Knowledge Base

History of Taxation in India

The word ‘tax’ is derived from the Latin word taxare or taxo. It means ‘to assess the worth of something’. Taxes are imposed by government for the use and service of the State. They are levied and collected by the State for the purchase or sale of merchandise or a service. Taxes provide revenue to the state, and is therefore one of the most significant aspects of any system of administration by any form of government.

The strength of an economy depends upon how good the tax system is. A just tax system can propel the economic growth of a country and lead to its prosperity. This in turns makes its citizens happy and more productive. An efficient taxation policy leads to growth in GDP; it is considered sound if it performs allocative, distributional and stabilization function in the economy. 

There are two types of taxes – direct and indirect. Direct taxes are those that an entity remits to the government directly, and include income tax, property tax, etc. indirect taxes are those that an entity remits through third parties. Service tax is an example of indirect tax imposed by the government of India.

Any tax imposed by the government (Central, state or local) has the following important characteristics:

  • It is mandatory: since any form of tax is imposed by the government for the benefit of the country, it is required by law to pay taxes
  • It is a contribution: tax is a contribution made by citizens for the betterment of their country. The government of India provides basic healthcare, infrastructure, defence, etc. with the money collected from taxes
  • It is for public benefit:  the purpose of collecting taxes is for the benefit and upliftment of the society in general. Taxes are not supposed to favour specific individuals. Disaster maintenance and rescue is an important aspect of the money collected in the form of taxes
  • It is paid out of income earned or wealth: you pay tax only when you generate income. If an individual does not generate a minimum threshold income (defined and modified from time to time by the government), they need not pay some taxes like income tax.
  • It boosts economy: this is one of the most important aspects of collecting taxes. Since the government provides for infrastructure in the form of roads, trains, power stations, damns, etc., it utilizes the tax revenue for economic growth of the nation

History of Taxation in India
Income is the money that an individual or business receives in exchange for providing a good or services.  A formal tax system was in existence in India since the time of Maurya dynasty. The higher class of citizens contributed 1/6th of their income as tax. It is said that even before the Mauryas, tax was mentioned in Manu Smruti, one of the most ancient scriptures of India. The subsequent Mughal invaders brought with them their own taxation system. The infamous Jezia was a tax imposed on the non-Islamic people of the land. In India, it was abolished by Akbar.

The income tax as we know today was first introduced in India in 1860 by the British. It was introduced to compensate for the losses sustained by the government due to the rebellion of 1857. Income tax is defined as the annual charge levied on both earned income (wages, salaries or commission) and unearned income like dividends, interest or rent. In addition to financing a government’s operations, progressive income taxation is designed to distribute wealth creation more evenly in a population and to serve as buffer in case of fluctuations in the economic cycle. There are two basic types of income tax: personal income tax and corporation income tax.

The Income Tax Act was passed in India in 1886, and there have been constant revisions and refinements in the Act since then. After the first World War, a new Income Tax Act was passed, in 1918, again to counter the residual effects of economic devastation caused by the war. This income tax Act was in place till 1922, when it was replaced by another Act. After 40 years, and 15 years after India gained freedom from the British, the income tax Act was modified again. The current Income Tax Act has been adopted in 1961, and bought into force with effect from April 1, 1962. It encompasses the whole of India, including Sikkim, Jammu and Kashmir. The Central Board of Revenue bifurcated and created a separate Board for Direct Taxes called as the Central Board of Direct Taxes under the aegis of Central Board of Revenue Act, 1963.

Currently, there are five broad heads under which income is taxed by the govt. of India:

  • Income from salary
  • Income from business or profession
  • Income from capital gains
  • Income from property
  • Income from other sources

Each successive government amends the Act with an aim to finance government operations, and to try and distribute wealth more evenly. A noticeable feature of the Income Tax Act of India is that agricultural income in India is not taxable. Income tax in India (and all other countries) is assessed annually for the previous financial year.

India currently has a three tier setup for taxation. The central government and the state government can both impose tax. The State government in turn can delegate taxation to the local governing bodies like the municipal corporations and grampanchayats. It is said that that the Indian tax system is one of the most complex in the world, including the likes of income tax, wealth tax, property tax, gift tax, sales tax, VAT, custom duty, excise duty (now replaced by GST),  corporate tax, income tax and a plethora or other taxes? Indeed, it is one of the reasons why there is a high demand in India for income tax consultants, GST consultants, auditors, and other professionals.

As a nation evolves, its needs change. India is no exception. No doubt as the nation progresses, the tax structure of India will undergo many refinements. For example, the Goods and Services Tax (GST), which has replaced the Central and State indirect taxes such as VAT, excise duty and service tax, was implemented in India on July 1, 2017. GST has been already introduced in more than 160 countries, starting from France where it was introduced way back in 1954. So, it can be safely said that GST is a tired and tested taxation solution; India need not worry unnecessarily about its effectiveness.