UPSC CSE Prelims
Taxation System Previous Year Questions (PYQs)

Detailed Explanation:

Answer: Option 2 — Only three

The Fifteenth Finance Commission used six criteria for horizontal tax devolution: Income Distance (45%), Population (15%), Area (15%), Forest and Ecology (10%), Demographic Performance (12.5%), and Tax and Fiscal Efforts (2.5%). Apart from the three mentioned criteria (population, area, and income distance), only three from the given list were used: Demographic Performance, Forest and Ecology, and Tax and Fiscal Efforts. Governance reforms and stable government were not used as criteria for horizontal tax devolution.

📝 Short Notes: Fifteenth Finance Commission - Horizontal Devolution Criteria

• Period: 2021-2026 (Award Period)
• Key Change: Demographic Performance replaced 'Demographic Change' used by 14th FC
• Not Included: Governance reforms, stable government, or political stability

Detailed Explanation:

Answer: Option 4 — Loss of revenue to the State Exchequer due to tax evasion.

The primary concern of the Government of India regarding black money is the substantial loss of tax revenue, which directly impacts the state exchequer's ability to fund essential public services, infrastructure development, and welfare programs. While other effects like investment in real estate, unproductive assets, or political donations are concerning, the most critical impact is the erosion of the fiscal capacity of the government due to systematic tax evasion. Black money, by its very nature, represents untaxed income that deprives the state of resources needed for national development and governance.

📝 Short Notes: Black Money and Its Economic Impact

• Black Money Definition: Income earned through illegal means or legal means but not reported to tax authorities to avoid taxation.
• Primary Government Concern: Revenue loss through tax evasion directly weakens fiscal capacity to fund public expenditure.
• Secondary Effects: Includes distortion of resource allocation, inflation in asset markets (real estate, gold), and undermining formal economy.
• Government Measures: Demonetization (2016), Income Declaration Schemes, Benami Transactions Act, Black Money Act (2015), and international cooperation through treaties.
• Economic Impact: Reduces GDP accuracy, creates parallel economy, increases income inequality, and hampers planned development.
• Estimation Challenges: Difficult to quantify precisely; various studies estimate black economy at 20-40% of GDP historically.

Detailed Explanation:

Answer: Option 1 — None

Both statements regarding India's equalization tax of 6% on online advertisement services are incorrect.

❌ Statement 1 – Incorrect: The equalization levy was introduced under the Finance Act, 2016 as a separate tax, not as a part of the Income Tax Act, 1961.

❌ Statement 2 – Incorrect: Since the equalization levy is not classified as an income tax but as a separate levy on specified transactions, non-resident entities cannot claim tax credit in their home country under Double Taxation Avoidance Agreements (DTAAs), which typically apply only to income tax.

📝 Short Notes: Equalization Levy

Detailed Explanation:

Answer: Option 2 — curbing of the tax evasion by multinational companies

Base Erosion and Profit Shifting (BEPS) refers to tax planning strategies used by multinational companies to artificially shift profits from higher-tax jurisdictions to lower-tax jurisdictions, thereby eroding the tax base of countries where actual economic activity occurs. The OECD/G20 BEPS Project aims to curb such tax avoidance practices through international cooperation and common standards. Governments worldwide have adopted BEPS measures to prevent multinationals from exploiting gaps and mismatches in tax rules across different countries, ensuring fair taxation where value is created.

Detailed Explanation:

✅ Statement 1 – Correct: A decrease in tax-to-GDP ratio often indicates slowing economic growth, as lower incomes and profits reduce tax collections, or reflects economic contraction where tax revenues fall faster than GDP.

❌ Statement 2 – Incorrect: The tax-to-GDP ratio measures government revenue collection efficiency, not income distribution equity. A decreasing ratio could occur with progressive tax cuts benefiting all income groups, or with regressive taxes declining – it provides no direct information about income inequality or distribution patterns.