Difference between direct and Indirect Tax

 👀 Direct vs Indirect Tax: Understanding the       Difference

Taxes are essential for the functioning of any government, funding everything from infrastructure to education and healthcare. But not all taxes are the same. Broadly, they are divided into two main categories: direct taxes and indirect taxes. Understanding the difference between these two can help you better manage your finances and make informed decisions.

What is a direct tax?

A direct tax is one that is paid by the person or entity that is subject to it directly to the government. It is impossible to transfer the tax burden to another person. Usually, these taxes are determined by wealth or income.

👉Examples of Direct Taxes:

• Individuals pay income tax on their earnings.

• Businesses pay corporate tax on their earnings.

• In certain nations, a wealth tax is imposed on a person's net worth.

• Owners of real estate pay property taxes based on the value of their holdings.

👉Key Features of Direct Taxes:

• paid by the individual or organization that generates the revenue.

• Non-transferable: The obligation to make payment cannot be changed.

• based on the taxpayer's financial capacity (progressive).

• more equal in general.

What is an indirect tax?

An indirect tax is one that is collected from the person who ultimately suffers the financial burden of the tax (the consumer) by an intermediary (such as a manufacturer or merchant). The cost of products and services includes these taxes.

👉Examples of  Indirect Taxes:

• Value-Added Tax (VAT) or Goods and Services Tax (GST)

• Excise Duty: Applied to the production of products such as tobacco and alcohol.

• imposed on imported products as a customs duty.

• In certain countries, sales tax is paid at the time of purchase.

👉Key Features of Indirect Taxes:

• collected by sellers from customers and given to the government.

• Transferable: the final consumer bears the tax burden.

• viewed as regressive since everyone pays the same tax rate, regardless of income level.

• easier to administer and gather.

Difference Between Direct and Indirect Tax

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

Context of Differentiation Between Direct Tax vs Indirect Tax

1. Imposition of tax   
2. course of payment 
3. Paying entity
4. Rate of tax payment
5. Transferability of payment 
6. Nature of tax

Direct Tax

1. It is levied on the income or profit of a taxpayer.
2. Taxpayers pay it directly to the government.
3. Individuals and businesses
4. based on income and profit
5. Cannot be transferred.
6. Progressive tax, i.e., its rate increases with the taxpayer's income.

Indirect Tax

An indirect tax is levied on goods and services rather than on income or profits.

Taxpayers pay it to the government through an intermediary.

End-consumers

Same for all taxpayers

Transferable 

Regressive tax, i.e., its rate decreases with increases in income.

Types of Direct Tax and Indirect Tax in India

There are several types of these taxes, which further accentuate the difference between direct tax and indirect tax. 

The following are examples of these types:

Direct Tax Types

India frequently imposes the following kinds of direct taxes:

Tax on Income

A person's income for a given fiscal year determines their annual income tax. The ITA defines "individual" as any artificial legal person, including cooperative groups, trusts, Hindu Undivided Families, or HUFs.

Wealth Tax

Wealth tax is levied on individuals, HUFs, or companies on the value of their assets in a financial year. It applies to a variety of asset types, such as cash, shares, real estate, fixed assets, bank deposits, pension plans, etc.

Corporation Tax

Businesses or corporations that operate in India pay it according to the money they make throughout a fiscal year. The tax rate differs depending on whether a business is incorporated domestically or overseas.

capital Gains Tax

Capital gains tax applies to the earnings made from the sale of the property. Residential real estate, stocks, bonds, precious metals, and other assets are all considered "property."

Types of Indirect Tax

Prior to the introduction of GST in India, there existed the following types of indirect taxes:

Sales Tax

The government levied sales tax on the sale of movable goods.

Service Tax

With the exception of those services listed on the negative list, all service providers must pay this tax to the government.

Value Added Tax

• Every time a product was manufactured or distributed, a consumption tax was imposed on it.

• In order to expedite the tax process in India, the government implemented the GST regime.

Benefits of Direct vs Indirect Tax

These are some key benefits of direct taxes:

• Curbs Inflation: When the economy is faced with monetary inflation, the government subsequently raises tax rates. This increase pulls down the demand for goods and services. thereby condensing inflation.

• Social and Economic Balance: The existence of clearly defined tax slabs and exemptions aids in balancing out disparities in income. As a result, those who earn less pay less in taxes, and vice versa.

The benefits of indirect taxes are

• Equal Contribution: Indirect taxes ensure that every individual pays some amount, however little, to the state. It also reaches people in lower-income groups, who are exempt from direct taxes.

• Non-evadable: These taxes exist within the price of a community. So, an individual can only evade an indirect tax if he/she does not consume the taxed item.

Drawbacks of Direct and Indirect Tax

Direct taxes are accompanied by some drawbacks, which are as follows:

• Tax Evasion: Despite the strict restrictions, some employ dishonest methods to either pay less than they should or avoid paying taxes altogether.

• Burdensome: Each year, direct taxes are paid in one big payment. They are therefore frequently viewed as a burden. Additionally, the documentation is extensive and time-consuming, which adds to the inconvenience.

A few downsides of Indirect taxes include

• Regressive: For people with lower earnings, indirect taxes may be seen as unjust because they are the same for all economic classes.

• Increased Product Price: An indirect tax is added to the cost of goods and services in the country, which makes these commodities more expensive.

Conclusion 

The economy depends on both direct and indirect taxes, yet they have different functions. While direct taxes are seen as more equitable, indirect taxes are simpler to collect and contribute significantly to government revenue. A balanced mix of both ensures a fair and efficient taxation system.