Indirect Tax: Meaning, Types, and Examples

What is Indirect Tax?

Indirect tax is a form of tax that you pay not on your income but on the things you buy or consume. What makes it “indirect” is that the person who pays the tax to the government (like a retailer or service provider) is not the same as the one who actually bears the cost. That’s you, the consumer. This separation between the payer and the bearer is what defines the nature of indirect taxes in India.

Every time you pay for a product or a service, a portion of that payment goes toward taxes, which the seller then forwards to the government. This way, the tax burden is transferred indirectly from you to the authorities, making it a crucial but often unnoticed part of daily expenses.

Examples of Indirect Tax

Let’s say you buy a branded shirt from a retailer. Here’s how the flow of tax works at each stage of the transaction, assuming a 12% GST rate:

Here’s what happens: the manufacturer charges ₹120 as GST and passes it to the government. The retailer, who paid ₹1,120 to the manufacturer, sells the shirt to you for ₹1,680 (₹1,500 + ₹180 GST). Since the retailer already paid ₹120 as input tax, they only owe ₹60 more to the government.

Ultimately, you (the end consumer) bear the full ₹180 tax. This table clearly shows how indirect tax examples work in everyday purchases, where the tax burden is indirectly passed on to you while sellers serve as collection agents for the government.

Different Types of Indirect Taxes

Indirect taxes in India 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. Here is a list of indirect taxes that will also help you understand the indirect tax structure in India:

Service Tax

A service tax is one of the best examples of indirect taxes in India. It can be defined as a type of indirect tax you are responsible for paying to the government when you consume a taxable service offered by numerous service providers, such as 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

Value-added tax, or VAT, is a flat tax levied on a commodity. It is similar to sales tax, except that the shopper pays the entire amount owed to the government 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 is an indirect tax payable on goods produced within the country. It can be termed 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 on all sources of entertainment, such as feature films that are widely released in the country, amusement parks, sports activities, primary commercial exhibits, and big parties and celebrations.

Stamp Duty

The state government levies stamp duty and may differ in rates. It is imposed on transferring immotile possessions within the state and applies to all legal documents. In older times, a physical revenue stamp was meant to be displayed in the document to notify people that the stamp duty was paid.

Goods and Service Tax (GST)

One of the most significant reforms in India’s tax structure, GST or Goods and Services Tax, has replaced many older levies that once fell under different types of indirect taxes. Introduced on July 1, 2017, GST consolidated multiple state and central taxes into a single tax applied to the supply of goods and services across the country.

GST is structured to promote transparency and remove the cascading effect of tax-on-tax. It is applicable at every stage of the supply chain, right from the manufacturer to the end consumer. The tax you pay is divided among different authorities based on the nature of the transaction:

• Central Goods and Services Tax (CGST): Collected by the central government on intra-state sales (within the same state).
• State Goods and Services Tax (SGST): Collected by the state government on intra-state sales.
• Integrated Goods and Services Tax (IGST): Collected by the central government on inter-state transactions (between different states).
• Union Territory Goods and Services Tax (UTGST): Applied in Union Territories where SGST does not apply.

Depending on the product or service, GST rates are categorized into different slabs: 0%, 5%, 12%, 18%, and 28%. While some essential items are exempted, most consumer goods and services fall within the 5% to 28% range.

By unifying the taxation system, GST has simplified compliance for businesses and ensured that you, as a consumer, pay a more streamlined and transparent form of tax.

Features of Indirect Tax

Indirect taxes are an important part of our financial system. They help create a fair and efficient way for the government to collect money. These taxes are added to the price of goods and services when you buy them, which makes it easier for the government to collect taxes without making it complicated for everyone.

Let’s break down some of the key features of indirect taxes and why they are beneficial for both individuals and society:

Streamlined Tax Liability

Indirect taxes help maintain a smooth tax process. When you buy a product or service, you’re charged tax, which the seller or manufacturer collects and then hands to the government. This simplifies the flow of taxes.

Progressive Nature

The nature of indirect tax has become more progressive with the consistent application of those taxes nationwide. It benefits buyers, sellers, and the government by eliminating confusion and tax overlaps. Plus, it has significantly reduced instances of tax fraud.

Reduced Tax Evasion

Since indirect taxes are applied directly to the sale and purchase of goods and services, there’s been a notable decrease in tax evasion. This helps create a more transparent process for both administering and collecting taxes.

Savings and Investment

Indirect taxes can indirectly encourage savings and investments. For example, when certain goods or services are taxed, you might save or invest that money instead of spending it on those taxed items. Over time, this can help boost your financial health.

Charged at the Point of Sale

“Point of sale” simply refers to where you make a purchase, whether in a grocery store, mall, movie theater, or online. Indirect taxes are usually added at this point, meaning the tax is already factored into the price. The seller then collects this tax and passes it on to the government.

Broader Social Coverage

One key advantage of indirect taxes is their broad reach. Because they’re tied to everyday products and services, more people pay them than direct taxes. This ensures that people from various income levels contribute, as these taxes are applied across a wide range of goods and services.

Benefits of Indirect Tax

Indirect taxes in India 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, they are imposed on goods and services.

Revenue Generation

One of the primary advantages of these 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 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 them by spending more on taxable goods and services. This indirect approach helps achieve 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 them, 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

They provide governments with a flexible policy tool that can be adjusted to address changing economic conditions. During 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 them a valuable instrument for economic management.

Reduced Tax Evasion

Compared to direct taxes, they 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.

Limitations of Indirect Taxation

While indirect taxes are an essential part of the Indian revenue system, they do come with a few downsides that can impact you directly:

Can discourage spending

When products or services become more expensive due to taxes, you might think twice before buying them. This can reduce overall consumer demand, especially for non-essential or luxury items, and indirectly affect businesses and job markets.

Unstable revenue for the government

Since indirect taxes are linked to consumption patterns, any economic slowdown or drop in demand can lead to inconsistent tax collections. This makes it harder for the government to forecast revenues and plan budgets effectively.

Impact on essential items

In some cases, essential goods like medicines, food items, and utilities may still attract taxes. Even small tax rates on these necessities can create financial stress for lower-income families and widen socio-economic gaps.

Understanding these limitations can help you be more aware of how indirect taxation affects not just your spending but also broader economic policies and household budgets.

Who is Eligible to Pay Indirect Tax?

If you’re buying goods or using services in India, you are likely paying an indirect tax. But that’s not all; different parties in the supply chain are also responsible for collecting or remitting these taxes based on their roles. Here’s a breakdown of who is typically eligible to pay indirect taxes:

Consumers

Every time you make a purchase, be it a cup of coffee or an online subscription, you pay GST, which is included in the final price. So technically, you’re contributing to indirect tax every day.

Businesses with Turnover Above Threshold

If you own a business and your annual turnover exceeds ₹20 lakhs (₹10 lakhs for North-Eastern and hill states), you’re required to register for GST and collect it from your customers. This tax is then paid to the government.

Importers and Exporters

If you deal in cross-border trade, you may be liable to pay customs duty, which is another form of indirect tax. It applies to goods being brought into or sent out of India and is governed by the Customs Act.

Manufacturers of Specific Goods

Although most excise duties have been subsumed under GST, some items like alcohol for human consumption and petroleum products still attract excise duty. If you manufacture or supply such goods, you are liable to pay this tax at the time of removal from the warehouse.

So, whether you’re running a large-scale business, importing goods, or just buying groceries, you are either directly or indirectly part of India’s indirect taxation system.

Wrapping Up

Indirect taxes play a vital role in shaping a nation’s fiscal landscape, significantly influencing market dynamics and consumer habits. By understanding the indirect tax list, which includes GST, customs duty, excise duty, and others, individuals and businesses can better comply with financial regulations and plan their expenditures wisely. As India’s taxation framework continues to evolve, keeping up with these changes is essential for both economic participation and policy alignment.

FAQs on Indirect Tax