Types of Taxes in India: Direct Tax and Indirect Tax

Taxes come across as obligatory expenses for the people of the country, forming a significant income source for the government and becoming a backbone to nurture the economy and infrastructure of the country. Let’s understand the different types of taxes in India and understand their impact.

Understanding Types of Taxes in India

The types of taxes in India can be structured into three tiers which include municipal bodies, state government, and central government. The classification of the taxes paid by the people falls into 2 main categories – direct tax and indirect tax. These categories give clarity about the segmentation of people bearing the responsibility of paying which types of taxes in India. The direct tax in India can be further classified based on the source of the tax deduction. Let’s understand more with direct tax examples and understand the difference between direct and indirect tax.

What is Direct Tax in India?

Direct tax implies the obligatory expense paid directly to the government without the involvement of any third party. The direct tax cannot be sent to others, becoming a direct contribution to the revenue of the country. The Central Board of Direct Taxes (CBDT) supervises the process of collection and management of direct taxes. The direct taxes in India are progressive, signifying the gradual growth in the tax rate based on the rise in income.

Let’s understand more with direct tax examples as follows:

Examples of Direct Tax

Income Tax:

The Government of India has enforced income tax on the income earned by individuals, businesses, and other legal entities. The specific amount for each individual or employee is determined according to the different tax slabs curated by the government. The income tax is a certain percentage of income deducted at the source when the employee receives the salary based on his/her tax bracket.

Securities Transaction Tax (STT)

When an individual trades in securities inclusive of shares, futures & options, derivatives, equity-oriented mutual funds, and other such financial instruments. STT is deducted by stockbrokers and further processed to the securities exchange and then contributed to the government. STT is added additionally to the trading value during trading.

Capital Gains tax

Besides the tax generated on the income, individuals also need to pay taxes for any profit generated on the assets bought through the income. This implies taxes need to be paid from the profit when selling real estate assets such as land, or buildings and for capital assets such as equity shares, and mutual funds. Based on the tenure of holding the assets, capital gains tax can be further classified as Short-term capital gains tax (STCG) and Long-term capital tax (LTCG).

What is Indirect Tax in India?

The indirect tax shifts the source from income and profits, and implements tax on the sale of goods and services. Contrary to direct taxes, indirect taxes involve tax payments to the intermediaries which are then processed to the government. The indirect taxes are added to the price of goods and services, reducing the visibility in front of the consumers. The Central Board of Indirect Taxes and Customs (CBIC) manages the administration of indirect taxes. Let’s understand more about tax collection via sales and services through indirect tax examples.

Examples of Indirect Tax

Goods and Services Tax (GST):

GST is one of the most common indirect taxes in India which is enforced on the supply of goods and services. GST ensures uniformity for central and state taxes and compilation into a single taxation system. The GST Council of India is the primary body determining the tax rates that businesses leverage for GST collection from customers.

Customs Duty:

When goods are subjected to export or import trading activities, the indirect tax applicable here is called customs duty. The customs duty facilitates contribution to tax with foreign goods on arrival and for goods that are exported from India. The customs duty increases the price of imported goods in a local market.

Excise Duty:

The indirect tax assigned on issuing licenses, sale, or production of specific goods within different parts of the country is called excise duty.

Value Added Tax (VAT):

The taxes are incorporated in the supply chain at different stages from production to distribution or from manufacturing goods to selling them. Every seller in the product supply chain charges VAT and can claim credit for VAT payout for every purchase, ensuring the value is increased at every stage. VAT is implemented when business activities are managed across different states by businesses, traders and other entities.

Difference Between Direct and Indirect Tax

The concept of direct and indirect tax is simplified and involves the deduction through different sources. Let’s navigate through the differences between direct and indirect tax here.

Advantages and Disadvantages of Direct Tax

Now that we know the difference between direct and indirect tax, let’s explore the advantages and disadvantages of direct tax here.

ADVANTAGES:

Progressive structure:

The direct tax system is progressive in nature and determines the amount of taxes to be deducted proportionately to the income earned. In simpler words, the individual with a lesser income will pay less tax relative to his salary.

Consistent revenue for the government:

The tax deductions from the income earned as well as from the capital gains ensure the government has a steady source of income- based on the tax bracket.

Supports public welfare:

With the consistent income generated by the government, direct taxes ensure adequate resources for integral functions of the economy such as healthcare, education, and infrastructure which further advances the economy.

Motivates investments and savings:

With specific schemes and mutual funds providing relief from different sections of tax deductions such as the Public Provident Fund (PPF) and Equity-Linked Savings Scheme (ELSS), individuals would opt for savings rather than tax deductions.

DISADVANTAGES:

Tax Evasion:

Several employees, business owners as well as companies may find loopholes in the system and pay lesser taxes or evade paying tax altogether, impacting the consistency in revenue for the government.

Compliance costs:

The businesses as well as salaried employees have to incur some expenses to comply with the tax regulations.

Disproportionate impact:

As the direct tax is progressive in nature, individuals in the higher income bracket have to pay significantly higher taxes as compared to the lower income bracket, leading to feeling burdened and overwhelmed.

Limited Coverage:

Several individuals and groups are not included as not all of them are paying direct taxes to the government.

Advantages and Disadvantages of In-Direct Tax

There are several advantages and disadvantages of indirect tax that can be discussed as follows.

ADVANTAGES

Easy collection:

With the inclusion in the cost of goods and services, indirect taxes can be easily collected by the government.

Avoids revealing income structure details:

As indirect tax is specific to products or services, the payout or tax deductions are independent of income structure and individuals need not reveal any details on their income structure.

Broader base:

The indirect tax payout is not restricted to income-earning individuals or any asset owners. The indirect tax is paid by every person purchasing any goods or services with tax implications.

Convenient for payout:

The indirect tax is collected by different intermediaries and then processed to the government. This is convenient for the taxpayers as it does not require a separate payment for the government.

Encourages savings:

The payout for indirect taxes does not impact the personal income of the individuals directly. With the awareness to selectively opt for products or services with tax implications, individuals can have savings.

DISADVANTAGES

Regressive structure:

The indirect tax affects the low-income bracket of people more than the high-earning bracket, as the amount of tax to be paid is the same for everyone despite their income.

Increase in price:

The indirect can significantly increase the price of the product or service, adding inflationary impact to the final price of the product or service.

Complex management:

Several small businesses find the GST process complicated and have difficulty managing it.

Hidden tax burden:

With indirect tax payout through GST, the consumers may lack awareness of the amount of tax paid as it is included in the price of the purchased services or goods.

How Taxes Impact Individuals and Businesses

The different types of taxes in India play a crucial role in generating revenue for the government and indirectly shaping the economy of the country. The tax structure divided into direct and indirect tax significantly impacts individuals as well as businesses or entities discussed here.

Impact on Individuals

• Influencing income and gains: The direct tax in India is paid by the employees and business owners or entities on the income and capital gains based on the tax slab and predetermined percentage respectively. The direct tax reduces the income in hand and also reduces the total gains received from selling capital assets or property.
• Unequal purchasing power: The indirect tax examples like GST, excise duty, VAT, etc. increase the price of the products and services regardless of the income bracket. This makes the tax structure uniform but makes purchasing power unequal for low-income brackets considering the inflated prices.

Impact on Businesses or entities

• Resources Allocation: Taxes also influence how resources are allocated across different sectors of the economy. By adjusting tax rates or introducing base-broadening measures, governments can encourage more efficient resource use, potentially leading to overall economic expansion.
• Economic Growth: The structure of tax changes is critical for long-term economic growth. While tax cuts may initially boost consumption and investment, if not accompanied by spending cuts or revenue-neutral reforms, they could lead to budget deficits that negatively impact national savings and interest rates.

Conclusion:

The different types of taxes in India are broadly classified into direct tax and indirect tax. The direct tax is directly paid to the government through the income earned or capital gains generated. The indirect tax is paid through intermediaries and then processed indirectly to the government through adding top-up value to the price of the goods and services.