Which one of the following statements regarding the levying, collecting and distribution of Income Tax is correct ?

1. Constitutional Basis of Financial Relations (basic)

In a federal system like India, the division of power is not just about who makes the laws, but also about who has the money to implement them. The Constitution of India provides an elaborate scheme to regulate financial relations between the Union and the States to ensure "maximum harmony and coordination" between the two levels of government Indian Polity, M. Laxmikanth, Chapter 15, p.144. While legislative and administrative relations are found in Part XI, the core of financial relations is housed in Part XII (specifically Articles 268 to 293).

The Indian Constitution is unique because it attempts to follow a clear-cut division of taxing powers. Unlike many other federations where there is often a "tax jungle" or overlapping jurisdictions, the Indian scheme seeks to minimize double taxation by providing distinct entries for the Union and the States in the Seventh Schedule. However, there is a built-in vertical imbalance: the Union government is assigned more expansive and elastic sources of revenue (such as Income Tax and Corporate Tax), while the States carry the heavy burden of welfare responsibilities like public health, education, and agriculture. To bridge this gap, the Constitution mandates a system of sharing taxes and providing Grants-in-aid.

It is important to note that while legislative, executive, and financial powers are divided, the judicial power in India is not divided; we have an integrated judicial system. Furthermore, these financial arrangements are not static. Significant updates, such as the 101st Amendment Act of 2016, have introduced the Goods and Services Tax (GST), creating a shared platform for taxation and shifting the landscape of fiscal federalism Introduction to the Constitution of India, D. D. Basu, Tables, p.525.

Sources: Indian Polity, M. Laxmikanth(7th ed.), Chapter 15: Centre-State Relations, p.144; Indian Polity, M. Laxmikanth(7th ed.), Chapter 15: Centre-State Relations, p.152; Introduction to the Constitution of India, D. D. Basu (26th ed.), TABLES, p.525

2. The Finance Commission of India (intermediate)

To understand how money flows from the Centre to the States, we must first look at the Finance Commission (FC), the constitutional 'balancing wheel' of Indian fiscal federalism. Established under Article 280, the FC is a quasi-judicial body appointed by the President of India every five years (or earlier if needed) Laxmikanth, Finance Commission, p.431. Its primary existence is due to a structural imbalance in our Constitution: the Centre has the most lucrative sources of revenue (like Income Tax and Customs), but the States carry the heavy burden of public welfare expenditures (like Health and Education). This is known as vertical imbalance, and the FC is the bridge that fixes it.
The Commission's core duties involve making recommendations to the President on how the 'divisible pool' of central taxes should be shared. This involves two distinct steps: Vertical Devolution (deciding what percentage of the total central tax revenue goes to all States combined—currently set at 41% by the 15th FC) and Horizontal Devolution (deciding how that total state-share is split between individual states like Bihar, Kerala, or Assam based on specific criteria like population and income distance) Vivek Singh, Government Budgeting, p.182. It's important to note that these tax shares never enter the Consolidated Fund of India; they are transferred directly to the States as 'untied' funds, meaning the States are free to spend them as they see fit.
Beyond tax sharing, the Commission also lays down the principles for Grants-in-aid to the States out of the Consolidated Fund of India under Article 275 D. D. Basu, Distribution of Financial Powers, p.387. Since the 73rd and 74th Amendments, the FC also recommends measures to augment the Consolidated Fund of a State to help supplement the resources of Panchayats and Municipalities. A pivotal turning point in this history was the 80th Amendment Act (2000), which implemented the 'Alternative Scheme of Devolution,' making almost all Central taxes shareable with the States, rather than just a select few Laxmikanth, Centre-State Relations, p.153.

Sources: Indian Polity, M. Laxmikanth, Finance Commission, p.431; Indian Economy, Vivek Singh, Government Budgeting, p.182; Introduction to the Constitution of India, D. D. Basu, Distribution of Financial Powers, p.387; Indian Polity, M. Laxmikanth, Centre-State Relations, p.153

3. Taxing Jurisdictions: Union vs. State Lists (basic)

To understand how India manages its money, we must look at the Seventh Schedule of the Constitution. This schedule acts as a clear map, dividing responsibilities between the Centre and the States. When it comes to taxation, the Constitution aims for a clear demarcation to prevent overlapping jurisdictions. Under Article 246, Parliament has the exclusive power to levy taxes on subjects mentioned in the Union List (List I), while State Legislatures have the exclusive power for subjects in the State List (List II) Basu, Distribution of Legislative and Executive Powers, p.376.

One of the most important distinctions in Indian fiscal federalism is the treatment of Income Tax. The Union has the power to tax income, but there is a major exception: agricultural income. Power over agricultural income tax is reserved exclusively for the States. Similarly, while the Union handles Customs duties and Corporation tax, the States have the authority over Land Revenue and Taxes on Professions. However, the Constitution places a specific 'ceiling' on Profession Tax—a State cannot charge more than ₹2,500 per person per year Basu, Distribution of Financial Powers, p.384.

What happens if a new type of tax is needed that wasn't envisioned by the makers of the Constitution? These are called Residuary Powers. Unlike some other federations where these powers might go to the states, in India, the power to impose any tax not mentioned in the State or Concurrent List belongs exclusively to Parliament under Article 248 Laxmikanth, Federal System, p.139.

Tax Category	Jurisdiction	Key Examples
Union List	Centre (Parliament)	Income tax (non-agri), Customs, Corporation tax.
State List	State Legislature	Agricultural income tax, Land revenue, Profession tax.
Residuary	Centre (Parliament)	Any tax not explicitly listed in List II or List III.

Sources: Introduction to the Constitution of India, D. D. Basu, Distribution of Legislative and Executive Powers, p.376; Introduction to the Constitution of India, D. D. Basu, Distribution of Financial Powers, p.384; Laxmikanth, M. Indian Polity, Federal System, p.139

4. The GST Regime and Fiscal Federalism (intermediate)

The introduction of the Goods and Services Tax (GST) in 2017 marked a paradigm shift in India's fiscal federalism. Before GST, the taxation powers were strictly divided: the Centre taxed the manufacture of goods and the provision of services, while the States taxed the sale of goods. This created a fragmented market. To create a 'One Nation, One Tax' system, the 101st Constitutional Amendment Act, 2016 was enacted, which replaced a multitude of indirect taxes with a single, comprehensive levy on the manufacture, sale, and consumption of goods and services D. D. Basu, Introduction to the Constitution of India, DISTRIBUTION OF FINANCIAL POWERS, p.392.

Because GST requires both the Centre and States to give up some of their sovereign taxation powers to a common pool, it necessitates a high degree of cooperative federalism. To manage this, the 101st Amendment inserted Article 279-A, which empowered the President of India to constitute the GST Council Nitin Singhania, Indian Economy, Indian Tax Structure and Public Finance, p.94. This Council is a unique joint forum where the Union Finance Minister and representatives from all States sit together to decide on tax rates, exemptions, and administrative rules. It ensures that neither the Centre nor the States can unilaterally change the tax structure, making it a cornerstone of modern fiscal coordination M. Laxmikanth, Indian Polity, Centre-State Relations, p.155.

It is important to view this in the broader context of tax devolution. While the 101st Amendment created the GST, the 80th Amendment Act of 2000 had previously reformed how central taxes are shared. Based on the 10th Finance Commission's recommendations, the 80th Amendment introduced the 'Alternative Scheme of Devolution,' ensuring that a specific percentage of the total income from central taxes is shared with the states M. Laxmikanth, Indian Polity, Centre-State Relations, p.153. Together, these reforms illustrate how India has moved from a system of rigid separation toward one of shared resources and collaborative decision-making.

Sources: Introduction to the Constitution of India, DISTRIBUTION OF FINANCIAL POWERS, p.392; Indian Economy, Indian Tax Structure and Public Finance, p.94; Indian Polity, Centre-State Relations, p.153-155

5. Grants-in-Aid and Statutory Transfers (intermediate)

In the federal structure of India, there is a natural fiscal imbalance: the Centre has more power to raise revenue, while the States have more responsibilities for public welfare. To bridge this gap, the Constitution provides for Grants-in-Aid. Think of these as financial oxygen pumped from the Union to the States to ensure that no state falls behind due to a lack of resources.

There are two primary types of grants you must distinguish between: Statutory Grants and Discretionary Grants. Statutory grants are provided under Article 275. These are charged on the Consolidated Fund of India and are given to states that the Parliament deems to be in financial need. Importantly, these are not given to every state but only to those requiring assistance, and the amounts are fixed based on the recommendations of the Finance Commission Laxmikanth, M. Indian Polity, Centre-State Relations, p.155. These grants can be general or specific, such as for the welfare of scheduled tribes or improving administration in scheduled areas.

On the other hand, Article 282 provides for Discretionary Grants. This article is unique because it allows both the Centre and the States to make grants for any "public purpose," even if that purpose falls outside their specific legislative jurisdiction. During the era of the Planning Commission, these discretionary grants actually became much larger than the statutory ones, as they were used to fund five-year plans. However, with the transition to NITI Aayog, the institutional landscape has shifted. NITI Aayog acts as a think-tank and a platform for cooperative federalism, focusing on policy design and monitoring rather than the direct allocation of funds Laxmikanth, M. Indian Polity, NITI Aayog, p.465. Today, the power to allocate these funds lies primarily with the Ministry of Finance.

Feature	Statutory Grants (Art. 275)	Discretionary Grants (Art. 282)
Nature	Obligatory based on need	Discretionary (no obligation)
Recommendation	Finance Commission	Executive (Union Ministry)
Source	Consolidated Fund of India (Charged)	Consolidated Fund of India (Voted)

Sources: Laxmikanth, M. Indian Polity, Centre-State Relations, p.155; Laxmikanth, M. Indian Polity, NITI Aayog, p.465

6. Understanding Cess and Surcharge (intermediate)

To understand the nuances of Indian taxation, we must look beyond the basic income or corporate taxes and identify two specific tools the Union government uses to raise revenue: Cess and Surcharge. At their simplest, both are often described as a "tax on tax," meaning they are calculated as a percentage of the tax payable, rather than the underlying income or value. However, they serve very different constitutional and fiscal purposes.

A Surcharge is an additional tax levied on an existing tax for the general purposes of the Union. Under Article 271 of the Constitution, Parliament has the power to levy surcharges on certain taxes and duties. The most critical feature for an aspirant to remember is that the proceeds of a surcharge go exclusively to the Centre. Unlike the divisible pool of taxes (like Income Tax), the states have no share in the revenue generated from surcharges Laxmikanth, M. Indian Polity, Chapter 15: Centre-State Relations, p.154. However, it is important to note that a surcharge cannot be imposed on the Goods and Services Tax (GST).

A Cess, while also a tax on tax, is purpose-specific. It is levied to raise funds for a particular objective, such as education, health, or infrastructure. For example, a Social Welfare Surcharge or a Customs Cess might be added to import duties to fund specific developmental goals Nitin Singhania, Indian Economy, Indian Tax Structure and Public Finance, p.95. If the government collects a "Health and Education Cess," that money must legally be spent only on those sectors. Like surcharges, the proceeds of a cess are generally retained by the Union and do not form part of the divisible pool shared with the states.

The following table summarizes the key distinctions:

Feature	Surcharge	Cess
Purpose	General revenue for the Union.	Specific purpose (e.g., Health, Education).
Distribution	Exclusively for the Centre (Article 271).	Exclusively for the Centre (earmarked for specific use).
Duration	Can be permanent or temporary.	Ideally discontinued once the specific goal is met.

Sources: Laxmikanth, M. Indian Polity, Chapter 15: Centre-State Relations, p.154; Nitin Singhania, Indian Economy, Indian Tax Structure and Public Finance, p.95

7. Article 270: Devolution of Union Taxes (exam-level)

In our federal structure, there is a natural imbalance: the Union has more 'elastic' and lucrative tax sources (like Income Tax and Corporate Tax), while States have massive expenditure responsibilities in sectors like health and education. Article 270 acts as the primary corrective mechanism for this. It provides for taxes that are levied and collected by the Union, but the proceeds of which are distributed between the Union and the States. This creates what we call the 'divisible pool' of taxes. M. Laxmikanth, Indian Polity (7th ed.), Chapter 15, p.154.

Historically, only a few taxes like Income Tax were shared. However, the 80th Amendment Act (2000) brought a revolutionary change by implementing the 'Alternative Scheme of Devolution'. This amendment widened the net so that almost all Central taxes and duties are now shared with the States. The specific percentage or 'quota' of this sharing is not fixed in the Constitution; instead, it is determined by the President based on the recommendations of the Finance Commission, which is constituted every five years. D.D. Basu, Introduction to the Constitution of India (26th ed.), Distribution of Financial Powers, p.386.

It is vital to understand what stays outside this sharing arrangement. While most Union taxes are shared, the following are excluded from the divisible pool and retained exclusively by the Centre:

• Surcharges levied under Article 271.
• Any Cess levied for specific purposes (like an Education Cess).
• Taxes mentioned in Articles 268, 269, and 269-A (which have their own specific rules of assignment).

The amount to be distributed is calculated as the 'net proceeds', which means the total tax collected minus the cost of collection. To ensure transparency, these net proceeds must be certified by the Comptroller and Auditor-General (CAG) of India, whose certificate is final. M. Laxmikanth, Indian Polity (7th ed.), Chapter 15, p.156.

Sources: Indian Polity, M. Laxmikanth(7th ed.), Chapter 15: Centre-State Relations, p.153-156; Introduction to the Constitution of India, D. D. Basu (26th ed.), Distribution of Financial Powers, p.385-386

8. Solving the Original PYQ (exam-level)

Now that you have mastered the constitutional classification of taxes, you can see how the building blocks of Centre-State Financial Relations come together. The key is understanding Article 270, which covers taxes that are levied and collected by the Union but are distributed between the Union and the States. This category includes major revenue earners like Income Tax (other than agricultural income) and Corporation Tax. As you analyze the question, remember that while the Union holds the administrative power to set the rates and gather the tax, the federal character of our Constitution ensures that the proceeds are shared based on the recommendations of the Finance Commission. This leads us directly to Option (A) as the only correct statement.

To navigate the traps in the other options, you must pay close attention to the exclusivity of certain funds. Option (B) and (C) are common UPSC distractors that suggest an 'all-or-nothing' approach, which contradicts the distributive nature of Article 270. The most sophisticated trap is Option (D); while it mentions sharing, it incorrectly identifies surcharges as the shared component. According to Article 271, surcharges and cesses are actually excluded from the divisible pool and go exclusively to the Centre. By recognizing that surcharges are the exception to the sharing rule, you can confidently eliminate the wrong choices. For a deeper dive into these categories, refer to the detailed classification in Indian Polity, M. Laxmikanth.