What Is The Difference Between Direct & Indirect Tax?

Aug 17, 2022

Taxes are among the major sources of income for the government. You pay taxes in various ways, on your salary, restaurant meals, multiplex movie tickets, driving your car on the road, and even buying a package of biscuits from a primary store.

You have a responsibility to pay taxes as a citizen of this nation. But understanding the various taxes in the nation is also crucial. Direct and indirect taxes are the two major categories into which we can place all of India’s numerous taxes. So let’s examine these two forms of taxes in greater depth.

What is Direct Tax?

To put it simply, a direct tax is a tax that you pay directly to the entity responsible for collecting it. For instance, the government imposes income tax, which you pay to them directly. Many acts govern direct taxes.

The Department of Revenue of India, which is in charge of the CBDT (Central Board of Direct Taxes), oversees the collection and administration of direct taxes. Additionally, the department is responsible for planning and advising the government on how to implement direct taxes.

Common Types Of Direct Taxes In India

Here are some of the direct taxes in India:

Income Tax

Income tax is the most common form of direct tax in India. It is based on the income tax slabs of the IT department and the money you make in a financial year. Both people and businesses pay the tax directly to the Income Tax department. But, under various sections of the IT Act, several tax deductions are available to individual taxpayers.

Securities Transaction Tax

If you trade stocks, a minor component known as the securities transaction tax also is a part of each of your trades. You need to pay this tax whether or not you have gained from the trade. The broker takes this tax from you and gives it to the securities exchange, which then pays the government.

Capital Gains Tax

You must pay capital gains tax on every capital gain you make. This capital gain may result from investments or the sale of a property. You need to pay either LTCG (Long-Term Capital Gains) tax or STCG (Short-Term Capital Gains) tax, depending on capital gains and how long you have kept the investment.

Benefits Of Direct Tax

The direct tax provides several important advantages, including:

  • Controls Inflation – When there is monetary inflation, the government can raise the direct tax rate to lower the demand for goods and services. As demand declines, inflation cools down.
  • Equitable – The progression concept forms the basis of direct taxation and you can call them equitable. Higher earners pay more in taxes, while those with lower incomes pay less.
  • Reduces Inequalities – The government uses the higher taxes it receives from the wealthy to fund programs for the underprivileged. These programs offer income sources for those with lower incomes and help them improve their living standards.

Disadvantages Of Direct Tax

The following are some disadvantages of direct taxes:

  • Taxpayers consider them a burden – Taxpayers need to pay direct taxes such as income tax in a lump sum every year. As a result, they view these taxes as a burden. Even the documentation procedure itself is typically complex and time-consuming.
  • Evasion is possible – Although the government has made tax evasion exceedingly challenging, there are still many fraudulent ways for people and corporations to evade or pay fewer taxes than they should.
  • Investment restrictions – Many people refrain from investing as a result of the application of direct taxes like the capital gains tax and securities transaction tax. In a way, direct taxes limit investment.

What Is Indirect Tax?

Indirect taxes are imposed on services and products as opposed to direct taxes, which are levied on income and profits. One significant distinction between direct and indirect taxes is that you pay direct taxes to the government directly, while an intermediary collects indirect taxes from you, the end consumer. Then, the intermediary must pass this indirect tax to the government.

Contrary to direct taxes, indirect taxes are independent of an individual’s income. As a result, everyone pays taxes at the same rate. In India, the Central Board of Indirect Taxes and Customs (CBIC) is primarily in charge of processing indirect taxes. The Department of Revenue oversees both CBDT and CBIC.

Common Types Of Indirect Taxes In India

The following are some of the most effective forms of indirect tax in India:

Goods and Services Tax (GST)

GST subsumed many different indirect taxes, including Service Tax, Central Excise, State VAT, and others. As a result, it is a single, all-encompassing indirect tax applied to all goods and services according to the tax brackets set by the GST Council. One of its significant benefits is that the GST essentially eliminated the cascading or tax-on-tax effect of the former tax regime.

Customs Duty

You have to pay customs tax when you buy an imported product from another country. You are responsible for paying the product’s customs duty whether it arrives in India by air, land, or sea. Taxing all goods entering India is the objective of the implementation of this indirect tax. 

Value Added Tax (VAT)

A value added tax (VAT) is a kind of consumption tax on goods whenever their value increases across the supply chain. The state government imposes it and determines the amount of VAT percentage applied to different goods. VAT is still used on some products, such as those that include alcohol, although GST has mostly eliminated it.

Benefits Of Indirect Tax

Below is a list of some essential advantages of indirect taxes:

  • Poor people contribute too – It is crucial for the nation that each person contributes to its development. Due to understandable reasons, many earning individuals who fall below the poverty line are excused from paying direct taxes. So, indirect taxes ensure that even such individuals contribute their part to the country’s development.
  • Convenience – You pay indirect taxes like GST in little increments, as opposed to direct taxes, typically paid in one single payment. The price when you buy a good or service already includes a tiny amount of GST, which makes it easier for taxpayers to pay.
  • The collection is simple –  One of the most significant distinctions between direct and indirect taxes is how people pay them. Paying indirect taxes doesn’t require paperwork or laborious processes, unlike paying direct taxes. You should pay this tax right when you buy a product or service.

Disadvantages Of Indirect Tax

Here are a few drawbacks of indirect tax:

  • Regressive – Indirect taxes have a regressive effect. They are not equitable, but they do ensure that everyone pays taxes regardless of their income. Individuals in every income bracket must pay indirect taxes at the same rate.
  • Increases the cost of goods and services – Indirect tax makes goods and services more expensive as you pay this tax over and above their price. For instance, items like cigarettes, luxury bikes, and premium vehicles are subject to the 28% tax slab of GST. This means that you pay 28% extra on the actual price of these products. 
  • Lack of civic consciousness – In the case of indirect taxes, most consumers are unaware of the tax they pay. In contrast, in the case of direct taxes, the taxpayer is fully aware of the tax that they pay.

Tax on Returns You Earn Through P2P Lending

In P2P lending, investors earn income in the form of interest on the amount they lend. P2P lending is one of the rapidly growing investment opportunities in India. The fixed maturity peer-to-peer investment plan from LenDenClub offers up to 10–12%* annual returns on your investment. Similar to the interest earned on any other instrument, such as a fixed deposit, the interest income in P2P lending is also taxable. Lenders’ interest income from peer-to-peer lending comes under “income from other sources” and is added to their taxable income. 

Conclusion

As you can see, both indirect and direct taxes have advantages and disadvantages. But, both are crucial to the economy. Though people view taxes as an unnecessary burden, they need to realize that they contribute to the nation’s development. Our infrastructure improves, defense grows strong, and we prosper as a nation when we pay taxes.

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