What are the types of direct and indirect tax?
Benjamin Franklin once said, “two things certain in life: death and taxes.” This amount that is deducted from your salary keeps the government and its services running, and it is a compulsory contribution made by every legal individual & organization. Taxes form an essential element of promoting the economic operation and growth of the nation.
The tax structure in India is a three-tier which includes the Central Government, State Governments, and Local Authorities.
There are distinct taxes applicable to individuals and organizations under the Indian taxation system. However, the 2 broad categories of tax in India are Direct Tax & Indirect Tax.
Doing your taxes and learning about them can be overwhelming. This short guide can help you understand the basics and make it a little easier to comprehend
What are Direct Taxes?
As the name suggests, direct taxes are levied directly on taxpayers. It’s a type of tax where the impact and the incidence of tax fall under the same category.
Direct taxes work at the ability-to-pay principle, in other words, as a percentage of the taxpayer’s income. This monetary principle claims that individuals who have greater sources of income or earn higher earnings ought to pay higher taxes. Thus maintaining a fair distribution of wealth.
Direct taxes in India are overseen by the Central Board of Direct Taxes (CBDT) which was formed as a result of the Central Board of Revenue Act, 1924.
What are the different types of direct taxes in India?
There are broadly two types of Direct Tax that are as follows:
Levied under the Income Tax Act 1961, income tax is the base tax paid by an individual based on taxable income in any given financial year.
The tax rate is determined according to the relevant tax slabs for that specific financial year. The taxable income refers to total income minus the applicable tax deductions and exemptions. Individuals in this case also include Hindu Undivided Family (HUF), companies, firms, cooperative societies, and trusts.
Companies, both private and public, registered in India under the Companies Act 1956 are liable to pay corporate tax. Corporate Tax is the amount paid on the income earned by them in a given financial year.
A surcharge at the rate of 5% is levied if the net income is in the range of Rs 1 crore to Rs 10 crore. If the net income exceeds Rs 10 cr, there is a surcharge at the rate of 10%.
In the case of foreign companies, royalty or fees received by them in a predefined time frame are subject to tax at the rate of 50%. Tax at the rate of 40% is applicable on any other income. Surcharge at the rate of 2% is levied if the net income is in the range of Rs 1 cr to Rs 10 cr. If the net income exceeds Rs 10 cr, the surcharge is increased to 5%.
An education cess of 3% is levied on the sum of income tax and surcharge irrespective of the level of net income. Marginal relief is given to both domestic and foreign companies in the case of net income exceeding Rs 1 cr and Rs 10 cr.
What are Indirect Taxes?
Taxes levied on goods and services are called Indirect Taxes. It is a type of tax where the incidence and impact of taxation do not fall on the same entity. With indirect tax, the burden of tax can be shifted by the taxpayer to another entity or individual.
Indirect Tax is generally imposed on suppliers or manufacturers who pass it onto the final consumer. Taxes are levied on manufacturing, sales, import, and even purchases of goods and services. The applicable indirect tax can increase the price of the products. It can be complex and cumbersome trying to understand the types and provisions of Indirect Taxes in India.
Indirect taxes have been streamlined following the introduction of the uniform Goods and Services Tax (GST).
The types of indirect taxes include:
Goods and Service Tax (GST)
Goods and Services Tax Law in India is a comprehensive, multi-stage, destination-based tax that is levied on every stage of value addition, from the manufacturer to the consumer. GST is a uniform domestic indirect tax law for the entire country.
Before the Goods and Services Tax could be introduced, the structure of the indirect tax levy in India was inefficient and complicated, cluttered with various levies at various stages.
GST subsumed the following Indirect Taxes:
- VAT, Service Tax
- Excise Duty
- Additional Customs Duty
- Customs Cess
- Entertainment Tax
- Luxury Tax
- Central Sales Tax
Under the GST regime, tax is levied at every point of sale. In the case of intra-state sales, Central GST and State GST are charged. Cases of inter-state sales are chargeable to the Integrated GST.
Customs Duty is defined under the Customs Act, 1962 and enables the government to levy duty on exports and imports, prohibit export and import of goods, prescribe procedures for importing and exporting, and determine offenses, penalties, assessments, etc.
Customs duty-related matters fall under the Central Board of Excise & Customs (CBEC). The CBEC, in turn, is a division of the Department of Revenue of the Ministry of Finance. CBEC also formulates policies that concern the collection or levying of customs duties, customs duty evasion, smuggling prevention, and administrative decisions related to customs formations.
What is the difference between Direct & Indirect Taxes?
If the distinction between the types of taxes is still unclear, the simplified table below provides better clarity on the implementation and value of both types of taxes:
|Direct Tax||Indirect Tax|
It is levied on income and activities conducted.
It is paid directly by the person concerned, i.e the burden of tax cannot be shifted.
It is paid after the income reaches the hands of the taxpayer.
Tax collection can be inconvenient, grueling, and can be evaded in the absence of proper administration.
Direct taxes can help curb inflation.
It is levied on products or services.
The burden of tax is passed on to the final consumer of goods or services.
It is paid before goods or services reach the taxpayer.
Tax collection is relatively easier and more streamlined through the process.
Indirect taxes can lead to inflation.
Directly or indirectly, you cannot escape tax obligations. Out of all the types of taxes, income tax seems to consume a major chunk of your hard-earned money. Fortunately, the Income Tax Act is a doctrine with prescribed ways you can save tax on certain expenses so it is not too heavy on your pocket. You can read more about tax-saving strategies here