Difference Between Direct and Indirect Tax in India

Taxes are one of the biggest sources of income for the government. From your salary, meals at a restaurant, watching a movie at the multiplex, driving your car on roads, to simply purchasing a packet of biscuit from a general store, you pay many different types of taxes in many different ways.As a responsible citizen of the country, it is your duty to pay the taxes. But it is also equally important to know the different types of taxes implemented in the country. All the various taxations in India can be broadly classified into two categories- direct and indirect tax . Let us have a detailed look at the meaning of these two types of taxes.

In simple words, a direct tax is a tax that you directly pay to the authority imposing the tax. For instance, income tax is imposed by the government, and you pay it directly to the government. These taxes cannot be transferred to any other entity or person. There are several acts which govern direct taxes.In India, CBDT (Central Board of Direct Taxes) which is governed by the Department of Revenue is responsible for the administration of direct taxes. The department is also involved in planning and providing inputs to the government regarding the implementation of direct taxes.Read also : Know The Different Types Of Income Tax Collected In India

Some of the most common types of direct tax implemented in India are as follows-

1. Income Tax

The most common type of direct tax in India is income tax. It is imposed on the income you earn in a financial year based on the income tax slabs of the IT department. The tax is paid by individuals as well as businesses directly to the IT department. For individual taxpayers, there are also several tax deductions available under various sections of the IT Act.

2. Securities Transaction Tax

If you are involved in stock trading, each of your trade also has a small constituent known as the securities transaction tax. Irrespective of whether you made money on the trade or not, you will have to pay this tax. The broker collects this tax from you and passes on to the securities exchange, which then pays it to the government.

3. Capital Gains Tax

Every time you make capital gains, you will be required to pay capital gains tax. This capital gain could come from the sale of a property or from investments. Based on the capital gains and the duration for which you held the investment, you will be required to pay either LTCG (Long-Term Capital Gains) tax or STCG (Short-Term Capital Gains) tax.

There are some key benefits of direct taxes such as-

• Curbs Inflation- In case if there is monetary inflation, the government can increase direct tax rates so that the goods and services demand can be reduced. As the demand falls, it helps in condensing inflation.
• Equitable- Direct taxes are also known to be equitable as the progression principle is at its foundation. People with lower income pay lower taxes, and people with higher income pay higher taxes.
• Reduces Inequalities- The higher taxes collected from the rich are used by the government to launch newer initiatives for the poor. The initiatives provide income sources to people with lower income, helping them improve their living standards.

Direct taxes also have some drawbacks such as

• Considered a Burden- As taxpayers are required to pay direct taxes like income tax in a single lump sum every year, they are considered a burden. Moreover, even the documentation process is generally complex and time-consuming.
• Evasion is Possible- While the government has made tax evasion very difficult now, there are still many fraudulent practices through which individuals and businesses can avoid or pay lower taxes than they should.
• Restrains Investments- Due to the imposition of direct taxes like securities transaction tax and capital gains tax, a lot of people avoid investing. So, in a way, direct taxes restrain investments.

While direct taxes are imposed on income and profits, indirect taxes are levied on goods and services. A major difference between direct and indirect tax is the fact that while direct tax is directly paid to the government, there is generally an intermediary for collecting indirect taxes from the end-consumer. It is then the responsibility of the intermediary to pass on the received tax to the government.Unlike a direct tax, indirect taxes do not depend on the income of an individual. The tax rate is the same for everyone. The CBIC (Central Board of Indirect Taxes and Customs) is mostly responsible for handling indirect taxes in India. Just like CBDT, CBIC also works under the Department of Revenue.

Some of the most important types of indirect tax in India are as follows-

1. Goods and Services Tax (GST)

GST subsumed as many as 17 different indirect taxes in India like Service Tax, Central Excise, State VAT, and more. It is a single, comprehensive, indirect tax which is imposed on all the goods and services as per the tax slabs laid by the GST council. One of the biggest benefits of GST is that it mostly eliminated the cascading or tax-on-tax effect of the previous tax regime.

2. Customs Duty

When you purchase something that needs to be imported from a foreign country, you are required to pay customs duty on it. Irrespective of whether the product has come to India by air, land, or sea, you will have to pay the customs duty on it. The goal of imposing this indirect tax is to make sure that every product entering India is taxed.

3. Value Added Tax (VAT)

A VAT is a type of consumption tax imposed on products whenever its value increases throughout the supply chain. It is imposed by the state government, which also decides the VAT percentage on different goods. While GST has mostly eliminated VAT, it is still imposed on some products such as items that contain alcohol.

Some significant benefits of indirect taxes are listed below-

• Poor Contributes Too- It is essential for the country that every individual contributes towards its development.As the poor are often exempt from paying direct taxes, the indirect taxes ensure that even poor contribute towards nation-building.
• Convenience- Unlike direct taxes which are generally paid in a lump-sum, indirect taxes like GST are paid in small amounts. When you purchase a product or service, a small amount of GST is already included in the price, and this makes its payment more convenient for the taxpayers.
• The collection is Easy- If you want to know what is the difference between direct and indirect tax , one of the biggest of them is how they are paid. Unlike direct taxes, there are no documents or complex procedures involved in paying indirect taxes. You are required to pay the tax right when you purchase a product or service.

Read also : Know The Basics Of Goods and Services Tax - GST

A few cons of indirect taxes are as follows-

• Regressive- Indirect taxes are widely known to be regressive in nature. While they make sure that everyone pays taxes irrespective of their income, they are not equitable. People from every income group are required to pay indirect taxes at the same rate.
• Makes Products and Services More Expensive- As indirect tax is added to the price of goods and services, it makes them more expensive. For instance, products like cigarettes, high-end bikes, premium cars, etc. are included in the 28% tax slab of GST.
• Lacks Civic-Consciousness- As indirect tax is added to the price of the product or service, the consumers are generally unaware of the tax they are paying. This is opposite to direct taxes where the taxpayer clearly knows the taxes he/she is paying.

Here is a table pointing out the biggest direct vs. indirect tax differences-

As you can see, direct as well as indirect taxes have their pros and cons , but both are abundantly important for the economy. While taxes are generally considered to be an unnecessary burden, it is from the taxes you pay that the government builds the nation, invests in defence, healthcare, infrastructure, launches welfare initiatives, and prospers. Our dream of seeing our country become a global superpower can only be achieved if the citizens continue to pay taxes with complete honesty.Now that you’ve understood the different types of direct and indirect taxes in India , fulfil your responsibility of paying taxes and being a responsible citizen of the country. Make use of the available tax deductions as much as possible but do pay the remaining tax liabilities on time every year as this will ultimately help the citizens and make the country more prosperous.

• Every responsible citizen is required to pay taxes as it is collected for the country's overall development and betterment.
• Whether you’re a salaried individual or businessman, one has to pay both direct or indirect taxes.
• Direct taxes can be in the form of income tax, capital gains tax or securities transaction tax, while indirect taxes such as GST, Customs Duty or VAT are levied on all end-consumers to buy any goods services.
• You may think of paying tax as an unnecessary burden, but the money is ultimately used by the government for infrastructure, welfare initiatives, healthcare, & other various developmental activities.
• Taxes indeed reduce your monetary gains. However, you can claim deductions as prescribed in the Income Tax Act, such as Section 80C, 80D, among others.

Direct taxes are levied on the income of taxpayers. The Department of Revenue of the Indian Government is responsible for the collection of direct tax in India. It is the central authority in all tax-related regulations. The Department of Revenue collects direct tax in India through a statutory body called the Central Board of Direct Taxes (CBDT).

Goods and Services Tax is a tax collected on the consumption of goods or services therefore, it is an indirect tax. It is divided into two parts, one that is distributed equally between the centre and the state in the form of the Central GST (CGST) and State GST (SGST). The other part is Integrated GST (IGST) taken by the central government for inter-state transactions.

The largest source of tax in India is GST which is an indirect tax. Collections from GST in FY 22 crossed Rs. 6.75 lakh crores accounting for 26.8%of the central government’s gross tax revenue in the year.The next largest tax in India is the corporate tax which is the direct tax levied on companies. It accounted for 25.2% of the total tax revenue in FY 22. Larger corporates are subjected to mandatory audits upon crossing a threshold, and the resultant tax is paid to the government.

There are many sources of income that are not taxable. Some of them include:

1. Agricultural income including farming, cattle rearing and poultry
2. Gift received from family members.
3. Scholarships and rewards
4. Gratuity
5. Leave encashment salary component
6. Receipts from HUF if the HUF is taxed
7. Dividend from shares of mutual fund units
8. Income from Provident Fund
9. Share from an LLP or a partnership firm
10. Interest income from specified sources like gold deposit bonds and Sukanya Samriddhi Scheme .

Section 10 of the Income Tax Act states income that is exempt from taxes.

TDS refers to tax deducted at source. It is the direct tax that is deducted by the payer and paid to the government on behalf of the taxpayer. The payer deducts the TDS component before completing payment to the taxpayer. Since it is a tax on the income earned by the taxpayer, it is a direct tax. It is paid by the payer against the PAN of the taxpayer and is reflected in the Form 26AS of the taxpayer, useful at the time of filing returns.

Three broad examples of direct tax include:

1. Income tax which is paid by the taxpayer on the income earned in a financial year.
2. Corporate tax which is paid by taxpayers that are companies on the net profits of a financial year.
3. Property tax which is paid on the property owned by a taxpayer and is collected by the state government.

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The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.