Difference Between Direct And Indirect Tax with Example
If one were to compile a list of most despised terms, the word ‘tax’ would probably appear towards the top. However, hating taxes doesn’t solve the problem as you will still need to pay them. It’s rather worthwhile to understand taxation and then to optimise the outgo. Easier said than done, you might say. Well, even a thousand-mile journey starts with a single step. Your first step towards understanding taxation could be this article.
Taxes in India can be broadly classified into direct and indirect taxes. Let’s understand what this classification means.
What Is Direct Tax?
Direct tax is levied directly on individuals or businesses or other entities by the government. It is based on their income, profits, or assets. One example of a direct tax in India is the income tax that individuals pay on their earnings from salary, business, or investments. The tax amount is calculated based on the income slab rates set by the government.
What Is Indirect Tax?
Indirect tax is not directly imposed but is passed on to them through the goods and services they purchase. It is included in the price of the products or services. One example of an indirect tax in India is the Goods and Services Tax (GST). When you buy goods or services, GST is added to the price you pay, and the seller collects it on behalf of the government.
The Difference Between Direct and Indirect Tax
| Direct Tax | Indirect Tax |
| It is levied directly on individuals or entities based on their income, profits, or assets. | Imposed indirectly on individuals or entities through purchase of goods or services. |
| Examples include income tax, corporate tax, wealth tax, etc. | Examples include GST, excise, and customs duties. |
| Paid directly by the taxpayer to the government. | Paid indirectly by the taxpayer as part of the price of goods or services. |
| The tax burden falls on the taxpayer who earns the income or possesses the assets. | The tax burden is generally passed on to the end consumer as part of the cost of goods or services. |
| The tax amount is based on the income slabs or specific calculations set by the government. | The tax amount is a percentage of the price of goods or services and is determined by the tax rate prescribed by the government. |
| Individuals and entities must file tax returns and disclose their income to calculate their tax liability. | Individuals and entities pay the tax when they make a purchase, and no separate filing is required. |
| The impact of direct tax is more visible, as taxpayers directly feel the tax burden. | The impact of indirect tax may be less visible, as taxpayers may not be aware of the specific tax amount included in the prices of goods or services. |
Different Types of Direct and Indirect Taxes in India
In India, there are several types of direct and indirect taxes levied by the government. Let’s look at some of the major types:
Types of Direct Tax
- Income tax: It is a tax imposed on the income earned by individuals, Hindu undivided families (HUFs), companies, firms, and other entities. The government determines the rates and slabs for income tax, which are subject to change from time to time.
- Corporate tax: This tax is applicable to domestic and foreign companies registered in India. The rates vary based on the type and size of the company.
- Capital-gains tax: It is a type of tax levied on the profits earned from the sale of capital assets, such as stocks, real estate, or valuable personal possessions. The tax rate for capital gains depends on the duration of the asset’s ownership and the applicable tax laws.
- Wealth tax: Wealth tax has been abolished in India. However, until its abolition, it was levied on individuals, HUFs, and companies on the value of their specified assets.
Types of Indirect Tax
- Goods and Services Tax (GST): GST is a comprehensive indirect tax that replaces multiple indirect taxes such as VAT, central excise duty, service tax, etc. It is levied on the supply of goods and services throughout the country. GST has different rates based on the type of goods or services.
- Customs duty: Customs duty is levied on importing and exporting goods. It includes basic customs duty, additional customs duty (countervailing duty), and special additional duty. The customs duty rates vary depending on the goods type and the country of origin.
- Excise duty: Excise duty is a tax levied on producing or manufacturing goods within the country. It is primarily levied on goods like petroleum products, alcohol, tobacco, and certain luxury items.
- Service tax: Service tax was subsumed under GST after its introduction. It was levied on specific services provided by service providers in India.
- Securities transaction tax (STT): STT is levied on purchasing or selling securities such as stocks, futures, and options. The buyer or seller of the securities pays it.
- Stamp duty: Stamp duty is a tax imposed on various legal documents, such as property transactions, leases, agreements, and share transfers. The rates vary across different states in India.
- Entertainment tax: State governments levied entertainment tax on activities such as movie tickets, amusement parks, and cultural events. However, after the introduction of GST, entertainment tax was subsumed in it.
It’s worth noting that tax laws and regulations can change over time, so it’s important to refer to the latest updates from the government or consult a tax professional for accurate and up-to-date information.
Benefits of Direct Taxes and Indirect Taxes
Benefits of Direct Taxes in India
- Progressive taxation: Direct taxes, like income tax, help ensure a progressive taxation system where higher-income individuals contribute a larger share of their earnings to the government.
- Revenue generation: Direct taxes are a significant source of revenue for the government, which enables funding for public infrastructure, welfare programmes, and development initiatives.
- Redistribution of wealth: Direct taxes help reduce income inequalities by redistributing wealth from higher-income groups to lower-income sections of society.
- Economic stability: Direct taxes play a crucial role in stabilising the economy by ensuring a steady flow of funds for public expenditure and promoting fiscal discipline.
Benefits of Indirect Taxes in India
- Broad-based revenue generation: Indirect taxes, like GST, help generate revenue from a wide range of goods and services, thus contributing to the government’s coffers.
- Simplicity and ease of collection: Indirect taxes are relatively easier to collect as they are often included in the price of goods or services, making the collection process more efficient.
- Consumption control: Indirect taxes can be used as a tool to control consumption patterns by imposing higher taxes on luxury goods and lower taxes on essential commodities.
- Encourage formalisation: Indirect taxes encourage businesses to formalise their operations by requiring tax compliance, promoting transparency, and reducing the scope for tax evasion.
Disadvantages of Direct Taxes and Indirect Taxes
Disadvantages of Direct Taxes in India
- Burden on individuals: Direct taxes, like income tax, can burden individuals, especially those in higher income brackets, reducing their disposable income.
- Tax evasion: Direct taxes are susceptible to tax evasion, as individuals and businesses may attempt to underreport their income or engage in tax-avoidance activities, resulting in revenue loss for the government
Disadvantages of Indirect Taxes in India
- Regressive Nature: Indirect taxes tend to be regressive, meaning they impact lower-income individuals more heavily as they consume a larger proportion of their income on essential goods and services.
- Inflationary pressure: Indirect taxes can increase the prices of goods and services, contributing to inflationary pressures in the economy, which can further impact the purchasing power of individuals and households.
FAQs
When are direct and indirect taxes imposed in India?
The government imposes direct and indirect taxes in India as part of its fiscal policy to generate revenue. The relevant tax laws and regulations govern the imposition of these taxes.
Which is better: direct or indirect tax?
The choice between direct and indirect taxes depends on various factors and policy objectives, and neither can be considered universally better as they serve different purposes and have different impacts on individuals and the economy.
What are indirect tax types?
Indirect taxes include Goods and Services Tax (GST), customs duty, excise duty, service tax (replaced by GST), securities transaction tax (STT), stamp duty, and entertainment tax (subsumed in GST).
Why is GST an indirect or direct tax?
GST (Goods and Services Tax) is an indirect tax because it is levied on the supply of goods and services, and the tax burden is passed on to the final consumers.
What are the features of direct tax and indirect tax?
Direct taxes are levied directly on individuals or entities based on their income, profits, or assets. Indirect taxes are imposed on the production, sale, or consumption of goods and services and are collected by intermediaries before being passed on to the end consumer.
Is TDS a direct or indirect tax?
TDS (tax deducted at source) is a form of direct tax in India. It is a tax-collection mechanism where tax is deducted by a payer while making certain payments to the payee.
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Written By Avneet Kaur
Avneet Kaur is Deputy Content Editor for ET Money. She has over 13 years of journalism experience covering economy and personal finance topics such as mutual funds, insurance, taxation and markets. She has an MBA from ICFAI University, Dehradun and B.Com(Hons.) from Delhi University.
