Expert Committee on Financial Provisions

REPORT  OF THE EXPERT COMMITTEE

December 5, 1947

To

The Secretary,

Constituent Assembly of India,

Council House,

New Delhi

Expert Committee on Financial Provisions

SIR,

I have the honour to forward herewith the Report of the Expert Committee on Financial Provisions of the Union Constitution for submission to the Hon’ble the President.

I have etc.

V. RANGACHARI,

Member-Secretary

TERMS OF REFERENCE

I. To examine, with the aid of the memoranda on the distribution of revenue between the Centre and the provinces sent by the Government of India and the provinces, the existing provisions relating to finance and borrowing powers in the Government of India Act, 1935, and their working during the last ten years and to make recommendations as to the entries in the lists and sections to be embodied in the new Constitution.

The following points shall, in particular, be kept in view in making the recommendations:

(a) How are taxes to be allocated between the Centre and the units as regards legislation, levy and collection?

(b) Which are the Federal taxes—

(i) whose net proceeds are to be retained entirely by the Centre;

(it) whose net proceeds are to be entirely made cwer to units;

(iii) whose net: proceeds are to be shared between thé Centre and the units?

(c) On what. principles are the taxes mentioned in (b} Gi to be shared between the Centre and the units?

(d) What is to be the machinery – for determining the shares: e.g., whether a Financial Commission should be appointed immediately after the enactment of the Constitution to report on the principles of sharing and their application to be brought into effect when the Constitution comes into force; and whether the same or a similar ‘Commission should review these principles and their concrete application periodically, say, once in five years?

II. What should be the principles on which Federal grants should be made to the units in future? What should be the machinery for the determination of such grants: could the same Financial Commission as is referred to in I(d) above act as the machinery for this purpose also, or should it be a different one?

III. How could the Indian States be fitted into this general system as far as possible on the same terms as provinces? Should a time lag be provided for their being ‘so fitted in?

IV. On the assumption of financial responsibility for Defence, Foreign Affairs and Communications on behalf of the Indian States under arrangements for accession to the Federation, what special financial arrangements, if any, are. necessary between the acceding States and the Federation

V. Should the existing rights of the Indian States as to Federal taxes now levied by them be acquired on payment of compensation?

VI. How far is it feasible, on the centralization of all customs levied at the Federal frontiers, to permit Indian States affected by. such centralization to retain such portion of the customs so levied at their frontiers as might be attributed to consumption in the States, etc.? [A review of the existing agreements between the Centre and certain important Indian States as regards maritime customs, excises etc. may be of value in this connection.]

VII. Some provinces have claimed a larger percentage of the’ income- tax to be made over to them than under the existing system. Does this claim merit consideration; if so, to. what extent?

VIII. A suggestion has been made that the Centre should be allocated only the excises on specified commodities, the rest of the field of excises being left to the. provinces to tap according to their needs. Would this be possible without any material detriment to Federal revenue?

IX. On the basis that the residuary powers are vested in the Centre in the new Constitution so far as the provinces are concerned, and in the States so far as the States. are concerned, is it necessary that any should be entered in the Provincial List, and if so, what?

X. Is it necessary to make any modifications in the existing provisions as regards procedure in financial matters contained in section 33 to 27 and 78 to 83 of the Government of India Act, 1935?

XI. A large number of Indian States at present derive substantial revenues from land customs levied at the frontiers between their limits and those of neighbouring States or provinces. One of the fundamental rights already adopted by the Constituent Assembly is to remove all internal barriers in regard to trade between unit and unit, Could these land customs be done away with either immediately or over a period of years, and if so, Should any prejudice caused thereby to the finances of particular States be compensated and in what manner?

[The committee should kindly indicate clearly which of its recommendations should go into the body of the Constitution and which should be provided for by Federal law.]

PREFATORY REMARKS

2. We began our work on the 17th November and have been sitting continuously. We have received memoranda from the various Provincial Governments setting out their claims for larger resources as well as their points of view in connection therewith. We have also received a memorandum from the Ministry of Finance of the Central Government giving a picture of the financial position of the Centre in the near future. The Secretariat of the Constituent Assembly has collected for us information on various matters relating to the States, and also helpful information regarding other Federations. It has also prepared a draft of the sections which come within our terms of reference; and this has considerably helped us in our work. We are indebted for all these memoranda, information and drafts. We are also indebted to some of the provincial authorities who appeared before us in person and discussed with us informally the questions arising out of the memoranda presented by their Governments. We availed ourselves also of the specialized knowledge and experience of not only some of the officials of the Central Secretariat, but of some members of the Constituent Assembly and others who have unique knowledge of some of the problems under our consideration. All our discussions, however, were free and informal; and we did not, therefore, record any evidence, apart from the memoranda placed before us.

3. In particular, the other two of us would like to place on record our grateful appreciation of the assistance we have received from our colleague and Secretary Mr. Rangachari, who amidst his exacting, multifarious duties, including the preparation of the interim budget, not only found time regularly to attend our meetings, but also placed his wide knowledge and experience at our disposal, and arranged to secure at short notice most of the available information required by us. We should also like to thank Mr. B. Das Gupta of the West Bengal Government Secretariat for the intelligent and extremely well informed assistance he gave us. We are also indebted to Mr. Mukerjee, Joint Secretary of the Constituent Assembly, for his help throughout our sittings and in particular for putting our recommendations in the shape of draft amendments to the Constitution.

4. Our terms of reference may be divided broadly into the four following groups:

(1) Relations between the Centre and the units, and between the units inter se;

(2) Financial procedure, ie., relating to the budget, expenditure and Money Bills;

(3) Borrowing powers of units; and

(4) Relations of the Union with the States.

We have accordingly, for convenience, regrouped our terms of reference as follows:

(1), I, VII, VIII, IX, II

(2) X

(3) I

(4) III, IV, V, VI, XI

and discussed them, as far as possible, in the above order.

BRIEF HISTORY OF FINANCIAL RELATIONS

5. Before dealing with the working of the financial arrangements in the Government of India Act, 1935, it is necessary to give a brief account of the earlier arrangements so that we can have a correct picture of the problems before us.

6. The period before the passing of the Government of India Act, 1935, falls into two well-defined parts, namely, the period ending with the 31^st March, 1921, i.e., before the operation of the Government of India Act, 1919, and the period covered by that Act.

7. The process of financial development in this country has been one of evolution from a unitary to a quasi-federal type. The Government of India started as a completely unitary Government in entire control of the revenues of the country with the Provincial Governments depending on the Central Government for all their requirements. In the earlier years, Provincial Governments were given fixed grants for meeting the expenditure on specific services, and the first step in making specific sources available to them was taken when the Provincial Governments were given the whole or part of certain heads of revenue like Forest, Excise, Licence Fees (later to develop into Income-tax), Stamps, Registration, Provincial Rates, Law and Justice, Public Works, Education, etc. The funds released by this allocation were not adequate for the requirements of the provinces and had to be supplemented, mainly by sharing with them in varying proportions the main source of Central revenue, namely; Land Revenue, and partly by making to them additional cash assignments. In 1904, the settlements with the provinces were made quasi-permanent, thereby making the provinces less dependent on the fluctuating grants from the Centre. This method of financing the provinces was examined more than once and retained as the best suited to the then circumstances.

8. The Government of India Act, 1919, which, among other things, aimed at giving a reasonable measure of autonomy to the provinces as the first step in the process of self-government, made the first clear-cut allocation of resources between the Centre and the provinces without having any divided heads between them. Under this Act, certain specific heads were given wholly to the provinces and the remaining sources were retained by the Centre. Thus among the principal heads of revenue, Land Revenue, Excise and Stamps were given to the provinces, while the Centre retained Customs, Income-tax, Salt and Opium. Of the three great commercial departments of Government, Railways and Posts and Telegraphs were retained by the Centre, while Irrigation was handed over to the provinces,

9. This allocation of resources between the Centre and the units, particularly the assignment of the whole of Land Revenue to the provinces, left the Central budget in a substantial deficit; and in the earlier years of this scheme, the Centre had to depend on the provinces for contributions for balancing its budget. These contributions were fixed by what is commonly known as the Meston Award, and were designed to produce for the Centre an estimated shortfall of Rs. 9.8 crores (ninety-eight millions) resulting from the arrangements of resources between the Centre and the provinces. The contributions ranged from Rs. 348 lakhs (34.8 millions) from Madras to Rs. 15 lakhs (1.5 millions) from Assam, while one province, namely, Bihar and Orissa, had to make no contribution at all. It is unnecessary for the present purpose to describe in detail the method by which these contributions were fixed. It is enough to mention that they became a source of constant friction between the Centre and the provinces; and when substantial provincial deficits occurred, an unceasing clamour developed for their withdrawal. Between 1925 and 1928 these contributions were partially remitted and they were completely extinguished in 1929.

10. The experience of. the years under the 1919 Act clearly showed that the sources of revenue allocated to the provinces were inelastic, and were insufficient. to meet the increasing requirements of the provinces for their expanding needs for nation-building services such as Education, Medical Relief, Public Health etc., which fell almost wholly in the provincial field. It was clear that some additional revenue heads had to be released to the provinces; and while the Government of India Act, 1935, did not make any radical change in the allocation of heads between the Centre and the units, it revived in a somewhat modified form the earlier principle of dividing the proceeds of certain Central heads, the two heads concerned being Customs and Taxes on Income. The Act also provided for the grant of fixed subventions to some of the smaller provinces, and gave the Centre power to raise excise and export duties for distribution among the provinces and federating States. After an enquiry into the relative needs of the Centre and the provinces by Sir Otto Niemeyer, the provincial shares in the divided heads of Central revenue and the subventions to some of the provinces were fixed by an Order-in-Council, which, subject: to a modification during the war, continued. till 15th August, 1947.

11. Under the Government of India Act, 1935, which is the starting point of our enquiry, the taxing jurisdictions of the Central and Provincial Legislatures are entirely separate. But, while the provinces retain the whole of the net proceeds of all taxes levied by them, the Central Government has to give away either in part or in whole the net proceeds of some of the taxes levied by it.

12. The taxes, the net proceeds of which are to be given away wholly to the provinces, if levied, are-

(1) Federal Estate and Succession duties,

(2) Federal Stamp duties,

(3) Terminal taxes on goods and passengers carried by Railway or Air,

(4) Taxes on Railway fares and freights

The Centre can levy a surcharge on those taxes entirely for its own purpose, none of these taxes has in fact been levied, except that the Federal Stamp duties continue to be levied under the old laws, the duties however, being collected and retained by the provinces.

13. The Federal taxes, the net proceeds of which are to be shared with the provinces, fall into two groups:

(1) taxes, the sharing of the net proceeds of which has been made obligatory by the Constitution viz., income-tax and jute export duty;

(2) taxes, the sharing of the net proceeds of which has been left to be determined by the Federal Legislature viz, Central Excises including duty on salt, and export duties except on jute and jute products. The Central Legislature has levied certain taxes under these heads, but has not provided for giving any share to the provinces.

14. Besides providing for giving away the net proceeds of taxes in whole or in part to the provinces, the Constitution also provides for fixed grants-in-aid to some provinces.

15. There is also a general provision for giving grants to provinces at the discretion of the Central Government either for general or specific purposes.

16. Two tables showing the constitutional position in respect of the revenues of the Federal and Provincial Governments respectively under the Government of India Act, 1935, will be found in Appendix I. We are indebted to Mr. Ayyangar’s commentary on the Government of India Act, 1935, for these tables.

REVIEW OF FINANCES OF PROVINCES AND THE CENTRE

17. Two tables giving the financial position of the provinces and the Centre during the years 1937-38 to 1946-47 are set out in Appendix II.

18. In considering the working of the existing arrangements during the last decade, the most important point to note is that war broke out soon after the Government of India Act, 1935, came into operation During the war, all provinces except Bengal and Assam had surplus budgets. Revenue receipts increased several times, mainly on account of war-time conditions and also because the provinces levied a number of new taxes and increased the rates of existing ones; there were remark. able increases in receipts under Provincial, ie., liquor and drugs, excises, and in the provincial share of income-tax. Most provinces were undersection 93 administration. All development work was stopped. The provinces are now faced with a heavy programme of expenditure without any corresponding increase in revenue. On the contrary, even apart from voluntary abandonment of revenue as in the case of liquor excises, the revenue is likely to go down much below wartime levels. Land revenue, both in the permanently and temporarily settled provinces, is not likely to expand. State purchase of zamindaries will not bring any return for years to come. In ryotwari provinces, remissions are likely to be more liberal than before, and there is thus little prospect of an increase in land revenue. Receipts from stamps and registration fees are not likely to increase much, while forest revenue will perhaps dwindle on account of large scale felling during the war. Receipts from sales tax, electricity tax and entertainment tax may not fall, though they will be below the war- time peak for some time to come.

19. During the war and after, most of the Provincial Governments have practically exhausted the entire field of taxation reserved for them. More-over, Provincial Governments have to share the provincial field with local bodies, and on that account too, need adequate resources. A substantial transfer of revenues from the Centre to the provinces, therefore, seems inevitable, if essential and overdue programmes of social service and economic development have to be undertaken.

20. At this stage, we would refer to the adoption, by most Provincial Governments, of a prohibitionist policy; and of the inevitable loss of substantial revenue by all of them. Obviously, it is for the provinces to find alternative provincial resources from which to recoup the loss; and in any case, it would not be practicable for provinces to expect sufficient assistance from the Centre for this purpose, at any rate for many years. The point that we wish to emphasize is that it will be for the Provincial Governments to balance the urgency of schemes of development against the advisability of social reforms like prohibition, and. that in any case, they must not embark on schemes, whether of reform or development, depending merely on the possibility of obtaining assistance automatically from the Centre.

21. To turn now to the Centre, it has been working on deficit budgets. The large surpluses that were expected some time ago have not been, and are not likely to be, realized, mainly because of the food shortage, the refugee problem and other causes arising out of the partition of the country, particularly continued heavy expenditure on Defence. These are, however, temporary problems, and we consider that the financial position of the Centre is essentially sound. As these temporary problems are solved, the budgetary position of the Centre will necessarily get better. There is scope for improvement in the administration of Central taxes, and particularly of taxes on income. In respect of taxes on income, it should be possible for the Centre not only to collect more in future in the ordinary course every year but secure for the exchequer, by legislative changes, if necessary, the large sums that are believed to have been successfully kept back from the Government in recent years, we do not, however, expect any appreciable change under Customs and Excise; and we do not expect Railway contributions on anything like the scale during the war. Even after the temporary problems referred to above have been solved, expenditure on Defence and Foreign Affairs would still be substantial. The Defence Services will probably be reorganized and reequipped, and it is not possible to foresee what would be the scale of expenditure for properly equipped defence services even on a peace-time basis. There is little prospect on the other hand of reduction in. the service of the national debt but there is, however, scope for reduction in the existing civil expenditure.

22. The problem before us is how to transfer from the Centre to the provinces sufficient amount which, while not placing too great a strain on the Centre, would provide adequate resources for the inauguration of useful schemes of welfare and development by the provinces. While the Centre, on its present basis, may not be in a position to part with substantial sums, we feel that with the resolution of its temporary difficulties and improvement in its tax administration, together with the levy and collection of taxes evaded in the past, it can with no serious risk to its own budget part with sizable sums every year. We are suggesting later in detail how these sums should be regulated. We have already referred to the need for provinces having clear priorities as between contending demands for money, and we have no doubt that the provinces will in the earlier years utilize the additional resources now placed at their disposal by concentrating on schemes that would add to the productive capacity of the country and consequently the income of the people and thus enable the provinces to embark on further schemes of reform and development.

CLAIMS OF PROVINCES

23. Every province has drawn pointed attention to the urgency of its programmes of social service and economic development and to the limited nature of its own resources, both existing and potential, and all of them have asked for substantial transfer of revenues from the Central sources.

A summary of the detailed suggestions made by them. which vary considerably, is set out in Appendix I

24. On the question of apportionment of income-tax among provinces algo the provinces differ widely in their views. Bombay and West Bengal support the basis of collection or residence, the United Provinces that of population, and Bihar a combined basis of population and origin (place of accrual); Orissa and Assam want weightage for backwardness. East Punjab, while suggesting no basis, wants her deficit of Rs. 3 crores somehow to be met.

25. In the case of excise taxes, the bases suggested are production, collection, consumption and population, while Assam suggests some weightage for its low level of revenue and expenditure. Assam has further pressed for special treatment of excise collected on wasting assets, ¢.¢, petroleum raised in Assam. Assam also wants a share of the export duty on tea.

GENERAL OBSERVATIONS

26. Before we proceed further we would make a few general observations, India has a federal form of government, and every federation is based on a division of authority and involves a certain amount of compromise. In this country, federation has been the result of gradual devolution of authority. It has not come into existence through agreements among sovereign States as in some other federations.

27. What we have to do is to distribute the total available resources among Federal and Provincial Governments in adequate relation to the functions imposed on each; so, however, that the arrangements are not only equitable in themselves and in the interests of the country as a whole but are also administratively feasible. We have also to ensure that there is not too violent a departure from the status quo, and also to see that while we have as much uniformity as possible, weak units are helped at least to maintain certain minimum standards of services.

28. The basic functions of a Federal Government are Defence, Foreign Affairs and the service of the bulk of the national debt, and they are all expensive functions, particularly in the light of the limited resources of the country. The head “Communications” would ordinarily at least pay for itself. The Federal Government may also have to assume leadership in the coordination and development of research and higher technical education. Normally, however, apart from war or large-scale internal disorder, the expenditure of the Centre should be comparatively stable. The needs of the provinces are in contrast almost unlimited, particularly in relation to welfare services and general development. If these services, on which the improvement of human well-being and increase of the country’s productive capacity so much depend, are to be properly planned and executed, it is necessary to place at the disposal of Provincial Governments adequate resources of their own, without their having to depend on the variable munificence or affluence of the Centre. The provinces must, therefore, have as many independent sources of revenue as possible. On the other hand, it is not practicable to augment their revenues to any considerable extent by adding more subjects to the Provincial Legislative List, without simultaneously upsetting the equilibrium of the Centre. We cannot, therefore, avoid divided heads; and what we have to aim at is to have only a few divided heads, well balanced and high-yielding, and to arrange that the shares of the Centre and the provinces in these heads are adjusted automatically without friction or mutual interference.

29.In this country the lack of sufficient economic and financial statistics and other similar data is a great handicap. Therefore, the allocation of resources has to be made largely on the basis of a broad judgment, at any rate until the necessary data become available. We attach great importance to the collection of these statistics and to connected research, and trust that the Government will make the necessary arrangements without delay. In the meantime we have made our recommendations on the best judgment we could give to the exiguous data available.

LISTS OF TAXES FOR CENTRE AND THE UNITS

30. We recommend no major change in the list of taxes in the Federal Legislative List as recommended by the Union Powers Committee. We, however, recommend the substitution of the limit of Rs. 250 for Rs. 50 in clause 200 of the Draft Constitution relating to taxes on professions, trades, callings and employments. We observe from the Draft Constitution that it has been proposed to transfer to the Federal Legislative List stamp duty on transfer of shares and debentures, but we presume that the duties will continue to accrue to the provinces. In view of the far-reaching effects on public credit and finance of stock exchange transactions, we consider that the Centre should have the power to legislate for the regulation of such transactions. If such regulation involves the levy of taxes, we recommend that such taxes should be retained by the Centre except that if the taxes take the form of mere duties on transfers of shares and debentures, the provinces should have these duties just like other stamp duties. We accordingly recommend the entry in the Federal Legislative List of a new item “Stock exchanges and futures markets and taxes other than Stamp duties on transactions in them”.

31. In the list of taxes in the Provincial Legislative List, we recommend the following changes:

(1) In entry 43, the words “hearths and windows” may be deleted. Such taxes are not likely to be levied. In any case, they would be covered by the word “buildings”.

(2) In entry 53, the word “cesses”. should, we think, be replaced by the word “taxes”.

(3) Similarly, in entry 56, we would substitute the word “taxes” for the word “dues”.

(4) In entry 50, we would make the following changes:

(a) for the word “sale”, we would substitute “sale, turnover or purchase”, in. order to avoid doubt.

(b) We would also add words such as “including taxes in lieu there- of on the use or consumption within the province, of goods liable to taxes by the province on sale, turnover or purchase”. This addition is suggested in order to prevent avoidance by importing for personal use from outside the province.

32. One of the provincial memoranda has suggested that the entry “State Lotteries” should be transferred to the Provincial List, but, as we do not wish to encourage State lotteries, we should prefer the subject to remain Central where, too, we hope, it will not be used.

SHARES IN CERTAIN TAXES

33. We have no new items to suggest for insertion in the Provincial Legislative List.

34. The Federal Government will levy and collect all the taxes in the Federal Legislative List. But, according to our recommendations in the following paragraphs the Centre will retain the whole of the net proceeds of the following taxes only, viz: –

(1) Duties of customs, including export duties.

(2) Taxes on capital value of assets and taxes on the capital of companies.

(3) Taxes on Railway fares and freights.

35.  At present, the Central Government shares the net proceeds of the jute export duties with the jute-growing provinces and has to hand over to the provinces the whole of the net proceeds of taxes on railway fares and freights, if levied. As regards the latter, we recommend that, if such taxes are to be levied at all, they should be wholly Central, for, we cannot see any difference in substance between such taxes and a straight addition to fares and freights. As regards the former we are of the opinion that as export duties are capable of very limited application and have to be levied with great caution, they are unsuitable for sharing with the provinces.

36. It is necessary, however, to compensate the provinces concerned for the loss of this item of revenue, and we recommend that, for a period of ten years or till the export duties on jute and jute products are abolished whichever may be earlier, fixed sums as set out below be paid to these Governments as compensation every year.

Province                                           Amount

Rs.

West Bengal                                     100 lakhs

Assam                                               15 “

Bihar                                                 17 ”

Orissa                                               3 “

In arriving at these figures which we have based on the figures of pre-war years, we have taken all relevant circumstances into account, and in particular the concentration of manufacture in West Bengal. If at the end of ten-years, which we think should be sufficient to enable the provinces to develop their resources adequately, the provinces still need assistance in order to make up for this loss of revenue, it would no doubt be open to them to seek grants-in-aid from the Centre, which would be considered on their merits in the usual course by the Finance Commission.

37. Of the remaining Federal taxes, we recommend that the net proceeds should be wholly or partly given away to the provinces as indicated below.

38. Taxes on Income: Under the present arrangement the provinces receive 50 per cent. of the net proceeds of income-tax, except what is attributable to Chief Commissioners’ Provinces and taxes on Federal emoluments. The net proceeds of the Corporation Tax are also excluded for the purpose of the sharing. Subject to what we have said in paragraph 49 regarding tax on agricultural income, we recommend that, while the net proceeds attributable to Chief Commissioners’ Provinces should be retained wholly by the Centre, the other reservations should go, and that the provinces should get not Jess than 60 per cent. of the net proceeds of all income-tax including the net proceeds of Corporation Tax, and taxes on Federal emoluments. For the purpose of the division, income-tax will mean any levy made under the authority of the entry “Taxes on Income” in the Federal Legislative List.

39. We also consider that over and above its share in the net proceeds retained by it normally, the Centre should be empowered to levy a surcharge whenever conditions require such a levy; obviously such occasions should be rare and not last for unduly long periods.

40. Central Excise Duties : Excise duties are ordinarily closely connected with customs duties and, barring liquor and drug excises, which we consider, should continue to remain provincial, are inherently not suited for provincial taxation. On the other hand, they are only a species of consumption taxes of which another species, namely, sales, turnover and purchase taxes have been the subject of provincial taxation for some time. The memoranda received by us from the Provincial Governments are almost unanimous in demanding some share under excises; and our problem is to find not only more resources for the units but to make their revenues more balanced. If it was possible to have excises on commodities not subject to Customs duties (whether revenue or protective) or not competing, or capable of competing with, or of substitution for, commodities subject to Customs duties, e.g., on rice or wheat or millets or on jute and jute goods consumed in India, we see no reason why such excises or a share thereof should not be allotted to the units, apart from the general political objection to the division of heads viz., the divorce of benefit from responsibility. But such excises are not likely to be levied. Again, it is obvious that Excise duties on commodities subject to a protective tariff or even a high revenue tariff could not be conveniently shared. In the circumstances, the utmost that we can suggest by way of assistance in this respect of the Provincial Governments is to hand over to them a share of one of the important Central Excises on a commodity not receiving tariff protection, viz., tobacco. Incidentally, the effective administration of this excise requires the active cooperation of Provincial Governments, which would be better forthcoming if they had a share in the tax. We are averse to giving the units a share in too many Central Excises; for, such an arrangement would not only magnify the political objection of benefit without responsibility but lead to administrative inconvenience, since the rates could not be altered except by the consent of all the beneficiaries.

We accordingly recommend that 50 per cent. of the net proceeds of the excise duty on tobacco should not form part of the revenues of the Federation but should be distributed to the provinces.

41. It will be seen from what has been said above that we are not in favour of the suggestion made in item VIII of the terms of reference viz., that the Centre should be allocated only the excises on specified commodities, the rest of the filed of excise being left to the provinces.

42. Estate and Succession Duties : These duties cannot be administered satisfactorily except by or in the closest touch with the income-tax staff; and in any case, if the Centre is to part with a substantial amount of taxes on income and also a part of certain Central excises, it is appropriate that it should get a share of the estate and succession duties. This will also give to the Federal Government a direct interest in the duty. Subject to what we have said in paragraph 49 about taxes on agricultural property, we recommend that not more than 40 per cent. of the net proceeds of such duties should be retained by the Centre.

43. Federal Stamp Duties : We recommend the continuance of the status quo, i.e., the legislation in respect of the duties on the specified documents should be Central but provinces will collect and retain the duties.

GRANTS-IN-AID AND SUBVENTIONS

44. Terminal taxes on goods or passengers carried by railway or air : These taxes are not suitable except for purely local purposes, i.e., for the benefit of municipalities, pilgrim funds, etc., but they can be conveniently levied and collected only by the Centre. The existing provisions may stand.

45. Item II of our terms of reference refers to Grants-in-aid.

Assam and Orissa now get fixed subventions of Rs. 30 and Rs. 40 lakhs per annum, respectively. The recommendations that we have made for the increase in the provincial share of income-tax and the transfer of a share in the excise on tobacco will increase their revenues substantially like those of other provisions. Even so, however, we have little doubt that these two provinces will still require fixed subventions on higher scales than at present.

The position of East Punjab is peculiar. Everything there is unsettled, and it will take some time for things to settle down. It is clear, however, that this province will require a substantial annual subvention for some time to come.

The position of West Bengal is uncertain, and it is not clear how her finances will shape as a result of the partition. The liability that she will have to take over as a result of the partition. The liability that she will have to take over as a result of the partition is not yet known. All told, however, she will perhaps need some temporary assistance.

46. For the lack of time and data, we have not been able to assess the subventions required by these four provinces. We, therefore, recommend that the Central Government should immediately take up the question so that the amounts required by each of these provinces may be determined in time. The amounts should be subject to periodical review by the Finance Commission to which we refer later.

47. We have suggested elsewhere that till the Finance Commission has been able to recommend a better basis of distribution, a part of the divisible pool of income-tax should be used in order to mitigate hardship in individual cases. This provision also contains an element of grants-in-aid.

48. It is clear that during the developmental stages of the country it will be necessary for the Centre to make specific purpose grants to the provinces from time to time. The provisions of clause 203 of the Draft Constitution seems to be adequate for the purpose. We have considered the question whether, as in Australia, grants should be made in order to equalize, or at any rate to reduce the disparity between the levels of services and of severity of taxation in the different provinces. There is undoubtedly some-thing attractive in seeking to bring up the backward units at least to ‘average’ standards, both in effort (severity of taxation) and in performance (standards of services). In Australia, the maximum difference between the levels is said to be of the order of 20 per cent. and the number of unit States is small. In India, on the other hand, as for example in the U.S.A., the difference in the levels is very wide and the number of units larger when acceding States come into the picture. In such a background ‘averages’ would be mere mathematical concepts totally unrelated to actual facts. On the other hand, even in a Federation of autonomous units, there is a great deal to be said for helping the less prosperous units to come up to the level of the more prosperous ones. AS in all such matters we must take a realistic decision with reference to the conditions in our country. While we do not recommend the adoption in this country of the Australian system, we have no doubt that the Centre, when distributing specific purpose grants under clause 203 of this Draft Constitution, will bear in mind the varying circumstances in the different provinces.

48A. Section 199 of the Draft Constitution provides for special assistance to Assam in respect of expenditure for promoting the welfare of Scheduled Tribes in the province. We agree with this provision. It has been represented to us on behalf of Orissa that a similar provision should be made for assisting her to develop the backward areas of the province. In the absence of any data, we have been unable to assess the measure of assistance, if any required by this province, and we content ourselves with expressing the view that if the Central Government, after a due examination of the question in all its aspects, decide that special assistance is necessary it should be provided on an adequate scale.

TAXES ON AGRICULTURAL INCOME AND PROPERTY

49. It is obvious that the taxation of agricultural income by the provinces, while all other income is taxed by the Centre, stands in the way of a theoretically sound system of income-tax in the country. We should, therefore, have liked to take this opportunity to do away with this segregation. In view of the ease with which the origin of agricultural income can be traced, it could be arranged that the tax from such income, even though levied and collected by the Centre as part of an integrated system of income-taxes, should be handed back to the provinces; and it could be further arranged that till such time as the Centre in fact levied a tax on agricultural income, the provinces already levying this tax might continue to levy it without restriction and with full power to vary the rates of tax. The interests of provinces could thus be fully protected, and there could, therefore, be no financial objections from them. On the other hand, the present arrangement has the political merit of keeping together in one place both benefit and responsibility, a rather important point, seeing that the provinces will have full control over but few important heads of revenue. A few provinces have, in fact, levied the tax and are administering it for some time. Perhaps also, the provinces can administer this particular tax with greater facility than the Centre. For the present, therefore, we have decided to continue the status quo, but, in view of the importance of the matter, would recommend that the provinces should be consulted at once and if a majority, including of course those now levying the tax, agree, tax on agricultural income may be omitted from the Provincial List of subjects, consequential changes being made elsewhere-in the Constitution. Our foregoing remarks apply mutatis mutandis to Succession and Estate Duties on agricultural property also.

DIVISION OF PROCEEDS OF REVENUE BETWEEN PROVINCES

50. Income-tax: As regards the basis of distributing between provinces the share of proceeds from taxes on income, we are of the opinion that no single basis would lead to equitable results. Origin or locus of income is no doubt relevant, but in the complex industrial and commercial structure of modern times, where a single point of control often regulates a vast network of transactions, where the raw materials come from one place, are processed in another, manufactured in a third, marketed wholesale in a fourth and ultimately sold in retail over a large area, contracts are made at places different from where they are performed, money is paid in at one place and goods delivered at another and more than one of these stages relate to the same tax-payer, the assignment of a share of profits to each stage can only be empirical or arbitrary.

51. Again, the residence of the tax-payer is an independent factor but apart from the artificial legal definition of residence for income-tax purposes, the predominance of joint stock enterprise in business, the dispersion of the shareholders of companies all over the country and even outside, the possibility (emerging from the artificial definition) of simultaneous residence in more than one area, the non-assessment (due to various reasons) of a large number of shareholders, and the absence of authoritative, i.e., tested, information in the income-tax records as to the province of residence of a resident of India (for, today, it is immaterial to the Income-tax Department in which particular province an assessee is resident), all these together make this criterion of residence a difficult factor to apply in practice in distributing the proceeds of the tax. Even if the statistical difficulties were got over, residence could be changed at the will of the tax-payer.

52. Another possible criterion is the place of collection. This place is usually the principal place of business of the tax-payer, or his residence, if he is not carrying on a business or profession. The objection to this factor is that it is unfair to the areas of origin and sale which it completely ignores, while it gives far too much weight to the place of control of a business, which is usually, though not necessarily, the place of collection. Moreover, even more than in the case of residence, the place of collection can be easily altered at the will of the tax-payer.

53. Another possible basis is that of needs i.e. the shares would be regulated somewhat like grants-in-aid, and rather than go into elaborate enquiries for this purpose, the population of a province could be taken as a rough measure of its needs. The objection to this basis is that a ‘share’ is something to which a province is entitled because its citizens or things have in some measure contributed to the fund, while a grant is something given to it without regard to its contribution to the Centre or to any common pool.

54. We have said enough to show the difficulties of the problem, but the difficulties have somehow to be faced and met, unless we keep the whole of the taxes on income as Central and permit provinces simultaneously to levy a provincial income-tax on the basis of origin. In our opinion the latter course is not feasible in the circumstances of this country even if justifiable in theory; and pending enquiry by the Finance Commission the setting up of which we suggest later, we have no choice except somehow to make the distribution on as equitable a basis as can be devised in the circumstances.

55. We propose to proceed on the basis of collection as well as population and also to make some provision for adjustment on the basis of need, We recommend that the provincial share i.e. 60 per cent. of the net proceeds be distributed among the provinces, as follows:

20 per cent. on the basis of population.

35 per cent. on the basis of collection.

5 per cent. in the manner indicated in paragraph 56.

=60

For the distribution of the first two blocks, population figures of the previous census and collection figures as certified by the Auditor-General should be accepted as authoritative.

56. The third block of 5 per cent should be utilized by the apportioning authority as a balancing factor in order to mitigate any hardship that may arise in the case of particular provinces as a result of the application of the other two criteria; in distributing this block it would be open to the authority to take into account all relevant factors.

57. Excise duty on tobacco: In our view, the most equitable method of distributing this duty is on the basis of estimated consumption. We have no doubt that the Government will take steps to obtain necessary statistical information if it is not already available.

58.Estate and Succession Taxes: These taxes have not so far been levied. One of the hurdles to be crossed before they can be levied is the determination of the manner of distribution of the net proceeds among provinces. Until the taxes are actually levied and collected for some time, no data about their incidence will be available. Hence, the levy will have to start with some a priori basis of apportionment among provinces. We accordingly recommend that until the Finance Commission is in a position to evolve a better method on the basis of data available to it, the net proceeds should be distributed among the provinces as follows:

The net proceeds attributable to real property—On the basis of the location of the property.

Of the balance—

75 per cent. on the basis of the residence of the deceased;

25 per cent. on the basis of the population of the province:

The administration and distribution of these taxes would, in the ordinary course, fall on the Central Board of Revenue, but it would be necessary to empower an appropriate authority to adjudicate in the case of disputes between provinces as to the residence of individuals.

EFFECT OF THE PROPOSALS

59. The net effect of all our recommendations together is that, on the present basis of revenue, the Centre will have to transfer to the provinces a sum of the order of Rs.30 crores annually. It will recover a part of this loss by the imposition of the Estate and Succession Duties, of the net proceeds of which it will retain 40 per cent. We believe that it will not be beyond the capacity of the Centre to part with this amount annually during the next five years, though it must cause some strain, while at the same time the transfer will enable the provinces to start their programme of essential social services and economic development.

60. In our recommendations regarding the distribution of proceeds of taxes among the provinces, we have not only proceeded on more than one basis, but have provided for an element of flexibility in order to mitigate hardship. We have also provided for a periodical review so that the method of apportionment can be adapted to changing conditions from time to time on basis of experience. We have further provided for grants-in- aid both to the weaker provinces and to provinces in difficulty.

61. We have also tried to make the whole arrangement as automatic and free from interference as possible. The basic features of the scheme will be embodied in the Constitution itself, while periodic changes will be made by the President on the recommendation of the Finance Commission, which, we hope, will command the confidence of all. As frequent changes are undesirable, we have recommended a five yearly review though in special circumstances the Finance Commission may embark on a review at a shorter interval. The provinces will not be sure of their position and can go ahead with their plans.

62. It is needless for us to add that to the extent that the Centre transfers its resources to the provinces in the shape of new or increased shares in revenue, its ability to give grants to the provinces for specific or other purposes must be correspondingly reduced.

63. We may not have been able in our proposals to satisfy everybody or to provide for every contingency that may possibly arise in the future, but we have tried to do the best possible under the circumstances.

FINANCE COMMISSION

64. For reasons already stated, our recommendation as to the initial basis of apportionment among provinces is not intended to be permanent. Conditions may change. The working of the scheme for some time will in itself produce some data that would indicate the nature and direction of the changes required, It is necessary, therefore, to have a periodical review of the whole position by a neutral expert authority.

65.We recommend for this purpose, among others, the appointment of a high level tribunal of five members including a Chairman who has been, or is, holding high judicial office, not lower than that of a judge of a High Court. This tribunal may be called the ‘Finance Commission’. There may not ordinarily be enough work for the Commission to keep it busy continuously, and the members need not, therefore, devote their whole time to the work. The members should be appointed by the President in his discretion if only because a Commission of this kind would have frequently occasion to deal with points of conflict between the Centre and the units. While we would not lay down any conditions in the statute as to how these members should be selected, we recommend that two should be selected from a panel of nominees of unit Governments and two others from a panel of nominees of the Central Government, the Chairman being selected by the President. One at least of the five should possess close knowledge of the finances and accounts of governments, while another at least should have a wide and authoritative knowledge of economics. It would be an advantage if one or more were public men with wide experience. It would be a further advantage if a member possessed more than one qualification, and steps should be taken to secure the services of such individuals. The appointments might be made for five years and be renewable for another five years.

66. Between now and the setting up of the Finance Commission, we recommend that the Central Government should take steps in consultation with the provinces, to collect, compile and maintain statistical information on certain basic matters such as the value, volume and distribution of production, the distribution of income, the incidence of taxes, both Central and provincial, the consumption of important commodities, particularly those that are taxed or likely to be taxed, etc. The Finance Commission, when set up, would then have some basic information to go upon, and would no doubt call for such further information as it may need. It would also, to the extent necessary, arrange for continuous examination and research in respect of all important matters.

67. The Finance Commission should be entrusted with the following functions:

(a) To allocate between the provinces, the respective shares of the proceeds of taxes that have to be divided between them;

(b) To consider applications for grants-in-aid from provinces and report thereon;

(c) To consider and report on any other matter referred to it by the President.

68. While these categories would exhaust the duties of the Commission, it should be open to the Commission to make any recommendations it may think expedient in the course of the discharge of these duties, It may, for example, suggest a variation in the heads of revenue assigned to the provinces, i.e., the transfer of new heads or the withdrawal of existing heads, or increases in the shares of existing heads or a reduction in these shares. In making all such recommendations, the Commission will take into account all relevant matters, including the state of finances of the Centre, its recommendations, in so far as they do not involve any change in the Constitution, would, when accepted by the President, be given effect to by him by order, while recommendations involving a change in the Constitution, if similarly accepted by him, would be dealt with like any other proposed amendment to the Constitution.

69. The Commission’s first function would be of the nature of an arbitration, and therefore, the Commission’s decisions will be final. As regards the second function, we have no doubt that the recommendation of the Commission in respect of grants-in-aid would be given the utmost weight by the President and not ordinarily departed from by him.

70. The basis for the allocation of revenues referred to in item (a) should ordinarily be settled by the Commission at intervals of five years, but it should be open to the Commission to shorten the interval if it feels satisfied in special circumstances that such shortening is called for.

71. We would further recommend, in order to save time, that the Finance Commission may be set up in advance of the coming into effect of the Constitution, and its status regularised after the Constitution comes into effect.

RESIDUARY POWERS OF TAXATION

72. It appears that under the new Constitution, residuary power will be vested in the Centre, so far as the provinces are concerned, while the corresponding residuary powers in respect of the States will be vested in the States themselves, he question has therefore been raised whether, as a consequence, as many specific taxes as possible should not be entered in the Provincial List of subjects. We cannot think of any important new tax that can be levied by the provinces, which will not fall under one or the other of the existing categories included in the Provincial List. We think that the chance of any practical difficulty arising out of the proposed constitutional position is remote, and, in any case, it seems to us that if a tax is levied by the Centre under its residuary powers, there will be nothing to prevent the proceeds of the whole or a part of this tax being distributed for the benefit of the provinces only. As a matter of abundant caution, however, it may be laid down in the Constitution that if any tax is levied by the Centre in future under its residuary powers, and to the extent that the States do not agree to accede to the Centre in respect of the corresponding subject, the whole or a part of the proceeds of the tax shall be distributed between the provinces and the acceding States only. This disposes of Item IX of our terms of reference.

EXEMPTION OF PROVINCIAL GOVERNMENTS FROM TAXATION

73. Section 155 of the Government of India Act provides that profits from trading by a Provincial Government would be taxable only if the trade was carried on outside the province. The exemption from Central taxation of trade by Provincial Governments carried on within the provincial limits did not matter much in the past; for the Governments had few trading operations. With the present tendency towards nationalisation e.g., many provinces have already taken up quite seriously the nationalization of road transport, the Centre should have some power to levy either income-tax or a contribution in lieu of income-tax in respect of these trading activities. Disputes as to such contributions should, we consider, be examined and adjudicated upon by the Finance Commission to which we have already referred. We feel that if nationalization of industries or trades takes place rapidly, the whole question would have to be reviewed de novo, for the entire structure of the tax system of the country would be completely changed.

74. In the meantime we make the following recommendations:

(a) The existing practice should continue in respect of trading operations of the Central Government, i.e., no income-tax should be levied on the profits. It should be open to the Centre, however, to levy a contribution, as in the case of Railways, for its sole benefit from such operations. If the trading is carried on by a separate juristic person, tax will be levied even if the Government is the dominant shareholder.

(b) Tax should be levied on the trading operations of units (as also of local bodies), whether carried on within or without their jurisdiction; and the tax or the contribution in lieu thereof should be treated as ordinary income-tax revenue for the purpose of the divisible pool. We presume that if there are no profits, there will be no contribution; but if this presumption is wrong, we suggest that the contribution should be treated as part of the divisible pool of income-tax.

(c) We recommend that quasi-trading operations incidental to the ordinary functions of Government such as the sale of timber by the forest department or of jail products by the jail department should not be treated as trading operations for this purpose.

EMERGENCY PROVISIONS

75. The needs of the Centre in times of emergency, such as war or large scale internal disorder, cannot be provided for through the detailed allocation of heads of revenue or of shares therein. It is obviously not possible to legislate how emergencies should be met. We would suggest that there should be a special provision in the Constitution authorizing the President in an emergency to suspend or vary the financial provisions in such manner as he may think best in the circumstances. For example, if there is a war and an Excess Profits Tax is levied, it might be necessary for the Centre to retain the whole of this tax for itself.

PROCEDURE IN FINANCIAL MATTERS

76.Item X of our terms of reference is as follows:

Is it necessary to make any modifications in the existing provisions as regards procedure in financial matters contained in sections 33 to 37 and 78 to 83 of the Government of India Act, 1935?

77. The present financial procedure in the federal sphere is laid down in sections 33-37 of the Government of India Act, 1935. The corresponding clauses in the Draft Constitution as prepared by the Secretariat of the Constituent Assembly are 74, 75 and 77-81. We have two recommendations to make:

(1) When a Money Bill is sent from the Lower House to the Upper, a certificate of the Speaker of the Lower House saying that it is a Money Bill should be attached to, or endorsed on, the bill and a provision to that effect should be made in the Constitution on the lines of the corresponding provision in the Parliament Act, 1911.

This will prevent controversies about the matter outside the Lower House.

(2) After clause 80, a provision may be made making it necessary for Government to approach the Legislature for regularizing any excess expenditure that might be discovered in audit after the close of the year. This is, in fact, done even now, but there is no statutory obligation to do so.

Subject to these two recommendations, we approve of the provisions in the Draft Constitution.

78. Financial procedure in the provincial field is governed by sections 78-82 of the Government of India Act, 1935. The corresponding provisions in the Draft Constitution occur in clauses 149-153. We recommend :

(1) that in a province with a bicameral legislature, if any, the powers of the Upper House over Money Bills should be exactly the same as at the federal level;

(2) that the new provision, in respect of a vote on excess grants, recommended by us at the federal level should be repeated at the provincial level also.

79. It is usual in written democratic constitutions to provide that no money can be drawn from the treasury except on the authority of the legislature granted by an Act of appropriation. In this country, the practice has been to authorize expenditure by resolutions of Government after the demands have been voted, and not by law. As the existing practice has been working well in this country, appropriation by law does not appear to be necessary.

AUDITOR-GENERAL

80. Though the question has not been specifically referred to us, we consider that the status and powers of the Auditor-General are so closely connected with financial procedure that we have gone into this matter also. The provisions in respect of the Auditor-General of the Federation are contained in clauses 106-109 of the Draft Constitution, and those in regard to the Auditor-General of the provinces, in clauses 174-175. In substance, all these clauses repeat the existing provisions in the Government of India Act. We consider the provisions to be adequate for the purpose of securing the independence of the Auditor-General. We notice that the Auditor-General of India is to perform the functions of the Auditor-General in respect of the Provincial Governments also for an initial period of three years, and thereafter, until a particular Provincial Government chooses to appoint its own Auditor-General, We favour the continuance of a single Auditor-General for the Government of India as well as for the Provincial Governments, and it is possible that the Provincial Governments will also prefer that course, and will choose not to use their power of appointing a separate Auditor-General of their own. The Draft Constitution, however, gives them the option to appoint Auditors-General if they think fit so to do. We are not sure whether it is possible altogether to do away with this option, much as we should like to do so; but if the option remains, we recommend that the provisions of sub-clause 3 of clause 174 should be amended so as to make the Auditor-General of a province eligible for appointment as Auditor-General of another province also.

BORROWING POWERS

81. This question is covered by item I of our terms of reference.

The present position is that the provinces have the freedom to borrow in the open market in India except when they are indebted to the Centre. The most outstanding advantage of the freedom of borrowing is the sense of financial responsibility it creates; for, there is no more accurate, sensitive and dependable meter of the credit of a borrowing Government than the reaction of the securities market, we do not therefore wish to withdraw this freedom. Nevertheless, it is necessary to have some machinery which would ensure that borrowing Governments do not, by their competition, upset the capital market. This machinery is now provided through the Reserve Bank which advises all the Governments, but in view of the ambitious programmes of development both by the Centre and by the units, it may become necessary to set up some kind of expert machinery, both competent and definitely empowered, to fix the order of priority of the borrowings of the different Governments. In some countries, this co-ordination is effected either by a Ministerial Conference or by a Loans Council. Such machinery should not affect the responsibility of a Government for its borrowing policy and should help only in the timing of the loan and avoidance of unnecessary competition, The co-ordination by the Reserve Bank has worked well in practice, and so long as it works well we do not recommend any change. We assume that there will be no distinction between federating States and the provinces in this respect.

82. We are of the opinion that it should not be open to a Provincial Government or to a Government of a State to go in for a foreign loan except with the consent of the Federal Government and except under such conditions, if any, as the Federal Government may think fit to impose at the time of granting the consent. We notice, however, that there is an entry, viz., “18. Foreign Loans” in the Federal Legislative List in the Draft Constitution. We are not sure whether, the insertion of this entry in the Federal Legislative List is enough to prevent the Government of a unit from going in for a foreign loan. We, therefore, recommend that the point be examined, and if the provision is not found to be adequate, a specific provision should be made in clause 210 of the Draft Constitution making it necessary for the Government of a unit to obtain the consent of the Federal Government before going in for a foreign loan.

PROBLEM OF INDIAN STATES

83. The points at issue are contained in items II, IV, V, VI and XI of our terms of reference. This part of our work is the most difficult part thereof, and the difficulty arises as much from the lack of statistical data as from the complications of the problem itself; for, not only do conditions differ widely between the provinces as a whole and the States as a whole, but from State to State, so that it is difficult to apply a common yard-stick.

84. The Union Powers Committee of the Constituent Assembly in para. 2(d) of their report, dated 17th April, 1947, has expressed its view on this subject in the following terms : “We realize that, in the matter of industrial development. the States are in varying degrees of advancement and conditions in British India and the States are in many respects dissimilar, Some of the above taxes are now regulated by agreements between the Government of India and the States. We, therefore, think that it may not be possible to impose a uniform standard of taxation throughout the Union all at once. We recommend that uniformity of taxation throughout the units may, for an agreed period of years after the establishment of the Union not exceeding 15, be kept in abeyance and the incidences, levy, realization and apportionment of the above taxes in the State units shall be subjected to agreements between them and the Union Government. Provision should accordingly be made in the Constitution for implementing the above recommendation.” We entirely agree with these observations.

85. We assume that the ultimate object of the Federation must be to secure for the federating States the same, or nearly the same standards of economic development, fiscal arrangements and administrative efficiency as in the provinces. It is only against this background that the States can have the same identity of interest with the Union as the provinces have.

86. The first difficulty met with in our investigation is that many of the smaller States have neither a budget nor effective audit, so that adequate and reliable information about their financial position, on a basis permitting comparison with provinces, is not available. We recommend accordingly that it should be made obligatory within as short a period as possible for each State to arrange for the preparation and authorization of a periodical budget and the maintenance of proper accounts and audit and to send copies of its budget, accounts and audit reports to the Union Government.

87. In the absence of sufficient data, we are not in a position to make recommendations other than of a general nature. We are clear in our mind that the States should gradually develop all the taxes in the Provincial Legislative List so that they may correspondingly give up reliance on taxes in the Federal Legislative List. This process however would necessarily take some time; and in the meanwhile it will be necessary to have transitional arrangements.

88. We will now take up Land Customs. We do not recommend the immediate abolition of Land Customs, for we find that such a course would lead to a serious dislocation in the finances of many States. Moreover, where there is no large re-export trade, these land customs, though a possible source of annoyance, are really of the nature of octroi duty levied at a few points of entry. On a long view, however, in the interests of the States themselves, these duties might be replaced by other taxes, such as sales and turn-over taxes. We recommend accordingly that Land Customs now levied by the States should be abolished during the next ten years. As a first step it may be arranged that—

(1) a State shall not in future levy land customs ‘on a commodity on which there is no such duty now:

(2) a State shall not after a fixed date increase the rate on any commodity; and

(3) a State levying land customs should grant refunds on exports.

Gradual abolition over a period of ten years should not cause any serious dislocation to the finances of these States, nor can there be any question of paying any compensation to these States, for the simple reason that the Union Government will not gain any corresponding revenue.

89. Maritime customs should be uniform all through the Union, and the Federal Government should take over the administration of such customs in all the maritime States. If this arrangement results in the loss of any State of the revenue now enjoyed by it, it is only fair that the State should be compensated for the loss. Pending determination of the appropriate compensation in each case by a States Commission, the appointment of which we recommend in a later paragraph, each State may be given an annual grant equal to the average revenue from this source during the last three years. The right of Kashmir to a rebate on sea customs may be similarly abolished on payment of a similar grant.

90. The Federal Government may levy Central Excises in all the States, but those States which now enjoy the benefit of a part or the whole of these revenues raised in their areas should, in lieu of such benefit, receive grants on the basis of the average revenue enjoyed by them from these sources during the last three years. In our opinion, neither this arrangement nor the one referred to in the foregoing paragraph should present any difficulty from the purely financial point of view either to the Union or to the States.

91.The Indian Income-Tax Act, with such modification as may be considered necessary by the President, may be applied to all the federating States. The net proceeds of the tax attributed to the States may be credited to a States Income-tax Pool and such portion not being less than 75 per cent of the net proceeds attributable to each State, as determined by the President, may be paid back to the States. We are aware that many problems will arise in the course of allocating these proceeds between the different States, but they are not insoluble, and can be solved on lines similar to those followed in allocating similar revenues between the provinces.

92. The need for a uniform system of income-tax both in the provinces and in the States has become urgent not only because of the facilities afforded for evasion and avoidance of the Central Income-tax by the existence of States with lower rates of taxation or no tax at all, but also because it is alleged that industries are being diverted artificially by the incentive of lower taxation to areas not inherently suited for the industries.

93. Though we do not favour any abrupt change in the status quo, we do not attach much weight to the argument that the States are, as a whole, industrially backward and that they cannot, therefore, stand the same high rates of taxation, particularly income-tax, as the provinces can. If the productive capacity of a State, and consequently its level of income, is low, it follows that the State will not have to contribute much by way of tax if it falls in line with the provinces. If, on the other hand, the point is that industries should be artificially stimulated in the States somehow by the incentive of lower taxes, it is obvious that if the State is not suited for industrial development, the cost of bolstering up its industries must ultimately fall upon the provinces and other States.

94. As already stated, we are not in a position to make detailed recommendations regarding the States. We recommend for this purpose the establishment of a States Commission with five members who should posses wide knowledge of the financial administration of Provincial, Federal or State Governments. Preferably, one of these members might be a member of the Finance Commission (for Provinces) referred to earlier in this report. The commission should advise the President, as also the States, about their financial systems and suggest methods by means of which the States could develop their resources and fall into line with the provinces as quickly as possible. One of the first tasks of the commission will be to examine in detail the privileges and immunities enjoyed by each State, and also the connected liabilities, if any, and recommend a suitable basis of compensation for the extinction of such rights and liabilities. We consider in particular that the States Commission should deal with the problems before it with understanding and sympathy and suggest solutions which would not only be fair both to the States and to the provinces, but enable the States to come up to the provincial standards in as short a time as possible.

95. The States which come into the above arrangements would pay their contribution for Defence and other Central Services through the share of the net proceeds of Central taxes retained by the Centre, and nothing more should be expected from those States. On the other hand, the States which accede but do not come into the above arrangements, should pay a contribution to the Centre, the amount of which should be determined by the States Commission having regard to all the relevant factors.

96. The constitutional arrangements in this respect, particularly during the interregnum of fifteen years, should, in our opinion, be kept very flexible. The President should be enabled by order to adopt any financial arrangement he may find expedient with each State until such arrangement is altered by an Act of the Federal Legislature after necessary consultation with the States.

97. While the outlines which we have indicated above are capable of being applied to most of the major or even middle-sized States, it is, in our opinion, necessary to group together a number of smaller States in sizable administrative units before they can be brought into any reasonable financial pattern.

98. We are sorry that we have not been able to contribute anything more precise than what we have done to this part of the terms of reference to us.

99.We enclose two Appendices (IV and V) one of which sets out in detail, as far as we have been able to collect, the rights and immunities enjoyed by various States, and the other setting out the total budgets of certain States and the part played by Land Customs in those budgets.

SUMMARY OF RECOMMENDATIONS

100. (1) No major change to be made in the list of taxes in Federal Legislative List as recommended by the Union Powers Committee. (Para. 30)

(2) The limit of Rs. 50 to be raised to Rs. 250 for taxes on professions etc. levied by local bodies. (Para. 30)

(3) An entry to be made in the Federal Legislative List of a new item “Stock Exchanges and Futures Markets” etc. (Para. 30)

(4) A few minor changes of a drafting nature to be made in the list of taxes in the Provincial Legislative List; and no new items for insertion in the Provincial Legislative List. (Paras. 31-33)

(5) The Centre to retain the whole of the net proceeds of the following taxes, viz. (a) Duties of Customs including Export Duties; (b) tax on capital value of assets, etc.; (c) taxes on Railway fares and freights; and (d) Central Excises other than on tobacco. (Para. 34)

(6) The grant of fixed assignments for a period of years to the jute-growing provinces to make up for their loss of revenue. (Paras. 35-36)

(7) The net proceeds of the following taxes to be shared with the Provincial Governments, viz. (1) Income-tax including Corporation Tax; (2) Central Excise on tobacco; (3) Estate and Succession Duties. (Paras. 38-42)

(8) The suggestion that the Centre should be allotted only the excises on specified commodities, not accepted. (Para. 41)

(9) Federal Stamp Duties and terminal taxes on goods, etc. to be administered centrally, but wholly for the benefit of the provinces. (Paras.43 and 44)

(10) Larger fixed subventions than now, necessary for Assam and Orissa, and subventions for limited periods for East Punjab and West Bengal, but no precise figures recommended for lack of data. (Paras. 45 and 46)

(11) Grants-in-aid on the Australian model not favoured. (Para. 48)

(12) Merging the tax on agricultural income in the Central Income-tax and similarly the Estate and Succession Duties on agricultural property in the similar duties on property in general to be examined in consultation with Provincial Governments and transfers made from the Provincial List of subjects, if necessary. (Para. 49)

(13) Not less than 60 per cent of the net proceeds of Income-tax including Corporation Tax and the tax on Federal emoluments, to be divided between provinces in the following manner: 20 per cent. on the basis of population, 35 per cent. on the basis of collection and 5 per cent as an adjusting factor to mitigate hardship. (Paras. 55 and 56)

(14) Not less than 50 per cent. of the net proceeds of the excise on tobacco to be divided between provinces on the basis of estimated consumption. (Para. 57)

(15) Not less than 60 per cent. of the net proceeds from Succession and Estate Duties to be divided between the provinces on the following basis:

Duties in respect of real property on the basis of allocation of the property, and of the balance, three-fourths on the basis of the residence of the deceased and one-fourth on the basis of population. (Para. 58)

(16) Net effect of the recommendations, to transfer annually a sum of the order of Rs. 30 crores from the Centre to the provinces. (Para. 59)

(17) A Finance Commission with a High Court Judge or ex-High Court Judge as Chairman and four other members to be entrusted with the following functions: viz. (a) allocation between the provinces of their shares of centrally administered taxes assigned to them; (b) to consider applications for grants-in-aid for provinces and report thereon; (c) to consider and report on other matters referred to it by the President. (Paras.65-67)

(18) The Commission to review the position every five years, or, in special circumstances, earlier. (Para. 70)

(19) A tax levied by the Centre under its residuary powers, not to ensure to the benefit of a non-acceding State unless it agrees to accede to the Centre in respect of that subject. (Para. 72)

(20) Trading operations of units, as of local bodies, whether carried on within or without their jurisdiction, to be liable to Central Income-tax or a contribution in lieu, but quasi-trading operations incidental to the normal functions of Government not to be taxed. (Para. 74)

(21) The President to be empowered in an emergency to suspend or vary the normal financial provisions in the Constitution. (Para. 75)

(22) A few minor changes suggested in regard to the procedure in financial matters. (Para. 77)

(23) No change to be made in respect of borrowing powers of units. (Paras. 81-82)

(24) Early arrangement to be made for the preparation of regular budgets and the maintenance of appropriate accounts and audit by all acceding States. (Para. 86)

(25) States gradually to develop all the taxes in the Provincial Legislative List and correspondingly give up taxes in the Federal List. (Para. 87)

(26) Maritime customs and excises in States to be taken over by the Centre, the States being compensated therefor, if necessary. (Paras. 89 and 90)

(27) The Indian Income-tax Act to be applied to all the federating States, and 75 per cent. of the net proceeds attributable to the States to be divided between them. (Para. 91)

(28) A States Commission to be set up with five members with wide knowledge of the financial administration of Provincial, Federal or State Governments. (Para. 94)

(29) The States Commission to examine the privileges and immunities etc. of States and to suggest suitable compensation for the extinction of these rights and liabilities. (Para. 94)

(30) States which do not come into the arrangements to pay a contribution to the Centre to be determined by the States Commission. (Para. 95)

(31) The interim constitutional arrangements with the States to be flexible and small States to be grouped together. (Paras. 96 and 97)

CONCLUSION

101. Some of our recommendations would need to be embodied in the Constitution while others would be given effect to by the order of the President. We have attempted a draft of the necessary provisions in the Constitution to give effect to the former; and these are set out in Appendix VI.

102. Mr. Rangachari has signed this report in his personal capacity, and the views expressed in it should not be treated as committing in any manner the Ministry of Finance of which he is an officer.

NALINI RANJAN SARKER,

S. SUNDARAM,

V. RANGACHARI.