As important as taxes are to our daily lives, many of us find it challenging to understand the various tax concept and systems in India. Taxes are levies imposed by the government on individuals and businesses to fund public services and projects. The revenue collected through taxes is used to finance education, healthcare, social security, infrastructure, defence, and other government initiatives. In this article, we will take a deep dive into the concept of taxes, different types of tax planning, basic direct and indirect tax concept, recent tax reforms, and other related aspects.
What is the tax concept and its types?
The term 'tax' refers to a compulsory financial contribution or levy imposed by a government or public authority on individuals, businesses, and other organisations within its jurisdiction. Taxes come in different forms, including direct tax, indirect tax, income tax, corporate tax, wealth tax, and others. Direct taxes are levied on individuals' income or wealth, while indirect taxes are charged on goods and services provided by individuals or businesses. Other taxes, such as capital gains tax, inheritance tax, and gift tax, are specific to transactions.
Different types of tax concepts
Tax planning involves organising an individual's finances in such a manner that it attracts fewer taxes. Tax planning involves legal minimising of tax liabilities. With the help of tax planning, an individual can make strategic investment or business decisions that save taxes.
Basic concepts of direct tax
Direct taxes are levied on individuals or entities based on their income, wealth, and other assets. The Income Tax Act, 1961, governs direct taxation in India and imposes various tax rates based on income ranges. The Income Tax Act provides that the taxable income of individuals must be calculated for every year, and tax-exempted income must be considered before calculating the tax. Individuals can also make use of tax deductions and tax credits provided by the Income Tax Act to minimise their tax liability.
Basic concepts of indirect tax
Indirect taxes are levied on goods and services at the point of consumption. These taxes are not directly paid by individuals or businesses, but the burden is passed on to consumers through the pricing of goods and services. Some common examples of indirect taxes include goods and services tax (GST), value added tax (VAT), customs duty, excise duty, and others.
Direct tax vs. indirect tax
Criteria |
Direct Tax |
Indirect Tax |
Definition |
Tax directly levied on individuals or companies by the government. |
Tax levied on goods and services rather than on income or profits. |
Nature |
Progressive (based on ability to pay). |
Regressive (same rate for everyone). |
Basis of Taxation |
Income, profits, and capital gains. |
Consumption, sales, and services. |
Collection |
Collected directly from taxpayers. |
Collected from consumers by intermediaries (e.g., businesses). |
Example |
Income Tax, Corporate Tax. |
GST, Customs Duty, Excise Duty. |
Impact |
Directly affects the disposable income of individuals and profits of businesses. |
Indirectly affects the prices of goods and services, impacting consumers. |
Ease of Collection |
Generally more challenging due to the need to assess and verify income sources. |
Generally easier due to point-of-sale collection mechanisms. |
Equity |
More equitable as it's based on ability to pay. |
May be less equitable as it affects everyone, regardless of income level. |
Recent reforms in taxes
The Indian government has made several significant changes in tax laws recently. One of the reforms is the introduction of the direct tax Vivad se Vishwas Act, 2020, which aims to provide tax relief and a quick dispute resolution process for taxpayers. Another significant change is the reduction in corporate tax rates for businesses, which has helped to boost investment and stimulate economic growth. Additionally, the government has implemented several measures to simplify compliance procedures and reduce the tax burden on taxpayers.
How to do tax planning?
- Understand tax slabs: Familiarize yourself with the income tax slabs and rates applicable for the financial year.
- Invest in tax-saving instruments: Utilise investments like ELSS, PPF, NSC, and tax-saving FDs to avail deductions under Section 80C.
- Health insurance: Invest in health insurance to claim deductions under Section 80D.
- Home loan interest: Benefit from deductions on home loan interest payments under Section 24.
- Education loan: Avail deductions on education loan interest payments under Section 80E.
- HRA exemption: If you receive HRA, claim exemption as per HRA rules.
- Gifts and donations: Deduct contributions made to eligible charities under Section 80G.
- Professional tax: Deduct professional tax paid from your taxable income.
- Consult a tax advisor: Seek advice from a tax consultant to maximize savings and compliance.
What is income tax?
Income tax is a type of direct tax levied on individuals based on their income. An individual's taxable income is calculated by subtracting their tax-exempted income, deductions, and exemptions from their total income. The Income Tax Act sets different tax rates for different income ranges. Higher rates of tax are imposed on individuals with higher incomes. It is a crucial tool for revenue collection that funds public services and national development.
Income tax deductions
The Income Tax Act allows individuals to claim deductions to reduce their taxable income, thereby lowering their overall tax liability. Some key deductions include:
- Section 80C: Investments in Public Provident Fund (PPF), Employee Provident Fund (EPF), Life Insurance Premiums, and other approved avenues (up to Rs. 1.5 lakh).
- Section 80D: Health insurance premiums for self, family, or parents (up to Rs. 25,000, with an additional Rs. 25,000 for parents).
- Section 24(b): Interest paid on home loans (up to Rs. 2 lakh for self-occupied property).
- Section 80G: Donations made to charitable organisations and relief funds.
Tax deducted at source
Tax deducted at source (TDS) is an indirect tax method, where a business employer or an individual must deduct and remit the tax before making payments such as salary, interest, rent, commission, and other income payments. It is applicable to professionals, contractors, and businesses with a significant turnover. TDS ensures that persons receiving income are paying tax regularly.
Tax evasion laws and implications
Tax evasion is a punishable offence under the Income Tax Act, and the violation of this law carries significant implications. If an individual fails to pay their taxes or deliberately underreports their income, they may face legal action, including interest, penalty, and imprisonment terms. Some banks also consider an individual's tax compliance while processing home loan applications. Therefore, tax compliance is crucial while taking loans, tax planning and investment decision making.
Income tax filing and compliance
Filing income tax returns is a mandatory requirement for eligible taxpayers. Compliance with income tax laws not only avoids legal troubles but also helps in claiming refunds on excess taxes paid, such as TDS. Moreover, timely filing of tax returns provides an official record of earnings, which is beneficial when applying for financial products like home loans.
Understanding income tax reforms
Over the years, the government has introduced several reforms aimed at simplifying tax compliance and reducing tax burdens on individuals. Some reforms include the introduction of the new income tax regime with lower tax rates but fewer deductions, e-filing procedures for convenience, and incentives for digital payments. Staying updated with these reforms helps individuals make informed decisions during tax planning.
Tips for effective tax planning
- Invest in tax-saving instruments: Utilize Section 80C investments like PPF, ELSS (Equity-Linked Saving Scheme), and National Savings Certificates.
- Claim deductions for home loan: Use deductions under Section 24(b) and Section 80EEA for home loan interest.
- Maintain tax records: Keep a record of investment proofs, receipts, and tax-related documents for smooth filing and verification.
- Consider the new regime vs. old regime: Evaluate whether to opt for the new tax regime, which offers lower rates but no deductions, based on your financial situation.
In conclusion, taxes play a significant role in financing public services and projects and understanding how taxes work is essential for individuals and businesses. Tax planning can help individuals minimise legal tax liabilities and make better investment decisions. There have been several recent reforms in tax laws in India aimed at simplifying compliance procedures and reducing the tax burden on taxpayers. Income tax, tax deductions, TDS, tax evasion laws are essential concepts to be understood by every taxpayer in India.
Related income tax sections
Click on any of the links below to explore crucial income tax sections that impact your financial planning, covering deductions, exemptions, and compliance for better tax management.
