribution of financial resources.

This category includes all taxes and duties mentioned in the Union List, except the three categories mentioned above, any surcharge (an additional charge, fee, or tax that is added at the cost of a good or service, beyond the initially quoted price) and any cess levied (a form of tax imposed over and above the base tax liability of a taxpayer) for specific purposes. On the recommendation of the Finance Commission, the mode of distribution of net income of these taxes has been determined by the President.

Article 271: – Surcharge on certain duties and taxes for purposes of the Union

Article 271 has the following major elements: –

• The Parliament has the right to raise any duty or tax except in the case of GST mentioned under Article 246A.
• All proceeds received from the surcharge will be the part of the Consolidated Fund of India.
• The Parliament will get all the increased amount in tax and will not be shared among the states.
• This article has its basis to section 137 and section 136 (1) of the Government of India Act, 1935.
• Furthermore, no officer has the power to prevent Parliament from imposing surcharges.

Article 273: – Grant in lieu of export duty on jute and jute products

According to Article 273, before Independence, the Government of India provided provisions related to the sharing of net income of jute export duty with the growing provinces of jute. But under the Constitution, states are not entitled to receive any such duty.

This provision states that after the enforcement of Indian constitution the states (West Bengal, Bihar, Odisha and Assam) who were exporting jute will receive export duty for 10 years. But since this provision was in force for 10 years after the Constitution came into force, this article no longer has any relevance.

Article 274: – President’s prior recommendation for bills affecting taxation in which states are interested

According to this article, no bill or amendment on the following listed subject matters can be introduced in any House of Parliament before prior approval from the President which includes the bill/amendment: –

• Implement or set aside any tax within which states are interested; or
• It amends or changes the meaning of “agricultural income” as laid down in the Indian Agricultural Tax Act; or
• It modifies or modifies any principle by which funds are distributed to states; or
• It levies a surcharge on state taxes for the purpose of the Union.

Article 274 provides the definition of the term “tax or duty in which States are interested”, which may be divided into two parts: –

• The whole or part of any tax or duty, assigned to any state; or
• Net income of any tax or duty which is actually a part of the Consolidated Fund of India but currently, is assigned to the states.

Article 275: – Statutory grant

These grants are given by Parliament to specific states who need an assistance.

• Under this, different amounts are fixed for different states.
• The amount is from the Consolidated Fund of India.
• There are two provisions to deal with the aid to the states for any developmental plan approved by the Government of India for the welfare of Scheduled Areas and Scheduled Tribes, with a particular focus for Assam.

Any order given by Parliament in relation to the grant made under Article 275(2), grant will require prior recommendation of the Finance Commission.

Further, it is also given below that the Finance Commission has the power to make recommendations other than those mentioned in the laws.

Article 276: – Taxes on professions, trade, calling and employment

Article 276 empowers a state or other local authority to impose taxes on businesses and trade. But the total amount payable under any such tax shall not exceed two thousand and five hundred rupees per year. Earlier this limit was only two fifty rupees and was increased after the recommendations of Sarkaria Committee in 1988.

Article 277: – Saving of pre-constitutional laws

According to Article 277, if any tax, duty, cess or fees which were legally imposed by the government of any State, Municipal, or local bodies before the commencement of constitution of India shall continue even after the commencement. This will not be affected by the fact that the same subject is now a part of the Union List. However, this will only continue till the Parliament enacts any law contrary to it.

Article 279: – Computation of net income

Article 279 basically defines the net income of a tax.

Article 279(1) states that all income from taxes, excluding the cost of collection, would constitute the net income of India. Further, it provides that the total income of tax or duty in any area or in any part shall be certified by the Comptroller and Auditor General and the decision of the CAG shall be final.

Article 280: – Finance Commission

Article 280 of the Indian Constitution is a very important article as it relates to the Finance Commission of India. It fulfills the structure, power and functions of the Finance Commission. The Finance Committee’s idea is borrowed from the Commonwealth Commission of Australia.

According to Article 280, the President has the power to establish a Finance Commission after a period of every five years. The Finance Commission will assist the President by making recommendations regarding the distribution of net income of taxes to be divided between the Center and the States.

Object of Finance Commission: – The objective of the establishment of the Finance Commission is to ensure an equitable distribution of funds between the Center and the State so that neither there is any loss to the autonomy of the States nor to limit the revenue resources of the Center.

Composition of Finance Commission: – The composition of the Finance Commission is mentioned under the Finance Commission Act, 1951, which, when read with the provisions of Article 280, states that the Commission is basically comprised of five members, one of them will be the Chairman, as appointed by the President of India.

The criteria for the selection of the Speaker is that he should have a special understanding of public affairs, while the members will have the following qualifications: –

• He/she can either be a judge of the High Court or be qualified enough to do so.
• He should have deep knowledge of the finances and accounts of the government.
• He should have experience in financial matters and in the field of administration; or
• He should have special understanding of economics.

Article 281: – Recommendations of the Finance Commission

Article 281 defines that how the recommendations of the Finance Committee will be introduced in Parliament. According to this Article, the President of India shall cause to lay down all the recommendations made by finance commission along with an explanatory memorandum before each House of Parliament under the provisions of this Constitution.

Impact of Emergency on Financial Relations of Center-States

During national emergency: – In situations of emergency, the President may order that all grant-in-aids received by the Union by the States shall remain suspended. However, such suspension is only temporary in nature and cannot proceed beyond the end of the financial year in which the declaration of emergency ceases to operate.

During financial emergency: – If a financial emergency is imposed as per Article 280 of the Indian Constitution, the financial relations of the center-states change considerably. In such cases, the center becomes so powerful and exerts extreme control over the states forcing them to follow certain criteria of financial control and other necessary safeguards.

The central government can give the following instructions to the states: –

• It includes instructions to state governments about salary cuts and allowances of all employees engaged in the service of the state, including judges of the High Courts.
• In situations of financial emergency, the President has the power to make changes in the distribution and allocation of taxes from the Centre to the States and to direct the States to follow the principles of financial ownership prescribed by Parliament.
• Further instructions may be issued to compel states to reserve the President’s view on all financial and money bills even after they are passed by the state legislature. 

Article 282: – Discretionary grant

According to Article 282, the Center may, at its discretion, assist certain States for public purpose. These grants are not mandatory in nature. The Center used these grants on the recommendations of the Planning Commission. Also, in the Planning Commission era, the amount under discretionary grant was larger than the statutory grant.

What is Discretionary grant?

A “discretionary” grant is a grant in which a federal agency selects the award winner (i.e., the recipient of the grant) based on merit and eligibility. In discretionary grant, the funds are awarded on the basis of competitive process.

Case laws on financial relations between Union and the States

1. Ved Vyas Chawla vs The Income Tax Officer,1964

The Allahabad High Court, while deciding on a writ petition, questioned the imposition of an additional surcharge as a violation of Article 271, the court observes: –

• The court stated that the term “anytime” used in the article is very important. It empowers the government to impose a surcharge from time to time. If Parliament imposed a surcharge in a fixed category, it does not allow the surcharge from being modified or implemented in any other form to meet changing needs.
• Parliament can only impose a surcharge on a particular class and not overall on the public in general. But it is necessary that the particular class must have some real and substantial difference from the rest of the others. In addition, it is also necessary that the act of imposing additional surcharges should have a proper nexus with the objects it wants to achieve.

2. T.M. Kanniyan v. Income Tax Officer, Pondicherry, 1967

The Supreme Court held that income tax is a part of the Consolidated Fund of India as per the application of Article 270. Further, the court stated that it is not necessary to distribute income tax to union territories which are centrally administered by the President. The Court also states that the objective behind Article 270 is to ensure the equal distribution of the financial resources between the Centre and the State.

3. State of Andhra Pradesh v. National Thermal Corporation Ltd., 2002

The Supreme Court clarified that within the scope of Section 3 and Section 6 of the Central Sales Tax Act, 1956, after the completion of transactions within the state, the movement of goods to some other state will not amount to inter-state trade or commerce.

Therefore, the court dealt with a very important question in this case, the scope of what constitutes inter-state trade is defined as follows: –

• When the conditions regarding the inter-state movement of goods are expressly or impliedly mentioned in the terms of the contract;
• The mere existence of such a term is not sufficient, but the actual movement of goods from one state to another must be done for such a contract;
• The goods must be transported from one state to another and the contract of sale should only be concluded in another state.