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GS Paper: GS3-03.Government Budgeting

  • Govt plans tax relief for offshore funds, electronics’ contract manufacturing

    Why in the News?

    The government has circulated the Taxation and Other Laws (Amendment) Bill, 2026, which relaxes the conditions under which offshore funds managed from India can claim tax exemption. The Bill also extends a tax exemption for foreign firms supplying equipment to electronics contract manufacturers and introduces a fresh tax holiday for rough-diamond trading in a notified zone. The measures respond to foreign outflows and to lobbying by manufacturers seeking tax certainty.

    What is the Taxation and Other Laws (Amendment) Bill 2026?

    1. Purpose: The Bill amends the Income-tax Act to promote fund management activity and provide tax certainty to specified foreign and offshore entities. It bundles relief for offshore funds, electronics contract manufacturing and rough-diamond trading.
    2. Replaces an Ordinance: The Bill replaces the Income-tax (Amendment) Ordinance, 2026 promulgated on 5 June, which had exempted foreign portfolio investors from capital gains and withholding taxes on government securities. The Ordinance was brought amid pressure on the rupee and foreign outflows.

    What is an Eligible Investment Fund (offshore fund)?

    1. Definition: An Eligible Investment Fund is an offshore pooled investment vehicle that can be managed by a fund manager based in India without the fund itself being treated as having a taxable business presence in India.
    2. Why the safe harbour matters: Without the exemption, the manager’s activity in India could create a business connection, exposing the fund’s global income to Indian tax at rates of up to 38%.

    Key Rules for an Eligible Investment Fund

    1. Outside Location: The fund must be created, registered, or incorporated outside the host country (for example, outside India).
    2. Non-Resident Status: The fund and its general members must live or reside outside the target country.
    3. Member Limits: It usually needs a minimum number of members (such as 25 non-connected investors) so that it is a true public or pooled vehicle and not controlled by a single family or small group.
    4. Diverse Ownership: No single member or direct group can hold a massive stake (usually restricted below 10% or 20% depending on precise tax codes) to prevent individual dominance

    How does the Bill ease conditions for offshore funds?

    1. Fewer conditions to qualify: The government proposes to remove 8 of the 13 conditions that offshore funds must meet so their activity does not constitute business income in India. Only five conditions would remain.
    2. Dropped thresholds: Removed conditions include a minimum of 25 investors, a maximum 10% interest for a single investor, a cap on investing more than 25% of the corpus in one entity, and a minimum monthly average corpus of Rs 100 crore.
    3. Remaining conditions: The fund must not be a resident of India and must not control or manage any business in India. Direct investment by Indian residents must not exceed 5% of the corpus on 1 April and 1 October of the tax year.
    4. Intended effect: Aligning safe-harbour rules with global fund structures aims to relocate offshore fund management activity to India and to unify the framework with the International Financial Services Centre (IFSC).

    What relief goes to electronics contract manufacturing?

    1. Extended exemption to FY41: Tax exemption for a foreign company that provides capital goods, equipment or tooling to a contract manufacturer of electronics in India is extended to tax year 2040-41, from the earlier 2030-31. The exemption was first introduced earlier in the year, valid only to 2031.
    2. Why it was sought: A major device maker lobbied for the change, fearing that ownership of high-end machinery supplied to contract manufacturers would be treated as a business connection and expose its profits to Indian tax, unlike in China.
    3. Scope of devices: The exemption applies to makers of mobile phones, tablets, laptops, hearing and wearable electronic devices. India is set to make 26% of the world’s iPhones in 2026, up from 6% four years earlier.
    4. Storage of components: Foreign firms’ income from storing and providing parts to contract manufacturers is exempt until 2041, applying to factories and warehouses in customs-bonded areas treated as outside the customs border.

    What is the rough-diamond tax holiday?

    1. Fifteen-year holiday: A new tax holiday of 15 years up to 31 March 2041 is proposed for specified foreign companies acting as mining companies, sightholders, brokers, aggregators and tender or auction entities. It exempts their income from the sale of rough diamonds in a notified special zone in India.
    2. Objective: The measure aims to bring rough-diamond trading, currently routed through overseas centres, into a notified Indian zone.

    What are the challenges to the tax-relief package?

    1. Revenue foregone: Long-dated exemptions to 2041 lock in a loss of tax revenue over more than a decade, with benefits concentrated among large foreign firms.
    2. Selective advantage: Relief tailored to a single dominant electronics buyer raises questions of a level playing field for smaller manufacturers.
    3. Uncertain relocation gains: Easing offshore-fund conditions may not by itself pull managers to India if enforcement and dispute practices remain aggressive.
    4. Base-erosion concern: Broad exemptions on cross-border income invite scrutiny over profit shifting through bonded zones and notified special zones.

    Conclusion

    The Bill uses targeted, long-dated tax exemptions to keep foreign capital and electronics manufacturing anchored in India while replacing a June Ordinance on government-securities taxation. Its success depends on whether removing safe-harbour conditions genuinely relocates fund management to India and whether the electronics concessions deepen domestic value addition rather than mere assembly. The Bill is expected to be introduced in Parliament during the week.

    Back2Basics

    1. Eligible Investment Fund: An offshore fund permitted to be managed from India without creating a taxable business connection, subject to safe-harbour conditions under the Income-tax Act.
    2. Foreign Portfolio Investor (FPI): An overseas investor registered with the Securities and Exchange Board of India to invest in Indian securities.
    3. International Financial Services Centre (IFSC): A jurisdiction, such as GIFT City in Gujarat, that provides financial services to non-residents in foreign currency under a distinct regulatory regime.
    4. Contract manufacturing: Production by a third-party manufacturer of goods for a brand owner, common in electronics assembly.
    5. Customs-bonded area: A warehouse or factory treated as outside India’s customs border, where import duty is deferred until goods enter the domestic market.

    PYQ Relevance

    [UPSC 2019] Which of the following is issued by registered foreign portfolio investors to overseas investors who want to be part of the Indian stock market without registering themselves directly?

    (a) Certificate of Deposit (b) Commercial Paper (c) Promissory Note (d) Participatory Note

    Answer: (d)

  • What is the meaning of the term ‘tax expenditure’? Taking housing sector as an example, discuss how it influences the budgetary policies of the government.

  • What were the reasons for the introduction of Fiscal Responsibility and Budget Management (FRBM) Act, 2003? Discuss critically its salient features and their effectiveness

  • Women empowerment in India needs gender budgeting. What are requirements and status of gender budgeting in the Indian context?

  • One of the intended objectives of Union Budget 2017-18 is to ‘transform, energize and clean India’.Analyse the measures proposed in the Budget 2017-18 to achieve the objective.

  • Comment on the important changes introduced in respect of the Long term Capital Gains Tax (LCGT) and Dividend Distribution Tax (DDT) in the Union Budget for 2018-2019.

  • The public expenditure management is a challenge to the Government of India in context of budget making during the post liberalization period. Clarify it.

    Post-1991 liberalisation transformed India’s economy from a state-controlled to a more market-driven system. This expanded public spending needs while simultaneously demanding fiscal discipline.

    Need for Public Expenditure

    Provision of Public Goods – Eg- spending on health, education

    Social Welfare & Equity – Eg – Poshan 2.0, PM-Jan Arogya Yojana.

    Infrastructure Development – Eg – National Infrastructure Pipeline.

    Poverty Alleviation & Employment – Eg – MGNREGA wage payments.

    Reducing Regional Imbalances – Eg – Aspirational Districts Programme.

    Counter-cyclical spending during downturns. – Eg – Pandemic stimulus packages.

    Human Capital Development – Eg – PM Kaushal Vikas Yojana.

    Technological & R&D Support – Eg – Funding for ISRO, Digital India.

    Major challenges in Public Expenditure management

    Interest Payment obligations – The budgetary estimate for 2025-26 – Rs 12.76 lakh crore on interest payments forming 25 % of the government’s total expenditure.

    Low Tax Buoyancy: The tax-to-GDP ratio in India is around 10-12%, lower, while for OECD its 33%.

    Expanding Welfare Commitments – Growth in health, education, pensions, MGNREGA raises recurring liabilities.

    FRBM Constraints – FRBM mandates FD of 4.4% of GDP, limiting fiscal space.

    Poor Budgetary Forecasting : Budgets often overstate revenue projections (15 out of 20 years since fiscal 1998) and understate expenditures (12 out of 20 years since fiscal 1998).

    Fiscal Populism – eg loan waivers to farmers

    Rise in Off-Budget Expenditure – Eg: Food subsidy via FCI, UDAY bonds by states.

    Rise in Public Administration Costs – Eg: 8th Pay Commission can increase salary & pension burden.

    Need for Infrastructure Investment in transport, energy, and urbanisation, but fiscal space remained limited. Eg- As per WB, $2.2 trillion by 2030 is needed

    Public Sector Inefficiencies – Persistent losses in PSUs require budgetary support, reducing room for developmental expenditure.

    External Challenges

    Volatile Crude Oil Prices due to geopolitical instability. India imports 85% of its crude.

    Rising International Commitments under Paris Agreement, SDGs, Sendai Framework etc. Eg- Renewable energy targets.

    Rupee depreciation increases the cost of external debt servicing and capital imports.

    Rising Protectionism and Trade Wars have impacted exports. Eg- Trump H1B visa restrictions

    Increased Defence spending due to External Threat. Eg- 5% increase in defence spending in 2025 than 2024.

    Way Forward for Effective Fiscal Policy in India

    Establish an independent fiscal council to provide unbiased analysis of fiscal policy and enhance transparency and accountability. (15th FC Report)

    Scrutiny of Populist Policies and Outcome-Oriented Budgeting (NITI Aayog)

    Leveraging PPP for mobilizing private sector investment for infrastructure projects. (Economic Survey)

    Reforming Social Welfare Programs: Eg- Shanta Kumar Committee estimated that reforms in PDS could

    Cut down administrative costs by 10-15% through e-governance. (2nd ARC)

    Enhance Tax Buoyancy – to achieve a medium-term growth trajectory of 6.5-7.0% and realize Viksit Bharat vision, tax buoyancy needs to be in the 1.2-1.5 range. (EY Report)

    Improve Centre-State Fiscal Coordination – Encourage states through capex-linked incentives, as in Union Budget 2023-24’s 50-year interest-free loans.

    Strategic Disinvestment – Use proceeds to fund infrastructure, logistics, transport, not for recurring expenditure. (NITI Aayog)

    Efficient expenditure is critical for sustainable budgeting and Viksit Bharat 2047.

  • Distinguish between Capital Budget and Revenue Budget. Explain the components of both these Budgets.

    Under Article 112, the Budget comprises the Revenue Budget, which covers routine government income and expenditure, and the Capital Budget, which deals with asset creation and long-term liabilities.

    Difference Between Revenue Budget and Capital Budget

    Components of the Revenue Budget

    Revenue Receipts

    Tax Revenue – Income tax, corporate tax, GST, customs, excise, etc.

    Non-Tax Revenue – Dividends & profits from PSUs/RBI, fees, fines, interest receipts.

    Grants-in-Aid – External grants from other countries/institutions.

    Revenue Expenditure

    Salaries, Pensions & Administrative Costs

    Subsidies – food, fertiliser, petroleum.

    Interest Payments on past borrowings.

    Grants to States & UTs, grants for social services.

    Expenditure on Routine Government Operations – police, defence services (revenue), judiciary.

    Components of the Capital Budget

    Capital Receipts

    Borrowings – Market loans, external loans, treasury bills.

    Disinvestment Proceeds – Sale of government equity in PSUs.

    Recovery of Loans – Repayment from states, PSUs, and others.

    Small Savings & Provident Fund Collections

    Capital Expenditure

    Creation of Assets – Roads, railways, bridges, irrigation, defence capital.

    Loans and Advances – To states, UTs, PSUs, and financial institutions.

    Investment in PSUs and Infrastructure Projects

    A healthy fiscal structure requires containing revenue expenditure and prioritising capital expenditure to strengthen productivity and economic growth.

  • Explain how the Fiscal Health Index (FHI) can be used as a tool for assessing the fiscal performance of states in India. In what way would it encourage the states to adopt prudent and sustainable fiscal policies?

    The Fiscal Health Index (FHI) initiative by NITI Aayog evaluates the fiscal health of eighteen major states through a composite index using data from the CAG, covering the Financial Year 2022-23.

    FHI as a tool to assess fiscal performance of states

    FHI uses uniform metrics-Tax Buoyancy, Debt-to-GSDP, Fiscal Deficit, Capex Share-allowing objective comparison across states.

    Multi-dimensional Evaluation – Covers five pillars and reveal structural strengths and weakness

    Measures states’ ability to mobilise resources through Own Tax Revenue (OTR) and Own Non-tax Revenue (ONTR). Eg – Higher OTR-to-GSDP ratio reflects stronger fiscal autonomy.

    Measures Quality of Expenditure – FHI differentiates between capital expenditure and revenue expenditure. Eg – States like Gujarat and Karnataka show higher capex ratios.

    Tracks Debt Sustainability – Assesses Debt-GSDP ratio, interest payment burden, and future liabilities. Eg – FHI flags high-debt states such as Punjab, Kerala, Rajasthan, and West Bengal.

    Monitors Fiscal Deficit and Compliance with FRBM Limits – Shows whether states adhere to 3% fiscal deficit glide path.

    Identifies Risk from Off-Budget Borrowings – Captures liabilities from power sector guarantees, state PSUs, and special purpose vehicles.

    Highlights Best Practices – Eg- Top states-Odisha (67.8 score), Chhattisgarh, Goa-show strong non-tax revenue, low fiscal deficits, and high capital outlays

    Role of FHI in Encouraging prudent and sustainable fiscal policies

    Promotes Fiscal Discipline – Poor rankings push states to reduce deficits and unsustainable borrowing.

    Incentivises Capital Spending – Encourages a shift from populist revenue expenditure towards productive capital outlay.

    Supports Long-Term Planning – Aligns state finances with sustainable development goals and resilience-building.

    Revenue Reforms-Stimulates states to improve tax buoyancy, and non-tax revenue mobilisation

    Drives Structural Reforms like subsidy rationalization, reduction in revenue leakages etc.

    Transparency & Accountability – Public scrutiny builds pressure on governments for fiscal prudence

    Encourages Inter-State Competition – Rankings foster a competitive spirit to achieve stronger fiscal performance.

    Strengthens Cooperative Federalism – Helps in Centre-State dialogue on shared fiscal risks and sustainability.

    Boosts Investor Confidence – Strong fiscal performance signals creditworthiness, attracting investment.

    Promotes Sustainable Borrowing Practices and enhances creditworthiness as better FHI improves a state’s credit rating.

    Challenges

    Data Gaps – CAG data of Financial Year 2022-23 used

    Off-budget borrowings not fully captured in FHI.

    Miss qualitative aspects such as governance quality, efficiency of welfare delivery etc.

    Inter-State Structural Variations are not fully captured – Eg- Resource-rich states (Odisha, Chhattisgarh) naturally perform better in non-tax revenues

    Competitive Populism reduces focus on fiscal discipline. Eg- farm loan waivers

    Weak Enforcement – FHI rankings have no binding effect on policy behaviour.

    By encouraging disciplined, sustainable, and quality spending, FHI can help realise the vision of Viksit Bharat@2047

    Industrial Policy

  • DAC Grants AoN Worth ₹3.6 Lakh Crore for Rafale, P-8I and Major Defence Modernisation Push

    Why in the News?

    The Defence Acquisition Council chaired by Rajnath Singh has granted Acceptance of Necessity for defence procurement proposals worth about ₹3.6 lakh crore, including 114 Rafale fighter jets and six P-8I aircraft.

    About Defence Acquisition Council

    • Apex decision making body for capital procurement in the Ministry of Defence after the Kargil War of 1999.
    • Headed by the Defence Minister
    • Grants Acceptance of Necessity, which is the first formal step in defence procurement
    • Functions under the framework of the Defence Acquisition Procedure 2020

    Composition 

    • The council is chaired by the Defence Minister (Raksha Mantri). Key members include the Chief of Defence Staff, the three Service Chiefs (Army, Navy, Air Force), and the Defence Secretary, with the Deputy Chief of Defence Staff (Planning & Procurement) as Member Secretary.

    Key Points: Recent procurement proposals: 

    • Acceptance of Necessity (AoN): First stage of capital procurement approval under Defence Acquisition Procedure 2020.
    • Indian Air Force: 114 Rafale Multi Role Fighter Aircraft, combat missiles, and High Altitude Pseudo Satellite for ISR and ELINT roles.
    • Indian Navy: Six P-8I long range maritime reconnaissance aircraft for anti submarine warfare and maritime strike capability.
    • Indian Army: Procurement of Vibhav anti tank mines and overhaul of T-72, BMP II and armoured recovery vehicles.
    [2024] Consider the following aircraft: 1. Rafael 

    2. MiG-29 

    3. Tejas MK-1 

    How many of the above are considered fifth generation fighter aircraft? 

    (a) Only one (b) Only two (c) All three (d) None