Centre-State Financial Relations in India: Tax Sharing, GST Council & Grants (Complete Guide)

• Revenue Raising Advantage to the Centre: The Centre controls major, elastic, high-yield revenue sources (Corporate Tax, Income Tax, Customs Duty, Central GST, IGST).
• Expenditure Burden on States: States are assigned major socio-economic development subjects (Public Health, Education, Agriculture, Police, Infrastructure, Rural Development).

CONSTITUTIONAL ARTICLES MATRIX (PART XII: ARTICLES 268–293) - Illustrative Reference

Distribution of Tax Revenues
├── 1. Levied by Union, Collected & Appropriated by States (Art 268) | Stamp duties
├── 2. Levied & Collected by Union, Assigned to States (Art 269) | Inter-state consignment tax
├── 3. Integrated GST (IGST) on Inter-State Trade (Art 269A) | Shared 50:50 Centre & Destination State
├── 4. Divisible Pool Taxes Shared between Centre & States (Art 270) | Income Tax, Corp Tax, CGST, Customs
└── 5. Union Surcharges & Cesses (Art 271) | 100% retained by Union (Not in Divisible Pool)

• 10th Finance Commission: 29%
• 11th Finance Commission: 29.5%
• 12th Finance Commission: 30.5%
• 13th Finance Commission: 32%
• 14th Finance Commission (Y.V. Reddy): Historic jump to 42% (increased state fiscal autonomy).
• 15th Finance Commission (N.K. Singh): Adjusted to 41% (1% reduction to account for the newly created Union Territories of Jammu & Kashmir and Ladakh out of central funds).

• CGST (Central GST): Levied by Union on intra-state supply of goods and services.
• SGST (State GST): Levied by States/UTs on intra-state supply.
• IGST (Integrated GST): Levied by Centre under Article 269A on inter-state supply and imports; revenue shared between Centre and consuming destination State.
• Subsumed Taxes: Replaced Central Excise, Service Tax, State VAT, Entry Tax, Octroi, Luxury Tax, and Entertainment Tax.

• Chairperson: Union Finance Minister.
• Members: Union Minister of State for Finance and Finance Ministers of all 28 States and 3 UTs with Assemblies (Delhi, Puducherry, J&K).
• Voting Formula:
• Centre's vote weight = 1/3rd (33.33%) of total votes cast.
• States' vote weight = 2/3rd (66.67%) of total votes cast (each state has equal vote regardless of size/population).
• Decision threshold = 3/4th (75%) majority of weighted votes present and voting.
• Veto Implication: Neither the Centre alone nor States alone can pass a resolution; both must agree for a 75% majority, embodying cooperative federalism.

• Recommendations of the GST Council are not legally binding on Parliament and State Legislatures.
• GST Council recommendations have persuasive value. Article 246A gives simultaneous power to both Parliament and State Assemblies to legislate on GST. Cooperative federalism relies on dialogue and consensus, not mandatory command.

• Central Government can borrow domestically or externally upon the security of the Consolidated Fund of India within limits fixed by Parliament under the FRBM Act.

• States can borrow ONLY domestically (cannot borrow directly from foreign governments or international agencies; foreign loans must be routed through Central Government).
• Article 293(3) - Central Control: A State CANNOT raise any fresh loan without the consent of the Government of India if there is still outstanding any part of a loan made to the State by the Central Government.
• Net Borrowing Ceiling (NBC): Centre fixes annual NBC (typically 3% of GSDP under FRBM norms) for each state.

• States (e.g., Kerala, Andhra Pradesh, Telangana, Punjab) raised loans through state-owned corporations (e.g., KIIFB in Kerala) without counting them under the official state budget deficit.
• In 2022, Union Finance Ministry ruled that off-budget borrowings serviced through state budgetary resources will be deducted from the State's annual NBC.
• Kerala SC Suit (2024): State of Kerala filed an original suit under Article 131 in the Supreme Court challenging the Centre's borrowing caps, arguing it violates state autonomy under Article 293.

• Cesses & Surcharges: Recommended that surcharges under Article 271 should be levied for short periods only and should eventually be integrated into the divisible pool.
• Consolidation of CSS: Recommended reducing the number of Centrally Sponsored Schemes and transferring funds directly as block grants.
• Corporate Tax: Recommended bringing Corporate Tax into the divisible pool (later implemented by 80th Constitutional Amendment Act 2000).

• Cess Cap: Recommended a strict cap on the proportion of cesses and surcharges relative to total central tax revenue to prevent erosion of the divisible pool.
• FC Terms of Reference: Recommended that Terms of Reference (ToR) for the Finance Commission should be drafted in consultation with State Governments.
• CSS Rationalization: Categorized CSS into core, core-of-core, and optional schemes with 90:10 funding for Himalayan/Northeast states and 60:40 for general states.

• Article 268-271 Sequence Mnemonic: "L-A-I-D"
• 268: Levied by Union, collected by States (Stamp duties)
• 269: Assigned to States (Inter-state consignment tax)
• 269A: IGST on inter-state trade
• 270: Divisible pool shared between Centre & States

• 15th Finance Commission Horizontal Formula Mnemonic: "I-P-A-F-D-T"
• Income Distance = 45%
• Population (2011) = 15%
• Area = 15%
• Forest & Ecology = 10%
• Demographic Performance = 12.5%
• Tax Effort = 2.5%

• Legal Entity: Non-government private company incorporated in 2013 under Section 8 (not-for-profit) of Companies Act 2013; converted into a 100% Government-owned entity in 2018 (50% Union + 50% States).
• Core Function: Provides shared IT infrastructure and frontend services (registration, return filing, tax payment, e-way bill generation) for Centre and all 28 States + 3 UTs.
• E-Way Bill System: Mandatory electronic document for movement of goods worth >₹50,000 across state borders or within state, preventing tax evasion.
• GSTR Return Filing Architecture: GSTR-1 (Outward supplies), GSTR-3B (Summary return & tax payment), GSTR-9 (Annual return).

• Constitutional Provision: Article 307 empowers Parliament to appoint such authority as it considers appropriate for carrying out the purposes of Articles 301 to 304 (Free Trade, Commerce, and Intercourse throughout India).
• Restrictions on State Taxation (Article 304): A State Legislature can impose non-discriminatory taxes on goods imported from other States, BUT cannot impose discriminatory tariffs favoring local goods over out-of-state goods.

• Legal Guarantee: Goods and Services Tax (Compensation to States) Act 2017 guaranteed States a 14% compound annual revenue growth over base year 2015-16 revenue for 5 years (1 July 2017 to 30 June 2022).
• GST Compensation Cess Fund: Funded by levying a special Compensation Cess on sin and luxury goods (pan masala, tobacco, aerated drinks, motor vehicles) over the 28% GST slab.
• COVID-19 Back-to-Back Loan Mechanism (2020-21): During COVID revenue shortfalls, Central Government borrowed ₹1.10 lakh crore (2020-21) and ₹1.59 lakh crore (2021-22) on behalf of States and passed it on as back-to-back debt without burdening state borrowing ceilings.
• Post-2022 Status: GST Compensation Cess collection extended up to March 2026 ONLY to service the principal and interest on back-to-back loans raised during COVID-19, not for fresh compensation to States.

• Grounds: Threat to the financial stability or credit of India or any part of its territory.
• Approval: Must be approved by both Houses of Parliament within 2 months by simple majority.
• Executive Effects:
• Executive authority of Union extends to giving financial directions to any State.
• President may direct reduction of salaries and allowances of all state public servants, Supreme Court & High Court judges.
• Money Bills and other Financial Bills passed by State Legislatures can be reserved for President's consideration.
• History: Financial Emergency under Article 360 has NEVER been proclaimed in India (not even during the 1991 balance of payments crisis).

• Article 285: Exemption of Central Government property from State taxation. State Governments cannot levy property tax on central infrastructure (e.g. Railways, Defence land, Central PSUs) unless authorized by parliamentary law.
• Article 286: Restrictions on States imposing tax on sale or purchase of goods taking place outside the State, or during import into / export out of India.
• Article 287: Exemption of Central Government and Railways from State electricity duty.

• Fiscal Council Concept: Recommended by the N.K. Singh FRBM Review Committee (2017) and supported by the 15th Finance Commission.
• Proposed Mandate: An independent statutory fiscal watch-dog body to conduct ex-ante micro-fiscal audits of central and state budget estimates, verify debt projections, evaluate off-budget liabilities, and advise Parliament on triggering FRBM escape clauses during national emergencies.

• Scheme for Special Assistance to States for Capital Investment (SASCI): Introduced in Union Budget 2020-21 and expanded in 2022-23.
• Provides 50-year interest-free loans to State Governments for capital projects (roads, bridges, irrigation, school buildings).
• Tied partly to states achieving specific structural reforms: urban planning reforms, scrapping old government vehicles, digitizing land records, and implementing single-window industrial clearances.

• Untied Grants (40%): Local self-governments can utilize untied grants for location-specific feel needs, basic maintenance, and civic amenities.
• Tied Grants (60%): Earmarked specifically for drinking water supply, rainwater harvesting, sanitation, and maintaining Open Defecation Free (ODF) status.