Financial Relations Between Centre and States: Non-Tax Revenue Sources and Key Provisions

Sources of non-tax revenue for Centre: Various services provided by the centre such as Posts and telegraphs, Banking, Railways, Broadcasting, Coinage and Currency. Other sources are Central Public Sector Enterprises (CPSE), escheat and lapse.

• Sources of non-tax revenue for the States: Irrigation, Forest, Fisheries, state public sector enterprises, escheat and lapse.

Types of Grant-in-Aid to States

The Constitution provides for  the following two types of grant-in-aids from the central resources:

Finance Commission and Financial Relations Between Centre and States

The Finance Commission is a quasi-judicial body established under Article 280 of the constitution. Every five years, or sometimes sooner, the President constitutes this body. It is tasked with advising the President on various issues, including:

1. Tax distribution: The distribution of the net proceeds of taxes to be shared between the Centre and the states, and the allocation between the states, the respective shares of such proceeds.
2. Grant-in-aids: The principles which should govern the grants-in-aid to the states by the Centre as per Article 275
3. Consolidated fund of state: The actions necessary to enhance the Consolidated Fund of a state in order to support the financial resources of local bodies such as panchayats and municipalities, based on suggestions from the State Finance Commission.
4. Other matters: Any other matter referred to it by the President in the interests of sound finance.

Protecting States’ Financial Interests in Financial Relations Between Centre and States

Some bills in the Parliament can be introduced only on the recommendation of the President so as to protect the financial interests of the State. 

1. Alters tax or duty: Legislation that creates or modifies any tax or duty that affects the states. 
2. Agricultural income: Legislation that changes the definition of ‘agricultural income’ as outlined for the purposes of income tax laws.
3. Principles of distribution: A bill which affects the principles on which money is or may be redistributed to the states. 
4. Surcharge or specified tax: A bill which imposes any surcharge on any specified tax or duty for the purpose of the Centre.

The term “tax or duty in which states are interested” refers to: (a) a tax or duty whose entire or partial net proceeds are allocated to any state; or (b) a tax or duty based on the net proceeds from which amounts are currently payable from the Consolidated Fund of India to any state.

Borrowing Powers of Centre and States

The constitution under article 292 and article 293 makes following provisions regarding the borrowings by the central or state governments:

• Borrowing power of centre: The Central government can borrow from either domestic or foreign sources upon the guarantee of consolidated funds of India within the limits prescribed by the Parliament. 
• Borrowing power of states: The state governments can borrow within India and not from abroad on the guarantee of consolidated funds of state within the limits prescribed by state legislature. 
• Guarantee by Central government: The central government is empowered to make any loans or give guarantees with respect to loans raised by the state. Any funds required for these loans will be charged to the Consolidated Fund of India.
• Prior consent of centre: A state is prohibited from securing a loan without the central government’s consent if there are any outstanding amounts related to a loan provided by the Centre or backed by a guarantee from the Centre.

Intergovernmental Tax Immunities and Financial Relations Between Centre and States

In line with other federal constitutions, the Indian Constitution also includes the principle of ‘immunity from mutual taxation’ and includes the following stipulations in this regard:

• Property of Central Government: The assets of the Centre are free from taxes levied by a state or any local authority within that state, such as municipalities and district boards. However, Parliament has the authority to lift this exemption, which does not apply to companies or corporations established by the central government.
• Property of State Government: The assets and income of a state are free from central taxation. Nevertheless, the central government can impose taxes on a state’s commercial activities if Parliament enacts legislation for it. It is important to highlight that local authorities within a state are not exempt from central taxation, nor are the assets or income from corporations and companies owned by a state.

Financial Relations Between Centre and States During Emergency Situations

• National Emergency: The President can modify constitutional distribution of revenue between the centre and the states. This means that the president can either reduce or cancel the transfer of finances i.e. both tax sharing and grants-in-aid from the Centre to the states. These modifications continue till the end of the financial year in which the emergency ceases to operate.

• Financial Emergency: In times of financial emergency, the central government can issue directives to the states, which include

1. Observing the prescribed financial propriety guidelines 
2. Reducing the salaries and allowances of all state employees, including High Court judges 
3. Requiring that all money bills and financial bills be reserved for the President’s consideration.