Income tax in India: An interesting history

While Manusmriti laid down the overall principles of taxation from the ancient times, the Income Tax Act of 1922 was a comprehensive law that today’s regulations draw heavily from.

The history of income tax in India can be traced back to Manusmriti, the ancient book of laws penned by the sage Manu, and Arthasastra, Kautilya’s famous treatise on economics.

According to economist DK Srivastava, currently Chief Policy Advisor at EY India, Manusmriti “is generally recognised as one of the most ancient texts on the principles of governance in India; Kautilya himself acknowledges having drawn from it extensively.”

Even James Wilson, British India's first Finance Minister, quoted from Manu while introducing the Income Tax Act in 1860 for levying income tax in the country.

Related: Should you stick to the old tax regime or move to the new one?

ANCIENT INDIA

Tax principles

In a paper that he wrote on Manu’s and Kautilya’s views on taxation, Srivastava refers to chapter 7 of Manusmriti, which he says explains the “overall principles of taxation”.

The underlying principle, he says, is that taxation should enable the king to discharge his duties, and economic agents and traders to generate and retain profits. “Considering the protection of that which is already there, and that which is to be increased, the King should levy tax on his traders."

According to the economist, this means the first principles of taxation calls for protection of the tax base, which is the productive base, and to ensure this base is augmented.

Chapter 7 of Manusmriti also lays down the other key principles:

• The tax collection should be annual
• Collection should be by reliable functionaries
• Taxation should be fair (here, Manu says the King should treat taxpayers equally, and not differentiate, just as a father does not favour one son over the other)
• Care must be taken to avoid excessive taxation – that is, the King has to ensure that the organic growth of the tax base is not harmed by excessive greed

Srivastava points out that Kautilya’s Arthasastra was somewhat similar in his analogy with trees, and likens taxation to the picking of ripening fruits; plucking unripe ones is self-destructive.

Related: Income Tax Returns: Who should file them and when?  

Tax rates

In contrast to the principles which are general, Manu’s and Kautilya’s proposals for tax rates are more specific.

Manu proposes rates for livestock, separate rates for fertile land and less fertile land, and different slabs for different produces that range from bamboo products to perfumes, and honey to salt.

Kautilya borrows liberally from Manu and even proposes ad valorem duty on imports from outside the kingdom, apart from proposing protectionism in the form of lower rates for locally produced goods.

MEDIEVAL INDIA

Like in the ancient period, the area now recognised as constituting ‘medieval India’ was dominated by various princely states, not everyone owing allegiance to the principal ruling dynasties in Delhi. But for the purpose of this discussion, we will look at how tax evolved during three separate periods.

The Sultanate period

The Sultans of Delhi introduced the jagirdar system, under which agents (or jagirdar) governed an ‘estate’ and collected tax from tenants. The system continued under the Mughals and was retained by Rajput, Saini, and Sikh rulers, and later in concept by the British.

The Delhi Sultans followed various ways to augment revenues, the chief ones being:

• Khiraj (land revenue): This was the major source, constituting a fifth of the taxpayer’s total produce/income, though it was raised to half under Alauddin Khilji and Muhammed bin Tughlak. The tax was imposed only on non-Muslims, though children, women, and monks were exempted.
• Octroi: Levied on commercial goods, with an additional import tax of 2.5%–10% on items sourced from other kingdoms.
• Zakat: A small tax imposed on Muslims.

Related: 6 Income sources that do not attract tax

The Mughal period

In the first decade of his reign till 1566, Emperor Akbar continued with Sher Shah’s crop rate of a single price-list. After experimenting with various tax collection systems over the next 14 years, Akbar instituted the zabti system in 1580, under which one-third of the produce of the assessed area constituted the state’s share.

The amount of due land revenue was first assessed in kind, and then converted into cash amounts with the help of price schedules (dastur-ul-amal) prepared at the dastur or regional level in respect of various food crops.

The zabti system, developed by Raja Todarmal, took into account both continuity and productivity of the cultivated area over a 10-year period for fixing the land revenue. Here are the specifics:

• Land under continuous cultivation was called polaj; this attracted ‘full rates’
• Land that was fallow for a year was charged polaj (full) rates only after being brought under cultivation
• Land that had been fallow for 3–4 years was called chachar, and was charged the polaj rate in the third year
• Cultivable wasteland was called banjar; if cultivated, the polaj rate was charged only in the fifth year

Akbar also followed a number of other systems of assessment, including sharing of crops, grain, or the fields themselves after sowing. Taxes were written off if the crops failed on account of drought, flood, or any such reason, with the peasants being given financial aid to buy seeds, implements, and livestock to help them tide over the crisis.

The Maratha period

Chhatrapati Shivaji Maharaj overhauled his kingdom’s revenue administration, and notable among the steps he took were:

• Abolishing the jagirdari/zamindari system
• Establishing direct links with the peasants
• Fixing the state’s share at two-fifths of the total produce, payable either in cash or kind
• Offering subsidies during famines etc. on easy repayment terms
• Introducing the special chauth tax, equal to a quarter of the total produce; payers of this tax were left untouched by Shivaji’s army

Related: Income Tax Returns: Who should file them and when?

Modern India

The modern income tax system was introduced in by the British in 1860, and interestingly, it was an Indian rebellion that forced them into it.

The Sepoy Mutiny of 1857 left the British government deep in a financial crisis, and on order to fill up the treasury, it decided to implement a tax-collecting mechanism that would help it do so. Consequently, the then Finance Minister James Wilson came out with British India’s first Income Tax Act in February 1860, which has been the basic model of India’s tax system ever since.

Wilson’s Act classified income under four schedules, each of which was taxed:

• Income from landed property
• Income from professions and trade
• Income from securities, annuities and dividends
• Income from salaries and pensions

The military and the police benefited the most from Wilson’s exemption limits for various categories of taxpayers; for them it was Rs 4980, as against Rs 2100 for naval and marine personnel, and Rs 200 for the general public. The tax rate was set at 2% for agricultural income ranging from Rs 200 to Rs 499 and 4% for incomes above this. 

Though the IT Act of 1922 was substantially amended in 1939, it remained the most comprehensive income tax law. It laid down the following:

• Fixing of tax rates every year by a special Finance Act at the time of the annual budget
• Provision for ex parte assessment
• TDS made compulsory for private employers
• Reopening of assessment allowed

After Independence, three new tax-related laws were passed: the Wealth Tax Act of 1957, the Expenditure Tax Act of 1957, and the Gift Tax Act of 1958.

The present-day IT Act was drafted in 1961 based on the recommendations of the Law Commission and the Enquiry Committee; it came into force from April 1, 1962, having undergone numerous amendments made from time to time by various Finance Acts.

Final Words

As it was in Manu’s time, so is it today: income-tax remains a key source of funds for the government to finance its activities and serve the Indian people. Undoubtedly, the entire system of tax collection has evolved. Unlike in the past, when everyone was bound by the king’s orders to pay tax, today only the 'financially eligible' need to do so.

That is why, by law, all businesses and individuals are required to file income tax returns every year so that the government can determine whether these entities and people owe any taxes or are eligible for a tax refund.

There are two types of taxes in India today – direct and indirect. 

Direct tax is the tax on your income you pay directly to the government; income-tax falls under this category, as does wealth tax.

Indirect tax is tax what business establishments charge you for products or a service they provide you, which in turn is passed to the government. The taxes you pay to restaurants, cinema halls and e-commerce websites – which come in various forms like VAT and GST – fall in this category.

As India gears up for another budget, speculation is rife over the impending 'tax slabs' – the level of tax as per a person’s income.

For what was true in Manu’s time is true today too: if you have a taxable income, you owe the government an income tax.  

Watch this gifographic to see important income tax milestones during the year.