(1) The property and income of a State shall be exempt from Union taxation.
(2) Nothing in clause (1) shall prevent the Union from imposing, or authorising the imposition of, any tax to such extent, if any, as Parliament may by law provide in respect of a trade or business of any kind carried on by, or on behalf of, the Government of a State, or any operations connected therewith, or any property used or occupied for the purposes of such trade or business, or any income accruing or arising in connection therewith.
(3) Nothing in clause (2) shall apply to any trade or business, or to any class of trade or business, which Parliament may by law declare to be incidental to the ordinary functions of Government.
Draft Article 266, Draft Constitution of India (1948)
Subject as hereinafter provided, the Government of a State shall not be liable to Union taxation in respect of lands or buildings situate within the territory of India, or income accruing, arising or received within such territory:
(a) Where a trade or business of any kind is carried on by or on behalf of the Government of a State, nothing in this article shall exempt that Government from any Union tax or the levy of a sum in lieu of such tax in respect of that trade or business or any operations connected therewith, or any income arising in connection therewith, or any property occupied for the purposes thereof;
(b) Nothing in this article shall exempt the Ruler of any State for the time being specified in Part III of the First Schedule from any Union tax in respect of lands, buildings or income being his personal property or personal income.
Explanation.-For the purposes of this article, any operations incidental to the ordinary functions of the Government of a State, such as, the sale of the forest produce of any forest under the control of the Government of a State or of any article produced in any jail within a State, shall not be deemed to be a trade or business carried on by or on behalf of the Government of the State.
Draft Article 266 (Article 289, Constitution of India 1950) was discussed in the Assembly on 9 September 1949. This Draft Article regulates taxation of a State Government by the Union. It did not permit the Union to tax State Governments on lands or buildings and income accruing within the State. However, it allowed the Union to tax State Governments on its trade or business. Further, it also allowed taxation of rulers of princely states on their personal property and income.
The Chairman of the Drafting Committee proposed an amendment to replace the Draft Article and provide that the Union would not tax property and income of the State governments. However, Parliament by law could empower the Union to tax income from trade or business of the State governments excluding trade or business declared as incidental to ordinary functions of government by Parliament.
Many Members proposed amendments to curtail the power the Union to tax the State Governments. They suggested excluding (i) trade and business carried on within the State, (ii) trade and business carried on before the commencement of the Constitution and (iii) programmes of their development and expansion; the preparations for which are complete.
The Finance Minister reassured the Members that public utility undertakings would be outside the scope of taxation and there would not be any discrimination between the Union and the State in regard to the taxation of industrial undertakings. Based on these assurances, these amendments were subsequently withdrawn.
The Assembly adopted the Draft Article as amended by the Chairman of the Drafting Committee on 9 September 1949.