What is Direct Tax?

What is Direct Income Tax?

As the name suggests, direct taxes are paid directly by you, the taxpayer, to the government. Unlike indirect taxes, they are not passed on to others. The tax liability rests solely with the taxpayer and cannot be shifted to another entity.

It is like paying your rent directly to your landlord – you cannot ask your neighbor to pay it for you. Direct taxes work the same way – the responsibility lies solely with the person earning the income. Some of the direct tax examples are income tax, capital gains tax, inheritance tax etc.

Types of Direct Taxes

Now that you know what is direct tax, let us understand its types. Understanding the various types of direct taxes is essential for knowing how governments generate funds to finance public services and infrastructure.

Income Tax

Income tax is one of the most common types of direct taxes and is levied on the income earned by individuals, corporations, and other entities. It is progressive in nature, meaning that higher-income earners pay a higher percentage of their income in taxes.

Corporate Tax

Corporate tax is imposed on the profits earned by businesses and corporations. Like income tax, corporate tax rates can vary, and they often depend on the level of profits generated by the company.

Capital Gains Tax

Capital gains tax is applied to the profits earned from selling assets such as real estate, stocks, or other investments. The rates may differ based on the holding period and the type of asset sold.

Inheritance Tax

Inheritance tax, also known as estate tax, is levied on the value of an individual’s estate after their death. The rate may vary based on the relationship between the deceased and the inheritor.

Minimum Alternate Tax (MAT)

MAT is a tax provision in India that aims to ensure that companies with substantial book profits (profits as per their financial statements) but low taxable income due to various deductions and exemptions still contribute a minimum amount of tax to the government.

Fringe Benefits Tax (FBT)

A direct tax paid by companies on the value of certain non-monetary benefits (such as drivers and maids) provided to their employees. FBT was introduced in 2005 but was abolished in 2009. After FBT was abolished, the tax burden shifted to employees. The value of these benefits is now included in the taxable income of employees.

Dividend Distribution Tax (DDT)

DDT was levied on dividends paid by domestic companies to their shareholders. Foreign companies are generally exempt from DDT. Before 2020, companies paid DDT on dividends. After 2020, shareholders pay income tax on the dividends they receive.

Securities Transaction Tax (STT)

This is a tax levied on profits generated from the trading of securities in the stock market. Introduced to curb tax evasion on capital gains, STT ensures efficient tax collection from securities market transactions.

Rates of Direct Taxes

Based on the age and income of the individual, they will be categorized into a specific tax bracket. The following outlines the distinct tax brackets:

For Resident Individuals and Hindu Undivided Families (HUFs) who are Below the Age of 60 Years

For Senior Citizens who are Above the age of 60 Years and Below the Age of 80 Years

For Resident Indians who are Above the Age of 80 years (Super Senior Citizens)

New Income Tax Slab for Individuals of all Age Groups

Direct Tax Code

The Direct Tax Code (DTC) was primarily designed to modernize India’s direct tax regime by replacing the existing Income Tax Act of 1961. Its core objective was to create a more just, streamlined, and efficient system for collecting direct taxes. The DTC also aimed to consolidate and simplify all relevant direct tax laws, fostering increased voluntary tax compliance and ultimately boosting the tax-to-GDP ratio.

Explanation of the Direct Tax Codes

Direct tax codes can be explained better if we look at their key features more closely:

• Unified Code: All direct taxes will be consolidated into a single code, creating a unified taxpayer system and streamlining compliance procedures.
• Minimized Litigation: The DTC strives to minimize ambiguity and the potential for misinterpretation to reduce the burden of tax-related litigation.
• Reduced Regulatory Burden: The DTC aims to minimize the regulatory functions of the tax authority, potentially shifting some responsibilities to other relevant agencies.
• Enhanced Stability: Tax rates will be defined within specific schedules within the DTC itself, reducing the reliance on annual Finance Acts for rate adjustments. Changes to these schedules will require parliamentary approval through an amendment bill.
• Flexibility and Adaptability: The code is designed to accommodate economic growth and evolving needs without requiring frequent amendments.
• Political Contributions: A deduction of up to 5% of gross total income will be allowed for political contributions.
• Fringe Benefits Tax Shift: The responsibility for paying fringe benefits tax will shift from employers to employees.

Advantages of Direct Taxes

Direct taxes in India play a pivotal role in the financial geography of a nation, providing governments with a direct means of generating revenue. Some of its advantages include:

Progressive Nature

One of the primary advantages of direct taxes is their progressive nature, which ensures that those with higher incomes contribute a larger percentage of their earnings. This promotes social equity and helps redistribute wealth within society.

Stability of Revenue

Direct taxes in India, particularly income tax and corporate tax provide a stable source of revenue for governments. The income generated through these taxes is relatively predictable, allowing governments to plan and allocate resources more effectively.

Encourages Fiscal Responsibility

Direct taxes encourage fiscal responsibility among citizens and businesses. Knowing that a significant portion of their income or profits will go towards taxes, individuals and corporations are motivated to manage their finances more prudently.

Targeted Policy Implementation

Governments can use direct taxes to implement targeted policies, such as offering tax credits or deductions to promote specific activities, industries, or social objectives. This flexibility allows for the implementation of economic and social policies tailored to the nation’s needs.

Final Thoughts

Direct taxes are a fundamental component of a country’s fiscal policy, serving as a means to generate revenue, promote social equity, and fund government initiatives. Understanding the various types, rates, and advantages of direct taxes and income tax returns is crucial for policymakers and citizens alike. A well-designed direct tax system contributes to a fair and sustainable financial framework that supports a nation’s economic and social development.

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