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What is the difference between a Direct Tax and an Indirect Tax?

Dec 06, 2018 | 2 years ago | Read Time: 3 minutes | By iKnowledge Team

Taxes are primarily levied to raise funds for government expenditures, and the purpose of taxation is to differentiate between the objectives of income redistribution, economic stability and resource allocation. Taxes are further classified into two categories, depending on whether the taxes are levied on an individual or an entity, or on every supply of goods and services.

The taxation system in our country is demarcated, with specific roles for the central and state governments. According to a survey conducted in 2016 by KMPG to find the highest individual tax rates in developed and emerging economies, India was placed in the middle, at 35.5%.

Source: LiveMint [1]

Types of taxes in India

In India, the central government levies taxes such as the income tax, service tax, custom duties and central excise duty, while the state government levies taxes on agricultural income, state excise duty, stamp duty, value added tax, land revenue and professional tax. The two types of taxations differ based on their implementation.

What is a direct tax?

Direct taxes are directly levied on individuals and corporate entities, and are paid directly to the government.

According to the Income Tax Act, 1961, every individual or entity, whose earning exceeds the maximum exempt limit must pay the direct tax. The Union Budget prescribes the tax structure and rates annually.

Corporate tax, income tax, gift tax and minimum alternate tax fall under the direct tax. The tax rate for large corporates is 30%, while the tax rate for MSMEs is 25% in India. However, the tax rate for foreign companies is 40%.

Source: India Briefing[2]

What is an indirect tax? 

Indirect taxes are not paid directly by the individuals or entities to the government. Instead, these are the taxes that are levied on goods and services collected by intermediaries.

Value added tax (VAT), customs duty, octroi, excise duty and service tax fall under the indirect tax.

The introduction of the Goods and Service Tax (GST) has been a significant step towards the indirect tax reformation in the country. GST is a comprehensive indirect tax, levied on sale, manufacture and consumption of goods in the country, and will absorb numerous indirect taxes levied by the central and state governments.

Direct tax versus Indirect tax

Apart from the differences in their taxation approach, both direct and indirect taxes have various distinctions. For instance, direct taxes are paid at the end of the financial year, while indirect taxes are levied on the goods and services individuals purchase. Another key distinction is the fact that direct taxes are progressive, which implies that the more you earn, the higher is the likelihood of the tax outgo. Indirect taxes are fixed, which implies that everyone pays the same tax, regardless of the disparity of the income levels. The indirect tax is sometimes referred to as ‘regressive tax’, because it places a comparatively higher burden on the poorer sections of the population.

Source: Reserve Bank of India[4]

Direct and indirect taxes both make up the Indian taxation system, and ensure economic stability, moving the country towards economic progress.

To easily understand your direct tax liability, you can make use of a variety of income tax calculators on offer. Aegon Life’s free income tax calculator is a convenient solution to understand your direct tax liability in a given year.

The Income Tax Act, 1961 provides several sections that facilitate efficient tax savings. Insurance is one of the financial instruments encouraged by the government via tax breaks. For instance, Aegon Life’s iMaximize Plan is an excellent tax saving instrument, that comes with 6 unit linked funds that you may choose from according to your requirements and risk profile. It enables tax saving under section 80C of the Income Tax Act, 1961.

Both direct and indirect taxes are important for the growth of the nation. Understanding the taxation structure better can help you understand how you are contributing towards the country’s growth.

II/Oct 2018/4513


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