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What is indirect tax and its types?

Indirect taxes are levied on goods and services collected indirectly during transactions. Types include value-added tax (VAT) and goods and services tax (GST), which influence revenue generation and consumer behavior.

  • 14,273 Views | Updated on: Mar 08, 2024

Indirect taxes are levied on goods and services collected indirectly during transactions. Types include value-added tax (VAT) and goods and services tax (GST), which influence revenue generation and consumer behavior.

In the form of service tax, excise duty, entertainment tax, customs duty, etc., these are charged to the sellers of goods or providers of services and then passed on to the final consumer. A common example of indirect taxation is the excise duty on alcoholic beverages.

What is Indirect Tax?

People are subjected to an indirect tax when they use products and services. A person’s income is not directly taxed when they pay indirect taxes. However, in addition to the actual cost of the goods or services the seller paid for, he must pay the tax. In general, sellers who pass the tax on to the final customer are subject to indirect tax.

There is a distinction between the person bearing the burden and the person paying the tax in indirect taxes. These taxes must be paid to the government by the sellers (e.g., manufacturers and retailers). However, businesses pass on the cost of paying the tax to you because they sell items to consumers.

Excise tax, Value Added Tax, service tax, customs duty, sales tax, entertainment tax, and Securities Transaction Tax are all examples of indirect taxes.

For instance, assume you are eating at a restaurant. Your total amount plus GST will be shown on the bill (Indirect tax). For example,

  • The total bill is ₹2500, and the GST rate is 5%.
  • Then you must pay a total of ₹2500 + ₹125=₹2625.
  • This ₹125 is the indirect tax the service provider passes you.

Different Types of Indirect Taxes

Indirect taxes constitute a diverse category of levies imposed on goods and services, crucial in generating government revenue and influencing consumer behavior. Understanding the various types of indirect taxes is essential for policymakers, businesses, and individuals alike.

Types of indirect taxes

Service Tax

A service tax can be defined as a type of indirect tax that you are responsible for paying to the government when you consume a taxable service offered by numerous service providers, for instance, restaurants, hotels, travel agents, cab services, cable providers, etc. The consumer pays the service charge to the service provider, who pays the tax to the central government.

Value Added Tax

The value-added tax, or VAT, is a flat tax levied on a commodity. It is similar to the sales tax, except that in the sales tax, the entire amount owed to the government is paid by the shopper at the time of sale. On the contrary, when the transaction takes place with VAT, different parts of the tax are paid by different parties.

Excise Duty

Excise duty or excise tax is a sort of indirect tax payable on the goods produced within the country. It can be termed as a tax on the sale of goods. It has been renamed and is now known as Central Value Added Tax (CENVAT). For example, taxes are imposed on selling things like tires, airline tickets, fuel, and heavy trucks.

Custom Duty

Customs duty, often called import duty, is a key component of a country’s trade policies, influencing the flow of goods across its borders. As an indirect tax imposed on imports and exports, customs duty serves economic and regulatory purposes.

Entertainment Tax

Entertainment Tax is a tax charged on all sources of entertainment, such as feature films that get a wide release in the country, amusement parks, sports activities, primary commercial exhibits, and big parties and celebrations.

Stamp Duty

Stamp duty is imposed on transferring immotile possessions located within the state, levied by the State Government, and may differ in rates. It is also applicable to all legal documents. In older times, a physical revenue stamp was meant to be impressed upon the document to notify that the stamp duty was paid.

Goods and Service Tax

Goods and Service tax, GST, is a tax assessed on the supply of goods and services from manufacturing to buying. It is of three kinds:

  • State Goods and Service Tax (SGST)
  • Central Goods and Service Tax (CGST)
  • Integrated Goods and Service Tax (IGST)

Benefits of Indirect Tax

Indirect taxes are crucial in shaping a country’s economic landscape by contributing to revenue generation and influencing consumer behavior. Unlike direct taxes, levied on individuals and businesses based on income and profits, indirect taxes are imposed on goods and services.

Revenue Generation

One of the primary advantages of indirect taxes is their significant contribution to government revenue. These taxes are collected at various stages of the supply chain, ensuring a broad base encompassing a wide range of goods and services. This diversity helps governments generate substantial funds, which can be utilized for public infrastructure, social welfare programs, and other essential services.

Progressive Nature

Indirect taxes are often considered more progressive than direct taxes because they are not directly linked to an individual’s income or wealth. In a progressive tax system, higher-income individuals tend to contribute more to indirect taxes by spending more on taxable goods and services. This indirect approach helps achieve a level of fairness in taxation, as the burden is distributed more equitably across different income groups.

Encouraging Fiscal Discipline

Implementing indirect taxes can foster fiscal discipline by encouraging governments to streamline spending and prioritize essential areas. Knowing that a significant portion of revenue is derived from indirect taxes, authorities are incentivized to manage public finances efficiently and allocate resources responsibly.

Controlling Consumption Patterns

Indirect taxes can influence consumer behavior and promote socially responsible practices. Governments can encourage or discourage consumption patterns by adjusting specific goods’ or services’ tax rates. For instance, higher taxes on goods harmful to health or the environment, such as tobacco or carbon-intensive products, can reduce consumption, contributing to public health and environmental sustainability.

Flexible Policy Tool

Indirect taxes provide governments with a flexible policy tool that can be adjusted to address changing economic conditions. In times of economic growth, tax rates can be modified to generate additional revenue, while during economic downturns, rates can be adjusted to stimulate consumer spending and boost economic activity. This adaptability makes indirect taxes a valuable instrument for economic management.

Reduced Tax Evasion

Compared to direct taxes, indirect taxes are generally more challenging to evade. Consumers pay these taxes as part of their regular transactions since they are embedded in the prices of goods and services. This inherent transparency minimizes the scope for tax evasion and ensures a more efficient and effective tax collection process.

Wrapping Up

Indirect taxes are a crucial component of a country’s fiscal policy, influencing economic activities and shaping consumer behavior. Understanding the various types of indirect taxes helps individuals and businesses navigate the complex tax landscape, ensuring compliance with regulatory requirements. As tax systems evolve, staying informed about indirect taxes becomes essential for taxpayers and policymakers.

Key takeaways

  • Indirect taxes are imposed on goods and services, collected indirectly as part of transactions, shifting the tax burden from businesses to end consumers.
  • Indirect taxes play a crucial role in generating government revenue by taxing the consumption of goods and services at various stages of the supply chain.
  • VAT is a common type of indirect tax applied at each stage of production and distribution, ensuring that tax is levied on the value added at each step.
  • GST is a comprehensive consumption tax aiming to harmonize and simplify the taxation system by applying a broad-based tax to the supply of goods and services.

- A Consumer Education Initiative series by Kotak Life

Amit Raje
Written By :
Amit Raje

Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.

Amit Raje
Reviewed By :
Prasad Pimple

Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors

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