Tax Structure & Taxation: GST's Federal Design, the Direct Tax Crossover, and the New Income Tax Act

This chapter has produced exactly 8 real Prelims questions so far, spanning 2016 to 2025, and it is the first deep treatment of tax policy on this site (the only other mention of tax in this site's Economy notes is a narrow accounting distinction, product tax versus production tax inside the GDP formula). It also arrives at an eventful moment: GST rates were rationalised into a near-two-slab structure in September 2025, the Equalisation Levy UPSC tested in 2018 no longer exists in any form, and a new Income-tax Act has replaced the sixty-year-old 1961 Act that every existing reference book still describes. Treat the dates below as load-bearing, not decorative: a textbook's description and the current legal position can quietly diverge here.

This chapter's material overlaps with NCERT Class 12, Introductory Macroeconomics, Chapter 5 (Government Budget and the Economy). This note goes further than that chapter's coverage.

Direct versus indirect taxes: the incidence test, and India's crossover

The line between a direct tax and an indirect tax is not about who writes the cheque to the government; it is about whether the burden can be shifted onto someone else. A direct tax, income tax, corporate tax, is levied on and paid by the same person who bears its economic burden. An indirect tax, GST, customs duty, is levied on one person (a manufacturer, an importer) but designed to be shifted forward, typically to the final consumer, through price. The technical vocabulary is impact (who the tax is initially levied on) versus incidence (who ultimately bears the burden): for a direct tax the two coincide; for an indirect tax they fall on different people. This is the most exam-tested line in the chapter, and the trap is almost always a statement that quietly swaps impact for incidence, or calls a tax "direct" merely because someone is legally required to remit it (GST is remitted by the seller, but its incidence falls on the buyer, which is exactly why it stays indirect).

The relative weight of the two categories in India's revenue has flipped inside the last decade, worth knowing precisely because most descriptions of Indian public finance still repeat the older, indirect-tax-heavy picture. Per the Economic Survey 2025-26, the share of direct taxes in India's total tax collections rose from 51.9% pre-pandemic to 55.5% post-pandemic, reaching 58.8% in FY25 (provisional actuals), driven by a widening income-tax base (return filings rose from 6.9 crore in FY22 to 9.2 crore in FY25) and buoyant non-corporate tax collections. Indirect taxes, GST, excise, customs together, now make up a minority of India's tax revenue, roughly 41%, a genuine reversal of the historical pattern. In Union Budget 2025-26 terms, of every rupee of government revenue, direct taxes contributed around 39 paise against roughly 27 paise from indirect taxes, the remainder from borrowings and non-tax receipts.

Progressive, proportional and regressive taxation

These three terms describe how a tax's rate behaves as the taxed base (usually income) rises, and UPSC tests whether a student can place a real Indian tax correctly on this spectrum rather than just recite definitions. A progressive tax charges a rising rate as the base rises, so a wealthier taxpayer pays a larger share of income, not just a larger amount. A proportional (flat) tax charges the same rate regardless of the base's size. A regressive tax effectively falls as the base rises, so a poorer taxpayer bears a proportionately heavier burden than a wealthier one.

India's personal income tax is the textbook progressive tax: under the new regime announced in Budget 2025-26, income is taxed in rising slabs, and a salaried taxpayer pays nil income tax up to ₹12.75 lakh a year (after the standard deduction), with rates climbing beyond that. GST, by contrast, is a proportional tax on the transaction itself (everyone buying the same item pays the same rate), but widely treated as regressive in its effective incidence on income, since a fixed consumption-tax rate takes a larger share of a poor household's income than a rich one's, given how much more of that income poorer households spend rather than save. This is why GST offsets its own regressivity through rate design, not the rate mechanism: essentials sit at nil or the lowest slab, luxury and sin goods at the top.

GST's constitutional foundation: the 101st Amendment

GST did not slot into India's existing tax architecture; it required rewriting the Constitution's own division of taxing powers, since the Seventh Schedule had separated the power to tax goods (Union via excise, State via sales tax/VAT) from the power to tax services (Union), while GST taxes the same supply as both, indivisibly. The Constitution (One Hundred and First Amendment) Act, 2016 solved this with two new articles.

Article 246A, in force from 16 September 2016, creates GST's taxing power itself: Parliament and every State legislature get concurrent power to make GST law, unusual since most subjects sit exclusively on one list, with one carve-out, Parliament alone holds exclusive power over inter-State supplies (IGST). Its Explanation clause also ties GST's commencement on petroleum crude, diesel, petrol, natural gas and aviation turbine fuel to a date the GST Council must recommend, the constitutional root of why these five products are not taxed under GST today (more below).

Article 279A, in force from 12 September 2016, established the GST Council as a constitutional body, the President constituting it by order within sixty days of the amendment's commencement. This site's Federal System note (Polity) covers the Council's composition and voting mechanics in full depth as a live illustration of quasi-federal design, so only the exam-critical numbers repeat here: the Union Finance Minister chairs it, every State nominates its own Finance or Taxation Minister, decisions need a three-fourths majority of weighted votes, Centre weighted at one-third, all States together at two-thirds (Article 279A(9)), and a quorum of one-half. The Supreme Court, in Union of India v. Mohit Minerals (2022), held the Council's recommendations to be persuasive rather than binding, a "cooperative federalism" reading the Federal System note discusses at length. Article 279A(4) gives the Council explicit scope over subsumption, exemptions and rates, so virtually everything below was, at some point, a Council call.

What GST subsumed, and what it deliberately left out

Per CBIC, GST replaced a genuinely long list of separately administered Central and State levies rather than merely adding a new one alongside them. Centrally, it subsumed Central Excise Duty, Duties of Excise on Medicinal and Toilet Preparations, Additional Duties of Excise (Goods of Special Importance, and Textiles), Additional Duties of Customs (CVD), Special Additional Duty of Customs (SAD), and Service Tax. At the State level, it subsumed State VAT, Central Sales Tax, Luxury Tax, Entry Tax, Entertainment Tax (except local-body levies), Purchase Tax, advertisement tax, and taxes on lotteries, betting and gambling, plus State-level surcharges and cesses. A PYQ has tested exactly this under the "genuine advantage of GST" framing: the point was to collapse a cascading, multi-point structure, where a tax was often charged on a price that already included an earlier tax, into one value-added levy administered through one chain.

What GST left outside its scope is a sharper, more commonly misstated distinction, since the two exclusions rest on different legal grounds. Alcohol for human consumption is excluded by the Constitution's own definition: Article 366(12A), also inserted by the 101st Amendment, defines "goods and services tax" as "any tax on supply of goods, or services or both except taxes on the supply of the alcoholic liquor for human consumption," a permanent, definitional exclusion; States tax alcohol separately through excise and VAT, a revenue source they guard closely. Petroleum (crude, diesel, petrol, natural gas, ATF) is different: constitutionally within GST's ambit already, but Article 279A(5) requires the Council to recommend the date GST will apply, and it never has, so these five stay under Central excise plus State VAT, exactly why fuel prices vary sharply across State borders while most other goods carry a uniform rate. The trap is treating both as equivalent exclusions; one is constitutionally permanent, the other a pending, revocable Council call.

The GST rate structure: from four slabs to "Simple Tax"

GST launched on 1 July 2017 with a multi-tier structure, a nil rate and standard slabs at 5%, 12%, 18% and 28%, with an additional Compensation Cess layered on the 28% slab for luxury and "sin" goods (tobacco, aerated drinks, large cars, coal). This four-slab structure is what most current editions of the standard reference books still describe, and it is now out of date. On 3 September 2025, at its 56th meeting, the GST Council approved what it called a "citizen-friendly Simple Tax," rationalising the structure into essentially two main rates, a 5% Merit Rate and an 18% Standard Rate, alongside a 40% special de-merit rate for a narrow set of luxury and sin goods, effective 22 September 2025. Items previously at 12% mostly moved to 5% (soap, toothpaste, packaged food, tractors), and items at 28% mostly moved to 18% (air conditioners, small cars, cement, televisions); individual life and health insurance was exempted entirely. The 40% slab absorbs what used to be the 28%-plus-cess combination for sin/luxury items, so it functions less as a new, higher tax and more as a consolidation of the old cess-inclusive burden into one headline rate.

The GST Compensation Cess: the five-year guarantee, and what came after

GST's rollout created an obvious political problem: States that were net sellers of goods taxed at the point of production (origin-based) stood to lose revenue under a destination-based consumption tax, since revenue would now accrue to the State of final consumption, not production. The Goods and Services Tax (Compensation to States) Act, 2017 addressed this by guaranteeing every State a 14% annual revenue growth rate over its 2015-16 base year, for five years from GST's launch, funded by a Compensation Cess on luxury and sin goods. That guarantee period ran out on 30 June 2022. Rather than end the cess immediately, the GST Council extended its collection (the compensation payments themselves had already stopped) up to 31 March 2026, via Notification No. 1/2022-Compensation Cess dated 24 June 2022, to service two back-to-back loans the Centre had raised on the States' behalf (roughly ₹1.1 lakh crore in FY21 and ₹1.59 lakh crore in FY22) covering the shortfall in cess collections when pandemic-era consumption collapsed. The September 2025 GST rate reform folded the cess into the new 40% de-merit rate for most previously cess-bearing goods, merging the levy into the headline rate itself; tobacco stayed the exception, at 28% GST plus a variable cess until the compensation loans clear, after which it too moves to 40%. What happens to the cess mechanism once the loan is retired, withdrawal, a new cess, or permanent absorption, remained under active discussion in a GST Council Group of Ministers as of the most recent reforms.

BEPS, the Equalisation Levy, and India's international tax track

Base Erosion and Profit Shifting (BEPS) describes the strategies multinationals use to shift taxable profit out of countries where real economic activity happens into low-or-no-tax jurisdictions, eroding the tax base of the countries actually generating that value. India participates in the OECD/G20 Inclusive Framework on BEPS, a 147-member grouping working toward coordinated international tax rules, including its "Pillar Two" global minimum effective tax rate of 15% on large multinationals, still an active, evolving negotiation rather than a settled rule as of 2026.

Ahead of that multilateral consensus, India moved unilaterally in 2016 with the Equalisation Levy, popularly the "Google tax," a 6% levy on payments to non-residents for online advertisement services (Finance Act, 2016), directly tested in a 2018 PYQ. The Finance Act, 2020 added a second, 2% levy on e-commerce supply by non-resident operators. Both have since been withdrawn, and the timeline matters because reference books describing the levy as still in force are out of date: the 2% e-commerce levy ended 1 August 2024, and the 6% advertisement levy ended 1 April 2025, reportedly to ease trade tensions around US reciprocal-tariff threats. The Income Tax Department's own current guidance confirms no equalisation levy provisions apply on or after 1 April 2025, so the levy, in both forms, is now history.

Black money and the parallel economy

India's two dedicated statutes against undisclosed wealth address different problems and should not be conflated. A benami transaction is one in which property is held by one person (the "benamidar") for the benefit of another, real "beneficial" owner who provided the consideration, typically to conceal the true owner's identity and evade tax or launder illicit income. The Benami Transactions (Prohibition) Amendment Act, 2016 (in force from 1 November 2016) overhauled a toothless 1988 predecessor with a genuine enforcement architecture: four authorities (Initiating Officer, Approving Authority, Administrator, Adjudicating Authority), drawn from Income Tax Department officers, empowered to attach and, on confirmation, confiscate benami property, which then vests absolutely in the Central Government without any compensation. Convicted offenders face one to seven years' imprisonment and a fine up to 25% of market value, with an Appellate Tribunal for appeals. This Act was tested directly in a 2017 PYQ.

The Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 addresses a narrower, higher-stakes problem: income earned, or assets held, abroad by an Indian tax resident and never disclosed here. It taxes such income and assets at a flat 30%, with a penalty of three times the tax, total exposure around 120% of the undisclosed value, alongside potential prosecution. A one-time compliance window (1 July to 30 September 2015) let holders come forward voluntarily at a reduced 100%-of-tax penalty with no prosecution, an amnesty not repeated since.

Direct tax reform: from the Direct Taxes Code to the Income Tax Act, 2025

For over a decade, "direct tax reform" in India meant the Direct Taxes Code (DTC), a project to replace the Income-tax Act, 1961 with a single, modernised code: drafted in 2009, introduced as a Bill in 2010, scrutinised by a Standing Committee reporting in 2012, revised again in 2014, and repeatedly lapsed with changes in government, never enacted. A Task Force constituted in November 2017 submitted a fresh draft report in August 2019, itself never legislated. In practice, the government reformed direct tax law through annual Finance Act amendments rather than one comprehensive replacement, for nearly two more decades.

That changed in 2025. The Income-tax Act, 2025 was passed by Parliament on 12 August 2025, received Presidential assent on 21 August 2025, formally repealing the 1961 Act, and came into force on 1 April 2026 (already in effect as this note is written), operationalised by the Income-tax Rules, 2026 notified by the CBDT on 20 March 2026. The exam-relevant nuance is what the new Act is, and is not: the Ministry of Finance frames it as a simplification exercise, cutting the law from 819 sections across 23 chapters to 536 sections (still 23 chapters), Rules from 511 to 333, Forms from 399 to 190, explicitly "without altering the underlying tax policy." It is not a rewrite of rates, slabs or exemptions, just a consolidation of the same substantive law into clearer drafting: it succeeded where the DTC repeatedly failed precisely because it did not attempt what the DTC always tried, changing policy in the same stroke as the redraft.

Quick revision points

• Direct tax: impact and incidence fall on the same person, cannot be shifted (income tax, corporate tax). Indirect tax: they fall on different people (GST, customs). Direct taxes reached 58.8% of India's tax revenue in FY25, up from 51.9% pre-pandemic, reversing the older indirect-tax-heavy pattern.
• Progressive (rate rises with the base, income tax), proportional (flat rate, GST itself), regressive (falls harder on lower incomes, GST's real-world incidence, offset by taxing essentials cheapest).
• 101st Amendment, 2016 inserted Article 246A (concurrent Union-State power to levy GST, Parliament exclusive for inter-State supply) and Article 279A (GST Council: Union FM as Chairperson, three-fourths weighted-vote majority, Centre one-third weightage, States two-thirds combined, quorum of half).
• GST subsumed Central Excise, Service Tax, CVD, SAD centrally; State VAT, CST, Luxury Tax, Entry Tax, Entertainment Tax, Purchase Tax at State level. Alcohol excluded permanently by definition (Article 366(12A)); petroleum (crude, diesel, petrol, natural gas, ATF) is constitutionally includable but awaits a GST Council date recommendation (Article 279A(5)), a different, revocable kind of exclusion.
• The 5/12/18/28 four-slab system became a two-rate "Simple Tax" (5% Merit, 18% Standard) plus a 40% de-merit rate from 22 September 2025 (56th GST Council meeting).
• Compensation Cess: five-year, 14%-growth guarantee to States ended 30 June 2022; collection (to repay Covid-era Centre loans to States) extended to 31 March 2026; September 2025 folded the cess into the 40% slab, tobacco excepted.
• Equalisation Levy fully withdrawn: 2% e-commerce levy ended 1 August 2024, 6% online-advertisement levy ended 1 April 2025.
• Benami Transactions (Prohibition) Amendment Act, 2016: in force from 1 November 2016, four authorities, confiscation without compensation, 1-7 years imprisonment plus a fine up to 25% of market value.
• Black Money Act, 2015: 30% flat tax plus a 3x penalty on undisclosed foreign income/assets, total exposure around 120% of value.
• The Direct Taxes Code was drafted repeatedly (2009, 2010, 2014) but never enacted. The Income-tax Act, 2025 succeeded where it failed, replacing the 1961 Act from 1 April 2026, but only simplifies drafting and structure, without changing underlying tax policy.

A chapter this current rewards knowing the actual dates, not just the mechanisms, since a stale but plausible-sounding version of any of these facts is precisely what a scrambled PYQ option looks like.