Difference between Direct Tax and Indirect Tax

Difference between Direct Tax and Indirect Tax will help you understand the tax structure in India, how they impact the Indian economy and what are the social impacts they create. In India, whether you are earning or making a purchase of any goods or services, you as an individual or any corporate entity are obliged to pay taxes. Tax is a kind of mandatory recurring fee which is paid to the central and state government. It is also regarded as the main source of revenue for the government which helps them to build the economy of a country.

Studying difference between Direct Tax and Indirect tax will be helpful for UPSC IAS Exam preparation. Mains GS paper-3 Indian Economy.

Table of content

• How many types of taxes are there in India?
• What is Direct Tax?
• Types of Direct Taxes
• What is Indirect Tax?
• Types of Indirect Taxes
• Difference between Direct Tax and Indirect Tax
• Benefits of Direct Tax and Indirect Tax
• Drawbacks of Direct Tax and Indirect Tax
• Frequently Asked Questions (FAQs)
• Conclusion

How many types of taxes are there in India?

• The tax structure in India is a three-tier structure: local municipal bodies, state, and central government.
• Typically, taxation in India is broadly classified into direct tax and indirect tax.

What is Direct Tax?

• Direct tax refers to a tax which the taxpayer must directly pay to any authority which is imposing the said tax.
• The taxpayer must bear the brunt of the tax and cannot transfer such liability to any other entity.
• The Central Board of Direct Taxes (CBDT), in India, has the responsibility of collecting and administering direct taxes.
• The Department of Revenue is the governing body of the CBDT.
• It provides the Indian government with inputs related to direct tax implementation.

Types of Direct Taxes

Income Tax

• This is, perhaps, the most common of all direct taxes which people and other entities pay to the Indian government.
• It is levied on any income that is earned in a financial year.
• The Income Tax Department of India has determined certain tax slabs depending on the income earned, and amounts of tax are paid aligned with this.

Capital Gains Tax

• In case anyone makes capital gains, a tax on those gains/returns is imposed.
• The tax, again, is paid to the Indian government.
• Capital gains can be generated from property (when you sell and make profits) or from any investments like equities.
• Depending on the duration of holding of the investments, capital gains tax is levied as either long-term capital gains (LTCG), or STCG (short-term capital gains).

STT or Securities Transaction Tax

• In case a person is engaged in trading in securities, he has to pay tax known as securities transaction tax, whether you make gains or do not make gains.

What is Indirect Tax?

• Indirect tax is a tax which is levied on products and services.
• It is included in the price of the products or services.
• The taxpayer must pay indirect tax to the Indian government through an intermediary, and so, this tax is referred to as “indirect”.
• The CBIC or the Central Board of Indirect Taxes and Customs collects and administers this tax,
• Indirect taxes are also governed by the Department of Revenue, as is the case with the CBDT.

Types of Indirect Taxes

Goods and Services Tax (GST)

•  This is the most common of all indirect taxes and has successfully replaced other Indian indirect taxes like excise duty, service tax, purchase tax and other taxes.
• Unified and single, the GST is a comprehensive indirect tax imposed on goods and services, based on the tax brackets specified by the GST authorities in India.

Customs Duty

• In case a person buys any goods and services from abroad, a customs duty is levied as a tax.
• Every product or service that enters India from is taxed via the customs duty.

Difference between Direct Tax and Indirect Tax

Incidence of collection

• Direct taxes are usually collected directly by the government through a variety of levies such as personal income tax and corporate tax.
• Indirect taxes are collected by an intermediary, such as a retailer, a service provider, an e-commerce operator etc. and are then passed on to the government.

Source or destination based

• Direct taxes are usually source/origin based, i.e. tax is levied in the country where the income is earned, assets are located, or the subject is a resident.
• Indirect taxes, such as value-added tax (VAT) or goods and services tax (GST), are typically imposed in the country where the goods or services are supplied or ultimately consumed, regardless of their place of origin/production or location of the supplier.

Regressive tax

• Direct taxes tend to be progressive, i.e. those with higher incomes or assets typically pay a higher tax.
• Indirect taxes are often regressive, i.e. those with lower incomes end up paying higher taxes proportionally because indirect taxes such as GST, VAT and sales tax are typically applied at a fixed rate, regardless of the taxpayer’s income level.

Transactional nature

• Direct taxes are income-driven and are only imposed on individuals or entities that meet certain income thresholds or specified criteria.
• Indirect taxes are more transactional, meaning they are imposed at every stage of the supply chain, from production to the final sale of goods or services.

Benefits of Direct Tax and Indirect Tax

Benefits of direct taxes:

Economic stability

• Direct taxes play a crucial role in stabilising the economy by ensuring a steady flow of funds for public expenditure and promoting fiscal discipline.

Revenue generation:

• Direct taxes are a significant source of revenue for the government, which enables funding for public infrastructure, welfare programmes, and development initiatives.

Social and Economic balance:

• There are well-defined tax slabs and exemptions in place, which helps to balance out income inequalities.
• Therefore, individuals with lower income pay lower taxes and vice versa.

Benefits of indirect taxes:

Equal contribution:

• Indirect taxes ensure that every individual pays some amount, however little, to the state.
• It also reaches people in lower-income groups, who are exempted from direct taxes.

Non-evadable:

• These taxes exist within the price of a commodity.
• An individual can only evade an indirect tax if he/she does not consume the taxed item.

Consumption control:

• Indirect taxes can be used as a tool to control consumption patterns by imposing higher taxes on luxury goods and lower taxes on essential commodities.

Drawbacks of Direct Tax and Indirect Tax

Drawbacks of direct taxes

Tax evasion:

• Although stringent laws are in place, individuals use fraudulent practices to evade taxes completely or pay lower amounts than they should.

Burdensome:

• Direct taxes are paid in a single lump sum every year.
• As a result, they are often considered a burden. Additionally, the documentation is extensive and time-consuming, which adds to the inconvenience.

Drawbacks of Indirect tax:

Regressive

• Since indirect taxes are the same for all economic classes, they can be deemed unfair for those with lower incomes.

Inflationary pressure

• Indirect taxes can increase the prices of goods and services, contributing to inflationary pressures in the economy, which can further impact the purchasing power of individuals and households.

 Conclusion:

Both direct and indirect taxes are important for the country as they are intricately linked with the overall economy. As such, collection of these taxes is important for the government as well as the well-being of the country. Both direct taxes and indirect taxes are collected by the central and respective state governments according to the type of tax levied.

Ref:Source-1

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