Taxation in India: Direct Taxes, GST and Tax Reforms

Principles of taxation

A good tax system follows Adam Smith's canons:

• equity: people pay according to their ability;
• certainty;
• convenience;
• economy: low collection costs.

Modern additions are neutrality (minimal distortion of decisions), buoyancy and simplicity.

Taxes can be classified in three ways:

• Direct vs indirect. With a direct tax, the impact (who pays) and the incidence (who finally bears the burden) fall on the same person, as with income tax and corporation tax. An indirect tax can be shifted, as with GST and customs.
• Progressive, proportional or regressive. A progressive tax rate rises with income. A proportional (flat) tax charges the same rate for everyone. A regressive tax takes a larger share of income from the poor; consumption taxes are often regressive in effect.
• Ad valorem vs specific. Ad valorem taxes are a percentage of value; specific taxes are charged per unit.

Tax buoyancy is the percentage change in tax revenue divided by the percentage change in GDP. It includes the effect of discretionary changes such as new rates. Tax elasticity measures the same response *without* discretionary changes. A buoyancy above 1 means revenue grows faster than the economy.

Constitutional distribution of taxing powers

• Union List: income tax (other than agricultural income), corporation tax, customs, excise on tobacco and some petroleum products, and taxes on capital value.
• State List: tax on agricultural income, land revenue, stamp duty (rates), excise on alcohol for human consumption, taxes on vehicles, electricity duty, and VAT/sales tax on petroleum products and alcohol.
• Concurrent List: GST, introduced by the 101st Amendment through Article 246A.
• Articles 268–270 deal with the distribution of taxes between the Union and states. Under Article 270, all central taxes are shared with the states, except cesses and surcharges, which is why their growing share is debated.

Direct taxes

Personal income tax is levied under the Income-tax Act 1961. A new tax regime, with lower rates and fewer exemptions, was introduced in 2020 and made the default from 2023–24. Under the 2025 Budget, income up to ₹12 lakh a year attracts no tax under the new regime, thanks to the Section 87A rebate (₹12.75 lakh for salaried taxpayers, including the standard deduction). Parliament passed the Income-tax Act 2025 to replace the 1961 Act from 1 April 2026, with simpler language and structure. Treat its detailed provisions as per the official text.

Corporation tax was cut in September 2019:

• the base rate fell to 22% (effectively about 25.17% with surcharge and cess) for firms that give up exemptions;
• new manufacturing companies were offered 15% (about 17%);
• the aim was to attract investment and match competing Asian economies.

Other direct taxes:

• Securities Transaction Tax and capital gains tax: rates were revised in 2024.
• Minimum Alternate Tax (MAT).
• The wealth tax was abolished in 2015.
• Estate duty was abolished in 1985.

Tax administration reforms:

• Faceless assessment and appeals (2020).
• The Taxpayers' Charter (2020).
• Pre-filled returns and the Annual Information Statement.
• Vivad se Vishwas schemes (2020, 2024) for settling disputes.
• Retrospective taxation ended: the 2012 amendment, which led to the Vodafone and Cairn disputes, was withdrawn by the Taxation Laws (Amendment) Act 2021.

International tax:

• India supports the OECD/G20 two-pillar solution. Pillar One reallocates taxing rights to market countries; Pillar Two sets a 15% global minimum tax.
• India abolished the 2% equalisation levy on e-commerce in 2024 and the 6% levy on online advertising from April 2025.
• Double taxation avoidance agreements (DTAAs): the Mauritius treaty was amended in 2016.

Goods and Services Tax (GST)

Background: before GST, India had a fragmented indirect tax system with central excise, service tax, state VAT, entry tax, octroi and others. This caused a cascading "tax on tax" and blocked a common national market. The Kelkar Task Force (2004) proposed GST. The 101st Constitutional Amendment (2016) enabled it, and GST was launched on 1 July 2017 ("one nation, one tax").

Key features:

• A destination-based consumption tax: revenue accrues to the state where goods or services are consumed.
• Dual GST: CGST (Centre) and SGST/UTGST (states) on intra-state supplies; IGST on inter-state supplies and imports, collected by the Centre and apportioned.
• Input tax credit (ITC) removes cascading.
• Exclusions: alcohol for human consumption is outside GST. Petroleum products (crude, petrol, diesel, ATF, natural gas) are within the GST framework, but the tax is not yet levied; the GST Council can decide a date.
• GST Council (Article 279A): the Union Finance Minister chairs it, and all state finance ministers are members. Decisions need three-fourths of the weighted votes. The Centre has one-third of the votes and the states two-thirds, so neither can push a decision through alone. In *Mohit Minerals* (2022), the Supreme Court held that the Council's recommendations are persuasive, not binding.
• Compensation to states: for five years (until June 2022), states were assured 14% annual revenue growth, funded by a compensation cess. The cess was extended until March 2026 to repay loans taken during the pandemic.
• Technology: the GST Network (GSTN), e-way bills, e-invoicing.
• GST Appellate Tribunal (GSTAT): notified in 2023 and operationalised in stages.

GST rate rationalisation (2025): the GST Council approved a major simplification, effective from 22 September 2025. It moved most goods to two main slabs, 5% and 18%, with a 40% rate on certain luxury and "sin" goods, replacing the earlier 5/12/18/28% structure. The compensation cess on many items was folded in. Treat item-level rates as subject to Council notifications.

Impact and issues:

• Gains: a common market, the removal of check-posts (faster logistics), formalisation through ITC, and buoyant collections (gross GST revenue crossed ₹20 lakh crore in 2024–25).
• Problems:
• compliance burden on small firms;
• ITC fraud through fake invoices;
• inverted duty structures, where inputs are taxed more than outputs;
• states' loss of fiscal autonomy and their dependence on compensation;
• disputes over classification;
• petroleum and electricity remaining outside the tax.

Tax-to-GDP ratio

India's combined (Centre plus states) tax-to-GDP ratio is around 17–18%. This is lower than in OECD countries (over 30%) but comparable with many emerging economies. Direct taxes now make up over half of the Centre's gross tax revenue, a sign of progressivity. Ways to raise the ratio:

• widen the base (only a small share of individuals pay income tax);
• tax property, which is under-used by local bodies;
• reduce exemptions;
• improve compliance through data analytics;
• bring more sectors into GST.

Common prelims traps

• Agricultural income is taxable only by states, and few states tax it.
• Cesses and surcharges are not shared with states.
• Stamp duty is levied by states, though the Centre fixes rates on some instruments.
• The GST Council is a constitutional body under Article 279A.
• IGST is collected by the Centre.
• Customs duty is not subsumed in GST, except for the IGST portion on imports.

Practice: Mains question

*"GST has advanced cooperative fiscal federalism but has also constrained the fiscal autonomy of states." Analyse, with reference to the GST Council and recent reforms. (250 words)*