Difference Between Direct and Indirect Tax

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Introduction

The government levies taxes on citizens and businesses of the country to generate income for its functioning. The Indian tax system which is drawn from the constitution of India encompasses various direct and indirect taxes. As a responsible citizen, it is important to have clarity on the difference between direct and indirect tax, how they are implemented and how it affects you.

What is Direct Tax?

As the term implies, direct tax is a form of tax that is paid by individuals or businesses to the government. Direct taxation is based on the ability to pay, which means higher taxes are to be paid by those with more resources and higher incomes. For example, an individual earning ₹10 lakh per year falls into a higher tax slab and pays more income tax compared to someone earning ₹3 lakh per year. This taxation helps in the circulation of wealth within the nation.

What is the Direct Tax Code 2025?

The Direct Tax Code of 2025 is set to replace the Income Tax Act of 1961, this code aims to simplify tax laws and modernize the system to make it more efficient and accessible to taxpayers. Some of the main highlights of this tax code is revised tax slabs that offer significant relief to middle-income earners, enhanced digital compliance to reduce paperwork, and lower corporate tax rates for SMEs to stimulate business growth. Additionally, the code aligns with global standards to curb tax evasion and double taxation. Overall, the Direct Tax Code 2025 aspires to create a fairer, more transparent taxation process that benefits all stakeholders.

Different Types of Direct tax

Direct taxes are those levied directly on an individual’s or organization’s income or wealth, and they are paid straight to the government. Here are some prominent examples:

1. Income Tax: One of the most well-known direct taxes. It is imposed on an individual’s or entity’s earnings, including wages, salaries, and business profits. The tax rate typically varies based on income levels. This tax helps fund public services like healthcare and education.
2. Property Tax: This tax is levied on real estate properties, including land and buildings. Property taxes are usually assessed by local governments and are used to fund public services such as schools, police, and fire departments.
3. Capital Gains Tax: This tax is charged on the profit realized from the sale of assets like stocks, bonds, or real estate. The tax is calculated based on the difference between the purchase price and the selling price of the asset.
4. Estate Tax: Also known as inheritance tax, this is levied on the total value of a deceased person’s estate before distribution to the heirs. It is designed to tax the transfer of wealth from one generation to the next.
5. Gift Tax: TThis tax is imposed on the transfer of property or money from one individual to another to another without receiving anything of equal value in return. It ensures that large gifts are taxed to prevent tax evasion through asset transfers.
6. Corporate Tax: This is a tax on the profits of corporations. The rate and regulations can vary significantly between countries, but it generally aims to ensure that businesses contribute to the national revenue.
7. Securities Transaction Tax (STT): A direct levy on buying and selling of securities like stocks, mutual funds, options, futures. For example, when buying and selling stocks, you’d pay and additional fee in STT.

These direct taxes are important for generating government revenue and ensuring the equitable distribution of the tax burden based on individuals’ and entities’ ability to pay.

What is Indirect Tax?

Indirect tax is charged by the government on the consumption of goods and services. As the term implies, the tax can be shifted from one tax-paying individual to another. For example, when you buy a restaurant meal, the bill includes GST, which the restaurant collects from you and later remits to the government. Generally, these taxes are included in the price of goods and services, often making them less visible unless specified on bills or through tax invoices.

Different Types of Indirect Tax

To understand how indirect tax is levied, read on to understand about the types of Indirect Tax:

• Goods and Services Tax (GST): It is a broad-based tax levied on the supply of goods and services. It’s a value-added tax, meaning it’s applied at each point of sale where value is added to the product or service. GST has replaced several indirect taxes in many countries, aiming for a simpler, more transparent and efficient tax system. GST is divided in four different types which are CGST (Central GST), SGST (State GST),IGST (Integrated GST) and UTGST (Union Territory GST).
• Customs Duty: This in an import tax imposed on goods entering the country, influencing the both the cost and price of imported products. For example, if you purchase something from a foreign country that costs $50 and the custom duty on it is around 10%, it will cost you $55 in total.
• Stamp Duty: This tax is levied on the execution of certain legal documents, particularly those involving property or financial agreements. For example, when purchasing a property, you will also have to pay for stamp duty during the documentation process based on the property value and state.

These indirect taxes play a crucial role in generating revenue for the government while influencing the cost of goods, services, and financial transactions. Understanding them helps businesses and individuals make informed financial decisions. Secure your future with strategic tax planning and a premium savings account that helps you manage your wealth efficiently.

Major Difference Between Direct Taxation and Indirect Taxation

Below is a table outlining the key differences between direct and indirect taxation:

Understanding these distinctions is crucial for comprehending how different taxation methods affect individuals, businesses, and the economy as a whole.

Advantages and Disadvantages of Direct Taxes

Direct taxes play a crucial role in shaping economic policies by directly impacting individuals and businesses based on their earnings and wealth. Here’s a look at their key benefits and drawbacks.

Advantages:

• Fair Taxation: Higher earners pay more, reducing the tax burden on lower-income individuals.
• No Hidden Charges: Consumers know exactly how much they are taxed.
• Encourages Savings: No direct tax on essential spending allows consumers to manage expenses effectively.

Disadvantages:

• Lower Disposable Income: Direct taxes reduce take-home earnings, affecting purchasing power.
• Complex Filing Process: Consumers must navigate tax returns, which can be time-consuming.
• Potential for Higher Burden: Tax increases directly impact personal finances without an immediate way to offset costs.

Advantages and Disadvantages of Indirect Tax

Indirect taxes affect consumers through the prices of goods and services, making them an essential source of government revenue. Below are their major pros and cons.

Advantages:

• Convenient Payment: Tax is included in product prices, eliminating the need for separate tax filings.
• courages Less Consumption of Luxury Goods: Higher taxes on non-essential items can promote responsible spending.
• Distributed Burden: Everyone contributes to taxation, rather than only income earners.

Disadvantages:

• Regressive Impact: Low-income individuals spend a larger share of their income on taxed goods, making the tax system less equitable.
• Hidden Costs: Consumers may not realize how much they are paying in taxes as it is embedded in product prices.
• Increases Living Costs: Higher indirect taxes raise the prices of goods and services, affecting affordability.

Conclusion

Understanding direct and indirect taxes is crucial for both individuals and businesses, as they significantly influence financial planning and expenses. While direct taxation and indirect taxation serve as key revenue sources for the government, their implementation and effects vary significantly.

Both have advantages and disadvantages, influencing economic behaviour, savings, and consumption patterns. By recognizing the difference between direct and indirect tax, taxpayers can make informed decisions and manage their tax liabilities efficiently.

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*Disclaimer: This article is for information purposes only. We recommend you get in touch with your income tax advisor or CA for expert advice.em>

1. Frequently Asked Questions

2. Is VAT a direct or indirect tax?

   Value Added Tax (VAT) is an indirect tax levied on the sale of goods and services at each stage of production and distribution. It is included in the final price paid by the consumer, making it a part of direct vs. indirect tax discussions.

3. Is GST a direct or indirect tax?

   Goods and Services Tax (GST) is an indirect tax that replaces multiple taxes, including VAT, excise duty, and service tax. Since GST is collected by businesses and passed on to the government, it is a key example in understanding the difference between direct and indirect tax.

4. Is excise duty a direct tax?

   No, excise duty is an indirect tax imposed on the manufacture of goods within a country. It is paid by the manufacturer but ultimately passed on to consumers in the price of goods, aligning with direct taxation and indirect taxation principles.

5. Does an NRI have to pay tax in India?

   Yes, Non-Resident Indians (NRIs) are required to pay tax in India on income earned or received in the country. Understanding what direct and indirect taxes are helps NRIs determine their tax liabilities under different income categories.

6. What is the full form of VAT?

   The full form of VAT is Value Added Tax. It falls under the types of indirect tax and is charged at various points in the supply chain before reaching the final consumer.

7. Is TDS a direct tax?

   Yes, Tax Deducted at Source (TDS) is a direct tax deducted from an individual’s income before it is credited to their account. It is an example of direct tax and indirect tax differences, as it directly affects earnings rather than consumption.

8. What is the tax rate for NRIs in India?

   The tax rate for NRIs in India depends on their income and the applicable tax slab. Income earned in India, such as rent, salary, or capital gains, is taxed as per direct taxation and indirect taxation laws.

9. What types of income are taxable for NRIs in India?

   NRIs are taxed on income earned in India, including salary received in India, rental income from property, capital gains from asset sales, and interest from Indian bank accounts. These factors are important when comparing direct and indirect tax examples for NRIs.

10. What are the TDS rates for NRIs?

    TDS rates for NRIs vary based on income type. For instance, capital gains on property sales have different rates based on holding periods. Understanding the difference between direct and indirect tax helps NRIs manage their tax liabilities effectively.

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