Difference Between Direct Tax and Indirect Tax

Direct taxes are levied directly on an individual's or company's income, while indirect taxes are collected on the consumption or purchase of goods and services, ultimately borne by the end consumer.

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Every individual in India, whether earning or spending, contributes to the nation’s economy through taxes. These taxes are either paid directly, such as income tax, or indirectly, like the tax added to goods and services. It is essential to understand the difference between direct and indirect tax because both play a vital role in how the government collects revenue.

Direct taxes are paid straight to the government based on your income or profits. Whereas, indirect taxes are applied to goods and services, which means you pay them when you make purchases. Both types of taxes help fuel public services and infrastructure, but they differ in how they are charged and collected. It is important to be able to distinguish between direct tax and indirect tax to understand how they affect your daily life.

What is Direct Tax and Indirect Tax?

Taxes are basically the money that individuals or businesses pay to the government, which helps run the country and provide public services. To understand the difference between direct and indirect tax, let us first review the definitions of both types.

Direct Tax

Direct tax is a tax paid by an individual to the government. This individual can be a person or an organization. As this type of tax is directly imposed by the government, it cannot be transferred to another entity. Direct taxes are usually based on your income or property. So, the higher your income, the more tax you pay.

A common example of a direct tax is income tax. Each year, you file your taxes and pay a portion of your earnings based on your income bracket.

Indirect Tax

On the other hand, an indirect tax is a type of tax imposed by the government on the supply of goods and services which someone else collects before it reaches the government. When you purchase goods or services, the business or retailer collects the tax from you and then pays it to the government. This tax can be passed along, so the person who ultimately pays it may not be the person or company responsible for collecting it.

The most common example of an indirect tax is the Goods and Services Tax (GST), which you pay whenever you buy things like groceries, electronics, or clothing. You do not pay it directly to the government, but it is included in the price itself.

What is the Difference Between Direct and Indirect Tax

We have already explored that taxes fall into two main categories: direct taxes (paid directly to the government by individuals/businesses) and indirect taxes (paid on goods and services and passed on to consumers through intermediaries).

For a better understanding of both direct and indirect taxes, let us take a look at this table that explains the difference between direct and indirect tax:

Feature	Direct Tax	Indirect Tax
Imposition of Tax	Levied directly on the income or profits of individuals or businesses.	Levied on goods and services rather than on income or profits.
Course of Payment	Taxpayers pay the tax directly to the government.	Paid to the government through an intermediary (like a retailer or service provider).
Who Pays	Individuals and businesses who earn income or make profits.	End-consumers who purchase goods or services.
Tax Rate	Based on the taxpayer’s income or profit varies.	The same rate applies to all taxpayers, regardless of income level.
Transferability	The burden of direct tax cannot be transferred to someone else.	The burden of indirect tax can be transferred to the end-consumer.
Nature of Tax	Progressive in nature, meaning higher income leads to a higher tax rate.	Regressive in nature, meaning it can affect all income levels similarly.
Examples	Income Tax, Corporate Tax, Wealth Tax	GST, VAT, Excise Duty, Customs Duty
Administration	Central Board of Direct Taxes (CBDT)	Central and State Governments (via GST Council)
Compliance	Requires annual filing of tax returns	Requires periodic filing by businesses (monthly/quarterly)

Types of Direct Tax

In India, various types of direct taxes are levied for both individuals and businesses. Let us take a quick look at them:

Income Tax

Income tax is a common tax paid by most salaried and self-employed persons. This tax varies from person to person as one pays income tax according to the tax bracket in which their income falls, which is directly levied on the salary.

Wealth Tax

Wealth tax is levied on the value of certain assets in the market for that particular financial year. It used to apply to individuals with net wealth exceeding a certain limit. However, it was abolished in 2015. Although not in use anymore, it is important to know that wealth tax was a type of direct tax.

Corporate Tax

Corporate tax is levied on the profits of companies and businesses in India. It helps the government raise money to run the country. This tax also applies to foreign companies whose income is arising from India.

Capital Gains Tax

Capital Gains tax is levied on the income from the sale of investments. The tax is charged based on how long you hold the asset. Capital gains are of two types, Long Term Capital Gains (LTCG) and Short Term Capital Gains (STCG) - according to which the tax rates differ.

Types of Indirect Tax

Before 2017, indirect taxes in India were classified into various categories based on the goods or services being taxed. With the introduction of the Goods and Services Tax (GST) in 2017, the classification of indirect taxes has been significantly simplified.

Goods and Services Tax (GST)

GST is a comprehensive indirect tax that is added to the price of most goods and services in India. It is charged twice: the central government levies central GST (CGST), and the State Government levies State GST (SGST) on intra-state supply of goods or services. The Centre also levies Integrated GST (IGST) on inter-state supply of goods or services. This tax is collected by businesses and passed on to the government.

Tax on Liquor and Petrol Products

Liquor and petrol products are subject to special taxes. You will notice that these products are often much more expensive due to the taxes included. These are examples of indirect taxes that raise revenue for the government.

Benefits of Indirect Tax

Indirect taxes have certain advantages that make them an important part of the tax system. Here are some benefits of indirect taxes:

They Promote Equal Participation

Since indirect taxes like GST are the same for all citizens, everyone contributes to indirect taxes regardless of income.

They are Easy to Pay

Paying indirect taxes involves no heavy paperwork. The collection happens during the sale, and the supplier pays the government.

They Help Create Awareness

Indirect taxes charged on harmful substances, such as alcohol, cigarettes, etc., are considerably higher than other routine products. This creates awareness and discourages people from using such products.

They May not Seem so High or Obvious

Indirect taxes are usually included in the price of the product or service, which is why they do not appear as high. People simply pay them when they make a purchase. There is no separate payment.

Benefits of Direct Tax

Direct taxes offer advantages, such as curbing inflation and distributing wealth equally in society. Here is why they are essential to the financial system.

They Help Control Inflation

Direct taxes can influence the demand for goods and services and help keep inflation in check. When the rate of inflation rises, the government increases direct taxes. With rising taxes, the demand for goods and services falls, and inflation is controlled.

They Promote Equality

Direct taxes are directly proportional to the payer’s income. So, people with a high income pay higher direct taxes, and people with a lower income pay lower direct taxes. These taxes help maintain equality.

They Benefit the Economically Weaker Section

The tax collected by higher-income people provides better facilities and initiatives to the poor. This stabilizes income inequality and helps lower-income groups in their daily lives.

Disadvantages of Direct Tax

Despite their benefits, direct taxes also have their downsides.

They can Lead to Fraud and Tax Evasion

Direct taxes are paid by the country’s citizens, just like income taxes. Since they are obligatory, some people may try fraudulent ways to avoid taxes.

They may Lead to Disputes Between Different Income Groups

High-income groups can feel overburdened since direct taxes are paid based on income. Similarly, lower-income groups may sense the economic divide that leads to social inequality.

They can be Inconvenient

Unlike indirect taxes, direct taxes are not included in the price of goods or services. They can come with their fair share of paperwork that can seem troublesome.

They may Discourage People from Investing

High direct taxes can discourage individuals from investing in property or stocks since they know they will have to pay taxes on any gains they make.

Disadvantages of Indirect Tax

Indirect taxes come with their own set of drawbacks.

There is no Awareness of the Tax Amount

Indirect taxes are included and hidden in the price of the goods or services purchased. Hence, people do not always know how much tax they pay to the government.

They are the Same for Every Income Group

Indirect taxes remain the same for all, irrespective of the income. This implies that people from a lower-income group will pay the same indirect tax on a product or service as people from a higher-income group. This may be equal, but it is not equitable.

They Add to the Price of Goods

Indirect taxes increase the price of goods and services for the local people. They end up paying a higher price than the product’s original price, and these taxes ultimately interfere with their monthly budgetary constraints.

Who Collects Direct Tax in India?

In India, direct taxes are collected by the Central Board of Direct Taxes (CBDT), which operates under the Department of Revenue in the Ministry of Finance. Here is a detailed explanation of the process:

Central Board of Direct Taxes (CBDT)

The CBDT is the apex body responsible for the administration of direct taxes in India. It provides essential inputs for policy and planning of direct taxes and is responsible for the implementation of direct tax laws through the Income Tax Department.

Income Tax Department

The Income Tax Department works under the CBDT and is directly involved in collecting income tax from individuals and businesses. It is also responsible for managing TDS (Tax Deducted at Source). It handles various functions such as:

Tax Assessment: Determining the tax liability of individuals and entities based on their income.
Tax Collection: Collecting taxes from taxpayers, including income tax, corporate tax, and capital gains tax.
Tax Refunds: Processing refunds for taxpayers who have paid excess tax.
Compliance and Enforcement: Ensuring compliance with tax laws through audits, investigations, and taking action against tax evaders.

Which Type of Tax is GST, Direct or Indirect?

GST (Goods and Services Tax) is an indirect tax. It is levied on the supply of goods and services and is collected by businesses from consumers at the point of sale, which is then remitted to the government. This tax is included in the price of goods and services and is ultimately borne by the end consumer, making it an indirect tax.

What is the Difference between GST and Income Tax?

The main difference between GST and income tax is that GST is an indirect tax added to goods and services, while income tax is a direct tax paid directly on your income. Let us further explore the difference between GST and income tax, take a look at this table:

Feature	GST	Income Tax
Type of Tax	Indirect Tax	Direct Tax
Tax Base	Consumption of Goods & Services	Income Earned
Who Pays	Ultimately borne by the consumer (collected by businesses)	Individuals & Businesses based on income slabs
Tax Rate	Fixed rates for different categories (e.g., 5%, 18%)	Progressive rates based on income level (higher income = higher rate)
Administration	Central & State Governments (GST Council)	Central Government (Income Tax Department)
Compliance	Businesses exceeding a turnover threshold must register	Individuals and businesses exceeding the income threshold must file returns
Frequency of Returns	Monthly, Quarterly, or Annual (depending on turnover)	Once a year

Paying Taxes is Your Responsibility

As a responsible citizen, it is crucial to understand and fulfill your tax obligations as per your tax slab. Here are a few reasons why paying taxes is important:

Funding Public Services: Taxes fund essential services such as education, healthcare, infrastructure, defense, and public safety, which contribute to society’s well-being and development.
Legal Obligation: Paying taxes is a legal requirement. Failure to comply with tax laws can result in penalties, fines, or legal action by tax authorities.
Economic Stability: Taxes help maintain economic stability by funding government spending and stimulating economic growth and development.
Social Responsibility: Contributing to the tax system ensures that resources are available for public goods and services, promoting social equity and helping those in need.
National Development: Taxes enable the government to invest in projects and initiatives that drive national progress and improve the quality of life for all citizens.

Paying taxes on time and accurately contributes to the nation’s development and helps maintain a functioning and fair society.

Wrapping Up

It is important to understand and distinguish between direct taxes and indirect taxes. Both types of taxes play a vital role in a nation’s economy, funding essential public services and infrastructure and ensuring economic stability and growth. By understanding these differences, taxpayers can better navigate their obligations and contribute to the nation’s development.

FAQs on Direct Tax and Indirect Tax

What is the difference between direct and indirect tax?

Direct tax is paid directly to the government by individuals or businesses, like income tax or corporate tax. Indirect tax is added to the price of goods and services, like GST, and is paid when you make purchases. Simply put, direct tax comes from your earnings, while indirect tax is added to what you spend.

Does Goods and Service Tax (GST) fall under the direct or indirect tax category?

GST is an indirect tax levied on the supply of goods and services.

How would I know which tax is direct or indirect?

Direct taxes, such as income tax, are paid directly to the government by the individual or organization. Indirect taxes, such as GST or sales tax, are collected by intermediaries (like retailers) from the consumer.

Is the rate of payment different for direct and indirect taxes?

Yes, direct taxes usually have fixed rates based on income or profits, while indirect taxes can vary depending on the type of goods or services.

Who is liable to pay direct tax?

Individuals, businesses, and entities earning taxable income or profits must pay direct taxes.

Which is the largest tax in India?

The largest tax in India by revenue is the Goods and Services Tax (GST).

Is TDS a direct tax?

Yes, Tax Deducted at Source (TDS) is a direct tax deducted from an individual’s income and paid to the government.

Which income is not taxable?

Certain types of income, such as agricultural income, gifts below a specified limit, and income from certain specified bonds, are not taxable under Indian tax laws.