Article 289

Article 289 of the Constitution of India establishes the exemption of a State’s property and income from Union taxation. It defines the fiscal boundaries between the Union and the States, ensuring that both levels of government maintain financial independence within the federal framework. This article is a key component of India’s constitutional structure of cooperative federalism, designed to prevent financial interference by the Union in the internal revenue affairs of the States.

Constitutional Objective and Framework

The primary purpose of Article 289 is to protect the financial autonomy of State Governments. It ensures that States have control over their property and income without being subject to Union taxation, thereby maintaining a balance of fiscal power between the two levels of government.
Article 289 is located within Part XII of the Constitution, which deals with finance, property, contracts, and suits. It mirrors Article 285, which grants reciprocal protection to the Union’s property from State taxation, together forming the foundation of India’s intergovernmental fiscal relationship.

Exemption of State Property and Income (Clause 1)

Under Clause (1) of Article 289, “The property and income of a State shall be exempt from Union taxation.”
This means that the Union Government cannot impose taxes on:

• Any property owned by a State Government, whether movable or immovable.
• Any income earned by a State Government in the course of performing its governmental functions.

The clause reflects the constitutional principle that each level of government should be fiscally independent in its own domain. By exempting State property and income from Union taxation, it prevents the Central Government from undermining the States’ financial base or interfering in their fiscal administration.

Union Taxation on State Trade or Business (Clause 2)

Clause (2) of Article 289 provides an important qualification to the general exemption. It states that “Nothing in Clause (1) shall prevent the Union from imposing, or authorising the imposition of, any tax to which this clause applies.”
This allows the Union Government to levy taxes on:

• Trade or business activities carried on by a State Government.
• Operations connected to such trade or business.
• Property used for such purposes.
• Income derived from such commercial operations.

The rationale is that when a State engages in commercial or profit-oriented activities, it acts like any other economic entity and should therefore be subject to taxation by the Union in the same way as private enterprises. However, such taxation must conform to laws enacted by Parliament, which regulates the scope and manner of its imposition.
Thus, while States are immune from Union taxation in their sovereign and governmental capacities, they are not immune when functioning as commercial entities.

Exemption for Ordinary Government Functions (Clause 3)

Under Clause (3), Parliament has the power to declare that certain trades or businesses carried on by a State are incidental to the ordinary functions of government. Once such a declaration is made, the exemption under Clause (1) applies again, and the Union cannot levy taxes on those activities.
For instance, activities related to public utilities, health services, or public distribution—though they may involve trade or business—can be declared by Parliament as being incidental to governmental functions. This clause ensures that taxation does not obstruct essential public services carried out by the States.

Key Features of Article 289

• Provides immunity to State property and income from Union taxation.
• Authorises the Union to tax State commercial enterprises under certain conditions.
• Empowers Parliament to decide which activities are considered incidental to ordinary government functions and hence exempt from taxation.
• Reflects the principle of fiscal federalism, ensuring clear financial boundaries between the Union and the States.

Judicial Interpretation and Case Law

The Supreme Court of India has clarified and reinforced the scope of Article 289 through several landmark judgments:

• State of West Bengal v. Union of India (1963): The Court elaborated that Article 289 upholds the financial sovereignty of the States within their constitutional domain and prevents the Union from taxing their property and income.
• K. K. Verma v. Union of India (1954): The Court discussed the distinction between governmental and commercial functions, holding that taxation by the Union on State trading activities is valid under Clause (2).
• State of Rajasthan v. Union of India (1977): The Court reaffirmed that the Constitution intends to maintain fiscal balance between the Union and the States, ensuring that taxation powers are exercised within their respective limits.

These judgments collectively underline that while the Union and the States enjoy reciprocal fiscal immunities, the scope of such immunity depends on whether the activity in question serves governmental or commercial purposes.

Related Constitutional Provisions

Article 289 must be read alongside other fiscal provisions that together shape the financial relations between the Union and the States:

• Article 285: Grants exemption of Union property from State taxation.
• Article 246: Defines the distribution of legislative powers between the Union and the States.
• Article 265: Establishes that no tax shall be levied or collected except by authority of law.
• Article 268: Deals with taxes levied by the Union but collected and appropriated by the States.

Together, these provisions form the basis of fiscal federalism in India, demarcating the taxation powers of both levels of government.

Significance and Implications

Article 289 has major implications for maintaining the balance of fiscal authority in India’s federal structure:

• Financial Autonomy: States are assured control over their resources and revenues without Central interference.
• Fiscal Balance: Ensures that both Union and State Governments operate within clearly defined financial jurisdictions.
• Promotion of Cooperative Federalism: Encourages coordination rather than conflict in fiscal policy-making.
• Accountability and Equity: The Union can tax State commercial undertakings only through laws passed by Parliament, ensuring legislative scrutiny and fairness.

Practical Applications

In practical governance, Article 289 enables States to:

• Generate and manage revenue from property and non-commercial income sources without Union taxation.
• Engage in economic activities with awareness of their potential liability to Union taxes.
• Seek Parliamentary declarations under Clause (3) when operating businesses incidental to public welfare functions.

It also provides a constitutional framework that encourages State-level economic development while maintaining consistency with national taxation policy.

Limitations

Despite its protective scope, Article 289 has certain limitations:

• States cannot claim immunity for revenue derived from commercial or trading operations.
• The Parliament’s discretion in declaring what constitutes “ordinary functions of government” can sometimes limit the practical autonomy of the States.
• The line between governmental and commercial activity may occasionally be blurred, leading to interpretational disputes.