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What is the Difference Direct Tax and Indirect Tax

Direct tax is paid by individuals directly to government, whereas indirect tax is collected by government on supply of goods & services. More on direct tax vs indirect tax.

  • Jan 17, 2020

Most people know about taxes as it gets deducted regularly from their salary and is charged while buying or consuming something. But have you tried to differentiate GST from corporate tax? Though not many are gleeful about the income tax deductions, they keep going on without knowing about taxes. Today let’s distinguish between direct tax and indirect tax and better understand the difference between them./p>

Direct Tax

What is Direct Tax?

Direct tax is a type of tax that is 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. Some advantages of direct tax are that it aids in curbing inflation and also distributing wealth equally in the society.

Types of Direct Tax

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 their income falls in which is directly levied on the salary. Besides, the Government of India allows taxpayers income tax exemption for various investments and expenditure schemes.

Wealth Tax

Wealth tax is levied on the value of certain assets in the market for that particular financial year. This asset can be held by an individual, HUFs (Hindu Undivided Family) or companies. Though wealth tax was widely used before, now it has been abolished.

Corporate Tax

Corporate tax is levied on the profits of companies and businesses in India. This tax is also applicable to foreign companies where the income is arising from India.

Capital Gains Tax

Capital Gains tax is taxed on the income arising out of the sale of investments. The tax is levied 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.

Benefits of Direct Tax

Here are some benefits of direct taxes:

  • They help control inflation

Direct taxes can influence the demand for goods and services and help keep inflation in check. In case of a rise in the rate of inflation, the government increases direct taxes. With a rise in taxes, the demand for goods and services falls and inflation is controlled.

  • They promote equality

Direct taxes are directly proportional to the income of the payer. 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 poor

The tax collected by people with higher incomes is used to provide better facilities and initiatives to the poor. This stabilizes the inequality in incomes and helps lower-income groups in their day to day lives.

Disadvantages of Direct Tax

Here are some disadvantages of direct taxes:

  • They can lead to fraud and tax evasion

Direct taxes are paid by the citizens of the country just like income tax. Since this is an obligatory tax, some people may try fraudulent ways to avoid paying them.

  • They may lead to disputes between different income groups

Since direct taxes are paid as per the income, high-income groups can feel overburdened. 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

Capital gains taxes may lead people to avoid investments in order to reduce their tax liability. This further disrupts the growth of the economy and hampers the individual’s financial health too.

Indirect Tax

What is Indirect Tax?

Indirect tax is a type of tax imposed by the government on the supply of goods and services and can be transferred from one entity to another. Recently, the Goods and Services Tax (GST) was introduced by the government on 1 July 2017 which subsumed all the other kinds of indirect taxes. Some of the benefits of GST as indirect tax are the elimination of multiplicity of taxes and an eventual decrease in the cost of goods due to the reduction in the cascading effect of taxes.

Types of Indirect Tax

Goods and Services Tax (GST)

GST is charged twice where 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 the inter-state supply of goods or services.

Tax on Liquor and Petrol Products

Taxes on liquor and petrol products do not come under GST and are taxed separately.

Benefits of Indirect Tax

Here are some benefits of indirect taxes:

  • They promote equal participation

Since indirect taxes are the same for all citizens, everyone gets to contribute to indirect taxes irrespective of their incomes.

  • They are easy to pay

There is no heavy paperwork involved in paying indirect taxes. The collection happens at the time of the sale and is paid to the government by the supplier.

  • 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.

Disadvantages of Indirect Tax

Here are some disadvantages of indirect taxes:

  • 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 end up paying 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 original price of the product, and these taxes ultimately interfere with their monthly budgetary constraints.

What is the difference between Direct Tax and Indirect Tax?

When looking at what is direct tax and indirect tax, there are various differences that you need to know. Here are some of the key differences:

1.Taxpayers of the particular type of tax

Direct taxes are levied on every individual, HUFs, and company. For indirect taxes, the end-consumer becomes the taxpayer

2.Applicability of the tax

Direct taxes are applicable only to the taxpayer whereas indirect taxes are levied on every single stage of the production-distribution stage of the goods.

3.Transferability of the taxes

Direct taxes cannot be transferred as compared to indirect taxes which can be transferred.

4.Evasion from paying tax

Direct tax can be evaded by investing in tax-savings instruments whereas indirect tax cannot be evaded.

Direct Tax vs. Indirect Tax

Here is a table for direct vs indirect tax to help you understand the distinction between the two better:

Direct Tax

Indirect Tax

For activities conducted and income earned

For products and services

Tax burden cannot be shifted

Tax burden can be shifted

The concerned person pays it directly

It is paid by one person and recovered by another

Collection is difficult

Collection is significantly easier

Example: Income Tax, Corporate Tax

Example: GST, Tax on Liquor

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