Direct Tax and Indirect Tax

Taxes are mandatory fees collected by governments to fund development. In India, you pay taxes on your income and on goods and services. These are categorized as direct taxes (income tax) and indirect taxes (GST, customs duty, etc.).

As responsible and informed taxpayers, you should know the differences between direct and indirect taxes.

Direct tax is a type of tax that’s paid directly by the taxpayer to the government. For direct taxes, the tax burden is borne by the individual on whom the tax is levied. In other words, the taxpayer cannot transfer this tax liability to another person. It is generally collected from the taxpayer's annual net income or earnings. In India, direct taxes fall under the purview of the Central Board of Direct Taxes (CBDT) which is in turn governed by the Department of Revenue.

Here are a few examples of direct taxes in India:
 

A. Income tax

Income tax is a direct tax imposed on the annual income of the taxpayer if their earnings fall under the income tax brackets instituted by the government. Income tax is collected at slab rates.
 

B. Corporate tax

Companies incorporated in India are liable to pay this direct tax to the Indian government. Corporate tax is collected at a flat rate on the business’s net profit in the relevant financial year.
 

C. STT

STT or the Securities Transaction Tax is a direct tax levied on the sales and purchase of equity securities listed on recognised stock exchanges.

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Indirect tax is a type of tax that taxpayers pay to the government through an intermediary. The intermediary collects the tax amount and then passes it on to the government. Indirect taxes are transferable taxes since the tax burden can be shifted to others. For instance, if the government imposes an indirect tax on a service provider, this tax burden is passed on to the end consumer, who finally pays it. Indirect taxes fall under the administrative purview of the Central Board of Indirect Taxes (CBIC), which operates under the Department of Revenue.

Here are a few examples of indirect taxes in India have previously existed in India:

• Sales tax
• Custom duty
• Excise duty
• Service tax
• VAT

These indirect taxes were subsumed and replaced by the GST or the Goods and Services Tax in 2017. The introduction of GST helped eliminate the cascading effect of multiple indirect taxes and streamline the indirect tax collection process.

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Direct tax:

Advantages of Direct Taxes

• Fairness: Taxes are based on income, ensuring that higher earners contribute more.
• Predictability: Individuals know their annual tax liability in advance.
• Improves Accountability: Filing returns fosters financial discipline and transparency.
• Stable Revenue: Offers a reliable and consistent income source for the government.
• Reduces Inequality: Progressive tax rates help redistribute wealth.

Disadvantages of Direct Taxes

• Risk of Evasion: Higher tax rates may push some taxpayers to hide income.
• Complex Compliance: Requires documentation, record-keeping, and regular filings.
• Impact on Investment: Higher taxes can lower disposable income and discourage savings or investments.
• Not Inflation-Indexed: Tax slabs may not adjust quickly to rising living costs.
• Time-Intensive: Often involves professional help, especially for businesses.

Indirect tax:

Advantages of Indirect Taxes

• Easy to Pay: Automatically applied at purchase, requiring no separate action from taxpayers.
• Wider Reach: Everyone who buys goods or services contributes to revenue.
• Hard to Evade: Since taxes are included in prices, avoiding them is difficult.
• Promotes Savings: Encourages saving, as income itself is not taxed.
• Policy Flexibility: Rates can be adjusted to regulate demand or support local industries.

Disadvantages of Indirect Taxes

• Regressive Impact: Affects low-income households more since everyone pays the same rate.
• Inflationary: Increases the overall price of goods and services.
• Lack of Transparency: Consumers may be unaware of the tax portion in prices.
• Business Compliance Burden: Requires accurate invoicing and regular tax filings.
• Cascading Effect (Pre-GST): Earlier tax systems caused tax-on-tax, a problem largely reduced under GST.

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Both direct and indirect taxes play crucial roles in the economic framework, each with its benefits and drawbacks. Direct taxes are more transparent and equitable but can be complex and discourage earnings. Indirect taxes are broader and easier to collect but can be regressive and hidden in consumer prices. Understanding these differences helps individuals and businesses navigate their financial responsibilities and plan their tax strategies effectively.

By following this guide, you can easily understand the differences between Direct and Indirect taxes in India. Additionally, consider securing your financial future with Bajaj Finance Fixed Deposit, offering a reliable savings option with AAA/Stable ratings from CRISIL and ICRA. Start investing.