Centre State Relation- Financial Relations

Introduction

States in India were not sovereign entities prior to the foundation of the federation. As a result, no specific guidelines to protect the states were required. The central-state financial relationship has undergone a substantial transformation as a result of the 101st amendment to the constitution and the implementation of the Goods and Services Tax (GST) in India. Bilateral financial relations between the Centre and states are set out in articles 268 to 280 of the Constitution of India.

Articles 268-293, mentioned in Part XII of the Constitution, specifies the financial relations between the Centre and the States.

Division of taxation authorities between the federal government and the states: 

• The Parliament has the authority to charge the union list taxes
• The state legislature has sole authority to impose the taxes listed in the State List. The Concurrent List enumerates the taxes that can be levied by both the Parliament and the state legislatures
• The Parliament has the residuary power of taxation (i.e., the authority to impose taxes not listed in any of the three lists). The parliament may levy a gift tax, a wealth tax or an expenditure tax under this article
• There are no tax entries available on the concurrent list. In terms of tax legislation, the concurrent jurisdiction is inaccessible. However, the 101st Amendment Act of 2016 provided an exemption by establishing a unique provision for goods and services tax. The concurrent competence to make legislators/legislation controlling goods and services tax has been given to parliament and state legislatures by this amendment.

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As time has passed, the Finance Commission has been effective in introducing dynamic and progressive reforms in the financial relations between the centre and the states. Inequitable borrowing power distribution remains a problem and a major concern that must be addressed in light of the changing dynamics of the states-centre financial relationship.

The Constitution has placed the following restrictions over the taxation powers of the states: 

• A state legislature may levy taxes on certain professions, crafts, callings and occupations. However, under 2500 p.a. cap, a state legislature is barred from levying a tax on the supply of goods or services or both, under the following two situations:
  • When such supply occurs outside the state; and
  • Where such supply occurs during the export or import process.
• The Parliament has the authority to establish standards for identifying whether a supply of commodities or services, or both, occurs outside of the state, or in the path of import or export
• The usage or sale of electricity is subject to a tax imposed by the state legislature. However, no tax could be levied on the sale or use of electricity, which is:
  • Consumed by the union or sold to the union; or 
  • Consumed in the construction, maintenance, or operation of any railway by the union or by the concerned railway company or sold to the union or the railway company for a similar purpose. 
• Any authority established by Parliament for controlling or developing any interstate river or river valley shall charge a tax on any water or power stored, generated, consumed, distributed, or sold by a state legislature. However, in order for legislation to be effective, it must be reserved for the President’s consideration and approval

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Distribution of Tax Revenues

The 80th Amendment Act of 2000 and the 88th Amendment Act of 2003 changed the way tax revenues were distributed between the federal government and the states

1. The Centre imposes taxes, while the states are in charge of collecting them. (Article 268): It contains a variety of duties and tax revenues, including:

• Stamp duty is charged on bills of exchange, promissory notes, insurance policies, checks, stock transfers, and other documents
• The collected duties levied by any state (inside the state) are given to the state rather than to the Consolidated Fund of India
• The centre imposes a service tax, but the states collect and appropriate it (Article 268-A) (now outlawed amid GST)

2. Taxes levied and collected by the federal government but distributed to state (article 269): This category includes the following taxes:

• Various tariffs were levied on the sale or purchase of commodities (other than newspapers) in the course of interstate commerce or trade
• Various tariffs on products sent in the course of interstate trade or commerce
• All of these taxes’ net proceeds do not go into the Consolidated Fund of India (CFI). According to the principles established by the Parliament, they are assigned to the involved states

3. Imposition and collection of Goods and Services Tax in line with interstate trade or commerce (Article 269- A):

• The Centre imposes and collects the Goods and Services Tax (GST) on supplies made in the course of interstate trade or commerce
• However, this tax is split between the Centre and the States in the manner proposed by Parliament based on the GST Council’s recommendations
• Furthermore, the Parliament has the authority to develop standards for establishing the site of supply and when commodities or services, or both, are supplied in the course of interstate trade or commerce

4. Taxes imposed and collected by the Centre but distributed amongst the Centre and the States proportionately (Article 270): This category comprises all taxes and duties referred to in the Union List except the following:

• Articles 268, 269, and 269-A deal with duties and taxes (mentioned above).
• Article 271 imposes a surcharge on taxes and duties (mentioned below).
• Any tax imposed for a specified purpose. The President, on the recommendation of the Finance Commission, prescribes the method for distributing the net earnings of all these taxes and duties (FCs).

4. Article 271-Surcharges on certain taxes and duties for purposes of the centre: 

• Articles 269 and 270 of the Constitution provide that the Parliament may impose surcharges on taxes and duties at any time (mentioned above).
• The Centre receives all of the profits from such surcharges. In other words, the states aren’t paying any of the levies. This fee is not applicable to the Goods and Services Tax (GST). To put it another way, the GST will not be subject to this surcharge.
• State Government Taxes: Taxes of this nature are entirely the responsibility of the governments. They are 18 in number and are included on the State List.

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Grants-in-Aid to the States

In addition to taxation shared between the Union and the states, the Constitution provides grants-in-aid to the states from federal funds.  Statutory grants and discretionary grants are the two types of grants-in-aid to states:

Statutory Grants

• Article 275 empowers the Parliament to offer grants to states which are in need of financial assistance, rather than to all states. Each year, these grants are charged to the Consolidated Fund of India (CFI)
• Aside from this standard provision, the Constitution additionally provides for special funds to promote the welfare of scheduled tribes (STs) in a state or to improve the quality of administration of scheduled territories in a state, such as Assam
• Under Article 275 statutory grants (both general and particular) are awarded to states on the Finance Commission’s recommendation.

Discretionary Grants

• Article 282 empowers the Union and the states to give grants for any public purpose, even if it falls outside of their own legislative jurisdiction. The Centre is responsible for enforcing this regulation

Conclusion

The financial relationship between the Centre and the States changes dramatically if a financial emergency is declared under Article 280 of the Indian Constitution. In such instances, the Centre gains enormous authority and exerts enormous influence over the States, forcing them to adhere to specific financial propriety standards and other important protections.