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.

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:
o When such supply occurs outside the state; and
o 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:
o Consumed by the union or sold to the union; or
o 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

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.

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

The Doctrine of Immunity of State Instrumentalities

This doctrine was first put forth in the US Supreme Court in the case of McCulloch v. Maryland.
At that junction, the centre in the US was comparatively weaker than the State Government, and
the US Supreme Court had to decide on the validity of a tax levied by a state on the Bank of
United States which had been incorporated by the Congress. At this point, the court presented
this doctrine and stated that “The states had no power, taxation or otherwise,” to retard, hitch,
burden, or in any way control, the operation of constitutional laws enforced by Congress to
execute the powers vested in the general government.” The doctrine’s application was restricted
later on by the Supreme Court as it was subjected to extreme usage by private institutions
associated with the state.

India is characterized by a federal feature in its functioning where each unit is given
independence and power to legislate wherever it is deemed to be necessary. But it is also
necessary that the instrumentalities of the centre of the units of our federal national maintain
non-interference which if exists will hamper the stability of the state. As such, there can be the
destruction of the existence of the state, too, if they are given mutual taxation power. This
“principle of mutual tolerance and non-interference” is coined as the Doctrine of Immunity. In
India, this doctrine finds its application with respect to immunity from taxation of states by
states. The doctrine finds its place in Article 285 and Article 289 of the Constitution of India.
Article 285 states that “1) The property of the union may be provided by Parliament by law,
otherwise exempt from all taxes levied by the state or by any authority within the state.

(2) Nothing in clause (1) shall, unless Parliament provides otherwise by law, prevent any
authority within a State from levying any tax on any property of the union, for which Such
property is deemed liable or as liable before the commencement of this constitution, as long as
the state continues to be taxed. “

The centre’s property thus enjoys exemption from imposition of tax by a state or authority of
such state. Parliament has got the power to lift this ban. The property includes “land, buildings,
chattel, shares, loans, everything that has a value of money, and every kind of property is
movable or immovable and tangible or intangible”. This property is used for sovereign or
commercial activity. The Corporations which are opened by the centre do not hold immunity
from such taxation as they have their own legal entity that is not the same as that of the centre.

Article 289 states that “(1) The property and income of a state shall be exempt from central
taxation. (2) Nothing in clause (1) shall prevent the union from enforcing, or authorizing any tax
to the extent, if any, by law in the form of Parliament in relation to any trade or business of any
kind, Or the State Government, or any business connected with any operation, or in connection
with property used or occupied for the purposes of such trade or occupation, or arising out of or
arising in connection therewith Any income. (3) Nothing in clause (2) shall apply to any trade or
business, or to any class of business or occupation, which Parliament may by law declare
incidental to ordinary functions. Government. “

The state’s property and any income enjoy exemption from any taxation that may be imposed by
the centre. This input of money may be from the discharge of any sovereign or commercial
activity. The commercial activities of such a state may be subject to taxation if the Parliament
decides to. But if the Parliament declares any of such activities incidental to that of the
Government’s, it enjoys exemption. It must be noted that any of such income of the authorities
within the state does not have an exemption from central taxation. Likewise, even the institution
that the state owns may be taxed.

In article 287 and 288 of the constitution also we find the provision of taxation with respect to
state and union. Under Article 287, “no State law can impose, unless Parliament provides
otherwise, a tax on the consumption or sale of electricity which is (a) consumed by the
Government of India or a railway company operating that railway, or sold for such
consumption.” Under Article 288, “no State law in force at the time of the inauguration of the
constitution was competent to impose a tax (unless the President by order provided otherwise)
The storage, generation, consumption, distribution of any water or electricity stored by any
authority established by Parliament to regulate or develop any inter-state river or river valley. Or
in connection with the sale.”

In the case of West Bengal v Union of India, The matter was adjudicated with respect to whether
the centre could take into acquisition those lands bearing coal in the State territories exercising
power under the Coal Bearing Areas Act of 1957. The court rules in favour of the union. The
court rejected the Doctrine of Immunity in this case and stated that such power was only subject
to express prohibition. In the case of In Re Sea Customs Act, the question that the court dealt
with was whether the exemption of state would extend to imports and manufactures of the state
from customs of the centre. The court held that such exemption was not extended and held that,
“The duties of customs, held by the court, were not a tax on property but an impost on imports
which formed an essential aspect of the Central power to regulate foreign trade. Similarly, excise
is not a tax on property but on the process of manufacture and production.”

Later in the case of Andhra Pradesh State RT Corporation v Income Tax Officer, it was held
that,” a corporation had a personality of its own, distinct from its shareholders and so also from
its creator, the state. Therefore, the income derived by a corporation could not be regarded as the
income of the state, and the constitutional provision exempting State income from Central-
taxation could not be extended to grant an exemption to the income of a corporation. It made no
difference that under the relevant law the corporation was required to turn over a part of its
income to the state to be spent on road development, as this did not render the corporation’s
income as that of the state.”

It can be said that the doctrine functions in favour of cooperative federalism where the centre and
the states work collectively to achieve the welfare of the nation. The application of the same has
been restrictive as observed from the various judicial decisions and thus proves to maintain
financial independence amongst the states from states and centre.