Taxation: Direct and Indirect Taxes, GST and Global Tax Issues

1. Taxes: meaning, canons and classification

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What a tax is

• A tax is a compulsory payment to the government. It is unrequited: the taxpayer gets no specific service in return. The state uses it to pay for the services it provides.
• A tax is not a fee or a charge. A fee (for a passport or a court case) is paid for a specific service and counts as non-tax revenue. Class 12, Government Budget and the Economy lists interest, dividends, profits, fees and foreign grants as non-tax revenue.
• Article 265: no tax can be levied or collected except by authority of law. An executive order alone cannot impose a tax.
• Canons of taxation (Adam Smith, Wealth of Nations, 1776):
• Equity: people pay according to their ability.
• Certainty: the amount, time and manner of payment are clear.
• Convenience: tax is collected at a time and in a way that suits the payer.
• Economy: collection costs little.
• Later writers added productivity (the tax should raise enough revenue) and elasticity (revenue should rise as income rises).

Direct vs indirect

Basis	Direct tax	Indirect tax
Who bears it	Impact and incidence fall on the same person	The burden can be shifted to others through prices
Levied on	Incomes of individuals and profits of firms	Goods and services
Examples	Personal income tax, corporation tax, capital gains tax, MAT, STT	GST, customs duty, excise duty, Social Welfare Surcharge
Nature	Can be made progressive	Generally regressive

• Class 11, Liberalisation, Privatisation and Globalisation: An Appraisal: direct taxes are "taxes on incomes of individuals, as well as, profits of business enterprises". Indirect taxes are "taxes levied on goods and services".
• Ad valorem tax: a percentage of value, as with most GST rates (e.g. 18% of the price).
• Specific tax: a fixed amount per unit of quantity, e.g. per-litre excise on petrol, the old ₹400/tonne coal cess, or the per-machine levy on pan-masala units.

Rate structures

• Progressive taxation: the rate rises with income. India's income-tax slabs are the main example. Class 12, Government Budget and the Economy calls it the government's main tool for redistribution.
• Proportional tax: one flat rate at every level of income. Example: corporation tax as a fixed proportion of profits.
• With T = tY, disposable income is (1 − t)Y, so the MPC out of income falls from c to c(1 − t).

• Multiplier = 1 / [1 − c(1 − t)]. NCERT's worked example: c = 0.8 and t = 0.25 give c(1 − t) = 0.6 and a multiplier of 2.5, against 5 with lump-sum taxes. A proportional tax therefore works as an automatic stabiliser. The full derivation is in the Government Budget and Fiscal Policy note.

• Regressive tax: takes a larger share of income from poorer people than from richer people. Examples are uniform consumption taxes and a poll tax (the same amount per head).

• NCERT error (Class 12, Government Budget and the Economy): the chapter says indirect taxes are regressive because "they impact all income groups equally". The correct reason is that an equal rate on consumption takes a larger share of a poor household's income. Poor households spend almost all their income; rich households save part of it.

Product vs production taxes (national accounts link)

• Product taxes are paid per unit of output: GST, excise, service tax, and import and export duties.
• Production taxes are paid whatever the volume of output: land revenue, and stamp and registration fees (Class 12, National Income Accounting).
• The bridge:
• GVA at factor cost + net production taxes = GVA at basic prices

• GVA at basic prices + net product taxes = GDP at market prices

• NCERT data for 2024-25 (constant prices): GVA at basic prices ₹1,71,87,446 crore + net taxes ₹16,09,509 crore = GDP ₹1,87,96,955 crore. The NCERT table labels this row "net production taxes". Under the formula above, the step from basic prices to GDP adds net product taxes. Details are in the National Income Accounting note.

2. Economics of taxation: incidence, revenue response, tax-to-GDP and tax expenditure

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Impact, incidence and shifting

• Impact is the legal liability: the person who hands the tax to the government.
• Tax incidence is the final burden: the person whose real income actually falls.
• Forward shifting passes the tax to buyers through higher prices. Backward shifting passes it to suppliers or workers through lower input prices or wages.
• The burden falls on the less elastic side of the market.
• Demand for cigarettes or petrol is inelastic, so buyers bear most of the tax.
• If buyers can easily switch, sellers bear more of it.
• See the Demand Elasticity note.

Laffer curve

• The Laffer curve (Arthur Laffer, 1974; associated with supply-side economics) plots tax revenue against the tax rate.
• At a 0% rate revenue is zero. At 100% it is also zero, because nobody works or reports income.
• Past an optimum rate, higher rates reduce revenue because people work less, avoid tax and evade it.
• Indian tests:
• After 1991, personal and corporate tax rates were cut. Class 11, Liberalisation, Privatisation and Globalisation: An Appraisal says "moderate rates of income tax encourage savings and voluntary disclosure of income".
• The same chapter also warns that "the tax reductions in the reform period … have not resulted in increase in tax revenue".
• The 2019 corporate-rate cut (see Section 3) is the latest test.

Buoyancy vs elasticity

	Tax buoyancy	Tax elasticity
Formula	% change in tax revenue ÷ % change in GDP	Same ratio, with rates and base held constant
Includes	Discretionary changes (new rates, new taxes, base widening)	Only the automatic response to growth
Reading	Above 1 means revenue grows faster than GDP (desirable)	Shows how well built-in the tax system is

• Worked example: revenue rises 12% and GDP rises 10%, so buoyancy = 1.2.

Tax-to-GDP and composition

• The tax-to-GDP ratio is total tax revenue as a percentage of GDP. It shows how much the state can raise.
• India: the Centre's gross tax is about 11.5-12% of GDP. General government (Centre + states) is about 17-18%. The OECD average is about 34% (verify current).
• Class 12, Government Budget and the Economy (Table 5.1, 2024-25 provisional actuals): the Centre's tax revenue net of the states' share is 7.9% of GDP.
• Direct taxes are now over half of the Centre's gross tax. Personal income tax has overtaken corporation tax (verify current).

Tax expenditure and incentives

• Tax expenditure is revenue the government gives up through exemptions, deductions and concessions. It works like a hidden subsidy.
• It has been reported every year since 2006-07 in the Receipt Budget's Statement of Revenue Impact of Tax Incentives.
• Tax incentives, such as those for industries in backward areas or for foreign investors, narrow the base. Class 11, Liberalisation, Privatisation and Globalisation: An Appraisal says they "further reduced the scope for raising tax revenues".
• Tax holiday: a temporary exemption for new firms or investments.
• SEZ units got an income-tax holiday under Sec. 10AA, but only units that started operations by 31 March 2020.

• Budget 2026-27 extended the IFSC-unit holiday from 10 to 20 years. It also gave a holiday to 2047 for cloud services from Indian data centres (verify current).

• The new-regime logic: lower rates in exchange for fewer exemptions. This shrinks tax expenditure and simplifies compliance.

3. Direct taxes in India

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Personal income tax

• Income tax is a direct tax on individual incomes at progressive rates.
• It was introduced in 1860 by James Wilson after the 1857 revolt.
• The Income-tax Act 1961 is replaced by the Income-tax Act 2025 from 1 April 2026. A single "tax year" replaces the old "previous year" and "assessment year" (verify current).
• Old vs new regime: the new regime (Sec. 115BAC) has lower rates and almost no deductions. It has been the default since FY 2023-24.

New-regime slabs (from FY 2025-26; unchanged in 2026-27) | Income (₹) | Rate | |---|---| | 0-4 lakh | Nil | | 4-8 lakh | 5% | | 8-12 lakh | 10% | | 12-16 lakh | 15% | | 16-20 lakh | 20% | | 20-24 lakh | 25% | | Above 24 lakh | 30% |

• A rebate makes income up to ₹12 lakh tax-free. For salaried people, the ₹75,000 standard deduction raises this to ₹12.75 lakh.

Collection and administration

• Tax deducted at source (TDS) is collected when a payment is made, e.g. by an employer from salary. Tax collected at source (TCS) is collected by the seller at the point of sale. The payer or seller deposits the tax with the government.
• TCS on LRS remittances for education and medical purposes was cut to 2% in 2026-27 (verify current).
• Faceless assessment (2020) is done electronically, with no face-to-face contact between taxpayer and officer. It aims to cut discretion and corruption. It was launched along with the Taxpayers' Charter.
• Paper taxes (Class 12, Government Budget and the Economy) were direct taxes that "never brought in large amount of revenue":
• Wealth tax was abolished in Budget 2015-16 and replaced by an additional surcharge on the super-rich.
• Estate duty ran from 1953 to 1985.

• Gift tax was abolished in 1998.

• Wealth tax and inheritance tax: a wealth tax is levied on net assets. An inheritance tax (estate duty) is levied on property passed on at death. India has neither today. The inheritance-tax debate revived in 2024.

Corporate tax

• Corporate tax is levied at a proportional rate on company profits. It does not accrue to households. Class 12, National Income Accounting subtracts it from National Income to arrive at Personal Income.
• September 2019 cut:
• Sec. 115BAA: 22% for firms that give up exemptions. The effective rate is about 25.17% with surcharge and cess.

• Sec. 115BAB: 15% for new manufacturing firms that started production by March 2024.

• Minimum Alternate Tax (MAT) is a minimum tax on a company's book profits where its normal tax is lower. It targets "zero-tax" companies that still pay dividends.

• It was introduced in 1987 and now sits in Sec. 115JB.
• The rate has been 15% since 2019.
• It is not levied on 115BAA firms.

Market taxes

• Capital gains tax is the tax on profit from selling a capital asset. From 23 July 2024:
• Listed equity, short-term: 20%.
• Listed equity, long-term: 12.5% on gains above ₹1.25 lakh.
• Holding period for long-term: 12 months for listed assets, 24 months for others.
• Indexation removed.

• Share buybacks are taxed as capital gains from 2026-27, with an extra levy on promoters (verify current).

• Securities Transaction Tax (STT) was introduced in 2004. It is a tax on the value of securities bought and sold on stock exchanges, including derivatives.

• F&O rates were raised in 2024.

• Budget 2026-27 raised them again: futures 0.02% → 0.05% and options 0.1% → 0.15% (verify current).

• Angel tax (Sec. 56(2)(viib), 2012) taxed the premium above fair market value that unlisted companies, mostly start-ups, received on share issues.

• It was extended to non-resident investors in 2023.
• It was abolished from AY 2025-26.

4. Cesses and surcharges: earmarked and unshared levies

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	Cess	Surcharge
Constitutional basis	Excluded from the divisible pool under Art. 270	Art. 271: levied for Union purposes
Purpose	Earmarked for a stated purpose	Not earmarked; goes to the general fund
Nature	Separate levy on income or on goods	A "tax on tax" (a % of the tax payable)
Shared with states?	No	No

Cess examples

• Health and Education Cess: 4% on income tax, from 2018. It replaced the 2% education cess and the 1% secondary and higher education cess.
• Road and Infrastructure Cess on petrol and diesel.
• Agriculture Infrastructure and Development Cess (AIDC): 2021.
• GST compensation cess (see Section 7).
• Health Security se National Security Cess (2025) on pan-masala manufacturing machines. It is a specific levy per machine or capacity, not per packet sold.

Surcharge rates

• Individuals: 10%, 15%, 25% and 37% on incomes above ₹50 lakh, ₹1 crore, ₹2 crore and ₹5 crore. The top rate is capped at 25% in the new regime.
• Companies: 7% (income above ₹1 crore) and 12% (above ₹10 crore). 115BAA firms pay a flat 10%.
• Social Welfare Surcharge (SWS) on customs duty (2018). It is levied on imports, so it is an indirect tax.

Issues

• Rising share: cesses and surcharges went from about 10% of the Centre's gross tax in the early 2010s to a peak of about 18-20% in 2020-22 (verify current).
• Weak earmarking: CAG audits found that cess proceeds were not fully transferred to their dedicated funds. Money meant for a purpose sat in the general pool.
• Federal cost: states get their share (41% under the 15th Finance Commission) only of the divisible pool. More cess and surcharge means less real devolution. The detail is in the Fiscal Federalism note.

5. Indirect taxes before GST and the reform path

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The pre-GST maze

Level	Tax	Key facts
Centre	Excise duty (on manufacture)	MODVAT 1986 → CENVAT (2000); cross-credit with service tax from 2004
Centre	Service tax	1994, on Chelliah's advice; negative list 2012 (all services taxed except those listed)
Centre	Customs	Customs Act 1962; today basic customs duty + IGST on imports + SWS + AIDC
Centre (collected by states)	Central Sales Tax	Origin-based tax on inter-state sales
States	State VAT	Haryana 2003, most states 2005; replaced sales tax
States/local	Entry tax, octroi, luxury and entertainment taxes	Check posts and fragmented markets

• Customs revenue: after 1991, tariff cuts "curtailed the scope for raising revenue through custom duties" (Class 11, Liberalisation, Privatisation and Globalisation: An Appraisal). Budget 2025-26 cut the number of tariff rates (verify current).
• Excise duty principle (Class 12, Government Budget and the Economy): necessities are exempt or taxed low, comforts and semi-luxuries moderately, and luxuries, tobacco and petroleum heavily.
• Today Union excise survives mainly on the five petroleum products and tobacco.
• States levy excise on alcohol.

The core defect: cascading

• Cascading effect of taxes: a tax on a tax.
• The old system taxed the full value of a good at each stage, including taxes already paid on intermediate inputs.
• Credit for input tax was minimal (Class 12, Government Budget and the Economy, Box 5.3).

• Final prices rose, markets were fragmented, and trucks lost time at check posts.

• Value added tax (VAT) fixes this. Each stage pays tax only on the value it adds.

• Under the invoice-credit method, a seller charges tax on the full sale value, then subtracts the tax shown on purchase invoices.

• GST extends this principle to all goods and services.

• Worked example:

• A cotton grower sells to a spinner for ₹100 and pays 10% tax, i.e. ₹10.
• The spinner sells yarn for ₹150. Under VAT, the spinner owes ₹15 − ₹10 credit = ₹5, which is 10% of the ₹50 value added.
• Without credit, the spinner pays ₹15 on a price that already includes ₹10 of tax. The tax cascades.

Tax reforms: milestones

• Tax reforms after 1991 aimed at a broader base, fewer and lower rates, simpler procedures and a common national market.
• Chelliah Tax Reforms Committee (1991-93): fewer and lower rates, a broader base, VAT, and service tax.
• Empowered Committee of State Finance Ministers (2000): steered state VAT and then GST.
• Kelkar Task Forces: 2002 on direct and indirect taxes; 2004 on FRBM implementation, which proposed a national GST.
• GST announced in the 2006-07 Budget speech.
• 122nd Amendment Bill (2014) → 101st Constitution Amendment Act (2016).
• Class 11, Liberalisation, Privatisation and Globalisation: An Appraisal describes indirect-tax reform as aimed "to facilitate the establishment of a common national market". It adds that simplification and lower rates were meant to "encourage better compliance".

6. GST architecture: dual, destination-based, credit-linked

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Constitutional base

• 101st Amendment: presidential assent on 8 September 2016.
• Art. 246A: Parliament and state legislatures can both make GST laws.
• Art. 269A: GST on inter-state supply is levied by the Centre and apportioned between Union and states.
• Art. 279A: GST Council. Its governance is covered in the Fiscal Federalism note.

• Art. 366(12A): defines GST.

• Goods and Services Tax (GST) is a single comprehensive indirect tax on the supply of goods and services, with input tax credit, that subsumes many central and state taxes.

• Launched on 1 July 2017 at a midnight session of Parliament (30 June-1 July).
• Laws: CGST, IGST, UTGST and SGST Acts.

Design

• Destination-based taxation: the tax goes to the state where goods or services are consumed, not the state where they are produced. This helps consuming states such as Uttar Pradesh and Bihar.
• CGST, SGST and IGST:
• Intra-state supply: CGST + SGST, or UTGST in union territories, levied together by the Centre and the state.
• Inter-state supply and imports: IGST, levied by the Centre and shared with the destination state.
• Example: a ₹1,000 intra-state sale at 18% attracts ₹90 CGST + ₹90 SGST. The same sale across a state border attracts ₹180 IGST.

Subsumed in GST	Outside GST
Centre: central excise, service tax, CST, KKC and SBC cesses	Alcohol for human consumption, kept out by the Constitution; states levy VAT and excise
States: VAT/sales tax, entry tax, octroi, luxury tax, entertainment tax, taxes on advertisements and on lottery/betting/gambling, state cesses	Five petroleum products: crude, petrol, diesel, ATF, natural gas. They are in the GST law, but the Council has not yet notified a date
	Electricity, stamp duty, basic customs duty
	Tobacco pays GST plus central excise

Mechanics

• Input tax credit (ITC) is credit for tax paid at the previous stage, set off at the next stage. It makes GST a tax on value addition.
• Utilisation order: IGST credit is used first, then CGST and SGST credit.

• Blocked credits under Sec. 17(5), e.g. food, personal cars and personal consumption, cannot be claimed.

• Reverse charge mechanism (RCM): the recipient, not the supplier, pays the GST.

• Examples: services of goods transport agencies and advocates, and notified supplies from unregistered persons.

• In Mohit Minerals (2022), the Supreme Court struck down RCM IGST on ocean freight. It also held that GST Council recommendations are persuasive, not binding.

• Composition scheme: a simple option for small taxpayers.

Category	Turnover limit	Rate
Traders and manufacturers	₹1.5 crore (₹75 lakh in special-category states)	1%
Restaurants	₹1.5 crore	5%
Service providers	₹50 lakh	6%

• Composition dealers get no ITC and cannot make inter-state supplies.
• Zero-rated supply vs exempt vs nil-rated:
• Zero-rated supplies (exports, SEZ supplies) carry no GST, but the supplier keeps input credit. It is claimed as a refund or by exporting under a Letter of Undertaking (LUT).
• Exempt and nil-rated supplies carry no GST and no ITC.

Compliance tools

• E-way bill (April 2018): an electronic document on the GST portal for moving goods worth over ₹50,000. It tracks movement and curbs evasion.
• E-invoicing: invoices are authenticated online with an Invoice Reference Number (IRN). Returns are then filled in automatically. The turnover threshold was cut to ₹5 crore from August 2023.
• GSTN portal (www.gst.gov.in): registration, returns and payments online.
• Registration thresholds: ₹40 lakh for goods, ₹20 lakh for services (verify current).
• Revenue neutral rate (RNR): the rate at which GST collects the same revenue as the taxes it replaced.
• The Arvind Subramanian committee (2015) put it at 15-15.5%, with a standard rate of 17-18%.

NCERT's promised benefits (Class 12, Government Budget and the Economy, Box 5.3)

• A common market and freer movement of goods.
• Lower business costs and less cascading.
• Greater competitiveness.
• Easier online compliance and less human interface.
• GDP "expected to rise by about 2%". Treat this as a claim to evaluate, not an established fact.

7. GST rates, compensation and the 2025 rationalisation

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Rate structure: then and now

• 2017 structure (GST rate slabs):
• 0, 5, 12, 18 and 28%.
• Special rates of 3% (gold) and 0.25% (rough diamonds).

• Compensation cess on top of 28% for sin and luxury goods.

• NCERT outdated (Class 12, Government Budget and the Economy, Box 5.3):

• It lists "6 standard rates … 0%, 3%, 5%, 12%, 18% and 28%" and "one rate for one type of goods".

• Since the 2025 reform: two main slabs plus a special rate. Even in 2017, one type of good could fall in different slabs by value or kind.

• 56th GST Council (3 September 2025), effective 22 September 2025:

Slab	Covers
Nil	Many staples; individual life and health insurance exempted
5% (merit)	Common-use goods and services
18% (standard)	Most goods and services
40% (special)	Pan masala, tobacco, aerated and sugary drinks, mid-size and large cars, yachts, private aircraft
3% / 0.25%	Kept for gold and rough diamonds

• Coal: GST rose from 5% to 18% and the ₹400/tonne compensation cess was removed.
• Petroleum and alcohol stay outside GST.

Compensation to states

• The GST (Compensation to States) Act 2017 guaranteed states 14% annual revenue growth over the 2015-16 base for five years, until June 2022.
• GST compensation cess on luxury and sin goods funded this guarantee.
• COVID shortfall: the cess did not collect enough.
• The Centre borrowed and passed the money to states as back-to-back loans: ₹1.1 lakh crore in 2020-21 and ₹1.59 lakh crore in 2021-22.

• The cess levy was extended to March 2026 to repay these loans.

• End of compensation cess: the 2025 rationalisation ends it for all goods except tobacco, which continues only until the loans are cleared.

• After that:
• The Central Excise (Amendment) Act 2025 keeps the tax burden on tobacco.
• The Health Security se National Security Cess Act 2025 does the same for pan masala.
• The aim is to keep sin products expensive after the cess ends (verify current effective dates).

Inverted duty structure

• An inverted duty structure exists when inputs are taxed at a higher rate than the finished product. Unused input credit piles up and blocks working capital.
• Examples: textiles (fibre and yarn vs garments), footwear, fertilisers, pharma.
• Refunds follow a set formula. Fixing the inversions was a stated aim of the 2025 reform.

Anti-profiteering

• Anti-profiteering (Sec. 171, CGST Act) requires businesses to pass rate cuts and ITC benefits to consumers.
• National Anti-profiteering Authority (2017) → Competition Commission of India (December 2022) → no new applications from 1 April 2025.

Debates

• Consumption boost vs revenue loss: the net loss from the 2025 changes is estimated at about ₹48,000 crore (verify current).
• States' revenue worries now that compensation has ended. See the Fiscal Federalism note.
• Bringing in petroleum, electricity and real estate would complete the ITC chain but cut states' own revenue.

8. Tax avoidance, evasion and black money

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Avoidance vs evasion

Tax planning	Tax avoidance	Tax evasion
Using reliefs as the law intends (e.g. choosing a regime)	Legal but exploits loopholes against the spirit of the law	Illegal: concealing income, fake invoices, false records

• Specific anti-avoidance rules target known tricks, e.g. transfer-pricing rules.
• The General Anti-Avoidance Rule (GAAR) gives a broad power to deny tax benefits.
• It sits in Chapter X-A and applies from AY 2018-19. The Shome committee (2012) had recommended deferring it.
• It applies only above a ₹3 crore tax benefit.
• It targets "impermissible avoidance arrangements": deals whose main purpose is a tax benefit and which lack commercial substance, are not at arm's length, or misuse the law.

Tax compliance

• Tax compliance is the extent to which people meet their tax obligations.
• Class 11, Liberalisation, Privatisation and Globalisation: An Appraisal: high income-tax rates were "an important reason for tax evasion". Moderate rates and simpler procedures encourage voluntary disclosure.
• Demonetisation (2016) and GST are credited with widening the tax net. The number of return filers grew. Whether this reflects real formalisation of the economy is debated.
• Other levers: faceless processes, wider TDS/TCS, data analytics and third-party reporting.

Black money

• Black money is income hidden from the tax authorities.
• Sources: evasion, corruption, crime, real estate deals and benami holdings.
• Studies: NIPFP estimate (1985) and the White Paper on Black Money (2012).
• Responses:
• Special Investigation Team (SIT): 2014.
• Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act 2015.
• Benami Transactions (Prohibition) Amendment Act 2016. A benami transaction is property held in one person's name while another person paid for it.
• Demonetisation: covered in the Money note.

Laundering networks

• Money laundering hides the illegal origin of money by passing it through legitimate-looking deals.
• Placement: putting cash into the system.
• Layering: moving it through many transactions to hide the trail.

• Integration: bringing it back as "clean" money.

• PMLA 2002 is enforced by the Enforcement Directorate (ED), with FIU-IND analysing suspicious transactions.

• FATF: India has been a member since 2010. The 2024 mutual evaluation placed India in "regular follow-up", the best category.
• Hawala moves money through a network of brokers. No money physically crosses borders and there are no formal records. It is an offence under FEMA and PMLA.
• Shell company: a company with no real operations or assets, used for layering, tax evasion and hiding the real owner.
• MCA deregistration drives began in 2017.
• Beneficial-ownership rules require disclosure of the real owners.

9. International taxation: treaties, profit shifting and the global minimum tax

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Basic principles

• Residence taxation: a country taxes its residents' worldwide income.
• Source taxation: a country taxes income earned within its territory.
• Permanent establishment (PE): a fixed place of business, such as an office or factory, that lets the source country tax a foreign firm.
• Double Taxation Avoidance Agreement (DTAA): a treaty so that the same income is not taxed twice. It works through the credit method (tax paid abroad is credited at home) or the exemption method.
• Treaty shopping is routing investment through a treaty country only to get tax benefits.
• India-Mauritius protocol (2016): capital gains on shares acquired from April 2017 are taxed in India (source-based).
• India ratified the MLI (the OECD multilateral treaty tool) in 2019. It added a principal purpose test: treaty benefits are denied if getting them was a main purpose of the deal.

Transfer pricing, havens and information exchange

• Transfer pricing is the pricing of deals between related units of a multinational. Tax law requires arm's-length prices, the prices unrelated parties would charge, so profits are not shifted.
• Secs. 92-92F (since 2001).
• Advance Pricing Agreements (2012): the price method is agreed with the tax department in advance.

• Safe-harbour rules: margins the tax department accepts without scrutiny.

• Tax haven: a jurisdiction with very low or no taxes plus strict secrecy. Leaks exposed users: Panama Papers (2016), Paradise Papers (2017) and Pandora Papers (2021).

• Automatic exchange of information: countries regularly share financial-account data on each other's residents.
• OECD Common Reporting Standard (CRS): India's first exchange was in 2017.
• FATCA agreement with the US: 2015.

Retrospective taxation: the tax-certainty lesson

• Retrospective taxation taxes past transactions under a law changed later.
• Vodafone won in the Supreme Court in 2012.
• The Finance Act 2012 then retrospectively amended the law on indirect transfers of Indian assets.
• India lost the Vodafone and Cairn arbitrations (2020).

• The Taxation Laws (Amendment) Act 2021 withdrew the demands and refunded amounts collected.

• Lesson: sudden changes to tax law hurt investor confidence.

BEPS and taxing the digital economy

• Base Erosion and Profit Shifting (BEPS): planning that uses gaps and mismatches in tax rules to move profits to low- or no-tax places.
• The OECD/G20 BEPS project ran from 2013 to 2015 and produced 15 actions.

• Action 1 covers the digital economy.

• Equalisation levy: India's own levy on payments to non-resident digital firms.

• 6% on online advertising (2016).
• 2% on e-commerce operators (2020).

• The 2% levy was abolished from 1 August 2024 and the 6% levy from 1 April 2025, amid US Section 301 trade-retaliation pressure.

• Significant economic presence (SEP): a non-resident is treated as having a taxable presence because of digital transactions or users, even with no office.

• Introduced by the Finance Act 2018.
• Thresholds from 2021: ₹2 crore of payments or 3 lakh users.

The Two-Pillar Solution (October 2021, about 136+ jurisdictions)

	Pillar One	Pillar Two (Global minimum tax)
Aim	Give market countries (where users are) a share of taxing rights	A floor on corporate tax
Scope	MNEs with over €20 billion revenue and over 10% profit margin	Groups with €750 million+ revenue
Rule	Amount A: 25% of residual profit (profit above 10% margin) reallocated	15% minimum effective rate in each country
Tools	Multilateral convention	GloBE rules: IIR (income inclusion rule), UTPR (undertaxed profits rule), QDMTT (domestic top-up tax); treaty-based STTR (subject-to-tax rule)
Status	Convention stalled	Many countries have put it into law

• US stance: the US withdrew in January 2025. The G7 reached a "side-by-side" understanding in June 2025: US-headquartered groups would be kept out of some Pillar Two rules (verify current).
• India's position: India backed the Two-Pillar deal. It gave up the equalisation levy but also offers IFSC and data-centre tax holidays that must fit with a 15% floor (verify current).
• UN track: negotiations on a UN Framework Convention on International Tax Cooperation run in parallel. They are pushed by developing countries that want a more inclusive forum than the OECD (verify current).

10. Corrective and special-purpose taxes

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Pigouvian and carbon taxes

• Pigouvian tax (A.C. Pigou, The Economics of Welfare, 1920): a tax on activities that create negative externalities, such as pollution.
• Ideally tax = marginal external cost, so private cost equals social cost.
• Double dividend: less pollution, plus revenue that can be used to cut other, more distorting taxes.

• Class 12, National Income Accounting's refinery-polluting-a-river example is exactly this kind of unpriced externality.

• Carbon tax: a Pigouvian tax on the carbon content of fuels or on emissions.

• Explicit: Sweden, Canada.

• Implicit: India's high excise on fuel acts as one.

• India's coal cess:

• Started as the Clean Energy Cess at ₹50/tonne (2010) and rose to ₹400/tonne (2016).
• Subsumed into the GST compensation cess in 2017.

• Removed in 2025, with GST on coal raised to 18%.

• Carbon tax vs cap-and-trade, India's Carbon Credit Trading Scheme and the EU's CBAM are covered in the Environment and Sustainable Development and International Trade Policy notes.

Sin tax

• Sin tax: a higher tax on harmful or demerit goods such as tobacco, alcohol and sugary drinks. It aims to promote healthier choices.
• India applies the 40% GST rate to tobacco and aerated drinks. Tobacco also carries central excise, and pan masala carries the HSNS cess.
• WHO recommends that excise make up at least 75% of the retail price of tobacco.

Windfall tax

• Windfall tax: a special, often one-time tax on unusually large profits caused by an outside shock, such as an oil-price spike.
• India: a Special Additional Excise Duty (SAED) on domestic crude and on exports of petrol, diesel and ATF ran from July 2022 until it was abolished in December 2024.
• UK: the Energy Profits Levy (2022).

Tobin tax

• Tobin tax (James Tobin, 1972): a small tax on currency transactions to curb short-term speculative flows ("throw sand in the wheels").
• The EU has proposed a financial transaction tax (FTT).
• India's STT (2004) and Commodities Transaction Tax (CTT, 2013) work like FTTs.

Design issues

• Behaviour vs revenue: if the tax works and people change behaviour, revenue falls.
• Pass-through: the tax is shifted to consumers (incidence again).
• Regressivity: fuel and tobacco taxes hit the poor harder.
• Evasion and smuggling: high sin taxes feed illicit trade.
• Capital flight: financial taxes can drive trading abroad.

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Exam angles

Prelims — high-yield facts and traps

• Direct: income tax, corporation tax, MAT, capital gains tax, STT. Indirect: GST, customs, excise, SWS. The trap "STT is indirect because it is on transactions" is FALSE.
• Progressive: income-tax slabs. Proportional: corporate tax (T = tY; MPC becomes c(1 − t)). Regressive: uniform consumption taxes, poll tax. "Indirect taxes are regressive because they affect all groups equally" is FALSE. They are regressive because they take a larger share of poor incomes.
• Ad valorem = % of value. Specific = fixed amount per unit (per-litre fuel excise, per-machine pan-masala cess).
• Cess is earmarked (Art. 270). Surcharge is a tax on tax and not earmarked (Art. 271). Neither is shared with states. Health and Education Cess = 4% (2018).
• GST: 101st Amendment (2016); Arts. 246A, 269A, 279A, 366(12A); launched 1 July 2017; destination-based; IGST on inter-state supplies and imports.
• Outside GST: alcohol for human consumption, five petroleum products (in the law but not notified), electricity, stamp duty, basic customs duty. Tobacco pays GST + excise.
• GST rates: 5/18/40% since 22 September 2025, plus 3%/0.25% special rates. Compensation guaranteed 14% growth over the 2015-16 base, for five years to June 2022.
• ITC removes cascading. RCM: the recipient pays. Composition: ₹1.5 crore limit, 1%/5%/6%, no ITC. Zero-rated keeps ITC; exempt/nil do not. E-way bill: ₹50,000. E-invoice: ₹5 crore.
• Buoyancy includes rate and base changes. Elasticity excludes them. Buoyancy above 1 means revenue grows faster than GDP.
• Laffer curve: beyond an optimum, higher rates reduce revenue. Incidence falls on the less elastic side. Tax expenditure = revenue foregone (statement since 2006-07). RNR = revenue-neutral rate (15-15.5%).
• Direct-tax numbers: new-regime rebate to ₹12 lakh (₹12.75 lakh salaried); corporate tax 22%/15% (2019); MAT 15% on book profits (introduced 1987); LTCG 12.5% above ₹1.25 lakh and STCG 20% on listed equity (July 2024); STT 2004; angel tax abolished from AY 2025-26; wealth tax abolished 2015-16; estate duty ended 1985; gift tax ended 1998; Income-tax Act 2025 in force from 1 April 2026.
• Global: BEPS has 15 actions. Pillar One: €20 bn revenue, 25% of residual profit above a 10% margin. Pillar Two: 15% minimum, €750 mn threshold, IIR/UTPR/QDMTT/STTR.
• Equalisation levy: 6% (2016) abolished April 2025; 2% (2020) abolished August 2024. SEP: ₹2 crore or 3 lakh users. APA: 2012. FATCA: 2015. CRS: 2017.
• Pairings: Pigou – externality tax (1920); Tobin – currency-transaction tax (1972); windfall tax – SAED (2022-24); GAAR – Shome committee; RNR – Arvind Subramanian; national GST – Kelkar Task Force (2004); service tax – Chelliah (1994); income tax – James Wilson (1860); Laffer – 1974.
• Traps: "Surcharge is shared with states" is FALSE. "GAAR applies to every avoidance arrangement" is FALSE (₹3 crore threshold). "Petrol is outside the GST law" is FALSE (it is in the law, but the rate is not notified). "Anti-profiteering applications are still accepted" is FALSE (stopped from 1 April 2025).

Mains — GS-III themes

1. Low tax-to-GDP and a narrow base: India's ratio vs OECD peers; the direct vs indirect balance; progressivity; the cost of exemptions (tax expenditure); whether the new-regime simplification and the Income-tax Act 2025 can widen compliance.
2. GST after eight-plus years: buoyancy, compliance and the formalisation debate; inverted duties; the 2025 rationalisation's trade-off between consumption and revenue; the end of compensation; the case for bringing in petroleum, electricity and real estate (federal angle in the Fiscal Federalism note).
3. Laffer logic in India: did the 1990s rate cuts and the 2019 corporate cut raise revenue or investment? Class 11, Liberalisation, Privatisation and Globalisation: An Appraisal argues that tax cuts and incentives did not raise revenue and squeezed developmental and welfare spending.
4. Black money and illicit flows: PMLA, the Benami Act, the Black Money Act, FATF, tax havens and offshore leaks; the revenue effect of demonetisation; the line between aggressive planning and avoidance (GAAR).
5. International tax: taxing the digital economy; unilateral levies vs OECD consensus; Pillar Two vs India's IFSC and data-centre holidays; the US exit and the "side-by-side" deal; the UN tax convention as a Global South forum; retrospective taxation (Vodafone, Cairn) and tax certainty.
6. Corrective taxes: carbon pricing for the green transition; sin taxes for public health (WHO benchmark, the 40% slab); windfall taxes vs policy certainty; regressivity and pass-through.
7. Cesses and surcharges: their rising share, weak earmarking (CAG) and erosion of the divisible pool, set against the Centre's revenue needs.

Current-affairs hooks

• Union Budget and Finance Act changes: slabs, rebate, capital gains, STT, buyback tax, customs tariff rationalisation, tax holidays. Rollout of the Income-tax Act 2025 with its new rules and forms.
• GST Council meetings and monthly GST collection data; reviews of the September 2025 rationalisation; the end of compensation cess; notifications on tobacco excise and the HSNS cess.
• CBDT direct-tax collection data and ITR filing numbers; the Statement of Revenue Impact of Tax Incentives; CAG audits of cesses.
• Pillar Two implementation, US stance, G7/G20 statements; sessions of the UN tax-convention negotiations; new offshore leaks.
• FATF plenaries; ED and PMLA cases; windfall-tax or sin-tax debates set off by oil-price shocks or health-policy moves.