Taxation in India — Direct, Indirect, GST

Taxation sits at the intersection of constitutional law, fiscal federalism and economic policy, which is precisely why it recurs across judiciary and CLAT-PG papers. A tax is a compulsory exaction of money by a public authority for public purposes, enforceable by law and not in return for any specific service rendered. India's system rests on a bedrock guarantee — Article 265: no tax shall be levied or collected except by authority of law — and divides the field into direct taxes (borne by the person on whom they are imposed, such as income tax) and indirect taxes (collected from one person but their burden shifted to another, such as GST). This chapter maps the constitutional distribution of taxing power, the doctrinal architecture of both limbs, the seismic shift effected by the Goods and Services Tax, and the case law every aspirant must command.

The Constitutional Foundation: Article 265 and the Rule of Law in Taxation

Every discussion of Indian taxation begins with Article 265, which mandates that "no tax shall be levied or collected except by the authority of law." The provision performs two functions: it requires a valid statute (not a mere executive order or circular) as the source of any levy, and it requires that both the levy and the collection conform to that statute. The word "law" here means a validly enacted law of a competent legislature; an administrative instruction can neither create a charge nor enlarge one. This is the citizen's primary shield against arbitrary exaction.

The Supreme Court has insisted that a taxing statute be construed strictly and that the four constituent components of any valid levy be clearly discernible. In Govind Saran Ganga Saran v. Commissioner of Sales Tax (1985), the Court identified these components: the character of the imposition (the taxable event), the person liable to pay, the rate of tax, and the measure or value to which the rate is applied. Justice R.S. Pathak held that "any uncertainty or vagueness in the legislative scheme defining any of these components of the levy will be fatal to its validity." This four-component test is a favourite of examiners because it converts an abstract idea into a checklist.

Article 265 must be read with Article 245 (extent of legislative power) and Article 246 (distribution of legislative subjects via the Seventh Schedule). Taxation is also subject to the fundamental rights chapter — a confiscatory or manifestly arbitrary tax can be struck down under Article 14, and historically a tax on property had to respect the now-repealed right under Article 19(1)(f). For the broader fiscal architecture in which these powers operate, see our chapter on public finance and the Budget.

Distribution of Taxing Power: The Seventh Schedule and Fiscal Federalism

India is a federal polity with a unitary bias, and nowhere is this clearer than in the allocation of taxing entries. Before the GST amendment, the Seventh Schedule kept Union and State taxing powers in watertight compartments. The Union List (List I) housed taxes on income other than agricultural income (Entry 82), customs duties (Entry 83), excise duties on manufactured goods other than alcoholic liquor (Entry 84), and corporation tax. The State List (List II) contained taxes on agricultural income (Entry 46), taxes on the sale or purchase of goods (the old Entry 54), taxes on land and buildings (Entry 49), and State excise on alcohol (Entry 51).

A cardinal principle is that the power to tax is not an incidental or ancillary power; it must be conferred by a specific entry. A general legislative entry does not carry with it the power to impose a tax. This separation produced the distinctive rule that there is no concurrent taxing entry — the Concurrent List (List III) contained no tax entries in the original scheme, so the Union and States did not ordinarily compete on the same tax base. The residuary power to tax (Entry 97 of List I, read with Article 248) vests in Parliament, which is how the Union levied gift tax, wealth tax and the service tax of 1994 before specific provision was made.

The Supreme Court has developed the doctrine of "pith and substance" and the concept of "aspect theory" to resolve overlaps. Under aspect theory, the same transaction may be taxed by two authorities if it presents two distinct aspects falling within two distinct entries — for example, a works contract has both a goods aspect (taxable by the State as sale) and a service aspect (taxable by the Union). This federal balance is the constitutional backdrop against which the GST experiment must be understood, and it connects directly to the centre-state planning architecture that has shaped resource transfers.

Tax, Fee, Cess and Surcharge: Drawing the Lines

Aspirants must distinguish a tax from cognate exactions, because legislative competence and procedural requirements differ. A tax is a compulsory exaction for the general revenues of the State, with no quid pro quo — the taxpayer cannot demand a corresponding service. A fee, by contrast, is levied for a specific service rendered and traditionally required a broad correlation between the amount collected and the cost of the service, though the Supreme Court has progressively diluted the strict quid pro quo requirement, holding that only a reasonable, not exact, correlation is needed.

The economic character of a levy was authoritatively examined in All India Federation of Tax Practitioners v. Union of India (2007), where the Supreme Court, upholding Parliament's competence to levy service tax under the residuary entry, explained that excise duty, service tax and value-added tax are all economically "value added taxes" and "destination-based consumption taxes" on the value addition at each stage. This judgment is doctrinally important because it located service tax conceptually within the same economic family that GST would later consolidate.

A cess is a tax levied for a specific, earmarked purpose (such as an education or health cess), while a surcharge is a tax on a tax, the proceeds of which form part of the Consolidated Fund of India and are not necessarily shared with the States under the Finance Commission's devolution formula — a point of recurring centre-state friction. The proceeds of cesses and surcharges escaping the divisible pool is a frequent subject in public finance questions.

Direct Taxes: Income Tax and the Charge under the 1961 Act

The principal direct tax is the income tax, governed for over six decades by the Income-tax Act, 1961. A direct tax is one whose burden cannot be shifted: the person legally liable to pay it also bears its economic incidence. The charging provision is Section 4, which levies tax on the "total income" of the "previous year" of every "person" at the rates prescribed by the annual Finance Act. The scheme classifies income under five heads — salaries, income from house property, profits and gains of business or profession, capital gains, and income from other sources — and aggregates them, subject to deductions, to arrive at taxable total income.

The constitutional anchor is Entry 82 of the Union List (taxes on income other than agricultural income), reinforced by Article 270 which makes income tax a divisible Union tax shared with the States on the recommendation of the Finance Commission. The carve-out for agricultural income — defined in Section 2(1A) and constitutionally reserved to the States under Entry 46 of List II — has generated extensive litigation over what qualifies as "agricultural," with the Supreme Court in CIT v. Raja Benoy Kumar Sahas Roy (1957) laying down that agriculture requires both basic operations (tillage, sowing) and subsequent operations on the land.

A landmark development for examiners: the Income-tax Act, 1961 is being replaced by the Income-tax Act, 2025, which takes effect from 1 April 2026 and applies from Tax Year 2026-27 onwards. The new Act reorganises the law into a streamlined set of chapters with simplified drafting and clearer definitions, while core principles and slab structures remain substantially unchanged; importantly, the repeal does not disturb assessments and proceedings relating to years before 1 April 2026. Aspirants should know both the continuity of substance and the change of statute. Direct tax revenues fund the borrowing and deficit calculations discussed in our budget and deficit chapter.

Tax Planning, Avoidance and Evasion: The McDowell–Azadi Bachao–Vodafone Trilogy

No topic in direct taxation is more heavily examined than the line between legitimate tax planning and impermissible avoidance. The foundational pronouncement came in McDowell & Co. Ltd. v. Commercial Tax Officer (1985), where Justice Chinnappa Reddy, in a celebrated concurring opinion, declared that "colourable devices cannot be part of tax planning and it is wrong to encourage the belief that it is honourable to avoid the payment of tax by resorting to dubious methods." The judgment signalled a shift from the formalist "every man is entitled to arrange his affairs" approach of the Westminster school towards a substance-over-form inquiry that looks at the reality of a transaction.

The pendulum swung back in Union of India v. Azadi Bachao Andolan (2003), where the Supreme Court upheld CBDT Circular No. 789 recognising a Mauritius Tax Residency Certificate as sufficient proof of residence under the India-Mauritius DTAA. The Court held that "treaty shopping" was not per se illegitimate where the treaty itself permitted it, and read down the broad McDowell dictum, observing that the phrase "liable to tax" is not the same as "pays tax." Azadi Bachao thus reinstated a measure of respect for the legal form of cross-border structures.

The trilogy culminated in Vodafone International Holdings BV v. Union of India (2012), where the Court held that India lacked jurisdiction to tax the offshore transfer of shares of a Cayman Islands company between two non-residents, even though the underlying asset was an Indian telecom business. Section 9(1)(i) of the 1961 Act, the Court reasoned, taxed only the transfer of a capital asset "situate in India," not the indirect transfer of an Indian asset through an offshore share sale. Parliament responded with a retrospective amendment via the Finance Act, 2012 — later substantially withdrawn after international arbitration pressure — and the episode remains the textbook illustration of the legislature overriding judicial interpretation in tax law. The General Anti-Avoidance Rules (GAAR) now codify a statutory substance-over-form regime.

Indirect Taxes Before GST: Excise, Customs, Service Tax and VAT

Indirect taxes are those where the legal incidence and the economic burden fall on different persons: the manufacturer or seller pays the tax to the government but passes it on to the consumer in the price. Before 1 July 2017, India's indirect tax landscape was a fragmented patchwork. Central excise duty, levied under Entry 84 of List I on the manufacture of goods, was the principal central indirect tax; the taxable event was "manufacture," a concept the Supreme Court repeatedly refined to mean the bringing into existence of a new and distinct article with a different name, character and use.

Customs duty, under Entry 83, is levied on the import and export of goods and remains outside GST; it continues under the Customs Act, 1962, with the import IGST now riding on top of basic customs duty. Service tax, introduced by the Finance Act, 1994 under the residuary power, grew from three services to a comprehensive levy on all services save a negative list, and its constitutional validity was settled in All India Federation of Tax Practitioners (2007).

At the State level, sales tax evolved into Value Added Tax (VAT) from 2005, designed to tax value addition at each stage with input tax credit and thereby remove the cascading "tax on tax" of the old single-point and multi-point sales tax regimes. The principle of single-point taxation was articulated in Govind Saran Ganga Saran, and the input-credit logic of VAT became the conceptual template for GST. The cascading problem these taxes created — and which GST was designed to cure — links to the consumption and price-level themes in basic economic concepts.

Inter-State Trade, Entry Tax and the Jindal Stainless Verdict

Part XIII of the Constitution (Articles 301 to 307) guarantees the freedom of trade, commerce and intercourse throughout the territory of India, and it interacts intimately with the States' power to tax goods moving across their borders. Article 301 declares trade "free," while Article 304(a) permits a State to tax imported goods provided it does not discriminate against them vis-à-vis locally produced goods, and Article 304(b) permits reasonable restrictions in the public interest with Presidential sanction.

For decades the validity of State entry taxes turned on the judicially evolved "compensatory tax" doctrine — the idea that a tax which merely recompensed the State for trading facilities provided was not a barrier to free trade and so escaped Article 301. This doctrine was authoritatively buried by a nine-judge Constitution Bench in Jindal Stainless Ltd. v. State of Haryana (2016). The Court held that taxes simpliciter do not fall within the contemplation of Part XIII at all, that the word "free" in Article 301 does not mean "free from taxation," and that only a discriminatory tax offends Article 304(a). The compensatory tax theory, having no textual basis in the Constitution, was discarded.

Jindal Stainless is doctrinally significant because it reoriented the entire inter-State trade jurisprudence around the touchstone of non-discrimination rather than the elusive notion of compensation. While GST has now subsumed most entry taxes, the reasoning of the nine-judge bench on the relationship between taxation and the freedom of trade remains a staple of constitutional and economy papers alike.

The GST Revolution: The 101st Constitutional Amendment

The Goods and Services Tax, operational from 1 July 2017, is the most far-reaching indirect-tax reform in independent India, and it required a constitutional amendment because it cut across the watertight Union-State division of the Seventh Schedule. The Constitution (One Hundred and First Amendment) Act, 2016 rewrote the fiscal map by inserting new provisions and pruning the old taxing entries.

The keystone is Article 246A, which confers concurrent power on both Parliament and the State Legislatures to make laws on goods and services tax — a historic departure, since the Constitution had previously contained no concurrent taxing entry. For intra-State supplies, both the Centre and the State levy GST (CGST and SGST); for inter-State supplies, Article 246A read with Article 269A gives Parliament exclusive power, the resulting Integrated GST (IGST) being levied and collected by the Union and apportioned between the Union and the destination State.

Article 366(12A) defines GST as "any tax on supply of goods, or services or both except taxes on the supply of the alcoholic liquor for human consumption," which is why alcohol for human consumption remains entirely outside GST and continues under State excise. Petroleum crude, high-speed diesel, petrol, natural gas and aviation turbine fuel are constitutionally within GST but kept out of its levy for the present by a decision of the GST Council, so they continue to attract central excise and State VAT. The amendment also abolished entry tax, octroi, central sales tax and the bulk of the old indirect taxes, subsuming them into a single levy.

GST Architecture: The Dual Model, Supply and Destination Principle

India adopted a dual GST model to preserve fiscal federalism: on every intra-State supply, the Centre levies Central GST (CGST) under Section 9 of the Central Goods and Services Tax Act, 2017 and the State simultaneously levies State GST (SGST) under the corresponding State Act, each on the same transaction value. On inter-State supplies, the Centre levies Integrated GST (IGST) under the Integrated Goods and Services Tax Act, 2017, which broadly equals CGST plus SGST and is apportioned to the consuming State.

The taxable event under GST is no longer "manufacture" or "sale" or "provision of service" but the single, unifying concept of "supply" defined in Section 7 of the CGST Act to include all forms of supply of goods or services made for consideration in the course or furtherance of business, together with specified supplies made without consideration. By collapsing the three earlier taxable events into one, GST eliminated the artificial boundary disputes (goods versus services, sale versus works contract) that had clogged the pre-2017 docket.

GST is a destination-based consumption tax: the revenue accrues to the State where the goods or services are finally consumed, not where they are produced — a reversal of the origin-based logic of central sales tax that benefited manufacturing States. The genius of the system is the seamless input tax credit chain, which allows a registered person to set off the tax paid on inputs against the tax payable on outputs, taxing only value addition at each stage and curing the cascading effect. The consumption orientation of GST and its macro-revenue implications tie back to the measurement of national income.

The GST Council and Mohit Minerals: Cooperative Federalism Tested

The institutional heart of GST is the GST Council, constituted under Article 279A within sixty days of the amendment's commencement. Chaired by the Union Finance Minister with the Union Minister of State for Finance and the State Finance Ministers as members, the Council recommends the rates, exemptions, threshold limits, model laws and special provisions, weighting the Union's vote at one-third and the States' collective vote at two-thirds, with decisions requiring a three-fourths majority of weighted votes present and voting.

The constitutional status of the Council's recommendations was decisively clarified in Union of India v. Mohit Minerals Pvt. Ltd. (2022). A three-judge bench held that the recommendations of the GST Council are not binding on the Union and the States but are merely persuasive, being "the product of a collaborative dialogue" in a system of cooperative federalism. The Court reasoned that since both Parliament and the State Legislatures possess equal, simultaneous power to legislate on GST under Article 246A, treating Council recommendations as binding edicts would disrupt fiscal federalism and reduce the States to subordinate units.

On the merits, Mohit Minerals struck down the levy of IGST on ocean freight under the reverse charge mechanism in CIF (Cost-Insurance-Freight) imports. The Court held that a CIF contract is a "composite supply" of goods and the accompanying transportation service, on which the Indian importer already pays IGST as part of the customs valuation; a separate IGST on the freight component would offend the composite-supply principle in Section 8 of the CGST Act and amount to double taxation. The judgment is essential reading for its dual contribution — on fiscal federalism and on the mechanics of composite supply.

GST Compensation, Borrowing and Centre-State Tensions

To persuade the States to surrender their cherished taxing powers, the Union promised to compensate them for any revenue loss arising from GST implementation for a transitional period of five years, guaranteeing a fourteen per cent annual growth over the 2015-16 base year. This guarantee was given statutory form in the Goods and Services Tax (Compensation to States) Act, 2017, funded by a compensation cess levied on luxury and demerit goods such as tobacco, aerated drinks and automobiles.

The arrangement came under acute strain when the COVID-19 pandemic collapsed collections in 2020-21, leaving a compensation shortfall the cess could not meet. The resulting dispute over whether the Union was constitutionally and statutorily obliged to borrow and pay the full guaranteed amount exposed the fragility of the cooperative-federal compact and was ultimately resolved through a special borrowing arrangement rather than litigation. The episode is a live illustration of how the Mohit Minerals principle — that neither tier is subordinate — plays out in fiscal practice.

These tensions over the divisible pool, cesses outside it, and the shrinking fiscal autonomy of the States feed directly into the resource-transfer debates that the Finance Commission and the erstwhile Planning Commission framework were designed to manage, explored in our chapter on the Five-Year Plans and NITI Aayog. They also intersect with the monetary and liquidity tools discussed under the RBI and the banking system.

Direct versus Indirect Taxes: Equity, Buoyancy and Policy

A recurring analytical question asks aspirants to compare the two limbs of the tax system on grounds of equity and efficiency. Direct taxes are generally progressive — the rate rises with the taxpayer's capacity, advancing the goal of vertical equity and redistribution — and their burden cannot be shifted, so the legal and economic incidence coincide. They are, however, more susceptible to evasion and avoidance, as the McDowell–Vodafone trilogy demonstrates, and their collection costs are higher.

Indirect taxes such as GST are typically regressive in their unmitigated form, because a flat rate on consumption takes a larger proportionate bite from the poor than the rich; GST partially corrects this through a multi-rate structure that taxes essentials at low or nil rates and luxury or demerit goods at higher rates plus cess. Indirect taxes are easier to collect, harder to evade at the point of consumption, and revenue-buoyant because they expand automatically with consumption and the formalisation of the economy.

The constitutional limits on both are the same — competence under the appropriate entry, the Article 265 requirement of legal authority, and the Article 14 bar on manifestly arbitrary or hostile discrimination. Courts accord the legislature wide latitude in fiscal matters, applying a deferential standard of review and presuming constitutionality, a posture repeatedly affirmed including in the fiscal-policy reasoning of Vivek Narayan Sharma v. Union of India (2023), the demonetisation Constitution Bench, which underscored judicial restraint in matters of economic policy. For the foundational vocabulary of progressivity, incidence and buoyancy, revisit basic economic concepts.

Emerging GST Jurisprudence and Examination Hotspots

Half a decade of GST has generated a rich body of case law that examiners increasingly mine. Beyond Mohit Minerals, the Supreme Court in Union of India v. VKC Footsteps India Pvt. Ltd. (2021) upheld the formula restricting refund of accumulated input tax credit in cases of inverted duty structure to credit on input goods, declining to extend it to input services, and counselled that anomalies in the formula were for the GST Council and not the courts to remedy — a reminder of judicial deference in fiscal technicalities.

The interplay between GST and pre-existing levies continues to throw up disputes: the treatment of intermediary services, the place-of-supply rules, the scope of "composite" versus "mixed" supply, the constitutionality of anti-profiteering provisions, and the GST treatment of online gaming and actionable claims have all reached the higher judiciary. The constitution of GST Appellate Tribunals, long delayed, is itself a frequently tested administrative-law issue.

For the judiciary aspirant, the safest preparation is to master the constitutional skeleton — Articles 246A, 269A, 279A, 366(12A) and the 101st Amendment — and to be able to state crisply the holding of each landmark: Govind Saran (four components), McDowell/Azadi Bachao/Vodafone (avoidance), Jindal Stainless (free trade and entry tax), All India Federation of Tax Practitioners (service tax as VAT) and Mohit Minerals (Council recommendations not binding). For the wider economic context in which these levies operate, return to the Indian Economy for Judiciary hub.