Pre and post Independence Tax Coverage- Dr. Akhedan Charan

Pre Independence Tax Journey:

Under British Rule, the country experienced significant and attention-grabbing alterations in its taxation structure. While the taxing system primarily favored the British government and its treasury, it was also founded on contemporary and scientific concepts of taxation. The imposition of excise duty began with salt in 1870, followed by cotton yarn in 1894, motor spirit in 1917 and kerosene in 1922. The Indian Taxation Enquiry Committee performed an investigation into the taxation system in 1925.

During that period, the economic landscape was inherently distinct from the present day. The country was a colony of the United Kingdom. British India encompassed territories such as Burma, the entirety of Bengal and the Punjab, as well as Baluchistan and Sind. The geography of India encompassed the entirety of the land that currently comprises four separate nations: India, Pakistan, Bangladesh, and Burma.

The coastal states enforced their own tariffs, while some others imposed import and export charges on their commerce with British India. There was a lack of economic development strategy and little effort was made to establish a welfare State. With the exception of cotton and jute, the organized industry in the country was still in its early stages of growth. The majority of the country’s manufacturing needs were fulfilled by imports from foreign countries. Customs played a dominant role in generating central revenues in the sphere of public finance, whilst land revenue was the primary source of income for the British Indian provinces. The salt tax served as a significant means of income for the Central Government, while excise duties on liquor became the second primary source of revenue for the British Indian provinces. There was neither a prohibition nor a sales tax. The Central Government relied heavily on income tax as a significant source of revenue. However, the highest rate of income tax and super tax was limited to 47% for incomes exceeding 5.5 lakhs. The state of affairs in the realm of public finance remained mostly unchanged until the onset of the War. Rapid changes occurred throughout the period of war and the subsequent years.

The Government of India Act, 1935, designated the tax on the sale of goods as a provincial matter. The introduction of sales tax in India occurred for the first time in the Province of Bombay through the enactment of the Bombay Tobacco (Amendment) Act, 1938. The legislation was implemented on 24 March 1938. This sales tax was imposed on the purchase of tobacco inside specific urban and suburban regions with strict limitations. Madras was the second state to implement a general sales tax in 1939, which was subsequently adopted by other states. Later on, a variety of indirect taxes were incorporated into the taxation system. India had approximately 20 different forms of indirect taxes.

Under British Rule, the country exclusively exported raw materials that would later return as finished products. The primary export was to the United Kingdom. The British formerly discouraged Indian producers from manufacturing completed goods. The Indian market was inundated with products manufactured in Britain.

The 18th and 19th centuries in Europe marked the onset of the Industrial Revolution, characterized by the utilization of machinery for the production of commodities and the rise of several new industries. The European market quickly became inundated with mass-produced goods, with garment fabric being particularly prominent. The European market quickly reached a point of saturation, making it no longer feasible to sell additional manufactured products there. Subsequently, the British choose India as their fresh market. The British put mechanized fabric in the Indian market, however, India had already achieved self-sufficiency in textiles. The British product was more expensive than the Indian products. Consequently, the issue of price emerged as a significant challenge. In order to resolve the issue, they imposed a fresh tax on items produced in India. The tax in question was referred to as ‘excise duty’. As a result, the prices of imported items became equivalent to those of goods produced in India. The Indian Khadi and handloom sector experienced significant adversity and sustained substantial financial losses as a result of the application of excise duty.

The economic and administrative structures of India were profoundly altered as a result of the British colonial authority that was administered there. The tax system was one of the most important factors in this regard. In particular, the indirect tax system was an essential component of the total revenue strategy that the British government implemented. Direct taxes are charged on income or wealth, whereas indirect taxes are levied on products and services. Indirect taxes compare to direct taxes. The construction, implementation, and impacts of the indirect tax system in British India are investigated in this essay, with a focus on the most important facts and the historical circumstance surrounding the system.

A Historical peep through

The tax system was initially formed by the British East India Company, which was the ruling power in India prior to the British Crown taking control of the country in 1858. A key purpose of Abhartiya tax system was to create income in order to provide financial support to the administration and to boost the economy of United Kingdom. Within this context, indirect taxes emerged as a significant instrument. These taxes included customs duties, excise duties, and sales taxes, all of which were levied on a variety of different goods and commodities.

Organizational Framework of the Indirect Tax System

1. Duties on Customs: Customs duties were one of the earliest forms of indirect taxation that were implemented by the British. These were taxes that were levied on items that were brought into India or exported out of the country. In addition to generating cash, the major objective was to safeguard British businesses by increasing the cost of goods imported from other countries. When it comes to textiles, for example, the British textile sector benefited from the imposition of hefty tariffs on Indian textiles.

2. Excise duty: Certain items that were manufactured and sold within India were subject to the imposition of excise duty. Salt, opium, and wine were among the most important items that were subject to excise levies. The Salt Tax, in particular, became notorious due to the influence it had on the day-to-day lives of Indians and the role it played in Mahatma Gandhi’s Salt March in 1930, which was a significant event in the campaign for Indian independence.

3. Sales Taxes: Although they were not as prevalent as customs and excise levies, sales taxes were imposed on a variety of products that were sold within the country. Frequently, these taxes were passed on to the consumers, which resulted in an increase in the cost of commonplace items.

The taxation system in British India

Zamindari, Ryotwari, and Mahalwari were some of the eminent primary methods of revenue collection during British India.

The Zamindari system

The Zamindari System was implemented by Lord Cornwallis in 1793 through the Permanent Settlement Act, which is commonly referred to as the Permanent Settlement. It was implemented in the provinces of Bengal, Bihar, Orissa, and Varanasi. The zamindars, as landowners, were granted the authority to collect rent from the peasants. The total sum would be divided into 11 equal portions. Zamindars own one-eleventh of the share, whereas the East India Company owned ten-elevenths of the share.

The Ryotwari System

Thomas Munro implemented this system in 1820 in the Madras presidency, Bombay presidency, and certain areas of Assam and Coorgh provinces in British India. The peasants were granted ownership rights under the Ryotwari System. Peasants directly provided taxes to the government. The tax rates were 1/2 in areas with dry land and 3/5 in areas with irrigated land, based on the total amount of produce.

The Mahalwari system

The introduction of this occurred in many regions of British India, including Central Province, North-West Frontier, Agra, Punjab, and Gangetic Valley, in 1833 under the governance of William Bentinck. Within this arrangement, the land was partitioned into Mahals. Each Mahal consists of one or more villages. The peasants were granted ownership rights. The village committee was accountable for the collecting of taxes.

Salt taxation

The practice of salt taxes has been in existence in India since ancient times, although it had a significant expansion during the British colonial control in India. In 1835, specific levies were enforced on Indian salt to expedite its importation. This resulted in significant financial gains for the traders of the British East India Company. The Indian public bitterly criticized the rigorous salt charges made by the British.

A view as how Bureaucracy was introduced as an instrument to nurture British interest

The administration of the British government established a large bureaucracy in order to carry out and collect these kinds of taxes. It was the Indian Civil Service (ICS) that was responsible for ensuring that the collection of taxes was carried out effectively. Nevertheless, the system frequently engaged in exploitative and discriminatory practices, and it greatly favored the economic interests of the British.
An example that is particularly noteworthy of the exploitative nature of the tax system is the salt tax. The price of salt, which is a product that is required by every household, was extremely high. Native Americans were not permitted to create their own salt and were instead required to purchase it from government warehouses at exorbitant fees. The disparities that exist within the British tax system were brought to light by the fact that this tax disproportionately affected the poor.

The influence on the economy and society of India

1. Economic Impact: One of the most significant effects that the indirect tax system had on the Bhartiya economy was that livelihood of artisans got suffocated. India’s manufacturing sector was severely strangled by the British government through the imposition of hefty tariffs on Indian commodities, particularly textiles. The result was deindustrialization, which resulted in the loss of livelihoods for a great number of artisans and weavers. Because of the emphasis placed on the generation of money rather than the development of the economy, there was a small amount of investment in industrial and infrastructure developments.

2. Impact on Society: The tax system was also responsible for a number of significant societal repercussions. A significant number of Indians saw their day-to-day lives negatively impacted as a result of the hefty tariff of necessary items such as salt and the ban on local manufacture. A significant factor that contributed to the expansion of the nationalist movement was the punitive nature of these taxes, which stoked anger. The Salt March led by Gandhi was a demonstration of how tax policies became a focal point for protest against the authority of the British.
3. The impact on administration: Despite the fact that the British developed a solid administrative system to manage tax collection, it was frequently plagued by corruption and inefficiency. A substantial amount of influence was held by tax collectors, who frequently exploited the local inhabitants. The colonial administration found itself the target of hostility and mistrust as a result of this.

Alterations and Revolutions

Over the course of time, the British government implemented a number of changes to the tax system. The Montagu-Chelmsford Reforms of 1919, which ultimately resulted in the Government of India Act of 1919, were created with the intention of increasing the amount of Indian representation in various aspects of governance, notably the administration of taxes. The exploitative nature of the tax system was not considerably altered by these revisions, which were restricted in scope and only partially implemented.

At the same time that it examined other administrative systems, the Simon Commission of 1927 also examined the tax system. As a result of its recommendations, the Government of India Act of 1935 was passed, which established the concept of provincial autonomy. This gave the provinces the ability to exercise a larger degree of responsibility over their financial matters, including taxation. In spite of these modifications, the essential nature of the indirect tax system continued to be directed toward giving advantages to the economic interests of the United Kingdom.

The structure of the indirect tax system in British India was Abhartiya, intricate and multi-faceted, with the primary purpose of catering to the requirements of the British government in terms of providing income. The Indian economy, society, and governmental institutions were all profoundly influenced as a result of this significant event. Even though it helped the British maintain their power by providing them with the finances they needed, it also contributed to the stagnation of the economy and the instability that occurred in society. One of the most important factors in the Indian independence movement was the hefty taxation of necessary items, particularly salt. This taxation became a symbol of colonial exploitation and played a significant role in the campaign. The economic history of colonial India and the origins of India’s fight for independence can be better understood by gaining an understanding of this system, which gives significant insights.

Post Independence Tax Journey

Beginning somewhere in the middle of the 20th century, the true history of modern indirect taxes may be traced back. 1944 was the year that saw the establishment of the Central Excises and Salt Act. For example, central taxes, state taxes, and local body taxes were all examples of indirect taxes. Manufacturing activity, import-export transactions, and the provision of services were all subject to central taxes being assessed. Local body taxes included municipal taxes, entertainment tax, and other similar taxes. State taxes were collected on the sale of commodities within the state by the state government.

The Provisions of the Constitution

The Union List (List 1), the State List (List 2), and the Concurrent List (List 3) are the three lists that are included in the Seventh Schedule of the Constitution of India, which was established in the year 1950. Because of this, the union and the states now have the authority to make any changes they want to their lists. In accordance with Article 246 of the Constitution, the Parliament possesses the unrestricted authority to enact laws concerning the things that are included in the Union List. It is within the authority of the states to enact legislation pertaining to any of the activities that are included on the State List. When it comes to subjects that are included in the Concurrent List, which is also known as List 3 of the Seventh Schedule, the jurisdiction to enact legislation is shared between the central government and the state governments.

The Centralized Indirect Taxes

Customs duty, central excise duty (CED), and service tax were the primary sources of income that were collected through indirect taxes prior to the implementation of the Goods and Services Tax (GST). A Central Sales Tax, commonly known as CST, was imposed by the union on all inter-state consignments of products as well as all inter-state sales and purchases of commodities respectively. Nevertheless, the state of origin was given the responsibility of CST.

Central Excise Duty

Excise duty was levied as per the terms of Central Excise Act (CEA), 1944 and Central Excise Rules, 1944. CED was a tax levied by the government on all the items created or produced in the country. Earlier, it was the principal source of revenue for the central government and was the backbone of the economy. The regulation was governed by two acts: (a) the CEA, 1944, and (b) the Central Excise Tariff Act (CETA), 1985. The CEA of 1944 included regulations for taxation, valuations, and administrations. In contrast, the CETA of 1985 provided a comprehensive list of commodities subject to taxation and the corresponding tax rates for each case. Since the makers collected it from the buyers of the goods, it was referred to as an indirect tax.

The CEA was enacted in 1944. Subsequently, it underwent progressive modifications on an annual basis. However, it is important to mention that the imposition of excise duty on salt occurred for the first time in 1870.

Subsequently, there were taxes imposed on cotton textiles in 1894, petroleum (motor spirit) in the 1920s, kerosene in 1922, silver in the 1930s (which became insignificant after the establishment of Burma in 1933), sugar and steel ingots in 1934, tires in 1941, manufactured tobacco and vegetable products in 1943, and coffee and tea in 1944.

The excise duty was eliminated promptly upon Independence of India in 1947. However, in 1949, an excise charge was implemented on mill fabric in order to address the revenue deficit and provide support to the handloom industry. However, it fell short of satisfying the requirements of the government. The post-Independence government faced significant challenges in generating cash. The Taxation Enquiry Commission, during the years 1953-1954, made the following observation: In order to generate significant revenue from commodity taxation and effectively reduce consumption in the entire economy, it became essential to expand excise and sales taxation to include lower income groups and goods that were commonly considered essential. There was no text provided.

During the initial ten years of Independence, the quantity of things subject to excise duty increased twofold to 33, encompassing products like cigarettes, soap, sewing machines, and electric bulbs. Over the course of the following ten years, the number increased to 80 and subsequently rose to 130 by 1975. In 1975, the central excise tariff was updated to include a residual category known as ‘Tariff Item 68’. This category encompassed all things that were not covered by the previous 67 categories. Initially, a 1% charge was imposed on certain commodities. However, Item 68 became a tool for succeeding finance ministers to collect taxes, since the rate was gradually increased to 12% by 1985. In the later part of the same year, the CETA of 1985 was implemented, which allowed for the imposition of excise duty on nearly all manufactured goods, with just a few exceptions.

Custom Duty

Custom duty is a form of indirect taxation. The federal government imposed this measure in 1962 to deter illicit imports and exports of products. It quickly emerged as the second primary source of central revenue in India. The government imposed and collected tariffs on imports and exports, established regulations for import and export procedures, and enforced restrictions on the importing and exportation of products. The primary objective of imposing customs duty was to stimulate the development of domestic businesses by affording them sufficient protection. Nevertheless, while accomplishing its primary objective, it also made a significant contribution to the treasury. Excessive protectionism resulted in the implementation of excessively high customs taxes in India, with some cases exceeding 300 percent prior to the reforms implemented in 1991. Each of the 28 budgets since 1991 implemented a gradual decrease in the highest rate of customs duty, resulting in a reduction to 10 percent.

Central Sales Tax

It refers to a tax imposed by the central government on the sale of goods within a country.

The Central Sales Tax (CST) was imposed by the central government on the transportation of products between states and the buying and selling of goods between states before the implementation of the products and Services Tax (GST). However, the centre did not keep the CST but instead assigned it to the state of origin, in accordance with the Central Sales Tax Act, 1956, which was created under Article 269 of the Constitution. The Central Sales Tax (CST) rate was 2 percent when a defined concessional form was available. In cases where the prescribed form was not available, the CST rate was set equal to the Value Added Tax (VAT) rate in the respective states where the items were situated at the time of sale.

Service tax

In the 1990s, there was a discussion regarding the inclusion of services in the tax classification. At that time, it was accounting for 40% of the nation’s GDP.  Mr. Manmohan Singh, the Finance Minister at the time, initiated the process of taxing services. In 1994-1995, he implemented a five percent service tax on specific services during his budget speech. Over the time, a 12% service tax was implemented on 120 specific categories of services, in addition to a 2% education cess and a 1% secondary and higher secondary education cess on taxable services. GST w.e.f 01 July, 2017 has now absorbed service tax.

Value-added tax

The VAT was a consumption tax that was incorporated into the sales price of a product. It was imposed on the domestic consumption of products and services. In 1976, L. K. Jha proposed the implementation of MANVAT as a method of collecting VAT. In 1986, the Finance Minister at the time, Mr. V. P. Singh, initiated the reforms in indirect taxes. He introduced a novel tax concept known as MODVAT. Initially, it was implemented on a limited number of carefully selected commodities that were subject to union excise duties. A few years later, the government expanded MODVAT to encompass nearly all commodities and decreased excise duty rates. In the 2000-2001 budget speech, the then Union Finance Minister Mr. Yashwant Sinha converted the MODVAT scheme into the CENVAT scheme, which was subsequently converted into the GST.

States’ Indirect Taxes

The primary source of revenue for states has been the tax on sale and purchase, excise duty on alcoholic beverages, opium, and narcotics, octroi and entry tax, electricity tax, and taxes on luxuries, entertainments, amusements, wagering, and gambling. Although it was imposed by the union, the Central Sales Tax (CST) was a significant source of revenue for the states and has since been incorporated into the Goods and Services Tax (GST) except some of the commodities.

Local governments, including municipal corporations and gram panchayats, assessed taxes on products that entered their jurisdiction. Each transport vehicle was required to pay the tax and submit the appropriate documentation upon entering the area, as the levy was dependent on a physical control mechanism. Octroi is of equal significance to local administrations as sales tax is to states and excise is to the central government.

Fiscal framework

The country’s taxation system consists of both direct and indirect taxes, with the latter now referred to as GST. An indirect tax refers to a tax on goods and services that is paid by an individual to the service provider, producer, or seller, who is responsible for remitting the tax to the government.

Ratio of Direct Tax and Indirect Tax

 The average share of indirect taxes in the country’s overall tax collection from 1990-1991 to 2018-2019 is 57.6 percent. In 1950-1951, indirect taxes made up 56.6% of the total central taxes and 2.45% of the GDP. However, in 2015-2016, the proportion of total tax revenue from indirect taxes increased to 48.9% and its contribution to the GDP reached 7.9%. The proportion of indirect taxes has generally declined from 1989-1990 to 2010-2011, with the exception of the year 1998-1999. Subsequently, there was an increase in the following periods: 2011-2012 and 2012-2013, followed by a subsequent decrease in 2013-2014. Between 2014 and 2016, there was a consistent upward trend. The projected percentage for the year 2018-2019 (BE) was 49.2%.

From the 1990s onwards, direct taxes have accounted for an average of 42.4 percent of the economy’s contributions, while indirect taxes have accounted for 57.6 percent. The percentage of direct tax, which stood at 23.2% in 1991-1992, rose to 60.6% in 2009-2010. However, it fluctuated above 50% in subsequent years, except for 2016-2017 when it dropped to 49.6%. The tax ratio in India, specifically the ratio of direct taxes to indirect taxes, is approximately 51:49. In contrast to the majority of OECD economies, where the ratio is the complete opposite (67:33) and in favor of direct taxes. Over the course of 50 years, India’s ratio of direct-to-indirect taxes has shifted from a low of 13:87 to its current high of 31:49. Over the course of 50 years, the ratio of direct-to-indirect taxes in OECD nations has remained relatively stable at around 65:35. The recent decrease in the proportion of direct taxes is a cause for concern.

As per Indian Union Budget estimates for financial year 2023, direct taxes accounted for 51.5 percent and indirect taxes accounted for 48.5 percent of total central tax collection in India. The source mentions that due to a cut in the corporate tax rate in 2019 and an increase in excise duty in financial year 2021, the share of direct taxes witnessed a fall following 2019. In a progressive tax system, the share of direct taxes is higher than indirect taxes.

Structure of Indirect Taxes

The structure of indirect taxes has experienced modifications since the country gained independence. During the period of 1950-1951, excise duties accounted for 29.2 percent of the overall central indirect taxes. The share nearly doubled, reaching 52.3 percent by 1995-1996. Subsequently, it rose to 61.1 percent in the fiscal year 2003-2004. Prior to the implementation of GST, it constituted 44.3 percent of the overall indirect tax.

The share of import duties as a percentage of total customs duties was 70% in 1950-1951 and steadily rose to 99.6% over a period of fifteen years. Subsequently, it is exhibiting a decline in trends. From 1990 to 1991, the percentage decreased to 45.7%, and further decreased to 34.3% in 2000-2001. The proportion of indirect taxes before GST was 26.2 percent.

The service tax, introduced in 1994-1995, is the most recent addition to the category of indirect taxes. It had an average contribution of 11.2 percent from 1994-1995 to 2016-2017. The percentage increased to 30.9% in 2014-2015, but decreased to 29.5% in 2016-2017 and 8.5% in 2017-2018 due to the implementation of GST. Now, it has been incorporated into the GST system.

The preceding research clearly indicates that indirect taxes played a major role in total tax collection during the first decade of the 1990s. It was equivalent to direct taxes in both the fiscal years 2005-2006 and 2006-2007. Subsequently, direct taxes surpassed indirect taxes and currently they are about equivalent. The implementation of GST incorporated service tax, custom duty, and excise duty. The relative income generated by indirect taxes will be contingent upon the government’s policy, regulation, and timely execution of the Goods and Services Tax (GST). However, in the majority of advanced countries, the proportion of direct taxes exceeds that of indirect taxes, and this should also be the case in India.

– Dr. Akhedan Charan