Direct and Indirect Tax, Indirect Tax Structure in India, Difference Between Direct and Indirect Tax

Direct and Indirect Tax, Indirect Tax Structure in India, Difference Between Direct and Indirect Tax

1. Direct Tax - Meaning, Types & Tax Rates

A type of tax where the impact and the incidence fall under the same category can be defined as a Direct Tax.

The tax is paid directly by the organisation or an individual to the entity that has imposed the payment. The tax must be paid directly to the government and cannot be paid to anyone else.

1.1 Types of Direct Taxes

The various types of direct tax that are imposed in India are mentioned below:

1. Income Tax: Depending on an individual's age and earnings, income tax must be paid. Various tax slabs are determined by the Government of India which determines the amount of Income Tax that must be paid. The taxpayer must file Income Tax Returns (ITR) on a yearly basis. Individuals may receive a refund or might have to pay a tax depending on their ITR. Huge penalties are levied in case individuals do not file ITR.
2. Wealth Tax: The tax must be paid on a yearly basis and depends on the ownership of properties and the market value of the property. In case an individual owns a property, wealth tax must be paid and does not depend on whether the property generates an income or not. Corporate taxpayers, Hindu Undivided Families (HUFs), and individuals must pay wealth tax depending on their residential status. Payment of wealth tax is exempt for assets like gold deposit bonds, stock holdings, house property, commercial property that have been rented for more than 300 days, and if the house property is owned for business and professional use.
3. Estate Tax: It is also called as Inheritance Tax and is paid based on the value of the estate or the money that an individual has left after his/her death.
4. Corporate Tax: Domestic companies, apart from shareholders, will have to pay corporate tax. Foreign corporations who make an income in India will also have to pay corporate tax. Income earned via selling assets, technical service fees, dividends, royalties, or interest that is based in India are taxable. The below-mentioned taxes are also included under Corporate Tax:

• Securities Transaction Tax (STT): The tax must be paid for any income that is earned via security transactions that are taxable.
• Dividend Distribution Tax (DDT): In case any domestic companies declare, distribute, or are paid any amounts as dividends by shareholders, DDT is levied on them. However, DDT is not levied on foreign companies.
• Fringe Benefits Tax: Companies that provide fringe benefits for maids, drivers, etc., Fringe Benefits Tax is levied on them.
• Minimum Alternate Tax (MAT): For zero tax companies that have accounts prepared according to the Companies Act, MAT is levied on them.

1. Capital Gains Tax: It is a form of direct tax that is paid due to the income that is earned from the sale of assets or investments. Investments in farms, bonds, shares, businesses, art, and home come under capital assets. Based on its holding period, tax can be classified into long-term and short-term. Any assets, apart from securities, that are sold within 36 months from the time they were acquired come under short-term gains. Long-term assets are levied if any income is generated from the sale of properties that have been held for a duration of more than 36 months.

1.2 Tax Rate for the Different Types of Direct Tax

A. Income Tax:

Depending on the individual's age and salary, he/she will fall under a particular tax slab. The three different tax slabs are mentioned below:

1. For resident individuals and Hindu Undivided Families (HUFs) who are below the age of 60 years:

Tax slab	Income tax
Up to Rs.2.5 lakh	Nil
From Rs.2,50,001 to Rs.5,00,000	5% of the total income that is more than Rs.2.5 lakh + 4% cess
From Rs.5,00,001 to Rs.10,00,000	20% of the total income that is more than Rs.5 lakh + Rs.12,500 + 4% cess
Income of above Rs.10 lakh	30% of the total income that is more than Rs.10 lakh + Rs.1,12,500 + 4% cess

2. For senior citizens who are above the age of 60 years and below the age of 80 years:

Tax slab	Income tax
Up to Rs.3 lakh	Nil
From Rs.3,00,001 to Rs.5,00,000	5% of the total income that is more than Rs.3 lakh + 4% cess
From Rs.5,00,001 to Rs.10,00,000	20% of the total income that is more than Rs.5 lakh + Rs.10,500 + 4% cess
Income of above Rs.10 lakh	30% of the total income that is more than Rs.10 lakh + Rs.1,10,000 + 4% cess

3. For resident Indians who are above the age of 80 years (Super Senior Citizen):

Tax slab	Income tax
Up to Rs.5 lakh	Nil
From Rs.5,00,001 to Rs.10,00,000	20% of the total income that is more than Rs.5 lakh + 4% cess
Above Rs.10 lakh	30% of the total income that is more than Rs.10 lakh + Rs.1,00,000 + 4% cess

In addition to the existing tax slabs mentioned above, the Finance Minister Nirmala Sitharaman has introduced a new tax regime on 1st February 2020. However, it should be kept in mind that the new income tax regime is optional and is an alternative for the existing income tax regime. The income tax slabs for the FY 2020-21 under the new regime can be summed up as follows:

New Income Tax Slab for Individuals

Income Tax Slab	Tax Rate
Up to Rs.2.5 lakh	Nil
From Rs.2,50,001 to Rs.5,00,000	5% of the total income that is more than Rs.2.5 lakh + 4% cess
From Rs.5,00,001 to Rs.7,50,000	10% of the total income that is more than Rs.5 lakh + 4% cess
From Rs.7,50,001 to Rs.10,00,000	15% of the total income that is more than Rs.7.5 lakh + 4% cess
From Rs.10,00,001 to Rs.12,50,000	20% of the total income that is more than Rs.10 lakh + 4% cess
From Rs.12,50,001 to Rs.15,00,000	25% of the total income that is more than Rs.12.5 lakh + 4% cess
Income above Rs.15,00,001	30% of the total income that is more than Rs.15 lakh + 4% cess

Note: The income tax rates mentioned above are optional.

B. Corporate Tax:

The tax rates for domestic and international companies are mentioned below:

Domestic companies:

• In case the turnover of the company is less than Rs.250 crore, the corporate tax that is levied is 25%. However, if the turnover of the company is more Rs.250 crore, the corporate tax that is levied is 30%.
• A surcharge of 10% of the taxable income is levied in case the taxable income is between Rs.1 crore and Rs.10 crore.
• In case the taxable income of the company is more than Rs.10 crore, the surcharge that is levied is 12%.
• 4% of the corporate tax is levied as cess.

International companies:

• In case companies are earning less than Rs.1 crore, a corporate tax of 41.2% is levied. The corporate tax includes 40% basic tax and 3% education cess.
• In case companies are earning more than Rs.1 crore, a corporate tax of 42.024% is levied. The corporate tax includes 40% basic tax, 2% surcharge, and 3% education cess.
• In case companies earn more than Rs.10 crore, a surcharge of 5% is levied apart from the basic tax. 

C. Capital Gains Tax

• According to the normal tax slabs, short-term capital gains is levied.
• In case Capital Gains Tax is computed considering indexation benefit, the long-term capital gains that are levied are taxed as 20%.
• In case Capital Gains Tax is computed without considering indexation benefit, the long-term capital gains that are levied are taxed at 10%

D. Wealth Tax

• Depending on the net wealth, Wealth Tax is levied. Net wealth can be calculated by the sum of all taxable assets minus the total debt that is owed.
• The formula for net wealth is, Net Wealth = (Sum of all assets) - (sum of all debt).
• The value of net wealth is considered on March 31 of every year that immediately precedes the assessment year.
• However, with effect from 1 April 2016, for wealth that was being held as of 31 March 2016, Wealth Tax has been abolished.

E. Direct Tax Code

The Direct Tax Code or DTC was mainly drafted to replace the Income Tax Act of 1961. The main aim of DTC is to establish a more equitable, effective, and efficient direct tax system. DTC was also drafted to amend and stabilise all laws that are related to direct taxes so that the tax-GDP ratio increases and voluntary compliance becomes easy.

Explanation of the Direct Tax Codes

The key features of the Direct Tax Code are explained below:

• All direct taxes have a single code: By bringing all direct taxes under one code, a single, unified taxpayer system can be brought into effect. All compliance features can also be unified under one code.
• Stability: Currently, based on the Finance Act of the relevant year, taxes are formed. However, under the Direct Tax Code, the tax rates are being made between the First and Fourth schedule of the DTC. Any changes to the schedule can be made by passing an Amendment Bill before the Parliament.
• Regulatory Functions are eliminated: Other regulatory authorities must handle all regulatory functions.
• Political contributions: 5% of the gross total income that can be deducted will be made towards political contributions.
• Flexibility: A law has been created so that changes and requirement to grow the economy can be accommodated without having to make amendments on a constant basis.
• Constant litigation problems have been eliminated: Special care has been put forth so that the code is not misused or misinterpreted in order to avoid contradiction and ambiguity.
• Fringe benefits tax: The tax is levied on employees rather than employers.

1.3 Advantages of Direct Taxes

The main advantages of Direct Taxes in India are mentioned below:

• Economic and Social balance: The Government of India has launched well-balanced tax slabs depending on an individual's earnings and age. The tax slabs are also determined based on the economic situation of the country. Exemptions are also put in place so that all income inequalities are balanced out.
• Productivity: As there is a growth in the number of people who work and community, the returns from direct taxes also increases. Therefore, direct taxes are considered to be very productive.
• Inflation is curbed: Tax is increased by the government during inflation. The increase in taxes reduces the necessity for goods and services, which leads to inflation to compress.
• Certainty: Due to the presence of direct taxes, there is a sense of certainty from the government and the taxpayer. The amount that must be paid and the amount that must be collected is known by the taxpayer and the government, respectively.
• Distribution of wealth is equal: Higher taxes are charged by the government to the individuals or organisations that can afford them. This extra money is used to help the poor and lower societies in India.

Even though there are a few disadvantages, direct taxes play a very important role in India's economy. If these taxes are brought into effect appropriately, they could play a huge role in sustaining price levels and to prevent inflation.

2. Indirect Tax

Indirect tax is something that a manufacturer pays to the Government of his country. The burden of tax payment is on the end consumer as they are the ones purchasing the products. Unlike direct taxes, these are levied on materialistic goods.

2.1 What is Indirect Tax?

The tax imposed on the use of products and services is known as an indirect tax. It is not imposed directly on an individual's income. Rather, in addition to the cost of the products or services the seller purchased, they must also pay the tax. A single party in the supply chain, like a manufacturer or retailer, collects and pays the government an indirect tax.

However, the manufacturer or retailer includes the tax on the price that the customer must pay when purchasing a good or service. In the end, the tax is paid by the customer by increasing the cost of the product.

Examples of an Indirect Tax

Excise Duty, Customs Duty, Entertainment Tax, Service Tax, Sales Tax, Gross Receipts Tax  and Value-Added Tax (VAT) are examples of Indirect taxes.

An example of GST (Indirect tax): Explanation

Let's say you eat at a restaurant. You could see your entire payment plus the GST on the bill (Indirect tax). The GST rate is 5%, so let's say the total was Rs.2500. Then, you will be required to pay Rs.2625(2500+125). The service provider passes on the indirect tax to you in the amount of Rs.125.

2.2 Overview of Indirect Tax in India

There are many indirect taxes applied by the government of India. Taxes are levied on manufacture, sale, import and even purchases of goods and services. These laws aren't also well-defined Acts from the government, rather orders, circulars and notifications are given out by relevant government bodies to this end. As such, it can be cumbersome trying to understand every feature of indirect taxes in India.

Indirect taxes are touted to be streamlined following the introduction of the uniform Goods and Services Tax (GST). The points below will help you understand more about the types of indirect taxes and where they are applicable from a consumer's perspective.

2.3 Different Types of Indirect Taxes

There are different types of indirect tax in India. However, after the implementation of GST, all these indirect taxes were bundled into one singular tax for the citizens of India. We will have a look at the different types of indirect tax in India:

1. Service tax: This tax is levied by an entity in return for the service provided by them. The service tax is collected by the Government of India and deposited with them.
2. Excise duty: When any product or good is manufactured by a company in India, then the tax levied on those goods is called the Excise Duty. The manufacturing company pays the tax on the goods and in turn recover the amount from their customers.
3. Value Added Tax: Also known as VAT, this type of tax is levied on any product sold directly to customer and are movable. VAT consists of Central Sales Tax which is paid to the Government of India State Central Sales Tax which is paid to the respective State Government.
4. Custom Duty: This a tax levied on the goods imported to India. Sometimes, Custome Duty is also levied on products which are exported out of India.
5. Stamp Duty: This is a tax levied on the transfer of any immovable property in a state of India. The state government in whose state the property is located charges this type of tax. Stamp tax is also applicable on all legal documents too.
6. Entertainment Tax: This tax is charged by the state government and is applicable on any products or transactions related to entertainment. Purchasing of any video games, movie shows, sports activities, arcades, amusement parks, etc. are some of the products on which Entertainment Tax is charged.
7. Securities Transaction Tax: This tax is levied during the trading of securities through Indian Stock Exchange.

2.4 Features of Indirect Tax

Here are the key features of indirect taxes:

1. Tax liability: The service provider or seller pays indirect taxes to the government, and the liability is transferred to the consumer.
2. Payment of tax: The seller pays indirect taxes to the government and the same is transferred to the consumer.
3. Nature: Indirect taxes were initially regressive in nature, but thanks to the implementation of the Goods and Services Tax, they are now pretty progressive.
4. Saving and investment: Indirect taxes are generally growth-oriented considering the fact that they encourage consumers to save and invest.
5. Evasion: It is difficult to evade indirect taxes because they are now implemented directly through products and services.

2.5 Advantages of Indirect Tax

Here are the main advantages of indirect taxes

1. Convenience: Indirect taxes do not burden the taxpayer and are convenient as they are paid only at the time of making a purchase. Moreover, state authorities find it convenient to levy indirect taxes because they are collected directly at the stores/factories which helps in saving a lot of time and effort.
2. Ease of collection: Indirect taxes are easy to collect in comparison with direct taxes. Since indirect taxes are only collected at the time of making purchases, the authorities need not worry about their collection.
3. Collection from the poor: Those who earn less than Rs.2.5 lakh p.a. are exempt from income tax, which means that they do not contribute to the government. Since indirect taxes are charged at the point of sale, all individuals, regardless of the income tax slab under which they fall, contribute towards the growth of the economy.
4. Equitable contributions: Indirect taxes are directly related to the costs of products and services. What this essentially means that the basic necessities attract lower rates of tax while luxury items are charged at higher tax rates, thereby ensuring that contributions are equitable.
5. Reduce Negative Consumption: The highest indirect taxes are placed on goods that are bad for our health, like alcohol, tobacco and other similar products. Thus, they are more expensive which helps curb the spending and consumption of such harmful commodities. 

2.6 Disadvantages of Indirect Tax

Some of the disadvantages of Indirect Tax are given below:

1. Indirect Tax charged sometimes are cumulative. This means that in a point-based transaction system, middlemen involved are likely to charge their own service tax which may result in the overall price of the product increasing.
2. Indirect Tax can be regressive in nature. For example, salt tax remains the same for both poor and rich, However, if a rich person defaults the payment, then the penalties imposed will be higher as well.
3. Indirect Tax are not industry friendly. Taxes are levied on raw materials and goods which in turn increases the cost of production, thus not allowing industries to expand as their competitive capacity is restricted.
4. Indirect Tax is unpredictable: The amount of indirect taxes collected fluctuates. It is based on the buying of goods and services. As a result, it is impossible for the government to predict how much money will be raised through indirect taxes. 

3. Difference Between Direct and Indirect Tax

The fundamental categorisation of taxes is premised upon who collects the taxes from taxpayers. An overview of direct tax and indirect tax difference is given below –

Context of Differentiation Between Direct Tax vs Indirect Tax	Direct Tax	Indirect Tax
Imposition of tax	It is levied on the income or profit of a taxpayer.	An indirect tax is levied on goods and services rather than on income or profits.
Course of payment	Taxpayers pay it directly to the government.	Taxpayers pay it to the government through an intermediary.
Paying entity	Individuals and businesses	End-consumers
Rate of tax payment	Based on income and profits	Same for all taxpayers
Transferability of payment	Cannot be transferred.	Transferable
Nature of tax	Progressive tax, i.e., its rate increases with taxpayer’s income.	Regressive tax, i.e., its rate decreases with increase in income.
Types of tax	Income tax, wealth tax, corporate tax, etc.	Sales tax, service tax, value added tax, etc.
Tax Collection	Collecting this type of tax is difficult.	Tax collection is relatively easier.