Immunity of State Agencies; Fundamental Rights & the Power of Taxation — Law of Taxation Notes

Immunity of State Agencies; Fundamental Rights & the Power of Taxation

Can the Union tax the property of a State, or a State tax the property of the Union? The framers said largely no — a federation works only if neither government can cripple the other by taxing it. The nine-judge Bench in New Delhi Municipal Council v State of Punjab (1997) wrestled with exactly this, deciding how far the Union’s immunity from State taxation (Article 289) really reaches.

The doctrine of mutual immunity

In a federation the Union and the States are co-ordinate governments. If one could tax the other’s property freely, it could use the taxing power as a weapon. So the Constitution grants a mutual (reciprocal) immunity:

Article 285 — Union property exempt from State taxation. The property of the Union is exempt from all taxes imposed by a State or by any authority within a State (subject to Parliament providing otherwise).
Article 289 — State property and income exempt from Union taxation. The property and income of a State are exempt from Union taxation. But there is a vital exception: if a State carries on a trade or business (a commercial activity), the Union may tax that trade or the income from it, unless Parliament declares it incidental to the ordinary functions of government.

Article 285(1): “The property of the Union shall, save in so far as Parliament may by law otherwise provide, be exempt from all taxes imposed by a State or by any authority within a State.”

Article 289(1) and (2): “The property and income of a State shall be exempt from Union taxation.” But “nothing… shall prevent the Union from imposing… any tax in respect of a trade or business of any kind carried on by… a State…”

So the immunity is not absolute: it protects the governmental functions of a State, not its commercial ventures. This asymmetry (Union property is broadly immune; a State’s business income is taxable) was the subject of the In re Sea Customs Act (1963) advisory opinion and NDMC (1997).

Fundamental Rights and the power to tax

A tax law is a law, and Article 13 makes every law subject to the Fundamental Rights. So although the taxing power is wide, it must pass through the Fundamental-Rights filter:

Article 265 itself — no tax without authority of law — is a guarantee against arbitrary exaction.
Article 14 (equality) — a tax must not be arbitrary or discriminatory. The State has wide latitude to classify (it may tax luxuries higher than necessities), but a tax with no rational basis is void — as in Moopil Nair (1961), where a flat land tax ignoring income was struck down.
Article 19(1)(g) (trade & profession) — a tax must not be so excessive as to be a restriction on the freedom to carry on trade; but a reasonable tax is a permissible restriction under Art. 19(6).
Article 301 — a tax must not impede the free flow of inter-State trade (Topic 7).
Article 27 — no person may be compelled to pay a tax whose proceeds are spent on promoting a particular religion.

The settled position: the power to tax is not outside the Constitution. Courts give the legislature great freedom in fiscal matters (they will not sit as a super-tax-tribunal), but a tax that is confiscatory, arbitrary, or that violates a Fundamental Right will be struck down.

🧩 WORKED EXAMPLE — Can the Union tax a State’s electricity board’s trading income?

Facts. A State runs a profit-making commercial undertaking selling electricity. The Union seeks to levy income tax on its profits.

Rule. Article 289(1) exempts a State’s income from Union taxation, but Article 289(2) allows the Union to tax the income of a trade or business carried on by a State.

Apply. Selling electricity for profit is a trade/business, not an ordinary governmental function. It therefore falls in the Art. 289(2) exception.

Conclusion. The Union may tax that trading income (unless Parliament has declared this activity incidental to ordinary government functions). The immunity protects governmental, not commercial, activity.

In Simple Terms: The Union and the States generally cannot tax each other’s property (Arts. 285 & 289) — but if a State runs a business, the Union can tax that business income. And every tax law must still respect equality (Art. 14) and freedom of trade (Art. 19) — an arbitrary tax is void.

flowchart TD
    ROOT["Limits on the taxing power"]:::root
    ROOT --> IM["Mutual immunity"]:::leaf
    IM --> U["Art. 285<br/>Union property free of State tax"]:::sub
    IM --> S["Art. 289<br/>State property/income free of Union tax"]:::sub
    S --> EX["EXCEPTION 289(2)<br/>State's TRADE/business is taxable"]:::sub
    ROOT --> FR["Fundamental Rights filter"]:::leaf
    FR --> F1["Art. 14 — not arbitrary"]:::sub
    FR --> F2["Art. 19(1)(g) — not excessive on trade"]:::sub
    FR --> F3["Art. 27 — not for a religion"]:::sub
    classDef root fill:#FFF8DC,stroke:#000,stroke-width:1px,color:#000;
    classDef leaf fill:#E6F3FF,stroke:#1E3A8A,color:#000;
    classDef sub fill:#F2F2F2,stroke:#555,color:#000;
    linkStyle default stroke:#888,stroke-width:1px;

Case Laws

New Delhi Municipal Council v State of Punjab (1997) — nine-judge Bench on the scope of Art. 289; State property immunity examined.
In re Sea Customs Act, S.20(2) (1963) — a State’s immunity (Art. 289) does not bar an indirect duty like customs/excise on a State’s imports; clarified that the immunity covers direct taxes on State property/income, not indirect duties.
K.T. Moopil Nair v State of Kerala (1961) — a tax violating Art. 14 (arbitrary, confiscatory) is unconstitutional.

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