In India, individuals earning any type of income are required to pay tax on such income. Similarly, tax is also payable on any type of goods or services transacted between individuals or between businesses. The tax regime of the country provides its Government with sufficient funds to spend on the country’s development. In fact, tax income constitutes the major income for the Government and so, it is levied by both the State and the Central Government of India.
Types of taxes in India
In India, there are two main types of taxes – direct tax and indirect tax.
- Direct tax
Direct tax is one that is levied directly on a taxpayer. It is non-transferable. Income tax is a common example of direct tax which is levied on your income. If you earn an income, you have to pay a tax on it. You cannot transfer your tax liability to someone else
Direct tax in India is administered by the Central Board of Direct Taxes (CBDT) and it is governed by the Department of Revenue.
- Indirect tax
Indirect tax, on the other hand, is not levied on income but on goods and services. It is levied on one taxpayer and paid by the other. For example, GST is levied on the sellers and manufacturers of goods and services. However, you, as a consumer, pay the GST when you purchase such goods and services.
In India, the Central Board of Indirect Taxes and Customs (CBIC) manages indirect taxes and is also governed by the Department of Revenue.
Difference between direct tax and indirect tax
Direct and indirect tax differs from one another. Here are some points how
- Imposition of the tax
- Indirect tax, on the other hand, is levied on goods and services. It has no correlation to your income.
- Imposition of the taxDirect tax is imposed on your income. It, thus, depends on how much income you earn and varies across taxpayers.
- Levying of the tax
- Direct tax is levied on the taxpayer himself. Indirect tax, however, is not directly levied on the consumer. It is levied on goods and services and when the consumer uses such goods and services, the tax is payable.
- Amount of tax
- The amount of direct tax depends on your income. Higher the income higher would be the tax payable and vice-versa.
- Indirect tax is, usually, the same for all consumers, irrespective of their income. The rate might vary depending on the nature of the goods and services.
- Possibility of transfer
- You cannot transfer your direct tax liability to another taxpayer. Indirect tax, however, can be transferred from one taxpayer to another. For example, GST is paid by the business but then it is transferred to the consumer who transacts with the business.
- Evasion of taxes
- It is possible to evade the payment of direct tax if you hide your income or do not disclose it correctly. Indirect tax, however, is impossible to evade.
- Calculation and payment of tax
- Calculation of direct taxes is a bit complex compared to indirect taxes. You need to keep the various income tax provisions in mind to calculate the correct tax liability and file your returns. For corporates, tax filing becomes more challenging given the different rules apply to the determination of income.
- Indirect tax, however, is easy to calculate and pay. The Government has specified a fixed rate of taxes which can be calculated on goods and services easily.
- Time of tax collection
- Direct tax is payable on the income earned in a financial year. There is a due date for the collection of direct taxes.
- There is no specific timeline for the collection of indirect taxes. They are collected when there is a purchase or sale of goods and services.
- Nature of taxation
- Direct tax is a progressive tax. If the income of the taxpayer increases, the tax liability would also increase. Indirect tax, however, is a regressive tax. If the income of the assessee increases, the burden of the tax would reduce.
Comparative analysis of the difference between direct and indirect tax
Now that you have understood the main points of difference between direct tax and indirect tax, here is a comparative table highlighting these differences in brief –
|Points of difference
|Imposed on income
|Imposed on goods and services
|Levied on the taxpayer himself
|Levied on the assessee but paid by the end consumer
|Amount of tax
|Depends on your income
|The rate depends on the type of goods and services but it is the same for everyone
|Cannot be transferred to another taxpayer
|It is transferable
|Is not possible
|Calculation and payment
|Is a bit technical and complex
|Is quick and simple
|The collection is done at a specified date
|The collection is done when a good or service is purchased or sold
|Nature of tax
Major types of direct tax
There are three main types of direct taxes in India. The others have been eliminated through various amendments in the Income Tax Act, 1961. These types of direct taxes are as follows
- Income tax
Income tax is the most common type of direct tax which is levied on your income. It is calculated based on your taxable income and the income tax slabs specified under the Income Tax Act, 1961. For companies, corporate tax is payable on the income earned by the companies.
- Securities Transaction Charge
Securities Transaction Charge (STT) is levied on the security transaction that you do if you trade in stocks. This tax is payable even when you incur a loss on the trade. The broker collects the STT on your trade value and pays it to the stock exchange which, then, pays it to the Government.
- Capital gains tax
Capital gains are a part of your taxable income. If you transfer any capital asset and earn a profit on the same, a capital gains tax would be payable on the profit that you earn. The rate of capital gains tax is not defined in the income tax slabs. The tax rate depends on the type of capital asset transferred and the tenure after which the transfer is done.
Advantages of direct tax
The direct tax has various advantages. These include the following
- Strategizing inflationary trend
Though direct tax does not impact taxation, it can be managed by the Government to check inflationary measures. If the Government feels that there is high inflation, it can increase the tax rates so that the disposable income is reduced and the demand for goods and services is reduced. So, direct tax helps the Government manage the inflationary trend in the country by changing the tax rates.
- Promotes equity
Direct taxes are equitable in nature. They are progressive in nature and increase with an increase in income. Moreover, the surcharge is also applicable on higher incomes, not for lower ones.
- Source of revenue
Direct taxes are the primary source of revenue for the Government. It helps the Government take developmental initiatives for the country and the backward sections of the population.
- Tax saving provisions
There are different types of tax-saving provisions allowed under the Income Tax Act, 1961 that help you lower the tax liability and help in tax saving.
Disadvantages of direct tax
Some of the disadvantages of direct taxes are as follows –
- There is a possibility of tax evasion
- The calculation of taxes is complex and requires the help of professionals in many cases. This increases the cost of tax filing for individuals and corporates alike
- The tax takes away the income of the taxpayer and hinders savings and investment
Types of indirect tax
Like direct tax, there are different types of indirect taxes too though GST has subsumed most of the indirect taxes. So, here’s a look at the different types of indirect taxes –
- Goods and Service Tax (GST)
Launched in 2017, GST unified the indirect tax system in the country. It has removed the cascading effect of taxes and made tax payments simple and easy to calculate. It is imposed on goods and services and so, every business registered in India has to register for GST, unless otherwise excluded.
- Customs duty
This is payable when you buy goods from international countries and import it to India. Customs duty is, therefore, levied on imports and goods brought to India after being bought abroad.
- Value Added Tax (VAT)
Though VAT on various goods was subsumed by GST, it is applicable on some items even today. It is applicable to any value-addition done to goods.
Advantages of indirect tax
The advantages of indirect tax are as follows
- It does not differentiate between the rich and poor. It is payable by all who consume goods or services on which the tax is applicable
- The calculation and determination of the tax liability is pretty simple. It, therefore, becomes easy to pay indirect taxes as and when they accrue. The tax is usually included in the price of the goods and services and makes it easier for the consumer to pay the tax liability without doing complex calculations
- Unlike a direct tax, indirect tax is easy to collect. Moreover, with the online medium, tax filing and collection has become all the simpler
- There is no threat of tax evasion
Disadvantages of indirect tax
- Since it does not differentiate between the rich and the poor, indirect taxes can prove to be challenging for the poor as it takes away a part of their limited incomes. As such, indirect tax is also called a regressive form of tax.
- Indirect tax increases the cost of goods and services making them financially dearer for people with limited resources.
- An increase in indirect taxes can cause inflation in the economy as goods and services become dearer
GST as an indirect tax
As mentioned earlier, GST has unified the indirect tax regime of the country. It has made true the motto ‘One Nation, One Tax’.
Before GST was levied, a tax was charged on the goods or services every time a value addition was done to them. This resulted in paying taxes on the tax already paid. For example, if three stages were involved in the manufacturing of a good, the tax was charged on the value of the good at all three stages. This resulted in increased taxation through the cascading effect.
However, with GST, this cascading was eliminated. Under the GST regime, if GST has been levied on the manufacture at multiple stages, you can claim a credit of the previously paid GST when calculating the final tax liability. This removes the effect of paying taxes on the tax already paid and reduces the tax liability.
As such, GST has been an important addition to the indirect tax system which has revolutionised the whole system altogether.
Benefits of GST
The different benefits of GST are as follows
- It is a unified and comprehensive system of levying indirect taxes
- It has a higher threshold limit of registration for businesses allowing small-sector businesses to avoid GST payments
- The compliance-related norms under GST is lower and easier to understand
- It is easier to calculate the tax liability and make collections
- Even the unorganised sector gets regulated under the GST norms
Disadvantages of GST
Though GST is quite an effective form of indirect tax, it has some disadvantages too. These include the following
- Businesses not complying with GST norms have to suffer from penalties
- GST software is needed for calculating GST liability for large businesses. This increases business expenses
- SMEs can face a higher tax burden
- The poor can face a higher tax burden through GST levied on basic necessities
Ways to save direct tax
Direct tax impacts your disposable income and reduces it. However, the Income Tax Act, 1961 has listed various ways in which you can reduce the burden of direct tax. Some of these ways are as follows –
- Invest in life insurance
Life insurance plans are tax-saving financial protection solutions. The premium invested earns you a tax deduction under Section 80C up to a limit of INR 1.5 lakhs. Similarly, the maturity benefit received is also tax-free under Section 10(10D) if your premiums are limited to 10% of the sum assured. The death benefit is always tax-free making insurance plans EEE in nature.
- Invest in health insurance
Like life insurance, health insurance plans also allow deduction in your taxable income. The premium paid is allowed as a deduction up to INR 25,000 under Section 80D. If you are above 60 years of age, the deduction limit is enhanced to INR 50,000. Furthermore, if you buy a health plan for your parents, you can claim an additional deduction up to INR 25,000 or INR 50,000 depending on your parents’ age.
- Invest in ELSS schemes
ELSS schemes are equity-oriented mutual fund schemes that allow deduction on your investment under Section 80C. These schemes have a lock-in period of 3 years and when you redeem, returns up to INR 1 lakh is allowed as a tax-free benefit.
- Invest in a home
A home financed with a home loan also gives tax benefits. The principal of the loan is allowed as a deduction under Section 80C. The interest paid, on the other hand, is allowed as an exemption under Section 24(b) up to INR 2 lakhs. If you buy your first home and some conditions are fulfilled, you can also claim an additional deduction of up to INR 1.5 lakhs under Section 80EEA.
- Invest in other 80C avenues
Section 80C allows a deduction of up to INR 1.5 lakhs through various avenues like PPF, EPF, Senior Citizen Saving Scheme, Sukanya Samriddhi Yojana, NPS, NSC, etc. So, invest in these avenues to utilise the benefit of Section 80C and save your taxes.
When planning your taxes, understand what is direct and indirect tax and their difference and then file the correct returns.
Yes, there are separate forms for filing direct tax and indirect tax in India. For direct tax, ITR forms are used depending on your income and its sources. For indirect tax, like GST, GSTR forms are used depending on your income and the nature of tax filing.
HUFs are taxed under the direct tax. So, your income would be subject to direct tax in India.
The input tax credit is a term associated with GST taxation. Under input tax credit, if you have paid GST on the product at the time of making value additions to it, the GST on the final product would be reduced by the GST already paid. For example, say you bought a second-hand machine and did repair works on it to sell it. GST was paid for the repair works that you did. Now, when the machine is being sold, the GST on the sales would be reduced by the GST paid on the repair work. This is the concept of input tax credit which removes the cascading effect of taxes.
The minimum threshold limit depends on your age. If you are under 60 years, the threshold limit would be INR 2.5 lakhs. For senior citizens aged between 60 and 79 years, the threshold limit is INR 3 lakhs. For super senior citizens aged 80 years and above, the minimum threshold limit is INR 5 lakhs. If your gross income is within this threshold limit, you would not be required to file an income tax return.
The financial year is the year in which you earn an income and on which income tax is calculated. Each financial year starts on 1st April and ends on 31st March of the following year.