Basics of Tax

Unit 1- Basics of Tax

Basics of Tax

Concept of Tax

Tax is a mandatory financial charge or levy imposed by a government on individuals, businesses,

or other entities to fund public expenditures. Taxes are considered to be the ‘cost of living in a
society’. It is a primary source of revenue for the Governments (central, state, and local) and is
used to finance public services, infrastructure, social programs, and other government functions.

Levy of Taxes

Taxes are levied primarily to generate revenue for funding public services, infrastructure, health
and social schemes of the Government. They play a crucial role in achieving economic and social
policy goals and contributing to national defence and security. Taxes serve as a key tool in fiscal
policy, allowing governments to manage economic cycles, stimulate growth during downturns, or
cool off inflationary pressures. Additionally, tax revenues support public health, safety, and
environmental initiatives, ensuring the overall well-being of citizens. The compulsory nature of
taxes provides governments with the means to meet their obligations and promote the
development and welfare of society.

Types of taxes

The taxes in India can be categorised under the following two broad heads:

Direct taxes Indirect Taxes

Direct taxes are taxes that are levied directly Indirect taxes are taxes that are not directly
on individuals or entities and are paid directly paid by the taxpayer to the government but
to the government by the taxpayer are collected by an intermediary, such as a
supplier of goods and/or services, who then
passes the ultimate tax burden on to the end
consumer
Examples include- Income taxes, Corporate Examples include- Goods and Service Tax
taxes, Property taxes, etc. (GST), Customs, VAT, CST, Excise duties, etc.

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Direct Taxes Indirect Taxes

The burden of direct The burden of

taxes cannot be indirect taxes can be
shifted to another shifted to others in
person the economic chain

Person on whom the The ultimate

tax is imposed bears customer bears the
the economic economic incidence
incidence of the tax of the tax

Power to levy tax

In India, the power to levy taxes is distributed between the central and state governments as per
the provisions of the Constitution of India. The distribution of taxing powers is outlined in the
Seventh Schedule of the Constitution (by virtue of Article 246)

The Seventh Schedule of the Indian Constitution delineates the distribution of powers and
responsibilities between the central government and the state governments. It consists of three
lists that categorize subjects for legislation and taxation. The relevant article that deals with the
Seventh Schedule is Article 246. Article 246, along with other related articles, specifies the
legislative powers of the Parliament (central government) and the State Legislatures (state
governments.

In the context of the Indian Constitution, the lists refer to three distinct lists that categorize the
subjects of legislation and taxation, outlining which Government (central, state, or concurrent)
has the authority to make laws on those subjects. These lists are part of the Seventh Schedule of
the Constitution, and they are:

a. Union List

b. State List

c. Concurrent List

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Union List The Union List exclusively enumerates subjects on which only the central
government can legislate and levy taxes. The central government has
exclusive powers over these subjects, and state governments cannot make
laws or impose taxes on them.

Examples of subjects in the Union List include defence, foreign affairs, atomic
energy and income tax.

State List The State List exclusively lists subjects on which only the state governments can
legislate and levy taxes. These subjects are within the exclusive domain of the
states, and the central government cannot interfere.

Examples include police, public health, agriculture, and state excise duties.

Concurrent The Concurrent List includes subjects on which both the central and state
List governments have the authority to legislate and levy taxes. Both levels of
government can make laws on these subjects simultaneously. However, in case
of a conflict between central and state laws on a concurrent subject, the central
law prevails.

Examples of subjects in the Concurrent List include bankruptcy and insolvency,

education, and goods and services tax (GST).

Article 246 also contains provisions for resolving conflicts between laws made by the central and
state governments on matters in the Concurrent List. Additionally, it empowers Parliament to
legislate on matters not explicitly mentioned in any list if they are of national importance or if
they pertain to the coordination between states.

Immunity of State Agencies

 In the Indian legal context, the concept of immunity for state agencies refers to the
principle that certain entities and individuals associated with the government enjoy
protection from legal actions under specific circumstances.

 This immunity is rooted in the idea that the government should be able to carry out its
functions without constant fear of legal challenges, but it is not absolute and has
exceptions.

 In the context of taxation, the immunity of state agencies in India primarily pertains to the
principle that government entities and certain activities are exempt from taxation. This
immunity is not absolute and is subject to the provisions of the Constitution and relevant
laws.

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o Article 285 and Article 289 of the Indian Constitution provide certain immunities
to the property and income of the Central government and the State Governments.

o Article 285 states that the property of the Union shall be exempt from all taxes
imposed by a state or by any authority within a state.

o Article 289 provides immunity to certain income of State Governments and their
respective municipalities from taxation by the Central Government.

Fundamental Rights
Fundamental rights are constitutional guarantees that protect individual liberties. Fundamental
rights in India are enshrined in Part III of the Constitution (Articles 12 to 35) and are considered
the cornerstone of the Indian Constitution.

These rights are designed to ensure the protection of individual liberties and freedoms of the
citizens of India. The six principle fundamental rights are:

 right to equality,
 right to freedom,
 right against exploitation,
 right to freedom of religion,
 cultural and educational rights, and
 right to constitutional remedies

Fundamental rights, particularly the right to equality, ensure that taxation does not discriminate
against individuals or classes without reasonable justification. Tax laws must adhere to the
principles of fairness and non-arbitrariness.

The link between fundamental rights and the power of taxation lies in ensuring that the
government's authority to levy taxes does not infringe upon or violate the fundamental rights
guaranteed to individuals by the constitution. While the power of taxation is essential for funding
government activities, it must be exercised in a manner that respects the principles enshrined in
fundamental rights.

Any taxation that encroaches upon fundamental rights may be subject to constitutional
review by the judiciary.

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Delegation of powers
In the Indian scenario, the delegation of taxing powers to the State legislatures refers to the
authority (power) granted by the Constitution of India that allows the State Governments to
legislate and impose taxes on certain subjects. The distribution of taxing powers between the
Central Government (Parliament) and State Governments (State Legislatures) is outlined in the
Seventh Schedule of the Constitution.

The salient features of delegation of powers by the Constitution to the State Legislatures are as
under:

a. The items come under the State List

The State List in the Seventh Schedule enumerates subjects on which only the state
legislatures (state governments) have the exclusive power to legislate and levy taxes. This list
includes matters of local or regional importance, and it grants significant autonomy to the
states in their legislative and taxation domains.

b. Taxing Powers under State List belongs to the Governments of each state
The subjects listed in the State List cover a range of areas, including state excise duties, stamp
duties, taxes on professions and trades, land revenue, agriculture, and more. State
governments have the authority to design and implement tax policies related to these subjects
within their respective jurisdictions.

c. Autonomy of each states

Delegation of taxing powers to state legislatures is a fundamental aspect of India's federal
structure. It allows states to raise revenue independently, manage their finances, and fund
state-level programs and initiatives.

d. Cooperative Federalism in GST

The Goods and Services Tax (GST) is a significant example of cooperative federalism in India.
GST is a destination-based consumption tax that subsumed various central and state-level
taxes. Both the central government and state governments have the authority to levy GST on
the supply of goods and services.

e. Legislative and Executive Powers

The delegation of taxing powers to the State legislatures encompasses both legislative and
executive powers. State legislatures formulate tax laws, while the executive implements and
administers them.

f. Bound by the Constitutional Framework

Though the State Governments have significant autonomy in taxation matters belonging to
the State List, there are constitutional limitations and principles that guide the exercise of
these powers. State taxes, for example, should not impede the free flow of trade and
commerce across state borders.

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Tax vs Fee
A tax is distinct from fee. The below table explains the distinctions between ‘taxes’ and ‘fees’.

Particulars Tax Fee

Purpose and Quid A tax is imposed to raise revenue A fee is charged in exchange for a
Pro Quo for general government purposes specific service or benefit provided
without a direct link to specific by the government, establishing a
services or benefits quid pro quo relationship

Voluntariness and A tax is compulsory and non- A fee is voluntary in the sense that it
Compulsion voluntary in nature is tied to the utilization of specific
services

Nature of levy Taxes are primarily levied to raise Fees are levied for regulatory
revenue and not necessarily purposes or to fund specific services
connected to a specific regulatory
or service-oriented purpose

Use of Revenue Revenue generated from Such generated revenue is

collection of taxes is directed to earmarked for specific purposes or
the general fund and used for services related to the entity paying
various government expenditures the fee

Regulatory Taxes are imposed through Fees may be imposed by regulatory

Authority and legislation by the legislative authorities or delegated bodies
Legislation bodies (Parliament or State
legislatures)

Welfare and Taxes are generally not linked to Fees are levied for the welfare of a
Regulation the welfare of a particular class or class or group or for regulatory
the regulation of specific activities purposes

In the case of Union of India v. Bombay Tyre International Ltd. (1983), the Supreme Court
emphasized that the nomenclature given to a levy is not decisive. The true nature and
characteristics of the charge determine whether it is a tax or a fee.

Further, in the proceedings of Ratlam Municipality Case (1980), The Supreme Court held that
for a levy to be considered a fee, there must be a specific benefit conferred upon the payer,
establishing a direct quid pro quo relationship.

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Cess
The key differences between tax and cess lie in their purpose, usage of funds, and the nature of
their imposition.

Taxes Cess

Taxes are not necessarily earmarked for Cesses are imposed with a specific purpose in
specific purposes, and the revenue collected mind. Cesses are intended to create a
contributes to the general fund. dedicated pool of funds for a defined purpose

The revenue generated from taxes can be used
for a wide range of government expenditures,
and there may not be a direct correlation
between the tax collected and a specific
service or benefit provided to the taxpayer
Cesses are introduced to ensure that the
revenue raised is utilized exclusively for the
designated purpose, often related to the
sector or issue for which the cess is imposed.

Examples of taxes include income tax, goods Examples of cesses include the Swachh Bharat
and services tax (GST), and corporate tax Cess, the Health and Education Cess, and the
Krishi Kalyan Cess

Tax Planning, Avoidance and Evasion

Tax Planning
 Tax planning is a legal and legitimate process of organizing one's financial affairs in a way
that takes advantage of tax laws to minimize the amount of taxes owed.

 It involves making strategic financial decisions, investments, and transactions to optimize

the tax liability within the framework of existing tax laws. Tax planning aims to maximize
after-tax income while remaining in compliance with tax regulations.

 Common tax planning strategies include taking advantage of deductions, privileges,

schemes, credits, exemptions, and other incentives provided by tax laws and legislations.

 Tax planning in any case will entirely depend on the individual facts and circumstances.
It is a tool in the hands of the taxpayer and tax practitioners for selective use. It is essential
to comprehend
(a) that the facts bearing on the issue are evidenced by proof;

(b) that the associated legal consequences, both under the personal and under the tax
laws, are fully borne in mind; and

(c) that the situation warrants implementation of “tax planning.

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 Successful tax planning must conform to two outstanding tests viz,

i. conformity with the current law and
ii. flexibility

 In order to be a successful venture, efforts at tax planning should not ignore the legislative
intent; they should be directed in every case to see that not only the tax benefits are
obtained but also the tax obligations are discharged without fail so that the penal
provisions are not attracted.

 In relation to income tax, the following may be noted as illustrative instances of tax-
planning measures:
i. Varying the residential status taking into consideration the number of days of stay
in India to be a resident, in case of an individual.

ii. Choosing the suitable form of assessable entity (individual, HUF, Firm, Co-
operative society, Association of persons, Company, Trust, etc. to obtain optimal
tax concessions)

iii. Choosing suitable forms of investment (share capital, loan capital, lease,
mortgages, tax exempt investments, priority sector, etc.), considering deductions
available in respect of interest or dividend etc.

iv. Programmed replacement of assets to take advantage of the provisions governing

depreciation

Tax Avoidance
 Tax avoidance refers to the use of legal methods and strategies to minimize tax liability.
It involves structuring financial activities in a way that aligns with the letter of the law but
may not necessarily align with the spirit of the law.

 Tax avoidance typically exploits loopholes, inconsistencies, or ambiguities in tax codes to

reduce the amount of taxes owed. While tax avoidance is legal, it may be viewed as
aggressive or ethically questionable, especially if it goes against the intent of the tax laws.

 The methods selected in this schemes, though technically satisfying the requirements of
the law, in fact, circumvent it with a view to eliminate or reduce tax burden.

 The dividing line between tax evasion and tax avoidance is very thin. The Direct Taxes
Enquiry Committee (Wanchoo Committee) has tried to draw a distinction between the
two items in the following words.

“The distinction between ‘evasion’ and ‘avoidance’, therefore, is largely dependent on

the difference in methods of escape resorted to”

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 In CIT vs. A. Raman & Co. 1 SCR 10, the Supreme Court observed that avoidance of tax
liability by so arranging commercial affairs that charge of tax is distributed is not
prohibited. The taxpayer may resort to a device to divert the income before it accrues or
arises to him. Effectiveness of the device depends not upon consideration of morality but
on the operation of the Income-tax Act, 1961. Legislative injunction in taxing statutes may
not, except on pain of penalty, be violated but it may lawfully be circumvented

 However, the Supreme Court in Mc Dowell's case clearly departed from the above views
and expressly disassociated itself with the earlier observations of the Supreme Court
echoing the sentiments of Westminster principle. The court enumerated the evil
consequences of tax avoidance as follows:
o Substantial loss of much needed public revenue.

o Serious disturbance caused to the economy of the country by the piling up of

mountains of black money, directly causing inflation.

o Large hidden loss to the community by some of the best brains of the country
involved in perpetual litigation.

o Sense of injustice and inequality which tax avoidance arouses in the minds of
those who are unwilling or unable to profit by it.

o The unethical practice of transferring the burden of tax liability to the shoulders
of the guileless, good citizens from those of the 'artful dodgers'.

 The court felt that there was as much moral sanction behind taxation laws as behind any
other welfare legislation and avoidance of taxation was not ethical.

 In order to curb tax avoidance, provisions such as

o applicability of transfer pricing provisions in respect of specified domestic
transactions,
o treating any transaction with the person located in the notified jurisdiction areas
to be treated as international transaction,
o General Anti-avoidance Rules,
o provisions relating to furnishing of Tax Residency Certificate for claiming benefit
of double tax avoidance agreements have been introduced.

Tax Evasion
 Tax evasion is the illegal act of intentionally not paying taxes owed. It involves
deliberately providing false or misleading information on tax returns, hiding income,
inflating expenses, or engaging in other fraudulent activities to reduce tax liability.

 In the context of Indian taxation, tax evasion refers to the illegal act of deliberately
providing false information or engaging in fraudulent activities to evade the payment of
taxes owed to the government. Tax evasion is considered a serious offense and is subject
to penal consequences under various provisions of the Income Tax Act, 1961.

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 Tax evasion is a criminal offense and is subject to severe penalties, including fines and
imprisonment. It is a clear violation of tax laws and is considered an unethical and illegal
practice.

 Common forms of Tax Evasion are as under:

i. Misrepresentation or suppression of facts;

ii. Failure to record investments in books of account;

iii. Claim of expenditure not substantiated by any evidence;

iv. Recording of any false entry in books of account;

v. Failure to record any receipt in books of account having a bearing on total income;
and

vi. Failure to report any international transaction or deemed international

transaction or specified domestic transaction

Elements of Tax
The following are the essential elements of a tax

1. Taxpayer: This refers to the individual, firms, companies, or other entities which are
subject to taxation and the related assessments. Taxpayers are responsible for reporting
their income, assets, and other financial information to the tax authorities and for paying
the required taxes.

2. Tax Authority: Taxing authority refers to the government agency or the authority
responsible for collecting and enforcing tax laws. The tax authorities in India include the
Central Board of Direct Taxes (CBDT) for direct taxes like Income Tax and the Central
Board of Indirect Taxes and Customs (CBIC) for indirect taxes such as Goods and Services
Tax (GST) and Customs.

3. Taxable Event: An event which warrants a levy of tax is called as a taxable event. Taxable
events in India vary based on the type of tax. For Income Tax, the taxable event is the
earning of income, while for GST, it's the supply of goods or services.

4. Tax Base: The tax base is the amount or value on which the tax is calculated. The tax base
for Income Tax includes a taxpayer's total income, which encompasses various sources
such as salary, business income, capital gains, and more. For GST, the tax base is the value
of the goods or services supplied while for property tax, it may be the assessed value of
the property.

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5. Tax Rate: The tax rate is the percentage at which the tax is applied to the tax base.
Different types of taxes, such as income tax, sales tax, and property tax, may have different
tax rates. For example, the income tax rates may vary depending on the income slab, and
GST has multiple slabs, including standard rates and concessional rates for specific goods
and services.

6. Tax Deductions, Rebates and Credits: Indian tax laws provide for various deductions,
rebates, reliefs and exemptions under Income Tax to reduce the taxable income.
Additionally, GST allows for Input Tax Credits (ITC), where taxpayers can offset GST paid
on inputs against GST collected on outputs.

7. Enforcement and Penalties: Tax authorities have the power to enforce tax laws and
impose penalties, interest, fines for non-compliance or tax evasion. Penalties vary
depending on the nature of the violation.

8. Appeals and Dispute Resolution: Taxpayers have the right to appeal tax assessments
and disputes through administrative channels or the judicial system. Taxpayers in India
have the right to appeal against tax assessments and disputes through various forums,
including the Income Tax Appellate Tribunal (ITAT) and the Goods and Services Tax
Appellate Tribunal (GSTAT). This element is crucial for protecting taxpayers' rights and
ensuring fair treatment

Commerce Clause
 The term "Commerce Clause" specifically refers to a provision in the United States
Constitution.

 The Indian Constitution does not have an equivalent provision known as the Commerce
Clause.

 The term "Commerce Clause" refers to a specific provision in the United States Constitution
that grants Congress the authority to regulate interstate commerce. This clause is found
in Article I, Section 8, Clause 3 of the U.S. Constitution and is commonly known as the
Commerce Clause.

 The extract of the article is reproduced below for your reference

"The Congress shall have Power... To regulate Commerce with foreign Nations, and among the
several States, and with the Indian Tribes."

 However, India has constitutional provisions that delineate the distribution of powers
between the central government and state governments concerning trade and commerce

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Sample Questions

1. Briefly explain the two types of taxes.

2. Explain the concept of levy of taxes.

3. Illustrate the differences between taxes and fees

4. What do you mean by immunity of State Agencies/Instrumentalities

5. Explain the concept of tax planning

6. Explain the concept of tax evasion

7. Explain the concept of tax avoidance

8. What is the interplay between fundamental rights and taxing powers?

9. How is a cess different from a tax?

10. Explain the concept of delegation of powers to the State

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