Centre-State Financial Relations

Articles 268 to 293 in Part XII of the Constitution deal with Centre-state financial relations. Besides these, there are other provisions dealing with the same subject. These together can be studied under the following heads:

Allocation of Taxing Powers
The Constitution divides the taxing powers between the Centre and the states in the following way:

• The Parliament has exclusive power to levy taxes on subjects enumerated in the Union List (which are 15 in number).
• The state legislature has exclusive power to levy taxes on subjects enumerated in the State List (which are 20 in number).
• Both the Parliament and the state legislature can levy taxes on subjects enumerated in the Concurrent List (which are 3 in number).
• The residuary power of taxation (that is, the power to impose taxes not enumerated in any of the three lists) is vested in the Parliament. Under this provision, the Parliament has imposed gift tax, wealth tax and expenditure tax.

The Constitution also draws a distinction between the power to levy and collect a tax and the power to appropriate the proceeds of the tax so levied and collected. For example, the income-tax is levied and collected by the Centre but its proceeds are distributed between the Centre and the states.

   Further, the Constitution has placed the following restrictions on the taxing powers of the states:

   (i) A state legislature can impose taxes on professions, trades, callings and employments. But, the total amount of such taxes payable by any person should not exceed Rs. 2,500 per annum.

   (ii) A state legislature can impose taxes on the sale or purchase of goods (other than newspapers). But, this power of the states to impose sales tax is subjected to the four restrictions: (a) no tax can be imposed on the sale or purchase taking place outside the states; (b) no tax can be imposed on the sale or purchase taking place in the course of import or export; (c) no tax can be imposed on the sale or purchase taking place in the course of inter-state trade and commerce; and (d) a tax imposed on the sale or purchase of goods declared by Parliament to be of special importance in inter-state trade and commerce is subject to the restrictions and conditions specified by the Parliament.

   (iii) A state legislature can impose tax on the consumption or sale of electricity. But, no tax can be imposed on the consumption or sale of electricity which is (a) consumed by the Centre or sold to the Centre; or (b) consumed in the construction, maintenance or operation of any railway by the Centre or by the concerned railway company or sold to the Centre or the railway company for the same purpose.

    (iv) A state legislature can impose a tax in respect of any water or electricity stored, generated, consumed, distributed or sold by any authority established by Parliament for regulating or developing any inter-state river or river valley. But, such a law, to be effective, should be reserved for the president’s consideration and receive his assent.

Distribution of Tax Revenues
The 80th Amendment of 2000 and the 88th Amendment of 2003 have introduced major changes in the scheme of the distribution of tax revenues between the centre and the states. The 80th Amendment was enacted to give effect to the recommendations of the 10th Finance Commission. The Commission recommended that out of the total income obtained from certain central taxes and duties, 29% should go to the states. This is known as the ‘Alternative Scheme of Devolution’ and came into effect retrospectively from April 1, 1996. This amendment has brought several central taxes and duties like Corporation Tax and Customs Duties at par with Income Tax (taxes on income other than agricultural income) as far as their constitutionally mandated sharing with the states is concerned.

   The 88th Amendment has added a new Article 268-A dealing with service tax. It also added a new subject in the Union List - entry 92-C (taxes on services). Service tax is levied by the centre but collected and appropriated by both the centre and the states.

   After these two Amendments, the present position in this regard is as follows:
A. Taxes Levied by the Centre but Collected and Appropriated by the States (Article 268): This category includes the following taxes and duties:
  (i) Stamp duties on bills of exchange, cheques, promissory notes, policies of insurance, transfer of shares and others.

  (ii) Excise duties on medicinal and toilet preparations containing alcohol and narcotics.
The proceeds of these duties levied within any state do not form a part of the Consolidated Fund of India, but are assigned to that state.

B. Service Tax Levied by the Centre but Collected and Appropriated by the Centre and the States (Article 268-A):
Taxes on services are levied by the Centre. But, their proceeds are collected as well as appropriated by both the Centre and the states. The principles of their collection and appropriation are formulated by the Parliament.

C. Taxes Levied and Collected by the Centre but Assigned to the States (Article 269): The following taxes fall under this category:
  (i) Taxes on the sale or purchase of goods (other than newspapers) in the course of inter-state trade or commerce.
   (ii) Taxes on the consignment of goods in the course of inter-state trade or commerce.
   The net proceeds of these taxes do not form a part of the Consolidated Fund of India. They are assigned to the concerned states in accordance with the principles laid down by the Parliament.

D. Taxes Levied and Collected by the Centre but Distributed between the Centre and the States (Article 270): This category includes all taxes and duties referred to in the Union List except the following:
  (i) Duties and taxes referred to in Articles 268, 268-A and 269 (mentioned above);
  (ii) Surcharge on taxes and duties referred to in Article 271 (mentioned below); and
  (iii) Any cess levied for specific purposes.
The manner of distribution of the net proceeds of these taxes and duties is prescribed by the President on the recommendation of the Finance Commission.

E. Surcharge on Certain Taxes and Duties for Purposes of the Centre (Article 271): The Parliament can at any time levy the surcharges on taxes and duties referred to in Articles 269 and 270 (mentioned above). The proceeds of such surcharges go to the Centre exclusively. In other words, the states have no share in these surcharges.

F. Taxes Levied and Collected and Retained by the States These are the taxes belonging to the states exclusively. They are enumerated in the state list and are 20 in number. These are18: (i) land revenue; (ii) taxes on agricultural income, succession and estate duties in respect of agricultural land; (iii) taxes on lands and buildings, on mineral rights, on animals and boats, on road vehicles, on luxuries, on entertainments, and on gambling; (iv) excise duties on alcoholic liquors for human consumption and narcotics; (v) taxes on the entry of goods into a local area, on advertisements (except newspapers), on consumption or sale of electricity, and on goods and passengers carried by road or on inland waterways; (vi) taxes on professions, trades, callings and employments not exceeding Rs. 2,500 per annum; (vii)capitation taxes; (viii) tolls; (ix) stamp duty on documents (except those specified in the Union List); (x) sales tax (other than newspaper); and (xi) fees on the matters enumerated in the State List (except court fees).

Distribution of Non-tax Revenues
A. The Centre The receipts from the following form the major sources of non-tax revenues of the Centre: (i) posts and telegraphs; (ii) railways;
(iii) banking; (iv) broadcasting (v) coinage and currency; (vi) central public sector enterprises; and (vii) escheat and lapse.

B. The States The receipts from the following form the major sources of non-tax revenues of the states: (i) irrigation; (ii) forests; (iii) fisheries;
(iv) state public sector enterprise; and (v) escheat and lapse.

Grants-in-Aid to the States
Besides sharing of taxes between the Centre and the states, the Constitution provides for grants-in-aid to the states from the Central resources. There are two types of grants-in-aid, viz, statutory grants and discretionary grants:

Statutory Grants Article 275 empowers the Parliament to make grants to the states which are in need of financial assistance and not to every state. Also, different sums may be fixed for different states. These sums are charged on the Consolidated Fund of India every year.

   Apart from this general provision, the Constitution also provides for specific grants for promoting the welfare of the scheduled tribes in a state or for raising the level of administration of the scheduled areas in a state including the State of Assam.

   The statutory grants under Article 275 (both general and specific) are given to the states on the recommendation of the Finance Commission.

Discretionary Grants Article 282 empowers both the Centre and the states to make any grants for any public purpose, even if it is not within their respective legislative competence. Under this provision, the Centre makes grants to the states.

     “These grants are also known as discretionary grants, the reason being that the Centre is under no obligation to give these grants and the matter lies within its discretion. These grants have a two-fold purpose: to help the state financially to fulfil plan targets; and to give some leverage to the Centre to influence and coordinate state action to effectuate the national plan.”

      Notably, the discretionary grants form the larger part of the Central grants to the states (when compared with that of the statutory grants).

     Other Grants The Constitution also provided for a third type of grants-in- aid, but for a temporary period. Thus, a provision was made for grants in lieu of export duties on jute and jute products to the States of Assam, Bihar, Orissa and west Bengal. These grants were to be given for a period of ten years from the commencement of the Constitution. These sums were charged on the Consolidated Fund of India and were made to the states on the recommendation of the Finance Commission.

Finance Commission
Article 280 provides for a Finance Commission as a quasi-judicial body. It is constituted by the President every fifth year or even earlier. It is required to make recommendations to the President on the following matters:

• The distribution of the net proceeds of taxes to be shared between the Centre and the states, and the allocation between the states, the respective shares of such proceeds.
• The principles which should govern the grants-in-aid to the states by the Centre (i.e., out of the Consolidated Fund of India).
• The measures needed to augment the Consolidated fund of a state to supplement the resources of the panchayats and the municipalities in the state on the basis of the recommendations made by the State Finance Commission.
• Any other matter referred to it by the President in the interests of sound finance.

Till 1960, the Commission also suggested the amounts paid to the States of Assam, Bihar, Orissa and West Bengal in lieu of assignment of any share of the net proceeds in each year of export duty on jute and jute products.

     The Constitution envisages the Finance Commission as the balancing wheel of fiscal federalism in India. However, its role in the Centre-state fiscal relations has been undermined by the emergence of the planning commission, a non-constitutional and non-statutory body.

Protection of the States’ Interest
To protect the interest of states in the financial matters, the Constitution lays down that the following bills can be introduced in the Parliament only on the recommendation of the President:

• A bill which imposes or varies any tax or duty in which states are interested;
• A bill which varies the meaning of the expression ‘agricultural income’ as defined for the purposes of the enactments relating to Indian income tax;
• A bill which affects the principles on which moneys are or may be distributable to states; and
• A bill which imposes any surcharge on any specified tax or duty for the purpose of the Centre.

The expression “tax or duty in which states are interested” means: (a) a tax or duty the whole or part of the net proceeds whereof are assigned to any state; or (b) a tax or duty by reference to the net proceeds whereof sums are for the time being payable, out of the Consolidated Fund of India to any state.

   The phrase ‘net proceeds’ means the proceeds of a tax or a duty minus the cost of collection. The net proceeds of a tax or a duty in any area is to be ascertained and certified by the Comptroller and Auditor-General of India. His certificate is final.

Borrowing by the Centre and the States
The Constitution makes the following provisions with regard to the borrowing powers of the Centre and the states:

• The Central government can borrow either within India or outside upon the security of the Consolidated Fund of India or can give guarantees, but both within the limits fixed by the Parliament. So far, no such law has been enacted by the Parliament.
• Similarly, a state government can borrow within India (and not abroad) upon the security of the Consolidated Fund of the State or can give guarantees, but both within the limits fixed by the legislature of that state.
• The Central government can make loans to any state or give guarantees in respect of loans raised by any state. Any sums required for the purpose of making such loans are to be charged on the Consolidated Fund of India.
• A state cannot raise any loan without the consent of the Centre, if there is still outstanding any part of a loan made to the state by the Centre or in respect of which a guarantee has been given by the Centre.
• Inter-Governmental Tax Immunities
  Like any other federal Constitution, the Indian Constitution also contain the rule of ‘immunity from mutual taxation’ and makes the following provisions in this regard:
  Exemption of Central Property from State Taxation The property of Centre is exempted from all taxes imposed by a state or any authority within a state like municipalities, district boards, panchayats and so on. But, the Parliament is empowered to remove this ban. The word ‘property’ includes lands, buildings, chattels, shares, debts, everything that has a money value, and every kind of property—movable or immovable and tangible or intangible. Further, the property may be used for sovereign (like armed forces) or commercial purposes.
       The corporations or the companies created by the Central government are not immune from state taxation or local taxation. The reason is that a corporation or a company is a separate legal entity.
  
• 
  Exemption of State Property or Income from Central Taxation
  The property and income of a state is exempted from Central taxation. Such income may be derived from sovereign functions or commercial functions. But the Centre can tax the commercial operations of a state if Parliament so provides. However, the Parliament can declare any particular trade or business as incidental to the ordinary functions of the government and it would then not be taxable.
  
  

    Notably, the property and income of local authorities situated within a state are not exempted from the Central taxation. Similarly, the property or income of corporations and companies owned by a state can be taxed by the Centre.

    The Supreme Court, in an advisory opinion (1963), held that the immunity granted to a state in respect of Central taxation does not extend to the duties of customs or duties of excise. In other words, the Centre can impose customs duty on goods imported or exported by a state, or an excise duty on goods produced or manufactured by a state.

Effects of Emergencies
The Centre-state financial relations in normal times (described above) undergo changes during emergencies. These are as follows:
National Emergency While the proclamation of national emergency (under Article 352) is in operation, the president can modify the constitutional distribution of revenues between the Centre and the states. This means that the president can either reduce or cancel the transfer of finances (both tax sharing and grants-in-aid) from the Centre to the states. Such modification continues till the end of the financial year in which the emergency ceases to operate.
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     Financial Emergency While the proclamation of financial emergency (under Article 360) is in operation, the Centre can give directions to the states: (i) to observe the specified canons of financial propriety; (ii) to reduce the salaries and allowances of all class of persons serving in the state (including the high court judges); and (iii) to reserve all money bills and other financial bills for the consideration of the President.