Financial Relations

Arts.264 to 293 govern financial relations. Taxes are classified by who levies, collects and appropriates them (Arts.268 to 271), the Finance Commission recommends devolution (Art.280), and Arts.275 and 282 provide grants. Surcharges under Art.271 are not shared.

Financial relations are dealt with in Part XII. The governing principle is stated in Art.265: no tax shall be levied or collected except by authority of law. Beyond that, the Constitution separates three questions which are often confused: who levies a tax, who collects it, and who appropriates its proceeds. The answers differ from tax to tax, and the classification in Arts.268 to 271 is built on exactly this distinction.

Legal Framework

Provision	Subject	Key Rule
Art.265	No tax without law	No tax may be levied or collected except by authority of law
Art.266	Funds	Consolidated Fund and public account of India and of each State
Art.267	Contingency Fund	Placed at the disposal of the President or Governor for unforeseen expenditure
Art.268	Levied by the Union, collected and appropriated by the States	Stamp duties mentioned in the Union List
Art.269	Levied and collected by the Union, assigned to the States	Taxes on the sale or consignment of goods in the course of inter-State trade or commerce
Art.269A	Goods and Services Tax on inter-State supplies	Levied and collected by the Government of India and apportioned between the Union and the States
Art.270	Levied and collected by the Union, distributed between the Union and the States	All taxes in the Union List except those in Arts.268, 269 and 269A, surcharges under Art.271, and cesses levied for specific purposes
Art.271	Surcharge for Union purposes	Proceeds form part of the Consolidated Fund of India and are not shared with the States; Goods and Services Tax is excluded
Art.275	Statutory grants	Grants in aid to States as Parliament may by law provide, charged on the Consolidated Fund of India
Art.279A	Goods and Services Tax Council	Recommendations on rates, exemptions and model laws, with weighted voting
Art.280	Finance Commission	Constituted by the President every fifth year or earlier, to recommend devolution and grants
Art.281	Laying of recommendations	The report, with an explanatory memorandum on action taken, is laid before each House
Art.282	Discretionary grants	The Union or a State may make grants for any public purpose, notwithstanding that the purpose is not one on which it may legislate
Art.285	Union property	Exempt from State taxation
Art.286	Restriction on State sales tax	No tax on a sale or purchase taking place outside the State, or in the course of import or export
Art.289	State property and income	Exempt from Union taxation, but the Union may tax a trade or business carried on by a State
Art.292 and Art.293	Borrowing	The Union may borrow on the security of the Consolidated Fund of India; a State may not borrow outside India, and requires the Union's consent while indebted to it
Art.360	Financial Emergency	Directions to States on financial propriety and reduction of salaries, including of Judges

The Four Classes of Tax

Class	Who levies	Who collects	Who appropriates	Example
Art.268	Union	State	State	Stamp duties in the Union List
Art.269	Union	Union	State, by assignment	Taxes on inter-State consignment of goods
Art.269A	Union	Union	Apportioned between Union and States	Goods and Services Tax on inter-State supplies
Art.270	Union	Union	Shared on the Finance Commission's recommendation	Income tax, central excise, customs
Art.271	Union	Union	Union alone	Surcharge on any tax or duty in Arts.269 or 270

Why Art.271 is the standard examination trap: A surcharge looks like a tax and is collected with it, but the whole of its proceeds go to the Union and no part is shared. The consequence is that the Union can raise revenue through a surcharge or a cess rather than through the base rate, and thereby keep the entire yield outside the divisible pool. This is one of the most persistent State grievances in financial relations, and the 101st Amendment addressed it only to the extent of excluding the Goods and Services Tax from Art.271.

The Finance Commission

Feature	Position
Constitution	By the President, at the expiration of every fifth year or earlier if he considers it necessary (Art.280(1))
Composition	A Chairman and four other members, with qualifications determined by Parliament by law
Terms of reference	The distribution of the net proceeds of shareable taxes and their allocation among the States; the principles governing grants in aid out of the Consolidated Fund of India; measures needed to augment the Consolidated Fund of a State to supplement the resources of Panchayats and Municipalities; and any other matter referred by the President
Status of recommendations	Recommendatory and not binding, though by convention accepted
Laying	Report and explanatory memorandum laid before each House (Art.281)

Note on Panchayats and Municipalities: Clauses (bb) and (c) of Art.280(3) were inserted by the 73rd and 74th Amendments, 1992, requiring the Finance Commission to recommend measures for augmenting a State's Consolidated Fund so as to supplement local body resources. This links national devolution to the third tier.

Grants

Provision	Nature	Character
Art.275	Statutory grants in aid to States in need of assistance, and specific grants for the welfare of Scheduled Tribes and the administration of Scheduled Areas	Charged on the Consolidated Fund of India, so beyond the annual vote
Art.282	Discretionary grants by the Union or a State for any public purpose	Voted, and not confined to the grantor's legislative field

The constitutional debate about Art.282: Read literally, the article allows the Union to fund activity on subjects wholly within the State List, since it applies "notwithstanding that the purpose is not one with respect to which Parliament or the Legislature of the State, as the case may be, may make laws". Centrally sponsored schemes rest on it. Critics, including the Sarkaria and Punchhi Commissions, have argued that the article was intended for occasional and specific grants and that its use as a routine instrument of policy lets the Union set the agenda in the States' own field, bypassing the Seventh Schedule. Defenders answer that the text is unqualified and that national minimum standards require some such power.

**In Re: Sea Customs Act, Section 20(2) (1963)** Supreme Court of India

Facts: A reference under Art.143 raised the question whether the immunity of State property from Union taxation under Art.289, and correspondingly of Union property from State taxation under Art.285, extended to indirect taxes such as customs duty and excise duty on goods imported or manufactured by a Government.

Issue: What is the scope of the mutual tax immunities in Arts.285 and 289?

Held: The immunity is confined to taxes on property and on income as such. It does not extend to indirect taxes such as customs and excise, which are levied on the taxable event of import or of manufacture rather than on ownership of property. Accordingly a State importing goods is liable to customs duty, and Union property is not immune from an indirect levy merely because it belongs to the Union.

Relevance: The leading authority on the reach of Arts.285 and 289. The distinction to remember is between a tax on property and a tax on a transaction or event connected with property.

**Union of India v H S Dhillon (1972)** Supreme Court of India

Facts: Parliament amended the Wealth Tax Act to include the capital value of agricultural land in the net wealth of an assessee. Agricultural land and taxes on it are State subjects, and it was contended that Parliament had no competence.

Issue: Whether Parliament may tax the capital value of agricultural land in the absence of any entry authorising it in the Union List.

Held: The levy was upheld. The correct method is to ask whether the subject falls within the State List; if it does not, Parliament is competent by virtue of Art.248 read with Entry 97 of the Union List, whether or not any specific Union entry covers it. Taxes on the capital value of assets, as distinct from taxes on lands and buildings in Entry 49 of the State List, were not in the State List, so the residuary power sufficed.

Relevance: The leading case on the residuary taxing power and on the method of testing legislative competence. Note the sequence: examine the State List first, and only then resort to the residuary entry.

**Union of India v Mohit Minerals Pvt Ltd (2022)** Supreme Court of India

Facts: The levy of integrated Goods and Services Tax on ocean freight in the hands of an Indian importer on a reverse charge basis was challenged. In deciding it the Court had to consider the constitutional status of the recommendations of the Goods and Services Tax Council under Art.279A.

Issue: Whether the recommendations of the Goods and Services Tax Council are binding on the Union and the States.

Held: The recommendations are not binding. They have persuasive value only. Under Art.246A both the Union and the States have simultaneous legislative power over goods and services tax, and Art.279A creates a body for deliberation and collaboration rather than an authority whose decisions override that legislative power. The Court described the relationship as one of collaborative dialogue, adding that neither the Union nor the States can act as though the other did not exist, and reaffirmed the Indian fiscal structure as one of cooperative federalism.

Relevance: The most important recent decision on fiscal federalism. Cite it for the twin propositions that Art.246A confers simultaneous power and that the Council's recommendations are recommendatory.

Illustrations

Stamp duty: The Union enacts the law fixing a stamp duty mentioned in the Union List, but the State collects it and keeps the proceeds. This is Art.268, where the levy is central and both collection and appropriation are with the State.
Surcharge not shared: The Union imposes a surcharge on income tax. Under Art.271 the whole of the proceeds forms part of the Consolidated Fund of India, and no part enters the divisible pool.
Cess excluded from the pool: The Union levies a cess for a specified purpose. Art.270 excludes such cesses from distribution, so again the States receive no share.
Grant outside the legislative field: The Union funds a State level school nutrition scheme. Though education and public health are not exclusively Union subjects, Art.282 permits the grant, since it applies notwithstanding the absence of legislative competence.
State importing goods: A State Government imports machinery and claims immunity from customs duty under Art.289. Applying In Re: Sea Customs Act (1963), the immunity does not extend to indirect taxes and the duty is payable.
Union taxing a State's business: A State runs a commercial transport undertaking. Under Art.289(2) the Union may tax the trade or business, since the immunity in clause (1) is confined to property and income of the State as such.
Residuary taxing power: Parliament taxes an asset not covered by any entry, and not falling within the State List. Applying Union of India v H S Dhillon (1972), Entry 97 read with Art.248 supplies competence.
State borrowing abroad: A State proposes to raise a loan from a foreign lender. Art.293(1) confines State borrowing to within the territory of India, so the proposal is impermissible.
State borrowing while indebted: A State indebted to the Union seeks to raise a domestic loan. Under Art.293(3) it requires the Union's consent.
Recommendations of the Goods and Services Tax Council: The Council recommends a rate which a State declines to adopt. Applying Union of India v Mohit Minerals (2022), the recommendation is persuasive but not binding, both levels having simultaneous power under Art.246A.

Recall Check

Classify Arts.268, 269, 269A, 270 and 271 by who levies, collects and appropriates.
When is the Finance Commission constituted and what are its four terms of reference?
Distinguish Art.275 from Art.282 as to source, character and legislative competence.

Key Cases

In Re: Sea Customs Act, Section 20(2) (1963) In Re Sea Customs Act 1963
Issue: Whether the immunities in Arts.285 and 289 extend to indirect taxes.
Rule: The immunity is confined to taxes on property and on income as such and does not cover customs or excise.
Held: A State importing goods is liable to customs duty, the taxable event being import and not ownership.

Union of India v H S Dhillon (1972) Union of India v HS Dhillon 1972
Issue: Whether Parliament may tax the capital value of agricultural land.
Rule: Competence is tested by asking first whether the subject is in the State List; if not, Art.248 with Entry 97 supplies the power.
Held: The wealth tax levy was upheld under the residuary power.

Union of India v Mohit Minerals Pvt Ltd (2022) Union of India v Mohit Minerals 2022
Issue: Whether the recommendations of the Goods and Services Tax Council bind the Union and the States.
Rule: Art.246A confers simultaneous legislative power, and Art.279A creates a deliberative body whose recommendations have persuasive value only.
Held: The recommendations are not binding, and the fiscal structure is one of cooperative federalism.

Distinctions

Basis	Art.275 grants	Art.282 grants
Character	Statutory, provided by law of Parliament	Discretionary
Charge	Charged on the Consolidated Fund of India, so not voted	Voted as part of the annual expenditure
Who may grant	The Union	The Union or a State
Legislative competence	Grants in aid to States needing assistance, and specified purposes	Any public purpose, whether or not within the grantor's legislative field
Criticism	Little	Used for centrally sponsored schemes, said to bypass the Seventh Schedule

Basis	Art.270 shared taxes	Art.271 surcharge
Divisible pool	Included	Excluded
Beneficiary	Union and States	Union alone
Basis of distribution	Finance Commission's recommendation	Not distributed
Goods and Services Tax	Covered under Arts.269A and 270	Expressly excluded from Art.271

Basis	Art.285	Art.289
Property protected	Property of the Union	Property and income of a State
Immunity from	State taxation	Union taxation
Exception	Parliament may otherwise provide	The Union may tax a trade or business carried on by a State (Art.289(2))
Extent	Confined to taxes on property, not indirect taxes	Confined to taxes on property and income, not indirect taxes

Flashcards

What does Art.265 lay down?

That no tax shall be levied or collected except by authority of law.

Under Art.268, who collects and appropriates the tax?

The State, although the Union levies it.

What is the position under Art.269?

The Union levies and collects the tax, but the proceeds are assigned to the States.

How is inter-State Goods and Services Tax dealt with?

Under Art.269A it is levied and collected by the Government of India and apportioned between the Union and the States.

Which levies are excluded from the divisible pool under Art.270?

Taxes in Arts.268, 269 and 269A, surcharges under Art.271, and cesses levied for specific purposes.

Who gets the proceeds of a surcharge under Art.271?

The Union alone; they form part of the Consolidated Fund of India and are not shared.

How often is the Finance Commission constituted?

At the expiration of every fifth year, or earlier if the President considers it necessary (Art.280(1)).

Are the Finance Commission's recommendations binding?

No. They are recommendatory, though accepted by convention.

What did the 73rd and 74th Amendments add to Art.280(3)?

A requirement to recommend measures to augment a State's Consolidated Fund so as to supplement the resources of Panchayats and Municipalities.

What is the significance of Art.282?

It permits the Union or a State to make grants for any public purpose even outside its own legislative field, and is the basis of centrally sponsored schemes.

Does the immunity in Art.289 cover customs duty?

No. In Re: Sea Customs Act (1963) confined the immunity to taxes on property and income.

Where does the residuary taxing power lie?

With Parliament, under Art.248 read with Entry 97 of the Union List (Union of India v H S Dhillon, 1972).

May a State borrow outside India?

No. Art.293(1) confines State borrowing to within the territory of India.

Are the recommendations of the Goods and Services Tax Council binding?

No. Union of India v Mohit Minerals (2022) held they have persuasive value only.

Which article confers simultaneous power on the Union and the States over goods and services tax?

Art.246A, inserted by the 101st Amendment, 2016.

Exam Scenario

Problem: The Union increases the surcharge on income tax by five per cent and simultaneously levies a new cess for a national infrastructure fund, leaving the base rate of income tax unchanged. State A complains that its share of central taxes has fallen sharply, and points out that the Finance Commission had recommended a higher share. State A also imports laboratory equipment for a State run hospital and claims exemption from customs duty. It proposes to raise a loan from a foreign bank, and separately declines to give effect to a recommendation of the Goods and Services Tax Council on rates. Finally, the Union announces a large centrally sponsored scheme on primary education in State A, funded under Art.282, which State A says intrudes on its own field. Advise.

Step 1: Show why the surcharge and the cess bypass the divisible pool

The Union's position is legally sound though the grievance is real. Under Art.271 the whole of a surcharge forms part of the Consolidated Fund of India and is not shared, and under the exclusion in Art.270 a cess levied for a specific purpose likewise stays outside the divisible pool.

Levy	Governing provision	Effect on the divisible pool
Base rate of income tax	Art.270	Shareable, and it has been left unchanged
Surcharge of five per cent	Art.271	The whole of it forms part of the Consolidated Fund of India and is not shared
Cess for the infrastructure fund	Exclusion in Art.270	Outside the divisible pool, being levied for a specific purpose

By raising revenue through a surcharge and a cess rather than through the base rate, the Union lawfully increases its own receipts without enlarging the pool. State A has no legal remedy. Its recourse is political:

The Inter-State Council under Art.263.
Representations to the Finance Commission.

Step 2: Place the Finance Commission recommendation in its proper class

Under Art.280 the recommendations are recommendatory only, though by convention accepted. Art.281 requires no more than that the report and an explanatory memorandum on the action taken be laid before each House.

Departure is therefore not unconstitutional, but it must be explained to Parliament.

Step 3: Deny the customs immunity under Art.289

Apply Art.289(1) and In Re: Sea Customs Act (1963). The immunity is confined to taxes on property and income as such and does not extend to indirect taxes, where the taxable event is import.

The duty is payable notwithstanding that the equipment is for a State run hospital. Under Art.289(2) the Union may in any case tax a trade or business carried on by a State.

Step 4: Rule out the foreign loan under Art.293

Apply Art.293(1), which permits a State to borrow only within the territory of India upon the security of its Consolidated Fund. A loan from a foreign bank is impermissible whatever the terms.

Borrowing	Provision	Position
Loan from a foreign bank	Art.293(1)	Not permitted at all, and no consent can cure it
Domestic loan while the State is indebted to the Union	Art.293(3)	Permitted, but requires the Union's consent

Step 5: Treat the GST Council recommendation as persuasive only

Apply Union of India v Mohit Minerals (2022). Under Art.246A both levels have simultaneous legislative power, and the Council under Art.279A is a deliberative body whose recommendations carry persuasive value only.

State A is therefore not legally bound. The Court described the relationship as one of collaborative dialogue.

Step 6: Uphold the centrally sponsored scheme under Art.282

Apply Art.282. The article expressly permits grants for any public purpose "notwithstanding that the purpose is not one with respect to which Parliament or the Legislature of the State... may make laws".

The scheme is therefore constitutionally valid even though education sits in the Concurrent List and its administration is largely with the States.

Five traps in this problem

Art.289(1) is narrow. It covers taxes on property and income as such. Customs duty is an indirect tax whose taxable event is import, so the immunity never engages. Art.289(2) also lets the Union tax a trade or business carried on by a State.

No consent cures a foreign loan. Art.293(1) confines State borrowing to the territory of India. Do not confuse this with the distinct Art.293(3) rule, which requires the Union's consent for a domestic loan while the State is indebted to the Union.

A departure from the Finance Commission is not unconstitutional. The Art.280 recommendations are accepted by convention, not by law, and Art.281 asks only that the report and memorandum be laid before each House.

Not bound is not the same as free to diverge. State A may lawfully ignore the GST Council, but the practical consequences of divergence within a common tax are severe.

The Art.282 criticism is an argument for reform, not a ground of invalidity. The Sarkaria and Punchhi Commissions objected that routine use of Art.282 lets the Union set priorities in the States' own sphere and bypass the Seventh Schedule. That does not make the scheme void.

Conclusion. All the Union's measures are lawful. State A must pay the customs duty, cannot borrow abroad, is not bound by the Council's recommendation, and cannot resist the scheme in law, so its remedies lie in the cooperative machinery rather than in the courts.