Definition of Tax:

A tax is a financial charge or other levy imposed upon a taxpayer (an individual or legal
entity), collected by a state or the functional equivalent of the same, such that failure to pay,
or evasion of or resistance to collection of tax, is punishable by law. The principle reason for
taxation was to pay for government expenditures.

A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an
individual or legal entity) by a governmental organization in order to fund government
spending and various public expenditures (regional, local, or national), and tax compliance
refers to policy actions and individual behaviour aimed at ensuring that taxpayers are paying
the right amount of tax at the right time and securing the correct tax allowances and tax
reliefs.

A tax is a mandatory fee or financial charge levied by any government on an individual or an

organization to collect revenue for public works providing the best facilities and
infrastructure. The collected fund is then used to fund different public expenditure programs.

Principles of Taxation

1. Canon of Equity (Fairness)

• Taxes should be imposed based on the taxpayer's ability to pay.
• People earning higher income should pay more taxes (progressive taxation).
• Example: Progressive income tax system.

2. Canon of Certainty
• The tax system should be clear, predictable, and certain, not arbitrary.
• Taxpayers must know how much, when, and how they must pay.
• Prevents harassment by tax authorities and reduces disputes.

3. Canon of Convenience
• The tax system should be convenient for the taxpayer.
• Taxes should be collected at a time and in a manner that is most likely convenient for
the taxpayer (e.g., deducting tax at source or during peak income periods).

4. Canon of Economy
• The cost of tax collection should be minimal relative to the revenue raised.
• Administrative costs of collecting taxes should not outweigh the benefits.
• Example: Automated systems for filing returns reduce administrative costs.

Additional Modern Canons of Taxation

Later economists and policymakers expanded on Smith’s canons to suit modern economies:

5. Canon of Productivity
• A tax should generate sufficient revenue to meet the government's needs.
• Example: Goods and Services Tax (GST) in India ensures consistent revenue
collection.
6. Canon of Elasticity
• The tax system should be flexible and capable of adjusting with changing economic
conditions (e.g., during recessions or booms).
• Example: Excise duties and customs duties can be adjusted quickly.

7. Canon of Simplicity
• The tax system should be simple and easy to understand.
• A complex tax structure can lead to tax evasion and administrative inefficiencies.

8. Canon of Diversity
• A country should not depend on a single source of tax revenue but have a balanced
mix (e.g., income tax, GST, customs duties, etc.).
• Reduces the risk of revenue fluctuations.

9. Canon of Expediency
• A tax should not conflict with the economic or social policies of the government.
• Example: Sin taxes (on alcohol, tobacco) discourage harmful consumption while
raising revenue.

Rationale to Leavy Taxes:

The taxes collected have been used by the government to carry out many functions. Some of
these include:

• Expenditures on war,
• The enforcement of law and public order,
• Protection of property,
• Economic infrastructure (such as roads, legal tender, enforcement of contracts, etc.),
• Public works,
• Social Engineering,
• The operation of Government itself, and
• To fund welfare and public services such as education systems, health care systems,
pensions for the elderly, unemployment benefits, and public transportation, energy,
water and waste management systems, common public utilities, etc.

Characteristics of Tax systems:

Tax is Compulsory and not Voluntary – A tax is imposed by law. So tax is compulsory
payment to the Governments from its citizens. Tax is duty of every citizen to bear his share
for supporting the government. The tax is compulsory payment, refusal or objection for
paying tax due leads to punishment or is an offence of the Court of law.

Tax is Contribution – Contribution means in order to help or provide something. Tax is

contribution from members of community to the Government. A tax is the duty of every
citizen to bear their due share for support to government to help it to face its expenditures.
Some wants are common to everybody in the society like defence and security, so these
wants cannot be satisfied by individuals. These social wants are satisfied by Governments,
hence it is the duty of the people to support government for these social wants.
Tax is for Public Benefit – Tax is levied for the common welfare of society without regard to
benefit to any special individual. Government proceeds are spent to extend common benefits
to all the people.

Tax is paid out of Income of the tax payer – Income means money received, especially on
regular basis, for work or through investment. Tax is paid out of income as long as the
income becomes realized, here the tax is imposed. Income owner has profit from any
business, so he should pay his share to support the Government.

Government has the power to levy Tax – Governments are practicing sovereign authority
upon the citizens through levying of taxes. Only government can collect tax from the people.

Tax is not the cost of the benefit – Tax is not the cost of benefit conferred by the
government on the public. Benefit and taxpayer are independent of each other, and payment
of taxation is of course designed for conferring of benefits on general public.

Tax is for the economic growth and public welfare – Major objective of the government is
to maximize economic growth and social welfare. Developmental activities of the nations
generally involve two operations, the raising of revenue and the spending of revenue, so the
government spends taxes for economic benefit, for entire community and for aggregate
welfare of the society.

Objectives:

The primary purpose of taxation is to raise revenue to meet huge public expenditure. Most
governmental activities must be financed by taxation. But it is not the only goal. In other
words, taxation policy has some non- revenue objectives. In today’s scenarios, taxation
besides being the main resource for supporting government has became a tool for economic
growth, social welfare; attract foreigner investment, economic stability, and income
distribution. The Objectives of taxation in brief are as under:-

Source of Revenue to Government: Taxes are imposed so as to produce the necessary

amount of revenue to meet the requirement of the government, as the public expenditure is
increasing in scope and size day by day. Therefore, the main objective of taxes is to raise
revenue to meet the government expenditures adequately.

Redistribution of Income and Wealth: Income differs from one person to another in the
society. Inequity in income leads to many evils, and the government aims to reduce
inequalities between members of the society, to secure social justice. Tax is a means of
ensuring the redistribution of income and wealth in order to reduce poverty and promote
social welfare. For achieving these goals, government adopts the following:

• Imposition of high rate tax upon luxury commodities.

• Applying progressive tax system when levying taxes from taxpayers.
• Imposition of tax exemption to basic goods.
Social welfare: Social welfare is the basic need of the society in the modern age. The
government functions have become very important to the society, because the society needs
saving, protection, education, health, and so on. All these functions are necessary to make
social welfare, so the government receives revenue from tax, and expends it for those
functions. Therefore revenue from taxes is fuel to the government for social welfare.

Safety of society from bad and injurious customs: Fighting the bad customs in the society
is the primary task of the government, so tax is a tool for fighting some of those customs.
From this angle tax imposition of very high percentage on the goods like tobacco and alcohol
is an effort to reduce these habits.

Economic Significance of Taxes: Taxes are used from economic point of view, so taxation
helps to encourage some economic activities, and as a tool to solve some economics
problems. Tax is also a means for directing of scarce economic activities. Taxation helps to
accelerate economic growth, and taxation plays very important role in case of economic
stability.

Economic growth: Taxes are considered as a tool for economic growth and it helps to
accelerate growth of economic development. Economic development has placed considerable
emphasis on objectives of taxation policy. Economic development is the main objective in all
the countries of the world. Economic development depends on mobilization of resources and
efficient use of such resources between different sectors of the economy activities. Tax policy
must be designed so as to mobilize the internal resources and use these resources in
productive manner.

Enforcing Government Policy: Government policy can easily be enforced by adoption of

suitable tax policy. The Government can encourage investment, saving, consumption, export,
protection of home industry, employment, production, protection of society from harmful
customs, and economic stability through suitable tax policy.

Economic Stability: Maintaining economic stability is one of the tax objectives. Economic
stability is a very important factor for the sustained economic growth. Government can
effectively use taxes in the case of inflation and depression. These may be increased in
inflationary situations. Increase in the rates of existing taxes and the imposition of new taxes
would check consumption, decrease the level of effective demand and therefore help in
bringing up stability in prices. Heavy taxation transfer purchasing power from the hand of
people to the government which if used for productive purpose will increase the level of
economic activity and employment.

In the case of depression taxes play an important role. Purchasing power in the hands of
people is reduced and they are able to spend less and the demand for commodities and
services is reduced. All these lead to a shrinkage of business activity and employment. In this
case government should increase the purchasing power in the hands of public through
reducing the burden of taxation on the people and impose tax upon saving so that people may
be encouraged to spend more and thus help to create more demand for goods and more
business activity and employment.
Evolution of Income Tax Legislation in India:

Income Tax Act, 1860

• The first Income Tax was introduced in India by the British in 1860.
• It was enacted in response to the financial difficulties caused by the Revolt of 1857.
• The Act was a temporary measure and remained in force for only five years, lapsing
in 1865.
• After its lapse, it was replaced in 1867 by a licence tax on professions and trades.
• The licence tax was later converted into a certificate tax in 1868.
• The system was finally abolished in 1873.
• A form of licence tax on traders remained operative until 1886.

Income Tax Act, 1886

• This Act marked a more permanent structure for income tax in India.
• It applied to both residents and non-residents with income accruing in India.
• Agricultural income was specifically defined and exempted from taxation due to the
existence of land revenue (a form of direct tax).
• Life insurance premiums paid by an assessee on their own life were exempted.
• For the first time, the Hindu Undivided Family (HUF) was recognized as a separate
taxable entity.

Income Tax Act, 1918

• This Act expanded the scope of taxable income to include casual or non-recurring
receipts arising from business or profession.
• Although income tax was always intended to be levied on net income, the 1918 Act
introduced specific provisions for business deductions to compute such net income.
• The Act remained in force only briefly and was replaced by a new Act in 1922.
• This change was necessitated by constitutional reforms introduced under the
Government of India Act, 1919.

Income Tax Act, 1922

• The 1922 Act marked a major development in India’s tax administration.
• It introduced a mechanism whereby income tax rates were fixed through annual
Finance Acts, rather than being part of the principal Act.
• This allowed for annual revision of tax rates in line with budgetary needs, lending
flexibility and adaptability to the taxation system.
• It laid down the structure of tax administration and clearly defined the income tax
authorities.
• It was the first Act to provide a structured framework for administering and
enforcing tax law in India.
• The administrative legacy of this Act is considered the foundation of India’s modern
Income Tax Department.
• This Act remained in force until it was replaced by the Income Tax Act, 1961, which
is currently in operation.

Types of Tax:

• Direct Tax
• Indirect Tax
Direct Taxes:

Taxes which are directly levied on Income of the person and its burden cannot be shifted. For
example - Income Tax.

A Direct tax is a kind of charge, which is imposed directly on the taxpayer and paid directly
to the government by the persons (juristic or natural) on whom it is imposed. A direct tax is
one that cannot be shifted by the taxpayer to someone else.

Indirect Tax:

Indirect taxes are imposed on price of goods or services. Person paying the indirect tax can
shift the incidence to another person. For example - GST or Customs duty.

An indirect tax is a tax collected by an intermediary (such as a retail store) from the person
who bears the ultimate economic burden of the tax (such as the customer). An indirect tax is
one that can be shifted by the taxpayer to someone else. An indirect tax may increase the
price of a good so that consumers are actually paying the tax by paying more for the
products.

Differences between Direct Tax and Indirect Tax

Direct Tax Indirect Tax

Direct tax is a tax wherein the levy In this the levy of tax is made on one
of tax is made on a person and the person
responsibility of paying such tax is and the responsibility of paying the tax
fixed on that person. to the
Government is fixed on some other
person.

Direct tax is levied on person. Indirect tax is levied on goods and

The burden of direct tax cannot be services.
transferred to other person. The burden of indirect tax can be
transferred to the end users.
The purpose of direct tax is to Indirect tax increases the price of goods
redistribute the wealth of a nation. or services.
E.g. Income Tax. E.g. Goods and Services Tax.
It is levied on the Assessee It is levied on supplier of Goods &
Services.

Merits of Direct Tax:

 1. Equity: Direct taxes have equity of sacrifice, depend upon the volume of income.
They are based on the progressive principle, so rates of tax increase as the level of
income of a person rises.
2. Elasticity and productivity: Direct taxes have elasticity because when the
government faces some emergency, like earthquake, floods and famine, the
government can collect money for facing those problems through the mode of Direct
tax.
3. Certainty: Direct tax has certainty on both sides ‘tax-payer’ and ‘government’. The
tax-payers are aware of the quantity of tax. They have to pay and rate, time of
payment, manner of payment, and punishment from the side of government is also
certain about the total amount they are getting.
4. Reduce inequality: Direct taxes follow progressive principles so it is taxing the rich
people with higher level of taxation and the poor people with a lower level of
taxation.
5. Good instrument in the case of inflation: Tax policy as fiscal instrument plays
important role in the case of inflation, so government can absorb the excess money by
raising in the rate of existing taxes or imposition of new taxes.
6. Simplicity: The rules, procedures, regulations of income tax are very clear and
simple.

Demerits of Direct Taxes

1. Evasion: Direct tax is lump sum therefore tax payers may try evasion.
2. Uneconomically: Expenses of collection are higher in the case of direct taxes,
because they require wide - spread staff for collection.
3. Little incentive to work and save: In Direct taxes, rates are of progressive nature. A
person with higher earning is taxed more, in turn he is left little with amount. So the
tax payer feels disincentive to work hard and save money after reaching a certain
level of income.
4. Not suitable for a poor country: Direct taxes are not enough to meet its expenditure.

Merits of Indirect Taxes

1. High revenue production: Nature of indirect taxes is imposition on the commodities
and services. Here indirect taxes cover a large number of essential goods and
luxurious goods which are consumed by the mass both rich and poor people, these
help in collecting large revenue.
2. No evasion: Nature of indirect tax is that, it is included in the price of commodity, so
tax evasion or tax evasion is difficult.
3. Convenient: Indirect taxes are small amount and indirect taxes are hidden in the price
of goods and services, hence the burden of these taxes is not felt very much by the
tax-payers, and not lump sum like
4. direct taxes.
5. Economy: Indirect taxes are economical in collection and the administrative costs of
collection are very low. Also the procedure of collection of these taxes is very simple.
6. Wide coverage: Indirect taxes cover almost all commodities like essential
commodities, luxuries, and harmful ones.
7. Elasticity: Since a large number of commodities and services are covered by indirect
taxation there is great scope for modifying of taxes, goods and tax rate, much depends
on nature of goods and on their demands.
Demerits of Indirect Taxes
1. Regressive in effect: Essential commodities are used by all members of community.
When taxing these commodities the burden would be equal, and no distinction is
made between the rich and poor people.
2. Uncertainty in collection: Discourage savings and Increase inflation. Indirect taxes
are payable when people spend their income or when people buy goods and services,
so tax authorities cannot accurately estimate the total yield from different indirect
taxes.
3. Discourage savings - Increase inflation: Indirect taxes are included in the price of
commodity, so people have to spend more money on essential commodities, when
levied indirectly. That means the customers cannot save some of their money.
4. Increase inflation: Indirect taxes increase the cost of input and output, increase in
production cost, push the price of goods.

Constitutional provisions for taxes:

The roots of every law in India lie in the Constitution. Therefore, understanding its provisions
is essential to grasp the framework of taxation laws:
• Article 265 – No tax shall be levied or collected except by the authority of law.
• Article 246 – Distributes legislative powers, including taxation, between the
Parliament and State Legislatures.
• Schedule VII – Enumerates the subjects under three legislative lists:
o Union List – Powers of the Central Government
o State List – Powers of the State Government
o Concurrent List – Powers shared by both, but in case of conflict, the Union
law prevails

Seventh Schedule – Taxation Entries

I. Union List (List I) – Parliament’s Exclusive Power
1. Entry 82 – Taxes on income other than agricultural income
2. Entry 83 – Duties of customs including export duties
3. Entry 84 – Excise duties on tobacco and other goods (excluding alcohol and
narcotics for human use)
4. Entry 85 – Corporation tax
5. Entry 86 – Taxes on capital value of assets (excluding agricultural land)
6. Entry 87 – Estate duty on property other than agricultural land
7. Entry 88 – Succession duties on property other than agricultural land
8. Entry 89 – Terminal taxes on goods/passengers (rail, sea, air); railway fares/freights
9. Entry 90 – Taxes (excluding stamp duties) on stock exchange and futures market
transactions
10. Entry 91 – Stamp duties on specified financial instruments
11. Entry 92 – Taxes on sale/purchase of newspapers and related advertisements
12. Entry 92A – Taxes on inter-State sale or purchase of goods (except newspapers)
13. Entry 92B – Taxes on inter-State consignments of goods
14. Entry 92C* – Taxes on services (not yet in force)
15. Entry 97 – Residual powers including any other tax not in State or Concurrent Lists
 II. State List (List II) – State Legislature’s Exclusive Power

1. Entry 46 – Taxes on agricultural income

2. Entry 47 – Succession duties on agricultural land
3. Entry 48 – Estate duty on agricultural land
4. Entry 49 – Taxes on lands and buildings
5. Entry 50 – Taxes on mineral rights
6. Entry 51 – Excise duties on alcoholic liquor, opium, Indian hemp, etc.
7. Entry 52 – Entry tax on goods into local areas
8. Entry 53 – Taxes on sale or consumption of electricity
9. Entry 54 – Taxes on sale/purchase of goods (other than newspapers and inter-State
transactions)
10. Entry 55 – Taxes on non-newspaper advertisements (excluding radio/TV)
11. Entry 56 – Taxes on goods/passengers by road or inland waterways
12. Entry 57 – Taxes on vehicles (including tramcars)
13. Entry 58 – Taxes on animals and boats
14. Entry 59 – Tolls
15. Entry 60 – Taxes on professions, trades, callings and employments
16. Entry 61 – Capitation taxes
17. Entry 62 – Taxes on luxuries, entertainments, amusements, betting and gambling
18. Entry 63 – Stamp duties (documents not covered by Union List)

III. Concurrent List (List III) – Powers Shared by Centre and States

1. Entry 35 – Principles for taxation of mechanically propelled vehicles

2. Entry 43 – Recovery of tax claims and public demands across States
3. Entry 44 – Stamp duties (excluding judicial stamps)

Constitutional Articles on Taxation:

Article Subject
246 Distribution of legislative powers (including taxation) between Union and States
246A Special provision for GST – concurrent power of Union and States
265 No tax shall be levied or collected except by authority of law
266 Consolidated Funds of India and States – destination of tax revenues
267 Contingency Fund of India – emergency finance
268 Stamp duties levied by Union but collected by States
269 Taxes levied and collected by Union but assigned to States
269A Levy and distribution of GST on inter-State supplies
270 Taxes levied and collected by the Union and distributed between Union and States
271 Surcharge on certain duties and taxes for Union purposes
275 Grants-in-aid to States from the Consolidated Fund of India
276 Taxes on professions, trades, callings, and employments
Article Subject
277 Saving of existing taxes (continuation of pre-Constitution taxes)
278 Agreements with States regarding taxation
279 Calculation of net proceeds of taxes
279A Constitution and powers of the GST Council
280 Finance Commission – distribution of revenues between Union and States
281 Recommendations of the Finance Commission to be laid before Parliament
285 Exemption of Union property from State taxation
286 Restrictions on taxation of inter-State trade or commerce
287 Exemption from tax on electricity consumed by the Government
288 Exemption from State taxation on Union property in respect of railways
289 Exemption of State property and income from Union taxation