Taxation System in India: Legal Framework and Regulatory Structure

Introduction

The taxation system in India represents one of the most vital components of the nation’s economic architecture, serving as the primary mechanism through which the government mobilizes resources for public welfare, infrastructure development, and essential services. India operates under a three-tier federal structure comprising the Union Government, State Governments, and Local Bodies, each possessing distinct powers to levy and collect taxes as defined by the Constitution of India. The evolution of India’s tax landscape has been marked by significant reforms, most notably the introduction of the Goods and Services Tax in 2017, which fundamentally restructured the indirect tax regime. Understanding the intricate legal framework governing taxation in India requires examining both direct and indirect taxes, their constitutional foundations, statutory provisions, and the extensive body of case law that has shaped their interpretation and application.

Constitutional Foundation of Taxation in India

The power to levy taxes in India derives entirely from the Constitution of India, which meticulously delineates the taxation powers between the Union and State governments. Article 265 of the Constitution establishes the bedrock principle that “No tax shall be levied or collected except by authority of law.”[1] This fundamental provision ensures that taxation cannot be arbitrary and must always be backed by valid legislative authority. The Supreme Court has consistently upheld this principle, emphasizing that both the levy and collection of taxes require proper legal sanction.

Article 246 of the Constitution, read with the Seventh Schedule, distributes legislative powers including taxation between Parliament and State Legislatures through three lists. The Union List grants Parliament exclusive authority over matters such as income tax, customs duties, and central excise. The State List empowers State Legislatures to levy taxes on subjects including land revenue, stamp duty, and taxes on agricultural income. The Concurrent List allows both Parliament and State Legislatures to legislate on specific matters, though notably, taxation powers are not included in this list, maintaining a clear demarcation of fiscal authority.

The 101st Constitutional Amendment Act of 2016 introduced Article 246A, which created a special framework for the Goods and Services Tax, empowering both Parliament and State Legislatures to make laws relating to GST on the supply of goods and services. This amendment represented a watershed moment in India’s fiscal federalism, enabling the creation of a unified national market for indirect taxation.

Direct Taxation Framework in India

Income Tax Act, 1961

The Income Tax Act, 1961 constitutes the primary legislation governing direct taxation in India.[2] Enacted to consolidate and amend the law relating to income tax, this statute came into force on April 1, 1962, replacing the Indian Income Tax Act of 1922. The Act comprises 298 sections organized into 23 chapters, along with fourteen schedules that provide detailed rules for computation and assessment of taxes.

The Income Tax Act operates on the principle that tax is levied on the total income of the previous year, computed under five heads: income from salary, income from house property, profits and gains from business or profession, capital gains, and income from other sources. Section 4 of the Act provides the charging section, establishing that income tax shall be charged for any assessment year at the rates prescribed by the Finance Act on the total income of the previous year of every person.

Section 5 defines the scope of total income based on residential status. For residents, the Act taxes global income including that which is received, deemed to be received, accrues, arises, or is deemed to accrue or arise in India. For non-residents, only income that is received or deemed to be received in India, or accrues or arises or is deemed to accrue or arise in India, falls within the tax net. This territorial nexus has been the subject of extensive judicial interpretation, with courts examining the concept of “accrual” and “receipt” of income in various contexts.

Administration and Enforcement

The Central Board of Direct Taxes, constituted under the Central Boards of Revenue Act, 1963, administers direct taxes through the Income Tax Department. The Board functions under the Ministry of Finance and exercises powers under the Income Tax Act through notifications, circulars, and instructions. The hierarchical structure of tax administration includes Principal Chief Commissioners, Chief Commissioners, Principal Commissioners, Commissioners, Additional Commissioners, Joint Commissioners, Deputy Commissioners, Assistant Commissioners, and Income Tax Officers, each possessing specific jurisdictional and functional powers.

The Act provides extensive powers to assessing officers for scrutiny, investigation, and assessment of income. Section 143 governs the assessment procedures, while Sections 131 to 133A confer powers of discovery, inspection, and requisition. These provisions enable tax authorities to call for information, conduct surveys, and in cases of suspected tax evasion, carry out searches and seizures under Section 132.

Corporate Taxation

Corporate entities in India are taxed under the same Income Tax Act that governs individual taxation, but with distinct rates and provisions. Section 115BAA, inserted by the Taxation Laws (Amendment) Act, 2019, provides domestic companies an option to pay tax at concessional rates subject to certain conditions. The standard corporate tax rate structure, as periodically amended by Finance Acts, distinguishes between domestic and foreign companies, with foreign companies attracting higher rates.

Section 115JB introduces the concept of Minimum Alternate Tax (MAT), ensuring that companies declaring book profits but minimal taxable income under the Income Tax Act still contribute a minimum level of tax. This provision addresses the concern that companies utilizing various deductions and exemptions might significantly reduce their tax liability despite showing substantial book profits.

Indirect Taxation Framework

Goods and Services Tax

The introduction of the Goods and Services Tax on July 1, 2017, marked the most significant indirect tax reform in independent India’s history.[3] GST subsumed multiple central and state taxes including central excise duty, service tax, value added tax, central sales tax, and various cesses and surcharges. The GST framework operates through five separate legislations: the Central Goods and Services Tax Act, State Goods and Services Tax Acts, Union Territory Goods and Services Tax Act, Integrated Goods and Services Tax Act, and the Goods and Services Tax (Compensation to States) Act.

The Central Goods and Services Tax Act, 2017 establishes the levy and collection of tax on intra-state supply of goods and services by the Central Government. Section 9 of the CGST Act constitutes the charging provision, stating that tax shall be levied on all intra-state supplies of goods or services or both, except on the supply of alcoholic liquor for human consumption, at rates not exceeding twenty percent as recommended by the GST Council.

The Integrated Goods and Services Tax Act, 2017 governs inter-state supplies and imports. Section 5 of the IGST Act provides for the levy of integrated tax on inter-state supply of goods or services or both at rates not exceeding forty percent as recommended by the GST Council. The IGST mechanism ensures seamless flow of input tax credit across state boundaries, eliminating the cascading effect that characterized the pre-GST regime.

The State Goods and Services Tax Acts, enacted by respective state legislatures, mirror the provisions of the CGST Act for state-level taxation. For intra-state supplies, both CGST and SGST are levied, with the tax being shared equally between the Centre and States. For inter-state supplies, IGST is levied and collected by the Centre, subsequently apportioned between the consuming state and the Union government.

Input Tax Credit Mechanism

Section 16 of the CGST Act embodies one of GST’s core features: the input tax credit mechanism. This provision allows registered persons to claim credit for taxes paid on inputs used in the course or furtherance of business, which can be set off against output tax liability. The conditions for claiming input tax credit include possession of a tax invoice, receipt of goods or services, payment of tax to the supplier, and filing of returns. This mechanism eliminates the cascading effect of taxes, ensuring that tax is levied only on value addition at each stage of the supply chain.

GST Council and Administrative Structure

The GST Council, constituted under Article 279A of the Constitution, serves as the apex body for making recommendations on GST-related matters. The Council, chaired by the Union Finance Minister and comprising ministers nominated by state governments, recommends tax rates, exemption lists, threshold limits, and special provisions for certain states. Its decisions require a three-fourths majority of votes cast, with the Union government holding one-third voting weightage and states collectively holding two-thirds.

The Central Board of Indirect Taxes and Customs administers GST at the central level, while state tax authorities handle state-level administration. The dual control mechanism ensures both levels of government maintain oversight while minimizing taxpayer harassment through coordinated procedures and cross-empowerment of officers.

Customs Duties

The Customs Act, 1962 provides the legal framework for levying duties on goods imported into or exported from India.[4] Section 12 of the Customs Act establishes that duties of customs shall be levied at rates specified under the Customs Tariff Act, 1975. The Act distinguishes between basic customs duty, additional duties, protective duties, anti-dumping duties, and safeguard duties, each serving distinct policy objectives.

The Customs Tariff Act, 1975 prescribes the rates of duty applicable to different classes of goods based on their classification under the Harmonized System of Nomenclature. Tariff classifications remain subject to frequent amendments through annual Finance Acts and executive notifications, reflecting changing trade policies and international obligations.

Section 28 of the Customs Act deals with assessment of duty, providing that imported or exported goods shall be assessed to duty on the basis of a bill of entry, shipping bill, or bill of export. The Act confers extensive powers on customs officers for examination of goods, questioning of importers and exporters, and prevention of smuggling. Chapter XIV prescribes offenses and penalties for violations including misdeclaration, undervaluation, and smuggling.

Judicial Interpretation and Landmark Cases

The Supreme Court and High Courts of India have developed an extensive body of jurisprudence interpreting various provisions of tax laws. In Commissioner of Income Tax v. Reliance Industries Limited, the Supreme Court addressed questions relating to allowability of interest deductions under Section 36(1)(iii) of the Income Tax Act. The Court held that when interest-free funds available to the assessee are sufficient to meet investments, a presumption arises that investments were made from interest-free funds, and consequently, no disallowance of interest expenditure is warranted.

Courts have consistently emphasized that tax legislation must be interpreted strictly, and ambiguities should be resolved in favor of the taxpayer. However, this principle does not extend to allowing aggressive tax planning or schemes designed primarily for tax avoidance. The concept of “substance over form” has gained increasing recognition, with courts examining the economic substance of transactions rather than merely their legal form.

The doctrine of “colourable device” has been applied in cases where transactions are structured artificially to avoid tax liability. Courts scrutinize whether transactions have genuine business purpose or are merely designed to circumvent tax obligations. This judicial approach seeks to balance legitimate tax planning with prevention of abusive arrangements.

Tax Collection and Compliance Mechanisms

The tax administration system in India employs various mechanisms to ensure compliance and timely collection of taxes. For direct taxes, the withholding system through Tax Deducted at Source (TDS) under Chapter XVII-B of the Income Tax Act ensures collection at the source of income. Section 194 and subsequent sections prescribe TDS obligations on various types of payments including salaries, interest, rent, professional fees, and payments to contractors.

For indirect taxes, the self-assessment mechanism under GST requires taxpayers to determine their tax liability, file returns, and remit taxes. Monthly or quarterly returns as prescribed under Section 37 to Section 44 of the CGST Act serve both compliance and information-gathering purposes. The information technology infrastructure supporting GST, including the GSTN portal, enables electronic filing, payment, and matching of invoices.

The advance tax system under Sections 207 to 219 of the Income Tax Act requires taxpayers to pay tax in installments during the financial year itself, rather than waiting until the end of the year. This system ensures steady revenue flow to the government while distributing the tax burden over the year for taxpayers.

Dispute Resolution and Appellate Mechanisms

The tax laws provide multi-tiered appellate mechanisms for resolution of disputes. Under the Income Tax Act, assessees aggrieved by assessment orders can appeal to the Commissioner of Income Tax (Appeals) under Section 246A. Further appeals lie to the Income Tax Appellate Tribunal under Section 253. Questions of law can be appealed to the High Court under Section 260A and ultimately to the Supreme Court.

Under GST laws, the first appellate authority is the Appellate Authority constituted under Section 107 of the CGST Act. Appeals from the Appellate Authority can be filed before the Appellate Tribunal. The GST Appellate Tribunal, though provided for in the GST Acts, took time to become operational, with jurisdictions initially exercising writ jurisdiction under Article 226 of the Constitution.

Alternative Dispute Resolution mechanisms have been introduced to reduce litigation. The Authority for Advance Rulings under Section 245N of the Income Tax Act and corresponding provisions in GST Acts allow taxpayers to seek advance rulings on tax implications of proposed transactions. Settlement Commissions, though largely phased out, previously provided avenues for voluntary disclosure and settlement of tax disputes.

Anti-Avoidance and Prevention Measures

To combat tax evasion and aggressive tax planning, Indian tax laws incorporate various anti-avoidance provisions. The General Anti-Avoidance Rule (GAAR) under Section 96 to Section 102 of the Income Tax Act empowers tax authorities to disregard arrangements or transactions undertaken with the main purpose of obtaining tax benefits. These provisions target arrangements lacking commercial substance or those that abuse the tax law.

Transfer pricing regulations under Sections 92 to 92F of the Income Tax Act govern international transactions between associated enterprises. These provisions ensure that transactions between related parties across borders occur at arm’s length prices, preventing profit shifting and base erosion. The arm’s length principle requires that prices charged in controlled transactions should be similar to those in uncontrolled transactions under comparable circumstances.

The Prevention of Money Laundering Act, 2002, though not strictly a tax legislation, complements tax enforcement by targeting proceeds of crime, which often includes tax evasion. The integration of the tax administration with financial intelligence units enhances detection of tax evasion and undisclosed income.

Recent Developments and Reforms of India’s Taxation System

The Taxation in India continues to evolve with ongoing reforms aimed at simplification, digitalization, and broadening of the tax base. The faceless assessment scheme introduced through amendments to the Income Tax Act aims to eliminate physical interface between taxpayers and tax officers, thereby reducing corruption and harassment while improving efficiency.

The Direct Tax Vivad Se Vishwas Scheme and various amnesty schemes have been introduced periodically to resolve pending tax disputes and provide taxpayers opportunities to settle disputes on payment of disputed tax without interest and penalties. These schemes aim to reduce the burden of litigation on both taxpayers and the judiciary.

The proposed Direct Tax Code, intended to replace the Income Tax Act, 1961, has been under consideration for years. While earlier versions of the Code were not enacted, the government continues to work toward comprehensive reform of direct tax laws to make them simpler, more equitable, and easier to administer. The Income Tax Act, 2025 was recently passed and will come into effect from April 1, 2026, replacing the Income Tax Act, 1961.

Conclusion

India’s tax system represents a complex but sophisticated framework designed to mobilize revenue while promoting economic growth and social equity. The constitutional foundations, statutory provisions, and judicial interpretations together create a robust legal structure for taxation in India. The shift from a fragmented indirect tax regime to GST demonstrates India’s commitment to tax reform and modernization. Direct taxes continue to be governed by well-established principles while adapting to contemporary challenges including digitalization, international tax avoidance, and the informal economy. Ongoing reforms focusing on technology integration, taxpayer services, and dispute resolution signal a progressive approach to tax administration. The effectiveness of the tax system depends not merely on legislation but on efficient administration, voluntary compliance, and a tax culture that recognizes taxation as essential for national development. As India’s economy continues to grow and integrate with the global economy, the tax system will need to remain dynamic, responsive, and aligned with international best practices while serving the unique needs of India’s diverse economic landscape.

References

[1] Constitution of India, Article 265. Available at: https://www.indiacode.nic.in 

[2] Income Tax Act, 1961. Available at: https://www.indiacode.nic.in/handle/123456789/2435 

[3] Central Goods and Services Tax Act, 2017. Available at: https://www.indiacode.nic.in/handle/123456789/15689 

[4] Customs Act, 1962. Available at: https://www.commonlii.org/in/legis/cen/num_act/ca1962124/ 

[5] Income Tax Department, Ministry of Finance, Government of India. Available at: https://incometaxindia.gov.in 

[6] Central Board of Indirect Taxes and Customs. Available at: https://cbic-gst.gov.in

[7] GST Council. Available at: https://gstcouncil.gov.in 

[8] Ministry of Statistics and Programme Implementation, Government of India. “Direct and Indirect Taxes.” Available at: https://www.mospi.gov.in 

[9] ClearTax. “Types of Taxes in India: Direct Tax and Indirect Tax.” Available at: https://cleartax.in/s/types-of-taxes-in-india-direct-and-indirect-tax