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What is the Difference between Direct and Indirect Tax? Benefits and Disadvantages

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Difference between Direct and Indirect Tax

The difference between direct tax and indirect tax is that direct tax is imposed on a taxpayer’s earnings or profits, whereas, instead of being imposed on earnings or profits, an indirect tax is imposed on products and services.

One of the main ways the government makes money is through taxes. You pay taxes in a variety of ways for a wide range of activities, including driving your car on public highways, eating out, watching films at the multiplex and even just buying a packet of biscuits from a local store.

It is your duty, as a responsible citizen of this nation, to pay your taxes. However, understanding the various tax regimes in place in the nation is also crucial. Direct and indirect taxes are the two main categories into which all other taxes in India can be roughly divided. Let’s examine these two categories of taxes in more depth.

What is Direct Tax?

An individual pays direct tax to the government directly. The taxpayer cannot assign this obligation to a different organisation or individual. In India, direct taxes are managed by the Central Board of Direct Taxes (CBDT), which is under the Department of Revenue’s jurisdiction. Additionally, CBDT helps with the planning stages of direct tax implementation. 

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Types of Direct Taxes

Income tax: It is a tax levied on the earnings of individuals, businesses, firms, Hindu undivided families (HUFs), and other entities. The income tax rates and slabs are set by the government and are subject to change at any time.

Corporate tax: Both domestic and foreign businesses that are registered in India are subject to this tax. The kind and scale of the business determine the different rates.

Capital-gains tax: Taxes on earnings received from the sale of capital assets, such as stocks, real estate, or precious personal belongings, are known as capital-gains taxes. The length of time an asset has been owned and the relevant tax regulations determine the capital gains tax rate.

Wealth tax: India no longer imposes wealth taxes. Nonetheless, it was imposed on people, HUFs, and businesses based on the value of their designated assets prior to its repeal.

What is Indirect Tax?

The Indian government imposes indirect taxes on products and services. Prior to being paid directly to the government, these taxes are first paid to the intermediaries. They are called indirect taxes as a result. In India, indirect taxes are managed and collected by the Central Board of Indirect Taxes and Customs (CBIC). Similar to CBDT, the Department of Revenue governs CBIC.

Types of Indirect Taxes

Goods and Services Tax (GST): The Goods and Services Tax, or GST, is a comprehensive indirect tax that takes the place of several other indirect taxes, including service tax, central excise duty, and VAT. It is imposed on the nation’s supply of goods and services. The rates of GST vary according to the kind of goods or services.

Customs Duty: When importing or exporting products, there is a customs duty. It consists of three types of customs duties: special additional duty, countervailing duty, and additional customs duty. The kind of goods and the country of origin affect the customs duty rates.

Excise duty: It is a tax imposed on the production or manufacturing of goods within the nation. It is mostly applied to products such as alcohol, cigarettes, petroleum products, and some upscale goods.

Service tax: Following its implementation, service tax was included in the GST. It was imposed on some services provided by Indian service providers.

Securities transaction tax (STT): The tax known as the securities transaction tax (STT) is imposed on buying or selling securities, including stocks, futures, and options. It is paid by the securities’ seller or buyer.

Stamp duty: It is a levy that is applied to a number of legal documents, including agreements, leases, share transfers, and transactions involving real estate. The prices range throughout India’s states.

Entertainment tax: Tickets for films, theme parks and cultural events were subject to an entertainment tax imposed by state governments. But when GST was introduced, entertainment tax was included in it.

Difference between Direct Tax and Indirect Tax

To make you explain better, the difference between direct and indirect tax is mentioned below in tabular form:

ParameterDirect tax
Indirect tax
Tax ImpositionThis tax directly affects the taxpayer’s income.
This tax is levied on taxpayers for the goods availed of or purchased.
Payment course Directly paid to the government
Indirectly paid to the government
Paying Entity Indivisuals and businesses pay this
type of tax
End-customers pay this type of tax
Rate of PaymentThe rate of tax is decided by the government based on profit and
income
Same tax rates are applied for everyone
Transferability of taxNon-transferrable tax
Transferrable tax
Nature of TaxProgressive type of tax
Regressive type of tax
Types of taxIncome tax, wealth tax, corporate tax, etc.
Sales tax, service tax, value added tax, etc.
Tax CollectionDifficulty in collecting this tax is highIt is way easier to collect this tax

Benefits of Direct Taxes

Progressive taxation: Like income tax, direct taxes contribute to a system of progressive taxation, in which those with higher incomes give the government a bigger portion of their earnings.

Income generation: The government receives a large portion of its money from direct taxes, which helps to support development projects, welfare programmes, and public infrastructure.

Redistribution of wealth: By shifting wealth from higher-income to lower-income segments of society, direct taxes contribute to the reduction of income disparities.

Economic stability: By guaranteeing a constant flow of money for public spending and encouraging budgetary restraint, direct taxes are essential for maintaining economic stability.

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Benefits of Indirect Taxes

Broad revenue generation: Indirect taxes, such as the commodities and services tax (GST), aid in raising money for the government by generating revenue from a variety of commodities and services.

Simpleness and ease of collection: Since indirect taxes are frequently included in the cost of goods or services, the collection procedure is made more effective and so indirect taxes are easier to collect overall.

Control of consumption: By placing higher taxes on luxuries and lower levies on necessities, indirect taxes can be used to manage patterns of consumption.

Encourage formalisation: By enforcing tax compliance, fostering transparency, and narrowing the window for tax evasion, indirect taxes encourage companies to formalise their operations.

Disadvantages of Direct Tax

  • The reliability of direct tax collection is compromised by fraudulent activities and tax evasion.
  • Since direct taxes must be paid annually in one single amount and require substantial and time-consuming documentation, they are frequently seen as harsh.

Disadvantages of Indirect Tax

  • Because indirect taxes are the same for all economic classes, people with lower earnings may feel that they are unjust.
  • Consumers must pay a higher price for goods and services due to indirect taxes.
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FAQs

How do I identify between direct and indirect taxes?

Direct taxes are levied against an individual’s income or business profits and are paid directly to the government. On the other hand, when people buy products and services, they pay indirect taxes to the government.

Is GST a direct or indirect tax?

GST is an indirect tax that is used to pay for goods and services availed.

Who is liable to pay direct tax?

Direct taxes are levied on both people and corporations in accordance with the Income Tax Act. Individuals who are subject to direct taxes are required to pay them. For instance, property taxes, asset taxes, income taxes, etc.

This was all about the “Difference between Direct and Indirect Tax”.  For more such informative blogs, check out our Study Material Section, you can learn more about us by visiting our  Indian exams page.

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