Difference Between Direct Tax and Indirect Tax in India

• Direct tax falls under the ambit of the Central Board of Direct Taxes and is typically levied directly on individuals and entities depending on their income.
• Indirect tax is not levied on income but is charged on goods and services. It is governed by the Central Board of Indirect Taxes and Customs.
• Income tax is an example of direct tax, and Goods and Service Tax is an example of indirect tax.

Understanding taxation is important from the perspective of financial planning. You can make informed decisions about eligible deductions to reduce your tax liability and maximise earnings.Broadly speaking, there are two types of taxes - direct tax and indirect tax. In this blog, we explain direct tax and how it differs from indirect tax. Knowing the difference between the two will help you understand how taxation impacts your finances.

Direct tax is governed by the Central Board of Direct Taxes (CBDT) and is levied directly on individuals and entities depending on their earnings. It is charged based on income slabs, the higher the income, more is the tax. Thus, a person with a higher income pays higher taxes than a person with a lower income.There is no intermediary involved and you need to discharge your tax liability directly. Failure to pay taxes on time may attract penal and interest charges. Income tax and corporation tax are examples of direct tax.

After having understood what direct tax is, let’s take a closer look at their types.

Income Tax

Income tax Link is a direct tax governed by the Income Tax Act, 1961 . It is payable by different persons, including individuals, entities, the Association of Persons (AOP), partnership firms, etc.You need to account for your total income from various sources like salaries, house property, business, capital gains, and other sources and then reduce it by the eligible deductions.The tax is calculated as a percentage of your taxable income. The income tax rate depends on the slab in which your income falls.Also, you must ensure timely payment of income tax and file your returns to avoid a levy of penalties.

Corporate Tax

Corporate tax is another direct tax which falls under the purview of the Income Tax Act, 1961. It is levied on companies, domestic and foreign at rates specified by the government.Domestic companies are taxed for income earned in India and overseas, whereas, a foreign company is taxed on profits arising from Indian operations.

Securities Transaction Tax (STT)

STT comes under the ambit of the Securities Transaction Tax Act and is a direct tax because it is levied directly on the transaction value of securities. You need to pay STT when you purchase and sell listed securities.These securities include equity shares, equity-oriented units, futures, and options among others.The tax rate depends on the security and transaction type.

Here is the category of persons eligible to pay direct tax:

Individuals

Resident as well as non-resident individuals meeting the criteria of a taxpayer are required to pay direct tax. Thus, if you are self-employed, salaried, or freelancing, you are liable to pay the applicable tax before the due date.

Companies

Companies, domestic and foreign need to pay applicable taxes under the Income Tax Act, 1961. It includes public limited companies, private limited companies, and one-person companies.

Hindu Undivided Family (HUF)

HUF is considered a separate tax entity, and the responsibility of paying taxes and filing income tax returns on behalf of the HUF is on the Karta . The Karta is the head of the family looking after family affairs.

Association of Persons (AOP), Body of Individuals (BOI)

AOPs and BOIs are treated as separate entities for tax purposes. A group of persons natural (individuals) and artificial persons (company, partnership firms, etc.) with a common purpose form an AOP. On the other hand, BOI comprises two or more individuals.

Partnership Firms/ Limited Liability Partnership (LLP)

Partnership firms and LLPs are also legally liable to pay applicable taxes on their income. The partners should ensure timely and accurate tax filings to avoid penalties.

Direct taxes are a source of revenue for the government and offer several advantages to the country.

Social Equality

The rate of direct tax is charged based on your income. This means, individuals with higher income typically have a higher tax liability. Such slab rates lead to a progressive tax system and those with higher incomes normally contribute a higher portion to taxes.

Clarity

Since the direct tax rates are known beforehand, both the government and taxable persons have clarity on the amount of taxation. Thus, the government can predict revenue collection and taxpayers can plan their finances accordingly.

National Progress

The tax collection is directly related to the total wealth of the country i.e. higher the income-generating population, the higher the revenue from direct taxes. In other words, a growing economy usually leads to increased direct tax revenue. Also Read: Types of Taxes: A Guide About Direct and Indirect Tax

Before we delve into the difference between direct and indirect tax , let’s understand what indirect tax is.Indirect tax is not levied on income but is charged on goods and services. Governed by the Central Board of Indirect Taxes and Customs (CBIC), indirect tax is payable on the goods and services purchased.You pay these indirectly through the increased prices of goods and services you consume.GST (Goods and Service Tax) and basic customs duty are examples of indirect taxes.

Here are some of the commonly known types of indirect taxes:

Goods and Service Tax (GST)

GST is an indirect tax levied on goods and services. Notably, GST eliminates the cascading effect, i.e. tax-on-tax.When GST was introduced, it replaced several indirect taxes, including excise duty, VAT (Value-added Tax), service tax, etc. The rate varies according to the type of goods and services purchased.

Custom Duty

Customs duty is applicable when goods are transported across international borders and imported to the nation. It strives to safeguard the nation’s own economy. While GST replaced additional duties of customs and special additional duty of customs, the basic customs duty is present post-GST.

Stamp Duty

Stamp duty is levied on property transactions and is payable within a stipulated period. Failure to pay on time attracts a penalty. Its rate depends on various factors like the age of the property, its location, etc.

The end-user consuming the goods and services is liable to pay indirect taxes. While the consumer pays the taxes, it is usually collected by the seller who deposits the collected taxes with the government.Since indirect taxes are passed on to the final consumers, this leads to a rise in the price of goods and services.

Here are some key advantages of the indirect tax system:

Nation-Building

Indirect tax is a source of revenue for the government, which in turn uses the tax collection for various programs like health care, rural development, infrastructure, etc. Thus, indirect taxes give every individual a chance to contribute to nation-building.

Equitable Distribution of Tax

Indirect tax usually promotes an equitable distribution of tax for tax rates on essential goods and services are comparatively lesser than the rates on luxurious goods and services.

Hassle-Free Collection

Since indirect taxes are usually embedded in the cost of goods and services, their collection is easy and hassle-free. Also, as a consumer, you need not worry about missing due dates as you pay it at the time of purchasing itself.

Both direct and indirect taxes have some drawbacks. The primary drawbacks are mentioned below:

Direct Tax

The two major drawbacks of direct taxes include potential tax evasion and reduced disposal income.

• Certain individuals use fraudulent activities to evade tax, such as underreporting income, claiming false deductions, etc. This amounts to tax law violations and is unfair to honest taxpayers.
• Direct taxes reduce the disposal income, which is the amount of income remaining after taxes and other deductions. Thus, many people look at direct taxes as a burden.

Indirect Tax

Unfavourable for the lower-income group and increased product prices are the two key drawbacks of indirect taxes.

• Since indirect taxes are levied on goods and services, they are not based on earnings. Hence, they are often perceived to be unfair to the lower-income group.
• Indirect taxes are integrated in the price of goods and services, resulting in an increase in the overall cost and ultimately leading to an increased cost of living.

Here are the primary differences between direct and indirect tax:

Regulation

While direct tax falls under the purview of the Central Board of Direct Taxes, indirect tax is governed by the Central Board of Indirect Taxes and Customs.

Payment

In the case of direct tax, you deposit the applicable taxes directly to the government. However, in the case of indirect tax, you pay the taxes while paying for the goods and services consumed.

Tax Rate

Direct tax is normally a progressive tax system where the tax rates depend on your earnings. In other words, those with higher incomes usually pay more taxes.On the other hand, indirect tax is not related to your income but depends on the goods and services you consume.

Examples of Direct and Indirect Taxes

Knowing a few examples of direct and indirect taxes may help you understand these taxes better.

• Income tax and corporate tax are examples of direct taxes.
• Whereas, GST and VAT are examples of indirect taxes.

Here’s a tabulation of the difference between direct and indirect tax.

Now that you know about direct and indirect taxes, you can optimise your tax-planning strategies. Remember that taxes need to be deposited with the government without delays. Make sure to pay them on time to avoid penal charges.Just like taxes, timely payment of your financial obligations like credit card bills is also crucial. It improves your credit score and chances of getting a loan in future.