Confused about the difference between direct and indirect tax?
Every time you earn a paycheck or buy a cup of coffee, taxes are at play. Taxes are the way government is able to fund public services and infrastructure for its citizens.
Taxes are the primary revenue source of any nation’s economy. They support public services, infrastructure and various development initiatives. In India, taxes are broadly categorised into Direct Taxes and Indirect Taxes.
What Are Direct Taxes?
Direct taxes are taxes paid directly by individuals, companies or organisations to the government. They are based on the taxpayer’s income or wealth and cannot be transferred to someone else. Direct taxes are governed by the Central Board of Direct Taxes (CBDT).
Examples of Direct Taxes
1. Income Tax
Such tax is levied on an individual’s annual income. Salaried employees and self-employed individuals are required to pay taxes based on their income slabs.
2. Corporate Tax
This is the tax that a company pays on its profits. In addition to that, domestic companies also pay surcharge, if profits exceed a certain threshold.
3. Capital Gains Tax
They are applied to profits earned from selling capital assets such as property or stocks. It is categorised as short-term or long-term based on the holding period.
Characteristics of Direct Taxes
1. Paid Directly by Taxpayer to Government
Direct taxes are directly imposed on individuals and organisations based on income, wealth or profits. The taxpayer pays the amount directly to the government without any intermediaries.
Take, for example, an employee earning ₹10 lakh annually pays income tax directly to the government either through payroll deductions (tax deduction at source) or self-assessment.
2. Non-Transferable
The burden of direct taxes cannot be shifted to another person. If an individual owes taxes, they are solely responsible for payment. Like even a business making ₹50 lakh in profit must pay corporate tax directly.
3. Progressive Nature
Direct taxes are levied based on the taxpayer’s ability to pay. This ensures that higher-income groups contribute more. This progressive structure promotes economic equity. In India, income tax rates increase with higher income brackets, ranging from 5% to 30%.
4. Levied as per CBDT
The Central Board of Direct Taxes (CBDT) oversees the administration, collection, and regulation of direct taxes in India.
Benefits of Direct Taxes
1. Promotes Fairness and Equality
As a progressive tax, higher earners pay a larger share, helping bridge the wealth gap. A high-net-worth individual contributes more to government revenue than someone earning ₹3 lakh annually. Thus, the burden of tax is rather progressive than putting strain on the lower income groups.
2. Helps Regulate Inflation
Governments can increase direct tax rates during inflationary periods to curb excess disposable income. They can do so by changing the tax rates and managing the cash flow in the money market, which reduces demand.
3. Encourages Saving and Investment
Tax benefits under Section 80C of the Income Tax Act, 1961 and similar provisions incentivise taxpayers to invest in financial instruments such as Public Provident Fund (PPF) or National Savings Certificate (NSC). You can invest ₹1.5 lakh in PPF to reduce taxable income by the same amount.
Limitations of Direct Taxes
1. Risk of Tax Evasion
People can sometimes underreport income or claim false deductions to avoid paying taxes. This kind of tax avoidance can impact the government revenue. Business owners might understate profits in financial statements to minimise tax liability.
2. Complex Compliance
Filing tax returns and understanding tax rules and regulations can be challenging, especially for people without financial expertise. Hence, many taxpayers hire accountants to go through counseling to file their taxes properly, with tax deductions and exemptions.
3. Can Discourage Higher Earnings
High tax rates might discourage you from earning more, as incremental income is taxed at higher rates. A professional might refuse additional freelance work to avoid entering into a higher tax bracket.
What Are Indirect Taxes?
Indirect taxes are applied to goods and services. These are collected by intermediaries (like retailers) and passed on to the government. The ultimate burden falls on the consumer. These taxes are governed by the Central Board of Indirect Taxes and Customs (CBIC).
Examples of Indirect Taxes
1. Goods and Services Tax (GST)
This tax has replaced Value Added Tax (VAT) and service tax in many state and central taxes. After 1st July 2017, GST applies to nearly all goods and services, with tax slabs ranging from 0% to 28%.
2. Customs Duty
Such taxes are levied on goods imported into India. For instance, if you import a luxury car from a foreign country, customs duty is charged which makes it more expensive.
3. Excise Duty
Such taxes are imposed on goods manufactured in India, particularly alcohol, tobacco and petroleum products.
Characteristics of Indirect Taxes
1. Levied on Goods and Services
Indirect taxes are levied on the price of goods and services where they are consumed by the end consumer. So, consumers pay them indirectly when making purchases. A 5% GST is levied on restaurant bills, which is included in the total amount paid.
2. Burden Can Be Shifted
The seller collects the tax from the buyer and transfers it to the government. This shifts the tax burden to the final consumer. A retailer adds GST to the price of a laptop and transfers the collected tax to the government. This is how the burden of indirect taxes are shifted.
3. Uniform Rates Across Income Groups
Indirect taxes are the same for everyone, irrespective of everyone’s income or wealth. Whether rich or poor, everyone pays 18% GST on luxury items like air conditioners.
4. Levied by the CBIC
The Central Board of Indirect Taxes and Customs (CBIC) oversees the collection and regulation of indirect taxes.
Benefits of Indirect Taxes
1. Broad Revenue Base
Indirect taxes apply to all consumers. So, they serve as a steady source of revenue stream for the government. Even a small grocery purchase contributes to tax collection through GST.
2. Easier to Collect
Businesses collect taxes on behalf of the government. This simplifies the administration and reduces enforcement costs. Like retailers include taxes in product prices, which they can remit directly to the government.
3. Difficult to Evade Taxes
All indirect taxes are included in prices. This makes it nearly impossible to avoid payment. For example, a movie ticket includes GST, which the theatre collects and pays to the government.
Limitations of Indirect Taxes
1. Regressive Nature
Since indirect taxes are uniform, lower-income groups bear a disproportionate burden. Like for example, ₹10 GST on an essential food item impacts a daily wage earner more than a high-income individual.
2. Inflationary Effect
Indirect taxes increase the cost of goods and services, thus reducing purchasing power. This is because a higher GST rate on luxury items makes them less affordable, even for middle-income consumers.
3. Impact on Essential Goods
Such taxes on necessities, such as medicines or food, can disproportionately affect economically weaker sections of the society i.e., the vulnerable population. A 5% GST on generic medicines increases healthcare costs for low-income families.
Differences Between Direct and Indirect Taxes
| Aspect | Direct Tax | Indirect Tax |
| Nature | Paid directly by individuals or organisations | Paid indirectly via intermediaries |
| Burden | Non-transferable | Transferable to the end consumer |
| Tax Base | Income or wealth | Goods and services |
| Taxpayer | Salaried individuals, companies | Final consumers |
| Governing Authority | CBDT | CBIC |
| Progressivity | Progressive; higher income = higher tax | Regressive; same rate for all |
| Evasion | Possible through false reporting | Difficult due to embedded collection |
Wrapping Up
Both direct and indirect taxes have their own roles in the Indian economy. While direct taxes promote fairness by taxing higher earners more, indirect taxes make sure that there isa broader participation as everyone contributes through consumption. However, they come with their own sets of benefits and limitations. Therefore, a balanced tax system lis what is need for equitable economic growth and development.
FAQs
What is the difference between Direct and Indirect Tax?
Direct taxes are levied on income and paid directly to the government, while indirect taxes are applied to goods and services and collected through intermediaries.
Is GST a Direct or Indirect Tax?
GST is an indirect tax, as it’s included in the price of goods and services and ultimately paid by the consumer.
Can the burden of Direct Taxes be shifted?
No, the burden of direct taxes cannot be transferred to another person.
Who pays Indirect Taxes?
Indirect taxes are paid by consumers when they purchase goods or services.
Are Direct Taxes progressive?
Yes, direct taxes are progressive, meaning higher earners pay a larger percentage of their income as taxes to the government.
Why are Indirect Taxes considered regressive?
Indirect taxes apply the same rate to everyone, regardless of income, disproportionately affecting lower-income groups.
Which authority governs Direct and Indirect Taxes in India?
Direct taxes are governed by Central Board of Direct Taxes (CBDT), while indirect taxes are managed by Central Board of Indirect Taxes and Customs (CBIC).
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