Financial Relations Between Centre And States Project

FINANCIAL RELATIONS BETWEEN CENTRE AND STATES

Submitted in the partial fulfilment of requirement of BA.LL.B. Degree. Army Institute of Law, Sector -68, Mohali. Submitted to:

Submitted by:

Ms. Chanpreet

Jasdeep Kaur

Kaur

Roll.no.-1478 BA, LL.B. (2nd Year)

1 INTRODUCTION 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.1 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 1. A complete separation of Central-State taxing powers, 2. Transfer of funds from the Centre to the States. All such aspects are discussed below with details.

Ankita Bhadouriya, “Financial Relations Between The centre And The States” assessed on 5 -3-16, http://rostrumlegal.com/financial-relationship-between-the-centre-and-the-states-by-ankita-bhadouriya/ 1

Consolidated fund of India and the states Clause (1) of Article 266 provides for the consolidated fund of India and consolidated fund of the states. The consolidated fund of India is formed of the following: -all revenues received by the government of India -all moneys raised by government of India by issue of treasury bills, loans or ways and means advances; -all moneys received by government of India in repayment of loans.

The consolidated fund of states include -all revenues received by the state government -moneys raised by government of states by the issue of treasury bills, loans or ways and means advances -all moneys received by the govt. of the state in repayment of loan.

Clause (3) of Article 266 lays down that no moneys out of the consolidated fund of the India or the state shall be appropriated except in accordance with the law and for the purposes and in the manner provided in the constitution.

Public accounts of India and the state Clause(2) of Article 266 provides that all other public moneys received by or on behalf of the govt. of India or of state shall be credited to the public account of India or the public account of the state , as the case may be . Main difference between the consolidated fund and the public account lies in respect of the appropriation of any money out of these funds. For the appropriation of money out of consolidated fund the procedure is laid down under the constitution of India while there is no such procedure laid down for the appropriation of money out of Public Account.

CONTINGENCY FUND (ARTICLE 267) Clause 1 of article 267 empowers the parliament to establish by law a contingency fund for India. Thus the parliament enacted the CONTINGENCY FUND OF INDIA ACT, 1950 but this has been replaced by AMENDENT ACT, 1970. This fund is placed at the disposal of the president. The amount of the fund is determined by Parliament by law. Clause 2 of this article empowers the legislature of the state to establish the contingency fund of the state by law. This will be at the disposal of the governor of that state. The fund is in the nature of an imprest with the executive to be used for meeting unforeseen expenditure, pending authorization of such expenditure by parliament under article 115 or 116 and by legislature of the state under article 205 or 206 respectively.

CUSTODY, ETC. OF THE CONSOLIDATED FUNDS, CONTINGENCY FUNDS AND MONEYS CREDITED TO THE PUBLIC ACCOUNTS. ARTICLE 283 deals with the custody as well as the expenditure of the public moneys .it aims at placing the custody as well as the expenditure of all public moneys under the control of the legislature. It provides that The custody of the consolidated fund of India and the contingency fund of India ,the payment of moneys into such funds ,the withdrawal of moneys from such funds, the custody of public moneys other than those credited to such funds received by or on behalf of the govt. of India , their payment into the public account of India and the withdraw of moneys from such account and all other matters connected with or ancillary to matters aforesaid shall be regulated by law made by parliament , and , until provision in that behalf is so made , shall be regulated by rules made by the president. And it provides that all aforesaid matters at the state level will be regulated by law made by the state and until such law is made, by the rules made by the governor of the state.

CUSTODY OF MONEYS RECEIVED BY PUBLIC SERVANTS AND COURTS (ARTICLE 284) Article 266 provides that all public moneys except those which are to be included in the consolidated fund, shall be credited to the public account. Article 284 says of the custody of such public moneys. It provides that all moneys received by or deposited with –

a- Any officer employed in connection with the affairs of the union or of the state in his capacity as such , other than revenues or public moneys raised or received by the govt. of India or the govt. of the state , as the case may be , b- Any court within the territory of India to the credit of any cause ,matter, account or persons, Shall be paid into the public account of India or the public account of the state, as the case may be.

DISTRIBUTION OF TAXING POWER The constitution divides the taxing powers between the Centre and the states. The taxes enumerated in the union list are leviable by the Centre and those included in the state list are leviable by the state exclusively. Taxation is treated as a distinct matter for the purposes of legislative competence vis-a-vis the general entries. Power to impose tax ordinarily would not be deduced from a general entry as an ancillary power. However theresiduarytaxing power is veted in the union by the 97 th entry of the Union list.

RESTRICTIONS ON THE STATE’S POWER TO LEVY TAXES 1. STATE’S POWERTO LEVY TAXES ON PROFESSIOINS AND TRADES (ARTICLE 276) A tax imposed by the state under entry 60 list II on Professions, trades, callings, and employments, is very similar to a tax on income which falls in the union list. The constitution permits this overlapping and to mitigate the evils arising from it the Clause (2) of article 276 lays down that the total amount payable by one person to the state or to any municipality ,district board ,local authority in the state by way of this tax ,shall not exceed Rs.2500 per annum. Clause 3 of this article states that the power of the legislature of a state to make laws under clause 1 shall not be construed as limiting the power of the parliament to make laws with respect to taxes on income accruing from or arising out of professions trades, callings, and employments.

2. STATE’S POWER TO LEVY SALES TAXES (ARTICLE 286)

Entry 54 of the state list confers power to levy tax on the “sale or purchase of goods other than newspapers “belongs to the states. But the taxes on the “imports and exports ”and “interstate trade and commerce” and “taxes on sale or purchase of goods “other than the newspapers, in the course of inter sate trade or commerce are exclusive union subjects . In order to ensure that sales taxes imposed by the states do not interfere with the imports and exports and inter-state trade and commerce, which are matters of national importance, Article 286, subjects the state’s power to levy sales tax to the following restrictions: (i)

(ii)

NO STATE CAN TAX A SALE OR PURCHASE TAKING PLACE OUTSIDE THE STATE (ARTICLE 286(1)(a)) It prohibits the state to impose a tax on sale or purchase taking palce outside the state .Clause 2 empowers the parliament to formulate by law principles for determining when a sale or purchase takes place outside the state. The Central Sales Tax Act, 1956 passed by the parliament lays down these principles. NO STATE CAN TAX A SALE OR PURCHASE TAKING PLACE IN THE COURSE OF EXPORT OR IMPORT(Article 286(1)(b)) It debars the state to impose a tax on the sale or purchase of goods when such sale or purchase takes place in the course of the import of the goods into or export of the goods out of the territory of India. Parliament may by law formulate the principles for determining when a sale or purchase takes place in the course of import or export of goods. In K.Gopinathan v. State of Kerala , cashewnuts, purchased and imported by the C.C.I. from African suppliers , were subsequently sold by the C.C.I. to local users for processing and export it was held that sale by C.C.I. was not in the course of import and were not covered by exemption provision of Section (5) of the Central Sales Tax Act,1956.

(iii)

NO STATE CAN TAX A SALE OR PURCHASE TAKING PLACE IN THE COURSE OF INTERSTATE TRADE AND COMMERCE Entry 92A in the union list empowers the Parliament to tax a sale or purchase taking place in the course of inter- state trade and commerce. Section 3 of the Central Sales Tax Act, 1956 provides: A sale or purchase of goods shall be deemed to be in the course of inter -state trade and commerce if the sale or purchase(a) Occasions the movement of goods from one state to another (b) Is effected by a transfer of documents of title to the goods during their movement from one state to another.

(iv)

TAXES ON SALE OR PURCHASE OF GOODS OF SPECIAL IMPORTANCE (ARTICLE 286 (3)(A))

Parliament may by law declare certain goods to be of special importance in the inter-state trade or commerce. In respect to such goods, taxing conditions would be as parliament by law specify. Section 14 of the Central Sales Tax Act, 1956 declares certain goods to be of special importance in the inter-state trade and commerce. (v)

(vi)

Taxes on the sale or purchase of goods in the course of inter-state trade and commerce specified under sub clauses b,c,or d,of clause (29-A) of Article 366 (Article286(3)(b)) The constitution (Forty sixth Amendment) Act,1982,has amended Clause (3) of Article 286 to the effect that State Sales Tax laws in respect to sales tax mentioned in the sub-clause (b),(c),(d) of clause (29-A) of Article 366have been subjected to restrictions which may be imposed by Parliament by law.

Clause 29-A of Article inserted by the Constitution (Forty-sixth Amendment) Act, 1982 defines that “tax on the sale or purchase of goods “ includes(a) A tax on the transfer of property in goods (whether as goods or in some other form) involved in the execution of a works contract; (b) A tax on the delivery of goods on the hire –purchase or any system of payment by installments ; (c) A tax on the transfer of the right to use any goods for any purpose (whether or not for a specified period) for cash,deferred payment or other valuable consideration ; And such transfer ,delivery shall be deemed to be sale of those goods by the person making the transfer or the delivery and a purchase of those goods by the person to whom such transfer or delivery is made. The state laws imposing taxes on such sales or purchases (mentioned above) shall be subjected to such restrictions and conditions as may be specified by parliament by law.

INTER –GOVERNMENT TAX IMMUNITY-DOCTRINE OF IMMUNITY INSTRUMENTALITY (Articles 285,287,288 &289) For the smooth working of the system of the double government set up by a federal Constitution, it is necessary that there should be immunity of the property of one government from taxation by the other. Such “mutual immunity from taxes saves a good deal of fruitless labour in assessment and calculation and cross checking of taxes between the two goverments.

The Doctrine of Immunity of Instrumentalities was for the first time propounded by the Supreme Court of the United States of America, in the well-known case of McCulloch v. Maryland. In this case the U.S. Congress enacted a law incorporating a Bank and a State (Maryland) levied a tax on the operations of the Bank, the American Supreme Court held the levy unconstitutional. Article 285(1) debars the state from taxing a union property unless Parliament by law otherwise provides. This article cannot be overridden by any executive order or a circle issued by any authority, either at the centre or in the states. Clause (2) of the same Article provides that the exemption from State Taxation would not be available with respect to any property of the union on which tax was leviable immediately before the commencement of the constitution , provided that such tax continue to be levied in that state. However parliament may make a law withdrawing the exception contained in clause (2). Article 289(1) lays down that the property and income of a state shall be exempt from Union Taxation. However Clause (2) of this article provides that immunity from the union taxation shall not apply to a trade or business carried on by or on the behalf of the Government of the State or any property used or occupied for the purposes of such trade or business or any income accruing or arising in connection therewith. Clause (3) of Article 289 empowers the Parliament to declare any trade or business or any class of trade or business to be incidental to the ordinary functions of Government. Such trade or business shall be exempt from union taxation. In New Delhi Municipal Corporation v. State of Punjab, the Supreme Court held that State property exempted from tax under Article 289(1) meant such property as was used for the purpose of Government and not for the purposes of trade or business. The Court observed that basic premise of one sovereign not taxing another sovereign is vested in the Articles 285 and 289, but while immunity in favour of Union of India under Article 285 is absolute, immunity in favour of state under Article 289 is qualified one.

NO TAXATION EXCEPT BY AUTHORITY OF LAW (Article 265) Article 265 declares that no tax shall be levied or collected except by authority of law. This article embodies the English principal of “no taxation without representation” the term “law” here means a statute law, or law made by the legislature.

NO BAR AGAINST DOUBLE TAXATION

There is nothing in Article 265 which prohibits double taxation .where more than one legislative authority such as a State legislature ,a local authority like a municipality ,possess the powers to levy a tax ,the same person or object may be validly subjected to separate taxes imposed by the State and the as well as the Municipality.

DISTRIBUTION OF REVENUES BETWEEN UNION AND STATES There are few Articles in the Indian Constitution which specifically focuses on distribution of revenues. They are:

Article 2682: Duties levied by the Union but collected and appropriated by the States: This Article was amended by the Constitution (seventh amendment) Act, 1956 with effect from 1st November 1956. Article 268 (1) provides that stamp duties and excise on medicinal and toilet preparation which are mentioned in Union List, the collection of duties shall be made by the State which shall be levied by the Union Government. The proceeds of any such duty leviable within any State in any financial year shall not form part of the consolidated Fund of India but shall be assigned to that State.

Article 268-A3: Service tax levied by Union and collected an appropriated by the Union and States: This Article was inserted by ninety-fifth 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 . Article speaks that taxes on services shall be levied by the Government of India which shall be collected by the States. Such tax shall be appropriated by the Government of India and the States.

Article 269: Taxes levied and collected by the Union but assigned to the States: This Article was lastly amended by the eightieth amendment with effect from 1st April, 1996. Taxes which shall be levied and collected by the Government of India which are included in this Article: (a) the

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Reference to Article 268 of the Indian Constituttion Reference to Article268 A of the Indian Constitution

consignment of goods which takes place in the course of inter-state trade or commerce, (b) sale or purchase of goods which takes place in the course of inter-state trade or commerce.4

Case: Goodyear India Ltd. V. State of Haryana In this case, the question was in relation with two sales tax act which speaks on consignment of goods. Section 9(1) (b) of the Haryana General Sales Tax Act, 1973 and Section 13AA of the Bombay Sales Tax Act, 1959 is the tax on consignment goods and these provisions are beyond the respective State Legislatures as the power vests with the Parliament. And so, it was held to be invalid. Clause 3 of this Article provides that Parliament may formulate principles for determining that when such sales and purchase or consignment takes place in the course of inter-state trade or commerce.

Case: State of Andhra Pradesh v. National Thermal Corporation Ltd The Supreme Court considered section 3 and 6 of Central Sales Tax Act, 1956. Supreme Court held that a movement of goods after completion of the transaction of sale within the State, does not constitute interState sale. Bench has also laid down few principles for considering inter-State trade or commerce: 1) Existence of a contract of sale incorporating a stipulation, express or implied regarding inter-State movement of goods; 2) Goods must actually move from one State to another pursuant to such contract; 3) Such movement of goods must be from one State to another, where the sales conclude.

Article 270: Taxes levied and distributed between Union and States: This Article was lastly amended in eightieth amendment which was in effect from 1st April, 1996. This Article specifically provides that taxes on income other than agricultural income and corporation tax shall be levied and collected by the Union and is distributed by the Union and States . The revenue which shall be transferred to the Sates is unconditional and the States shall be free to use their income as and when they like. In spite of the large transfer, the fact remains that States are not happy and the main reason being that due to political reasons, the States do not make adequate efforts to impose more tax. The tax proceeds shall not form a part of consolidated fund of India but shall be distributed among States.5

Case: T.M. Kanniyan v. I.T.O Supreme Court gave a judgment with regard to income tax and said that “the income tax attributable to Union territories forms a part of the Consolidated Fund of India. It is not necessary to make any distribution

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Komal Dave, “Constitutional Law:Disrtibution of Revenues”, assessed on 09-03-2016, http://www.legalserviceindia.com/article/l233-Distribution-Of-Revenues.html 5 ibid

of income tax with respect to Union territories as those territories are centrally administered through the President.”

Article 271: Surcharge on certain duties and taxes for purposes of the Union: This Article corresponds to S. 137 and S. 138(1) of the Government of India Act, 1935. Article basically speaks that Parliament is empowered to levy a surcharge from time to time as it’s the parliament who has imposed a surcharge and so it won’t be precluded to surcharge in another form. All proceeds from such surcharges are to form part of the Consolidated Fund of India and are not liable to be distributed among the states. No one can prevent Parliament to impose a surcharge.

Article: 272: Taxes which are levied and collected by the Union and may be distributed between the Union and the States: This Article has been omitted by the Constitution Act, in eightieth amendment.

Grant – In – Aid: Article 273: Grants in lieu of export duty on jute and jute products: Under the Government of India Act, the Central Governement shared the net proceeds of the jute export duty with the jute growing provinces. Under this Constitution, the States are not entitled to any such share.

The Provision specifies that for a period of 10 years from the commencement of the Constitution, the jute growing states of West Bengal, Bihar, Orissa and Assam will receive grants-in-aid from the Union in lieu of the above share of the jute export duty to the extent of sums specified by the President with the consultation of Finance Commission

Article 275: Grants from the Union to certain States This Article was amended in twenty-second Amendment which came in effect in 1969. Parliament is empowered to make such grants, as and when it is necessary to the States which are in need of financial assistance. Special grants may also be made to promote welfare schemes for Scheduled Castes and Scheduled Tribes.

Article 282: Expenditure defrayable by the Union or a State out of its revenues:

This Article corresponds to (i) Section 150 of the Government of India Act, 1935; (ii) Article 1, Section 8(1) of the Constitution of the United States, and (iii) Section 81 of the Commonwealth of Australia Constitution Act, 1900. This Article provides that the spending power of the Union or State Legislature is not limited to the legislative powers. Thus, they can spend more money but the purpose should be “public”.6 Criticism: This Article has very wide wings. How this money is to be utilized, is not mentioned in this article. So, any political party can misuse the money in name of “public purpose”.

Case: Cf. Narayanan Nambudripad, kidangazhi Manakkal v State of Madras Supreme Court has decided that the exercise of religion is a private purpose. But, if the States themselves take the management of such religious endowment in the interest of public order, mortality, or health, then it is for pubic purpose.

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ibid

CONCLUSION 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 like1. The economic conditions prevailing within the boundaries 2. Also states have to share their revenue with the local authority of its state. 3. 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.7

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Supra note 1