Taxation system in India Notes for UPSC

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Taxation system in India

Taxation system India upsc

Off course You won’t like to fail prelims


  1. A.266 – CFI
  2. A.266 (2) – Public account of India
  3. A.267 – Contingency Fund of India

Articles related to budget

  1. A.112 – Annual financial statment
  2. A.265 – Finance bill
  3. A.114 – Appropriation bill (Permission to spend money from CFI)

Type of taxes

  1. Progressive
  2. Proportional
  3. Regressive
  4. Degressive (Progressive + Proportional)

Laffer curve

  1. Till some point tax rate and revenue collection has positive relation later it is negative relation (okuns curve)

Tax Buoyancy

  1. If GDP grew by x% then by how much % income tax collection will grow ?

Tax Elasticity

  1. changes in tax revenue in response to changes in tax rate.

Tax to GDP ratio

  1. Tax/GDP
  2. India’s gross tax-to-gdp ratio fell to 10.9 per cent in 2018-19 on account of lower than estimated GST collection.

Ease of doing business


  1. Starting a business +
  2. Construction permit + (Highest )
  3. Getting electricity +
  4. Registering property –
  5. Getting credit +
  6. Paying taxes –
  7. Trading across border +
  8. Enforcing contracts –
  9. Resolving insolvency –

How to promote EODB?

Labor reforms

Mains & Interview

Current Corporate Tax rate – 22%

Equalisation levy / Google tax

  1. 6% tax on the profit earned by the digital advertisement

Minimum Alternate Tax

  1. Companies uses accounting tricks to show profit 0 (Done using transfer pricing)
  2. Thus MAT was introduced on such companies (18%)

Dividend distribution tax

  1. Levied on dividend (Now abolished)

Capital Gain tax

  1. Short term & long term
  2. If profit earn by selling house is invested in other house then CGT wavier (One time)
  3. For start up owner CGT profit is exempted from the CGT

Income tax

  1. To compensate British losses in 1857 revolt IT introduced in the 24 July 1860 by James Wilson
  2. 24 July Income tax day


  1. 10% surcharge is applicable on income tax if income exceeds  50 lacs but upto  1 crore
  2. 15% surcharge is applicable on income tax if income exceeds  1 crore
  3. 4% Health & Education Cess is applicable on the income tax and applicable surcharge.


  1. Tax saving tools
  2. Asset of family is polled together
  3. HUF has pan and can pay salary to its member it is used as a deduction

Reasons for low tax in India

  1. Lack of civic sense
  2. Informal sector
  3. Concentration in hand of few who are greedy to engage in tax evasion
  4. Loopholes in tax law
  5. Co operative banks
  6. Populist measure annoys tax payers.

How to increase Tax compliance ?

  1. Boards like “tax money at work”
  2. Highlighting the tax paid by other taxpayers
  3. create exclusive membership of “clubs” that exude not only social status but also honour.
  4. In Hinduism, non-payment of debts is a sin and also a crime.
  5. Islam – A person cannot enter Paradise until his debt was paid off
  6. Given the importance of religion in the Indian culture,the principles of behavioural economics need to be combined with this “spiritual/religious norm” to reduce tax evasion and wilful default in the country.
  7. Every program must go through a “behavioural economics” audit before its implementation.
  8. Project insight – Use big data

Who wont gain in new tax slab?

  1. More than 1.38 lakh deduction for 8 lakh to 2.5 lakh deduction for 15 lakh including standard deduction of 50000 rs

Presumptive taxation

  1. Self employeed people
  2. Profit is computed as percentage of gross receipts and then profit is taxed

How tax is paid ?

  1. If annual tax liability is more than 10k then on quarterly basis in advance installements
  2. TDS ensures income of the employee is reported to the IT department along with the PAN. It will force employees to file IT return to unlock his TDS
  3. TCS is collected by goods seller to ensure that buyer has to file tax return to unlock this amount
  4. If extra tax is paid refund will be given by tax department

Tobin tax/ Robin hood tax

  1. Small tax on foreign exchange to avoid speculaiton
  2. Similar is security transaction tax – Levied on sales and purchase of shares and other securities
  3. Commodity transaction tax – On commodities other than the agri commodities

Six stages

  1. Presentation
  2. General discussion (Now a days vote on account is not necessary)
  3. Scrutiny by departmental committee
  4. Voting on demands of grants
  5. Passing of appropriation bill
  6. Passing of finance bill

Budget Affects

  1. Full employment
  2. Inflation
  3. Economic growth
  4. Inclusive growth
  5. Regionally balanced growth
  6. Exchange rate stability

Merit of direct taxes

  1. Progressive
  2. Civic consciousness
  3. Encourage savings and investments

Demerits of direct taxes

  1. Narrow base
  2. Increases litigation

Indirect taxes merit

  1. Convenient to collect
  2. Larger vase
  3. Can reduce harmful consumption
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Indirect taxes Demerit

  1. Regressive
  2. Less civic consciousness
  3. It is more trade disrupt than the direct taxes

Timeline of indirect tax reforms

  1. MODVAT – Input credit on excise duty already paid on the material
  2. CENVAT – Input tax credit on excise duty and service tax already paid
  3. Problem with VAT was that cascading still continued on the taxes outside VAT.
  4. GST – 101 st CA act 2014

GST act

  1. Only union has power to tax inter state supply of goods
  2. IGST will be distributed among States and centre according to the GST councils
  3. CGST will be distributed between state and government according to the FC recommendation
  4. A.279(A) -> GST council headed by FM

What is relevance of input tax credit ?

  1. It eliminates cascading effects
  2. Self policing


  1. Composite tax creditor
  2. Has to file monthly summary
  3. Delay in return of credit

Is GST anti federal?

  1. No
  2. GST council acts as a federal body
  3. 2/3rd voting power is with states
  4. 3/4 th votes are required for the approval of taxes

Centres taxes in CGST

  1. Central sales tax replaced with IGST
  2. Service tax
  3. Excise duty
  4. Note : Import is subject to custom duty + IGST

State taxes in SGST

  1. VAT
  2. Purchase tax
  3. Advertisement tax
  4. Luxury tax
  5. Entry tax
  6. Taxes on lottery

GST Composition scheme

  1. Monthly compliance is very tedious for the small entrepreneurs so composition schemem
  2. Flat GST rate of 1% on good, 5% on restaurants and 6% on all services


  1. Unavailability of tax credit
  2. Difficult for them to enter into value chain

Reverse charge mechanism

  1. When seller is not registered with GST and buyer is registered with GST then buyer will have to deposit tax to the government

E way bill mechanism

  1. Its generated when goods >50k are moved within state or outside state
  2. Its generated from GSTN porta/app/sms
  3. It is self declaration that truck is carrying x type of good with y value
  4. Reduces tax avoidance
  5. Reduces waiting time at check posts
  6. Problems
    1. Poor internet facility
    2. Glitches in generating e way bill

Compensation to states

  1. As GST is destination based tax, industrialised state fear that it may reduce their revenue income
  2. Thus to compensate states GST compensation cess was introduced on the luxury goods
  3. Cess collected will be used for revenue losses of states for first 5 years

GST revenue collection figure

  1. Average monthly collection 97k crore in 2019
  2. In December it crossed 1 lakh crore mark (July to december below 1 lakh crore)

Reasons for fall in revenue

  1. Low growth

National Anti profiteering authority

  1. Despite of reduction in GST and introduction of input credit companies have not reduced prices
  2. To curb profiteering NAA under CGST act 2017
  3. In 2019 its period extended for 2 years

Authority for advanced ruling

  1. Statutory body
  2. For advance clarification

GST benefits

  1. Unified market
  2. Increases Ease of doing business
  3. Reduces cascading effect
  4. Due to input credit mechanism ancillarisation and outsourcing will take place
  5. Zero rated export regime will boost production

GST challenges

  1. Petrol diesel are outside GST
  2. Composite GST scheme
  3. State revenue shortfall issues
  4. Inconvenience to small traders (Can opt for GST composition and even in previous era the same regime was there)
  5. GSTN server crashes often, for crossing monthly deadlines

Measure to simplify GST

  1. The first target should be to move to at least a three-rate structure—a lower rate for essential goods, a relatively high rate for luxury goods, and a standard rate for the majority of goods and services. In this context, the outgoing chief economic adviser, Arvind Subramanian, has rightly noted that the 28% rate should go
  2. Apart from rates, some of the operational issues, such as those related to ease of filing and refund, need to be resolved.
  3. Delays in refund affect the working capital of firms and should be avoided, particularly in the case of exporters, in an environment of widening trade deficit.
  4. Further, the council will need to work on bringing items such as electricity, petroleum products and real estate into the GST net.

The Finance Commission

What is fiscal federalism?

Division of responsibilities of taxation & expenditure in different layers of the government

Need of finance commission

Compared to centre states have limited resources for revenue collections thus to distribute Union revenue resources with state finance commission is necessary

Grants to the states

  1. Grants to PRI and ULB
  2. Disaster management grants


Vertical devolution – From centre to state

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Horizontal devolution

YV Reddy formula (14th FC)

Income distance is the distance of the state’s income from the state with the highest income.

15 th FC TOR

  1. How to augment state governments CF to help their PRI
  2. Use census 2011
  3. Recommend measures for fiscal consolidation and fiscal discipline
  4. Keep in mind New India vision 2020 (doubling farmers income, 175 GW renewable energy, housing for all)
  5. Performance based incentives
  6. States efforts in achieving replacement levels of population growth
  7. States efforts in controlling expenditure on populist measures

FC and permanent status

  1. Previous finance commission should continue to function and oversee the implementation of its recommendation until new FC is formed
  2. Emergencies can occur in between like war, slowdown, etc in that case FC can revisit the devolution
  3. Earlier we had 5 year plans in that case five year formula tax devolution could have worked. But now planning commission is gone

Special category status – Aid curse so do not support it

Why change in term of 15th FC ?

  1. Scrapping of article 370. J&K was created as UT
  2. Slowdown

15th FC recommendation (Interim report)

  1. The share of states in the centre’s taxes is recommended to be decreased from 42% during the 2015-20 period to 41% for 2020-21.  The 1% decrease is to provide for the newly formed union territories of Jammu and Kashmir, and Ladakh from the resources of the central government.
  2. In 2020-21, the following grants will be provided to states: (i) revenue deficit grants, (ii) grants to local bodies, and (iii) disaster management grants (Lower allocation)
  1. Recommendations on fiscal roadmap
    • Fiscal deficit and debt levels:   It recommended that both central and state governments should focus on debt consolidation and comply with the fiscal deficit and debt levels as per their respective Fiscal Responsibility and Budget Management (FRBM) Acts.
    • Off-budget borrowings:   It recommended that both the central and state governments should make full disclosure of extra-budgetary borrowings.   The outstanding extra-budgetary liabilities should be clearly identified and eliminated in a time-bound manner.
    • Statutory framework for public financial management:  It observed that an overarching legal fiscal framework is required which will provide for budgeting, accounting, and audit standards to be followed at all levels of government.
    • Tax capacity:.    The Commission recommended: (i) broadening the tax base, (ii) streamlining tax rates, (iii) and increasing capacity and expertise of tax administration in all tiers of the government.
    • GST implementation: The Commission highlighted some challenges with the implementation of the Goods and Services Tax (GST).  These include: (i) large shortfall in collections as compared to original forecast, (ii) high volatility in collections, (iii) accumulation of large integrated GST credit, (iv) glitches in invoice and input tax matching, and (v) delay in refunds.  The Commission observed that the continuing dependence of states on compensation from the central government (21 states out of 29 states in 2018-19) for making up for the shortfall in revenue is a concern.  It suggested that the structural implications of GST for low consumption states need to be considered.
  2. Other recommendations
    • Financing of security-related expenditure: The ToR of the Commission required it to examine whether a separate funding mechanism for defence and internal security should be set up and if so, how it can be operationalised.  In this regard, the Commission intends to constitute an expert group comprising representatives of the Ministries of Defence, Home Affairs, and Finance.  The Commission noted that the Ministry of Defence proposed following measures for this purpose: (i) setting up of a non-lapsable fund, (ii) levy of a cess, (iii) monetisation of surplus land and other assets, (iv) tax-free defence bonds, and (v) utilising proceeds of disinvestment of defence public sector undertakings.  The expert group is expected to examine these proposals or alternative funding mechanisms.

Black Money and Allied issues

Tax Planning – Invest money in LIC/PPF to save taxes

Black money – It is income which is not reported to the any government authority

Parallel Economy – Economy that runs on black money

Tax Evasion – When person hides income or transactions from authorities

Tax Avoidance – Disclose full income but use loopholes to avoid paying taxes

Tax Heavens – Country that demands little taxes rom foreigners and offers legal loopholes for tax avoidance

Money laundering – Hide the origin of illegal obtained money and try to show it as a legal

Hawala – Illegal money transfer (Low transaction cost + no tax)

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Tax terrorism – When tax authorities out undue pressure on honest tax payers to pay more taxes (Vodaphone-Hutch deal tax case – They won in the supreme court)

Organisations involved in the black money

  1. ED – Enforces FEMA and PMLA
  2. Directorate of revenue intelligence
  3. Financial intelligence unit
  4. FATF – Brainchild of G7 for prevention of money laundering and terror financing, HQ@ Paris


  1. PMLA
  2. Undisclosed foreign income and Assets act
  3. Benami transactions prohibition act

Tax Evasion disclosure scheme

  1. Tax evader can declare undisclosed income, pay taxes and penalty (No case by income tax department but illegal income will be questioned)
  2. INCOME Declaration scheme – 45% taken away
  3. Pradhan Mantri Garib kalyan Yojana – 50% income taken away + 255 as FD with 0 interest rate with RBI
  4. Sabka Vikas Legal dispute regulation – Businessman accept his fault and tax officials give him wavier in penalty (Indirect tax dispute)
  5. Vivad se vishawas – Same as Sabka Vikas (For direct taxes)

Tax evasion other measures

  1. Problem with banking transaction tax – Shift to barter system (Hawala would be promoted)
  2. Operation clean money – IT officials verified large deposits after demonetisation
  3. Project insights – Data mining to track tax evaders
  4. Restriction on cash transaction – For single event can not accept cash> 2 lakh
  5. Angle tax – Income tax payable on capital raised by unlisted companies via issue of shares where the share price is seen in excess of the fair market
  6. DTAA
    1. Signed between two or more countries
    2. To avoid double taxation – Person/company will be taxed only once
    3. However misused for round tripping – Money leaves country through carious channel and makes way back into country as foreign investments
    4. 2016 – India amended the treaties, Now even Mauritius and Singapore are subjected to Indian taxes (CGT – 3% in Singapore and 10% in India)
  7. POEM

Overseas companies are used for the round tripping

  1. POEM charges such companies according to the Indian taxation system
  2. Base Erosion and profit shifting
    1. MNC shifts profit from its source company to tax heaven to avoid paying tax known as BEPS
  3. Transfer pricing
    1. Two subsidiary companies that are part of the same multinational group trade with each other
    2. Hutch Vodafone case was related with transfer pricing
    3. Advanced pricing agreements ensures that transfer pricing is agreeable to both of us
  4. General Anti avoidance rule
    1. Empowers tax officials to send notice to both Indians and foreigner in suspect of tax avoidance
  5. Global treaties
    1. Tax information exchange agreements with multiple countries
    2. TIEA with Marshal island (This country is first to start sovereign cryptocurrency)
    3. India Switzerland bank information sharing agreement
    4. USA – FATCA

Reforms to reduce tax terrorism

  1. Tax charter which showcase rights and duties of tax payers
  2. Faceless assessment in e mode
  3. Simple direct tax code should replace the IT act (Easwar panel on direct taxes 2015 – Not submitted report yet) [Direct Tax-GDP ratio rose to 6%]


Financial Secrecy Index by the Tax Justice Network, a U.K.-based financial advocacy group. On the surface, India has managed to reduce its contribution to global financial secrecy, with its rank falling from 32 on the 2018 index to 47 in 2020. [Fall is good]

Why demonetisation failed?

  1. 99.30 bank notes returned
  2. Use of Jandhan bank account accounts
  3. Salaries paid in advance
  4. Kiran bough in advance
  5. Co operatives banks don’t use core banking system thus back dates FD created using black money
  6. Shown as agriculture income
  7. Donation to trusts, NGO and temples

Its not failure

  1. Poor people benefitted by commission thus redistribution of wealth
  2. Operation clean money and operation insight -> Notice to suspicious account
  3. Tax returns increased after demonetisation

If democracy is contract then taxation is glue which binds citizens and government into this contract. (Survey 2015 observed)