16th Finance Commission

The Union Government has accepted the recommendations of the 16th Finance Commission. Read here to learn more.

The government’s acceptance of the 16th Finance Commission report reaffirms its commitment to cooperative federalism, fiscal discipline, and equitable development across States.

Finance Commissions, constituted under Article 280 of the Constitution, play a pivotal role in correcting vertical and horizontal fiscal imbalances between the Union and States.

16th Finance Commission

The 16th Commission, chaired by Dr Arvind Panagariya, is responsible for recommending the tax-sharing formula and disaster management grants for the period starting April 2026.

The acceptance of the 16th Finance Commission report sets the fiscal roadmap for Centre-State relations for the award period beginning FY 2026-27, at a time of post-pandemic consolidation and rising development aspirations.

Key recommendation of the 16th Finance Commission

Direct Tax Reforms

1. New Income Tax Act, 2025

• The New Income Tax Act, 2025, to be effective from April 2026, seeks to replace the existing complex law with a simpler, citizen-centric framework.
• Redesigned rules and forms aim to reduce interpretational ambiguity and compliance burden, especially for ordinary taxpayers. This reform aligns with global best practices of clarity, predictability, and voluntary compliance.

2. Enhancing Ease of Living for Taxpayers

Several provisions directly benefit individuals and small taxpayers:

• An exemption of interest awarded by the Motor Accident Claims Tribunal removes hardship taxation on compensation for personal loss.
• Rationalisation of TCS rates:
  • Overseas tour packages are capped at 2%.
  • LRS remittances for education and medical purposes have been reduced to 2%, supporting students and patients abroad.
• Simplified TDS for manpower supply supports labour-intensive industries.
• Automated, rule-based lower or nil TDS certificates eliminate discretionary delays and corruption.
• Single-window Form 15G/15H filing through depositories improves efficiency in TDS exemptions on dividends and interest.
• Extended timeline for return revision till 31 March, enabling genuine error correction with minimal fees.
• Staggered return filing timelines reduce system congestion.
• PAN-based challan replacing TAN in NRI property transactions simplifies compliance for resident buyers.
• One-time 6-month foreign asset disclosure window encourages voluntary compliance among small taxpayers.

3. Rationalisation of Penalty and Prosecution

The reforms adopt a non-adversarial tax administration approach:

• Integrated assessment and penalty orders reduce multiplicity of proceedings.
• Updated returns allowed even after reassessment initiation, with additional tax, to lower litigation.
• Immunity from misreporting penalties upon payment of additional tax incentivises disclosure.
• Decriminalisation of procedural lapses, such as non-production of books or TDS on payments in kind.
• Immunity for non-disclosure of small foreign assets (below ₹20 lakh) with retrospective effect enhances fairness.

4. Cooperative Sector Support

Recognising cooperatives as instruments of inclusive growth:

• Expanded deductions for primary cooperatives supplying cattle feed and cottonseed.
• Dividend income deductions for inter-cooperative transfers under the new tax regime.
• Three-year dividend tax exemption for notified national cooperative federations, strengthening cooperative capital formation.

5. Supporting the IT Sector as a Growth Engine

To consolidate India’s global IT leadership:

• Unified classification of IT services with a common safe harbour margin of 15.5%.
• Safe harbour eligibility threshold raised to ₹2,000 crore, benefiting mid-sized firms.
• Automated approval and 5-year continuity of safe harbour reduce uncertainty.
• Fast-tracked unilateral APA process (2-2.5 years) enhances transfer pricing certainty.
• Extension of the modified returns facility to associated entities improves compliance flexibility.

6. Attracting Global Business and Investment

India is positioned as a global services and manufacturing hub through targeted incentives:

• Tax holiday till 2047 for foreign cloud service providers using Indian data centres.
• Safe harbour margins for related data centre services and bonded warehousing.
• Five-year tax exemptions for non-resident suppliers of capital goods to bonded toll manufacturers.
• Tax exemption on the global income of non-resident experts under the notified schemes.
• MAT exemption for presumptive-tax-paying non-residents, enhancing investor confidence.

7. Tax Administration Reforms

• Alignment of ICDS with IndAS eliminates parallel accounting systems from FY 2027-28.
• Rationalisation of the definition of an accountant for safe harbour rules improves clarity and uniformity.

8. Other Key Direct Tax Proposals

• Buyback taxation shifted to capital gains for all shareholders, protecting minority investors.
• Higher buyback tax on promoters ensures equity.
• Rationalised TCS rates on liquor, scrap, minerals, and tendu leaves.
• An increase in Securities Transaction Tax (STT) on futures and options reflects risk considerations.
• MAT made a final tax at 14%, with limited set-off of accumulated credit, nudging companies towards the new regime.

Indirect Tax and Customs Reforms

1. Tariff Simplification and Sectoral Support

• Enhanced duty-free input limits for marine exports.
• Extended exemptions for leather, textiles, electronics, and civil & defence aviation.
• Continued support for energy transition, including lithium-ion cells, solar glass, and biogas.
• Extension of customs exemptions for nuclear power projects till 2035.
• Duty exemptions for critical mineral processing capital goods.

2. Ease of Living Measures

• Reduction of customs duty on personal imports from 20% to 10%.
• Exemption of duties on 17 essential medicines.
• Expanded duty-free import for drugs and food for rare diseases.
• Revised baggage rules to align with modern travel realities.

3. Customs Process Simplification and Trust-Based Systems

• Minimal intervention customs clearance.
• Extended duty deferral for Tier 2 & 3 AEOs.
• Advance ruling validity increased to 5 years.
• Automated clearance for trusted importers.
• Warehouse operator-centric framework with self-declaration and risk-based audits.

4. Ease of Doing Business and Digital Integration

• Single digital window for cargo clearances involving multiple agencies.
• Integration of food, drug, plant, and wildlife clearances by April 2026.
• Rollout of the Customs Integrated System (CIS) within two years.
• Expansion of AI-based non-intrusive scanning across major ports.

5. New Export Opportunities

• Fish caught in EEZ/high seas are treated as duty-free exports, even when landed abroad.
• Removal of the ₹10 lakh cap on courier exports, empowering MSMEs, artisans, and startups to access global e-commerce markets.

Significance of Government Acceptance

Strengthening Cooperative Federalism: Acceptance signals trust in the constitutional mechanism for Centre-State financial relations, reducing ad-hocism and reinforcing rules-based fiscal transfers.

Predictability for State Planning: Multi-year fiscal certainty enables States to:

• Plan capital expenditure
• Improve welfare delivery
• Attract private investment

Balancing Equity and Efficiency: By combining income distance with tax effort and demographic performance, the framework avoids penalising both:

• Poor States (for being underdeveloped)
• Performing States (for good governance)

Supporting Post-Pandemic Recovery: With States responsible for nearly 60% of public expenditure, enhanced transfers play a crucial role in sustaining growth, infrastructure creation, and social sector spending.

Concerns

• GST compensation gap: Some States argue that post-GST revenue uncertainty remains insufficiently addressed.
• Conditionality vs autonomy: Performance-linked grants, while reform-oriented, may constrain the fiscal autonomy of poorer States.
• Rising expenditure mandates: States face pressure from welfare schemes, salaries, and pensions without commensurate revenue buoyancy.

Conclusion

The government’s acceptance of the 16th Finance Commission’s recommendations marks a decisive step toward stable, transparent, and reform-oriented fiscal federalism.

By ensuring predictable transfers, incentivising good governance, and supporting climate resilience and local bodies, the framework aligns fiscal policy with India’s broader development vision.

Its success, however, will depend on effective implementation, Centre-State trust, and sustained fiscal prudence, ensuring that cooperative federalism remains both constitutional in spirit and developmental in practice.

Related articles:

• Union budget 2026-27
• Economic survey 2025-26
• 15th Finance Commission