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Direct and Indirect Taxes in India

Last Update Date : August 11, 2018

Difference between Direct and Indirect Tax

Direct and indirect taxes are levied by the central and state government. Tax is an involuntary fee imposed and collected by the government to pay for the goods and services it provides including schools, infrastructure, law enforcement and military production. The tax comes into picture where there is a sale of product or service, ownership of assets or where profits are earned. The amount of tax paid by an entity or an individual depends fairly upon its earnings and spending.

Types of Taxes in India

Taxes are broadly classified into two categories: Direct and Indirect Taxes

What is Direct Tax?

Direct taxes are directly imposed on the tax payer. They depend on the income and wealth of an individual or entity.

What is Indirect Tax?

The indirect taxes are included in the prices of the commodities purchased and the services rendered. Indirect taxes are applied to the manufacture or sale of goods and services. Both direct and indirect taxes are eventually collected by the government.

Direct and Indirect Tax Collection in India

The collection of taxes depends on the nature of taxes. Direct taxes which include the income tax, wealth tax and corporation tax are levied and collected by the central government. The Department of Income Tax is responsible for monitoring the payments of income tax. Therefore, when the liability to pay the tax and the burden of the tax falls on the same person, it is called a direct tax. Individuals pay indirect taxes when they purchase goods or use services. Indirect taxes are collected by intermediaries from the person who bears the ultimate economic burden of the tax.

Progressive and Regressive Nature of Direct Indirect Taxes

Progressive tax liability increases as the income of the individual or entity increases. Progressive taxation depends on the ‘ability to pay’ of the payer. Under this system, higher the income higher is the tax liability whereas the lowest income group people are exempted from paying taxes. Direct taxes are progressive in nature. Regressive taxation does not consider the ability to pay. It levies the same liability on people belonging to different income groups. VAT and Service Taxes were of regressive nature. Now GST has come into the picture and is of a progressive nature.

Types of Direct Taxes in India

Direct taxes cover the following:

  • Income Tax: It is charged by the central government on the income of individuals and organisations. Slabs of income tax have been formulated depending on the different income groups.
  • Corporation Tax: It is a flat rate charged on the domestic corporates for the profits earned for a particular period.

Advantages of Direct Taxes

  • The lower income group carries a lower burden of tax
  • Self-payment of direct taxes makes one socially aware and responsible
  • The distribution of wealth is equal under direct taxation
  • Direct tax rates can be used as an anti-inflationary tool

Disadvantages of Direct Taxes

  • Direct taxes might discourage savings and investments
  • The biggest disadvantage being it leads to tax evasion
  • It might be inconvenient to pay direct taxes as the procedure is complicated

Types of Indirect Taxes in India

Indirect taxes cover the following

  • Goods and Services Tax: The GST law which was implemented on 1st July 2017 has subsumed 17 indirect taxes.
    • At the state level, it covers central excise duty, additional excise duty, service tax, countervailing duty and special additional duties of custom.
    • At the central level, it covers sales tax, entertainment tax, central sales tax, octroi and entry tax, purchase tax, luxury tax, taxes on lottery gambling and betting.
  • Taxes on products not covered under GST: Taxes on item containing alcohol and taxes on petroleum products.

Difference between Direct and Indirect Taxes

Direct and Indirect taxes differ on various parameters

Nature Direct Tax Indirect Tax
Payment and Bearing of Taxes The payment of direct taxes is to be made by the tax payer himself and borne by him only. The seller or the service provider has to make the payment of indirect taxes and the same is transferred to the ultimate consumer
Tax Liability The amount of tax liability in direct taxes depends on the income group of the individuals Indirect taxes are levied equally on the tax payers irrespective of their income
Nature of Taxes As the taxes are directly related to the tax payers’ income, it is progressive in nature Earlier the indirect taxes were regressive in nature, but now with the implementation of GST, it has become progressive in nature too.
Tax Evasion Due to the lack of administration, tax evasion is possible under direct taxes As the tax is levied on the goods and services, the indirect tax cannot be evaded
Savings and Investments Direct taxes can reduce savings and investments as a portion of an individual’s income is to be given to the government Indirect taxes are more growth-oriented as they discourage consumptions and enhance savings.

 

Coverage of Society Direct taxes only cover those falling in respective tax brackets Indirect taxes have a wider coverage as they are charged to every individual who buys a product or service

Role of Tax Rates in Controlling Money Supply in the Market

Taxes take away the spending capacity of corporations and individuals leaving investors with less money to save and invest, and more money in the hands of the government. Taxing a product or service, thus making it expensive will lead to decrease in consumption and eventually decrease in inflation. Thus, reducing the tax rates will relatively empower the individuals to use their capacity. However, taxes are relatively inflexible and are relatively used to control inflation.

The latest tax reforms in Indian economy are taking a progressive turn. With the introduction of GST Bill and other amendments in the income tax slab, the government is attempting to liberalise the tax system to give broader paths to the global market. Such reforms have also been undertaken to close loopholes which may be used to carry out tax evasion and other such activities.

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