Difference Between Direct & Indirect taxes
Difference Between Direct & Indirect taxes
Tax is a mandatory recurring fee paid to the Central and State Governments of India and is the Indian government’s primary source of income. It aids in the country's overall economic development. Indian citizens must pay their taxes according to their income slabs on time. This applies to corporate entities as well. Sounds simple enough, but people are often confused between direct tax and indirect tax.
Despite being obligatory and exceedingly common, many Indians are unaware of the terms of taxation and have difficulty understanding the difference between direct and indirect tax. This can be problematic, especially during tax season, as failure to pay your taxes within the due date can result in huge penalties.
At a broad level, taxes can be differentiated into two categories: Direct and Indirect. Their categorisation is based on how the taxes are paid to the Indian Government. Therefore, understanding the difference between direct and indirect tax is essential when filing your own tax returns.
First, let's start by answering the question, "What is direct and indirect tax?"
What is Direct Tax?
Direct taxes need to be paid directly to the authority imposing the tax. As a taxpayer, you can not transfer this liability to another entity and must pay this amount yourself. Simply put, the tax must be paid directly to the government and cannot be paid to anyone else.
The Central Board of Direct Taxes (CBDT) collects and administers direct taxes. The CBDT is governed by the Department of Revenue, which provides the Indian government with input related to direct tax implementation.
You should also note that the direct tax system is levied on a bracket system. This means that individuals and corporations that earn a higher income will pay higher taxes.
A direct tax example would be if you invest in a company, you get some shares allotted to you that you can sell to earn a profit. You will then have to pay a direct tax on the profit you earn.
The Benefits and Drawbacks of Direct Taxes
Here are some points to consider in the direct tax vs indirect tax debate:
Benefits of Direct Tax
Direct taxes primarily benefit the Indian economy through wealth redistribution, inflation curbing, and promoting class equity. Here are how these benefits play out in practice:
Curbs Inflation: In cases of monetary inflation, the government can increase the direct tax rate to reduce the demand imposed on goods and services. This reduction in demand helps to lower inflation.
Equitable: Direct taxes are based on the progression principle, which surmises that equality in taxation means equality in sacrifice. This simply means that taxpayers are taxed proportional to their incomes.
So people with high incomes pay higher taxes, and those with lower incomes pay lower taxes, so they are not made to pay excessive tax rates. This is also a major difference between direct and indirect tax.
Redistributes Wealth: This ties into the previous two benefits. Higher taxes collected from the upper classes and the top earning percentile of the population are used by the government to launch new initiatives for low-income people.
Drawbacks of Direct Tax
Direct taxes play a significant role in increasing the government's revenue, leading to better economic development, but they have their downsides.
Too Much Paperwork: Direct taxes like income tax must be paid as a lump sum at the end of the year. This can burden taxpayers since the documentation process can be tedious and complex.
Possibility for Evasion: The Indian government has made every effort to minimise the possibility of tax evasion and fraud. However, individuals and corporations still find ways to either avoid or pay lower taxes than they should.
Discourages Investments: Direct taxes fully depend on the taxpayer's income, and the imposition of direct taxes like capital gains tax and securities transaction tax can discourage many from investing or seeking investments.
Types of Direct Tax
Here are the various types of direct taxes with direct tax examples given below:
Income Tax: Income tax is paid based on the taxpayer’s age and earnings and is levied based on their residency status. Individuals who are Indian residents must pay taxes on their worldwide income in India. This includes money generated in India and abroad.
NRIs or Non-Residents of India must only pay taxes on their Indian income. Their residential status for each fiscal year (FY) must be determined independently.
The Government of India determines the income tax rate for each group, and taxpayers must file their Income Tax Returns (ITR) every year. Taxpayers can sometimes receive a refund or may have to pay a tax, depending on their ITR. Failure to file your ITR can result in huge penalties.
Corporate Tax: Except for shareholders, domestic and foreign companies who make an income in India must pay corporate tax. The profit and income acquired while selling services like technical service fees, dividends, royalties, or interest rates based in India are all taxable under corporate tax.
Other taxes that fall under corporate tax include:
Securities Transaction Tax (STT): Any income earned via taxable security transactions. For example, this can be income earned through stock trading.
The broker collects the tax from you and passes it onto the securities exchange, which then passes it to the government.
Dividend Distribution Tax (DDT): DDT is levied on any domestic companies that declare, distribute, or are paid any amounts as dividends by shareholders. However, DDT is not levied on foreign companies.
Fringe Benefits Tax: Levied on companies that provide fringe benefits for maids, drivers, etc.
Minimum Alternate Tax (MAT): Levied on zero-tax companies with accounts prepared according to the Companies Act.
Capital Gains Tax: Capital gains tax is a direct tax levied on profits earned from the sale of investments or assets. This can include property, bonds, shares, businesses, art, etc. This tax can be classified into long-term and short-term capital gains tax based on its holding term.
Short-Term Capital Gains Tax: Any assets excluding securities, sold within 36 months from the time they were acquired.
Long-Term Capital Gains Tax: Levied on the sale of properties or assets held for over 36 months.
[Note: Wealth tax and Estate tax have been abolished and are therefore not included here.]
What is Indirect Tax?
Indirect taxes are imposed on goods, products and services and are paid to the Indian Government through an intermediary party. Hence they are called indirect taxes. The main difference between direct and indirect taxes is that indirect taxes do not depend upon the taxpayer’s income.
This means the tax rate is the same for everyone. So your tax rate will not differ if you are in a higher tax bracket or earn a higher income.
The Central Board of Indirect Taxes and Customs (CBIC) collects and administers this tax and is also governed by the Revenue Department, the same as direct taxes.
For example, GST is a form of indirect tax charged on goods and services and is the most common type of indirect tax you will encounter. These taxes are collected from retail and wholesale owners regularly.
The Benefits and Drawbacks of Indirect Tax
Here are some benefits and drawbacks of indirect tax to help you better answer the question, "What do you mean by direct and indirect tax?"
Benefits of Indirect Tax
Indirect taxes are easier to pay and are generally more convenient overall when compared to direct taxes. Here are some key benefits of indirect taxes.
**Everyone Plays a Part: A country's economy is only as good as its contributors. This is exemplified through indirect taxes, where everyone participates, unlike direct taxes, where people with lower annual incomes are often exempt from paying.
Convenient: Indirect taxes are paid in small amounts throughout the year rather than a lump sum, which is the case with direct taxes. So every time you purchase a product or service, the GST is already included in the overall price, which makes payments more convenient.
Easy Collection: The key difference between direct and indirect tax lies in how they are paid. Unlike direct taxes, where there is an excessive documentation and payment process, indirect taxes require you to pay only when purchasing a product or service.
Drawbacks of Indirect Tax
The ease and convenience of indirect taxes, however, come at a cost. Here are some drawbacks of indirect taxes that you must remember when considering taxation terms and differences.
Regressive: Unlike direct taxes, which are progressive, indirect taxes are regressive. They require everyone to pay the same tax rate, irrespective of their income or tax brackets. This can be inequitable and lead to burdening taxpayers from lower tax brackets.
Makes Products and Services More Expensive: Since indirect taxes are an additional price added to goods and services, it can make them more expensive. For example, products like cigarettes, luxury bikes and cars are included in the 28% tax slab of GST.
Taxpayers are Unaware of the Charges: Unlike direct taxes, where the taxpayers know exactly what taxes they are paying, with indirect taxes, people are often unaware of the charges.
This is because indirect taxes are imposed on all goods and services, and it can be hard to keep track of every purchase you have ever made.
Types of Indirect Tax
Here are the types of indirect taxes you will most likely encounter when purchasing goods, products or services in India.
Goods and Services Tax (GST): GST comprises as many as 17 different types of indirect taxes. It is a single, comprehensive indirect tax imposed on all goods and services to eliminate the tax-on-tax effect of the precious tax regime.
The tax rates are implemented according to the tax slab laid down by the GST Council. For example, Tata AIG's health insurance plan GST rate is charged at 18%, and all Indian citizens must pay this tax when purchasing a medical insurance plan.
Value-Added Tax: It is a consumption tax added to products whose value increases according to supply. The State Government imposes the VAT tax rate, which decides the taxation rate for different goods.
This tax was mostly eliminated after the introduction of GST. However, it is still imposed on certain products, like alcohol.
Customs Duty: Products that must be imported from a foreign country require you to pay customs. This fee is implemented regardless of how the product gets shipped to India. The customs duty tax was brought forth to ensure that all products entering India are taxed.
The Differences Between Direct and Indirect Taxes
Now that you know what is direct and indirect tax, this section will help you understand the differences between them. Doing so will better help you grasp the definitions of direct tax and indirect tax and, consequently, learn how it impacts taxpayers.
Direct tax and indirect tax distinguish between themselves in the following ways:
|Context||Direct Tax||Indirect Tax|
|Definition||Paid directly to the government by the taxpayer.||Paid to the government via an intermediary party.|
|Imposed On||Taxpayer’s profit and income.||Goods and services.|
|Who Is Paying?||Individuals, HUFs (Hindu Undivided Family), Corporations and businesses.||End consumers of goods, products and services.|
|Tax Rate||Directly depends on the taxpayer’s income and profits.||Same for everyone.|
|Taxation Process||Complex and Tedious.||Simple and Convenient.|
|Transfer Of Liability||Non-transferrable.||Can be transferred.|
Tax Slabs for Direct Tax Rates Under Both Regimes (FY 2022 - 2023)
Currently, Indian taxpayers can choose between the new and old tax regimes when filing their taxes for a fiscal year. Their tax rates will be different based on the regime they choose.
Indian citizens are eligible to pay income tax if they are aged below 60 years and their annual income exceeds ₹2.5 lakhs. For Indian citizens over 60 years, their annual income should exceed ₹3 lakhs to be eligible to pay income tax in India.
Below are the slab rates for the various groups under the new and old tax regime during FY 2022 - 2023, imposed by the Government of India. These direct tax examples will give you a better idea about direct taxes.
Beyond these slab rates, you must also note that the Government of India levies a 4% health and education cess as a direct income tax liability for individuals.
Here are the various income tax slab rates for the various categories:
Income Tax Rate for Individuals Below 60, HUFs, and NRIs
These are the slab rates for taxpayers below 60 years under the new and old tax regimes for FY 2022 - 2023.
Indirect Tax Slab: GST Slab Rates
The GST Council is responsible for deciding the GST slab rates for various groups of goods and services. They are typically high for luxury items and lower for necessities. There are four main slabs for GST rates in India: 5% GST, 12% GST, 18% GST, and 28% GST.
In addition, there are two more GST rates that are less commonly used, 3% and 0.25%. These are used as tax rates for cut and semi-precious stones like diamonds. Furthermore, TDS and TCS are also included under GST with 2% and 1% rates, respectively.
Lastly, GST law imposes a cess on certain items like tobacco, cigarettes, aerated water, gasoline, and motor vehicles, with rates ranging from 1% to 204%.
Now that you know the slab rates for the most common types of direct and indirect taxes, you should have a clearer understanding of what direct and indirect taxes are.
Tax Exemptions and Deductions - Section 80D and Section 80C
Here are the most common tax exemptions and deductions taxpayers can avail on their direct and indirect taxes under sections 80C and 80D.
Income Tax Exemptions for Salaried Employees - Section C
One of the most well-liked sections among taxpayers is Section 80C under the Income Tax Act. Section 80C primarily allows taxpayers to lower their taxable income by making specific tax-saving investments or incurring qualified costs.
The highest annual deduction taxpayers can make under this section is ₹1.5 lakhs, with an additional ₹50,000 that is permitted under Section 80CCD (1b).
In addition, individuals and HUFs can take advantage of this discount to get a tax deduction on their direct and indirect taxes. Various expenses and investments like PPFs, tuition fees, medical insurance plans, post office tax-saving deposits, etc., can be claimed under Section 80C.
Subsections 80CCC, 80CCD (1), 80CCD (1b), and 80CCD are all also part of Section 80C.
Section 80D for Medical Insurance Plans
Health insurance is a key example of investments and purchases that make you eligible for this tax deduction. These deductions can be availed through your health insurance premiums, with the maximum limit being ₹1.5 lakhs.
Here is a further breakdown of the deductions under health insurance.
- Deductions for Medical Insurance Plan Premiums
Section 80D allows individuals and HUFs to deduct ₹25,000 for insurance for themselves, their spouse and their dependent children. An additional ₹25,000 can be deducted if your parents are under 60 years and ₹50,000 if they are older than 60.
If the taxpayer and the taxpayer's parents are 60 years or older, their maximum deduction amount is ₹100,000.
- Deductions for Medical Expenditures
These medical expenses can be either for you or a dependent relative. Here are the deductions for the various groups insured under a medical insurance plan:
- People and HUFs Under 60 Years: People that fall under the categories of resident individuals or HUFs are eligible for a deduction of up to ₹40,000.
The policyholder can use this amount to cover treatments and expenses covered under the policy for either themselves or their dependents.
- Senior Citizens: Taxpayers can claim a standard deduction of up to ₹100,000 for elderly and super senior citizens whose medical costs were incurred during the policy term.
Remember, to claim these deductions, you must have the necessary documentation. This means you will need the relevant bills, receipts, and prescriptions for the medical treatments and expenses from the hospital or physician.
Key Takeaways on Direct and Indirect Taxes
Here are some key takeaways from this article to better help you understand the difference between direct and indirect tax:
Direct taxes are paid directly to the Indian government by the taxpayer (you); the tax rate depends on your annual income and earnings, and only you can pay them.
Indirect taxes are paid whenever you purchase a product or service and are paid to the Indian Government by the intermediary party (the retailer). These can be transferred.
Direct and indirect tax rates are both governed by the Revenue Department.
Direct taxes include income tax, corporate tax and capital gains tax. All three must be filed every year.
Indirect taxes include GST, value-added tax and customs tax. These are paid when purchasing the product or service.
Direct taxes like income tax allow for exemptions for specific groups of people. Namely, those under 60 years earning below ₹2.5 lakhs and those over 60 earning below ₹3 lakhs.
Indirect taxes do not have any exemptions because they are included as a part of the overall price of the product or service you are buying.
Direct taxes are progressive. The higher your income, the higher your tax rate. In contrast, indirect taxes are regressive and have the same rate for everyone, which can make products and services more expensive than they actually are.
Indirect taxes are impossible to evade. However, direct taxes can be evaded.
Direct and indirect taxes play a crucial role in sustaining the Indian economy. This is why It is imperative that residents pay their taxes one time, as it effectively curbs inflation, redistributes wealth and encourages equity.
Similarly, getting a medical insurance plan from Tata AIG as it makes you eligible for a tax deduction, making it a wise investment choice. However, the tax deductions also depend on your health insurance premiums, so it is best to compare health insurance plans before purchasing them.
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Your policy is subjected to terms and conditions & inclusions and exclusions mentioned in your policy wording. Please go through the documents carefully.
What is income tax on salary, and how is it calculated in India?
What is income tax on salary, and how is it calculated in India?
Income tax on salary is the tax that individuals must pay on their income through employment or salary. The income tax is calculated based on the individual's income tax slab rates, which vary based on their income level. The income tax calculation on salary in India considers various deductions, such as standard deduction, professional tax, and other tax-saving investments under various sections of the Income Tax Act.
What are the income tax slab rates for calculating income tax on salary in India?
The income tax slab rates for calculating income tax on salary in India are as follows:
There is no tax for individuals with an income of up to ₹3 lakhs.
For individuals with an income between ₹3 lakhs and ₹6, the tax rate is 5%.
For individuals with an income between ₹6 lakhs and ₹9 lakhs, the tax rate is 10%.
For individuals with an income between ₹9 lakhs and ₹12 lakhs, the tax rate is 15%.
For individuals with an income between ₹12 lakhs and ₹15 lakhs, the tax rate is 20%.
For individuals with an income above ₹15 lakhs, the tax rate is 30%.
What are the deductions available for calculating income tax on salary in India under the new regime?
There are various deductions available for calculating income tax on salary in India. Some of the most common deductions include: Standard deduction for salaried people up to ₹50,000 Standard deduction on such pension: ₹15,000 or 1/3rd of pension, whichever is lower. Interest on Home Loan (24B) on Let-out property Employer's contribution to NPS (National Pension Scheme) All contributions to Agniveer Corpus Fund (section 80CCH)
What is Form 16, and why is it important for income tax calculation on salary in India?
Form 16 is a certificate issued by an employer to their employee at the end of the Financial Year (FY). It contains details of the employee's salary, allowances, tax deducted at source (TDS), and other relevant information. Form 16 is important for income tax calculation on salary in India as it provides a comprehensive summary of the employee's income, which can be used to calculate their tax liability and file their income tax returns.
How can I calculate my income tax on my salary online?
You can calculate your income tax on salary in India using an online income tax calculator available on the Income Tax Department and other financial websites. To calculate your income tax, you will need details such as your gross salary, deductions like Provident Fund (PF), National Pension System (NPS), and other tax-saving investments such as Public Provident Fund (PPF), Equity-Linked Savings Scheme (ELSS), Life Insurance Premium, and other eligible investments. Once you have entered all the required details, the calculator will estimate your income tax liability.