Taxation for UPSC: Direct vs Indirect Taxes, GST 2.0, Income Tax Act 2025 & Budget 2026-27 Tax Measures

Principles of Taxation and the Constitutional Division

🎯 Exam priority: High-yield. Taxation questions mix constitutional basics (who can tax what), GST design and the latest reform news. 2025 asked whether poultry income is tax-exempt and whether rural agricultural land is a capital asset; 2026 will draw on GST 2.0 and the Income Tax Act 2025. Learn the rules, then the dates.

Taxes are how the state turns private income into public spending. This note covers how India divides tax powers, what the main taxes do, and the three big reforms of 2019, 2025 and 2026.

Principles and constitutional division

• Direct taxes fall on the person who bears them — income tax, corporation tax, wealth/capital-gains taxes; indirect taxes are passed on to others — GST, customs, excise. Direct taxes are progressive (higher incomes pay a higher share); indirect taxes tend to be regressive (the same rate on rich and poor buyers). A tax is proportional if the rate is constant.

• Article 265: no tax can be levied or collected except by the authority of law. The Seventh Schedule divides power: the Union taxes income other than agricultural income, corporation tax, customs and (earlier) excise; States tax agricultural income, land and buildings, alcohol for human consumption and electricity sales; Article 246A (101st Amendment, 2016) gives both Parliament and State legislatures concurrent power over GST.

• Sharing: the net proceeds of Union taxes (the "divisible pool") are shared with States on the Finance Commission's formula (41% — see Article 11). Cesses and surcharges are outside the divisible pool, which is why the Centre uses them.

• Tax buoyancy = % change in tax revenue ÷ % change in GDP. A value above 1 means revenue grows faster than the economy. The Survey reports non-corporate tax buoyancy of 1.8 in FY23–FY25 and corporate tax buoyancy close to unity.

• Agricultural income is exempt from central income tax (s.2(1A) of the 1961 Act) — but only income from farming; poultry and wool rearing are not exempt as agricultural income; and rural agricultural land is not a "capital asset", so selling it attracts no capital-gains tax (UPSC 2025).

Direct Taxes: Base, Rates and the Income Tax Act 2025

India's direct-tax base is broadening, and the rules were rewritten in 2025.

Direct taxes: base, rates, new Act

• Broadening base (Survey): direct taxes are 58.8% of total taxes in FY25 (51.9% pre-pandemic); the number of income-tax returns filed rose from 6.9 crore (FY22) to 9.2 crore (FY25); non-corporate tax collections rose from about 2.4% of GDP pre-pandemic to 3.7% in FY25. Behavioural NUDGE campaigns (non-intrusive data-driven prompts) improved compliance.

• Corporate tax: the 2019 reform cut the rate to 22% (new regime without exemptions) and 15% for new manufacturing companies — the first leg of the "tripod" of tax reforms. Minimum Alternate Tax (MAT) ensures profitable companies pay a minimum; Budget 2026-27 makes MAT a final tax (no credit carry-forward) while allowing set-off of existing MAT credit up to one-fourth of liability in the new regime.

• Personal income tax: Budget 2025-26 made income up to ₹12 lakh tax-free (₹12.75 lakh for salaried taxpayers) under the new regime through a rebate — the second leg of the tripod.

• The Income Tax Act, 2025 was enacted on 21 August 2025 and takes effect from 1 April 2026, replacing the 1961 Act with a simpler structure; the older "previous year / assessment year" distinction gives way to a single "tax year".

• TDS and TCS: tax deducted at source (on salaries, interest, contractor payments) and tax collected at source (on foreign remittances and some sales) catch revenue early. Budget 2026-27 cuts TCS to 2% on overseas tour packages (from 5%/20%) and on education and medical remittances under the Liberalised Remittance Scheme (from 5%).

• Capital gains: gains on assets are short-term or long-term depending on the holding period; buybacks will now be taxed as capital gains for all shareholders, with an additional buyback tax on promoters (an effective 22% for corporate promoters and 30% for non-corporate promoters).

• Securities Transaction Tax: raised on futures from 0.02% to 0.05% and on options premium/exercise to 0.15% (Article 8).

Goods and Services Tax and GST 2.0

GST — the "one nation, one tax" of July 2017 — is the second great reform, and in September 2025 it was redesigned.

Goods and Services Tax

• What it is: a destination-based, multi-stage, value-added tax on the supply of goods and services, with input tax credit at every stage. Dual structure: CGST (Centre) + SGST (State) on intra-State supply; IGST on inter-State supply (revenue goes to the destination State); UTGST for Union Territories without legislatures. Brought in by the 101st Constitutional Amendment (2016), effective 1 July 2017.

• GST Council (Art 279A): chaired by the Union Finance Minister, with State finance ministers; decisions need three-fourths of the weighted votes of members present and voting, where the Centre has one-third and all States together two-thirds — so neither side can pass a decision alone.

• Outside GST (for now): alcohol for human consumption, and petroleum crude, petrol, diesel, aviation turbine fuel and natural gas (electricity too).

GST 2.0 — the September 2025 overhaul

• The 56th GST Council meeting replaced the old four-slab structure with a two-rate structure — a 5% merit rate and an 18% standard rate — plus a 40% de-merit/"sin" rate on a few goods (the earlier compensation cess is folded into it, so there is no net rise in burden). The new rates took effect on 22 September 2025; the Survey calls it the third leg of the tripod after the 2019 corporate-tax cut and the 2025 income-tax reform.

• Examples: tractors, agricultural machinery, fertiliser inputs (sulphuric/nitric acid, ammonia) cut to 5%; small cars, motorcycles up to 350cc, three-wheelers, buses, trucks and ambulances cut from 28% to 18%; ACs and larger TVs to 18%; zero GST on UHT milk, Indian breads and packaged paneer; 5% on most packaged foods, hair oil, soap and toothpaste; zero on select life-saving drugs and 5% on other medicines and medical devices; hotel rooms up to ₹7,500 a day 5%; individual life and health insurance exempted; motorcycles above 350cc and larger cars moved to 40%.

• Performance: gross GST collections were ₹17.4 lakh crore in April–December 2025 (up 6.7%, tracking nominal GDP growth — lower inflation holds the percentage down); registered taxpayers rose from about 60 lakh (2017) to over 1.5 crore; e-way bill volumes grew 21%.

Customs, Excise and Budget 2026-27 Tax Measures

Customs and excise are the older indirect taxes; they have been shrinking as a share of GDP while the Centre uses them for trade and industrial policy.

Customs, excise and policy use of taxes

• Customs duty (Union Entry 83, Customs Act 1962) on imports/exports: basic customs duty, IGST on imports, anti-dumping, countervailing and safeguard duties. Excise now remains mainly on petroleum products and tobacco-type goods outside GST. The Survey notes excise collections fell from about 1.7% of GDP (FY22) to 0.9% (FY25) because of petrol-diesel excise cuts, and customs buoyancy is only 0.4 as basic customs duties were calibrated down to support manufacturing. In April–November 2025 excise rose 9.3% while customs fell 7.3%.

• Taxes as policy tools: Pigouvian taxes on pollution or tobacco correct negative externalities; subsidies and tax holidays attract investment; the Laffer curve idea is that above some rate higher rates yield less revenue. Tax evasion is illegal; tax avoidance uses legal loopholes (the GAAR targets abusive avoidance).

Union Budget 2026-27: tax measures at a glance

Why this matters for UPSC

• Expect: GST Council voting weights, items outside GST, who taxes agricultural income, and the 2025 reforms with dates — GST 2.0 on 22 September 2025 (two rates + 40%), Income Tax Act effective 1 April 2026, Income up to ₹12 lakh tax-free.

Further Reading

• NCERT Economics textbooks (Class 11–12), the Economic Survey, the Union Budget documents and RBI publications cited in this note — the primary sources behind every figure above.

Test Yourself: Practice Questions & PYQs

Ten practice questions on GST, constitutional tax powers and the 2025-26 reforms, followed by real UPSC questions on taxation.

Practice Questions

Q1. With reference to the Goods and Services Tax Council, which of the following statements is/are correct?
1. It is chaired by the Union Finance Minister.
2. Decisions require three-fourths of the weighted votes of members present and voting.
3. The weighted vote of the Centre is two-thirds and that of the States together is one-third.

• (a) 2 and 3 only

• (b) 1 and 2 only

• (c) 1, 2 and 3

• (d) 1 only

Q2. Which of the following is outside the ambit of GST at present?
1. Crude petroleum, petrol and diesel
2. Alcohol for human consumption
3. Services such as insurance

• (a) 2 and 3 only

• (b) 1 and 2 only

• (c) 1, 2 and 3

• (d) 1 and 3 only

Q3. The GST rate structure introduced with effect from 22 September 2025 consists of

• (a) a 5 per cent merit rate and an 18 per cent standard rate, with a 40 per cent rate for a few sin goods

• (b) a single flat rate of 12 per cent

• (c) 5, 12, 18 and 28 per cent slabs

• (d) 0, 5, 10 and 20 per cent slabs

Q4. Statement-I: In India, income from poultry farming and wool rearing in rural areas is exempt from income tax as agricultural income.
Statement-II: Rural agricultural land is not considered a capital asset under the Income-tax Act, 1961.
Which one of the following is correct in respect of the above statements?

• (a) Both Statement-I and Statement-II are correct and Statement-II explains Statement-I

• (b) Statement-I is correct but Statement-II is not correct

• (c) Statement-I is not correct but Statement-II is correct

• (d) Both Statement-I and Statement-II are correct but Statement-II does not explain Statement-I

Q5. Under the Constitution, which of the following taxes can be levied by the Union Government?
1. Income tax on non-agricultural income
2. Customs duties
3. Tax on agricultural income

• (a) 2 and 3 only

• (b) 1 and 2 only

• (c) 1 and 3 only

• (d) 1, 2 and 3

Q6. The Income Tax Act, 2025

• (a) was enacted in August 2025 and takes effect from 1 April 2026

• (b) replaces the GST Act

• (c) was enacted in 2015 and takes effect from 1 April 2020

• (d) applies only to corporations

Q7. 'Tax buoyancy' refers to

• (a) the rate at which a tax is levied

• (b) the percentage change in tax revenue for a one per cent change in GDP

• (c) the shift of the tax burden to consumers

• (d) the ratio of indirect to direct taxes

Q8. Which of the following describes IGST?

• (a) Tax levied by the Centre on inter-State supplies and imports, with revenue going to the destination State

• (b) Tax levied by a State on intra-State supplies

• (c) Tax on income of companies

• (d) A cess on luxury goods

Q9. Which of the following is a feature of Budget 2026-27's taxation of share buybacks?

• (a) Buybacks are exempt from tax

• (b) Only promoters are taxed

• (c) Buybacks are taxed as capital gains for all shareholders, with an additional levy on promoters

• (d) Buybacks are taxed at the company level only

Q10. According to the Economic Survey 2025-26, the share of direct taxes in total taxes in FY25 was about

• (a) 58.8 per cent

• (b) 68.8 per cent

• (c) 38.8 per cent

• (d) 48.8 per cent

UPSC Previous Year Questions (PYQs)

Real UPSC Prelims questions, checked against the official paper and answer key.

Q1. (2025) Consider the following statements:
Statement I: In India, income from allied agricultural activities like poultry farming and wool rearing in rural areas is exempted from any tax.
Statement II: In India, rural agricultural land is not considered a capital asset under the provisions of the Income-tax Act, 1961.
Which one of the following is correct in respect of the above statements?

• (a) Statement I is correct but Statement II is not correct

• (b) Both Statement I and Statement II are correct and Statement II explains Statement I

• (c) Statement I is not correct but Statement II is correct

• (d) Both Statement I and Statement II are correct but Statement II does not explain Statement I

Q2. (2016) The term 'Base Erosion and Profit Shifting' is sometimes seen in the news in the context of

• (a) exploitation of genetic resources of a country by multinational companies

• (b) curbing of the tax evasion by multinational companies

• (c) lack of consideration of environmental costs in the planning and implementation of developmental projects.

• (d) mining operation by multinational companies in resource-rich but backward areas

Q3. (2022) Which one of the following situations best reflects "Indirect Transfers" often talked about in media recently with reference to India ?

• (a) An Indian company investing in a foreign enterprise and paying taxes to the foreign country on the profits arising out of its investment

• (b) A foreign company investing in India and paying taxes to the country of its base on the profits arising out of its investment

• (c) An Indian company purchases tangible assets in a foreign country and sells such assets after their value increases and transfers the proceeds to India

• (d) A foreign company transfers shares and such shares derive their substantial value from assets located in India

Q4. (2018) With reference to India's decision to levy an equalization tax of 6% on online advertisement services offered by non-resident entities, which of the following statements is/are correct?
1. It is introduced as a part of the Income Tax Act.
2. Non-resident entities that offer advertisement services in India can claim a tax credit in their home country under the "Double Taxation Avoidance Agreements".
Select the correct answer using the code given below:

• (a) 2 only

• (b) Both 1 and 2

• (c) 1 only

• (d) Neither 1 nor 2

Mains Practice Questions

Use these to frame full-length answers. You don't have to answer one exactly — they show the angles UPSC tests, so let them guide which points you cover.

• Discuss the constitutional scheme of taxation in India — which taxes belong to the Union, the States and GST — and the role of cesses and surcharges.

• Explain the structure of GST and the GST Council. How does GST 2.0 (September 2025) change the rate structure and what are its expected effects?

• Examine the three-pronged tax reform strategy (2019 corporate tax, 2025 personal income tax, 2025 GST) and its impact on revenue buoyancy.

• What are the key features of the Income Tax Act, 2025 and the 2026-27 tax proposals?

UPSC Mains — Previous Years’ Questions on this topic (last 10 years)

These are the actual GS Mains questions UPSC has asked on this theme — real proof of how, and when, it is tested. Try to write a full answer to each.

• 2020 (GS-III): Explain the rationale behind the Goods and Services Tax (Compensation to States) Act of 2017. How has COVID-19 impacted the GST compensation fund and created new federal tensions?

• 2019 (GS-III): Enumerate the indirect taxes which have been subsumed in the Goods and Services Tax (GST) in India. Also, comment on the revenue implications of the GST introduced in India since July 2017.

• 2018 (GS-III): Comment on the important changes introduced in respect of the Long-term Capital Gains Tax (LCGT) and Dividend Distribution Tax (DDT) in the Union Budget for 2018-2019.