Difference Between Direct And Indirect Taxes

Direct tax is directly levied on an individual or organisation, while indirect tax can be transferred from one person or entity to another.

Though this is the basic difference between direct and indirect taxes, several other notable differences deserve attention. Understanding direct vs indirect taxes will help you identify your responsibilities as a taxpayer and ensure compliance when it is of utmost importance.

Here is a quick insight into the differences, direct vs indirect tax examples and everything you need to know. 

What is Direct Tax?

Direct tax is a type of tax imposed directly by the government on an individual or business entity. The taxpayer is responsible for paying this tax to the government and cannot pass it on to another person or business entity.

Direct tax is charged on income or profits. Furthermore, it is progressive and increases based on the type and amount of income earned by the taxpayer.

In India, direct taxes are collected and governed by the Central Board of Direct Taxes (CBDT).

What is Indirect Tax?

Indirect tax is a type of tax imposed by the government on goods and services and can be transferred from one taxpayer to another. For instance, a wholesaler of cosmetic products will transfer the responsibility of paying the tax to the retailer. Further, the retailer will pass it on to the end customer.

Therefore, the end customers are liable to pay the indirect tax applicable to the goods or services. Intermediaries, such as retailers, are responsible for collecting the tax from the consumers and then remitting it to the government.

In India, indirect taxes are collected and governed by the Central Board of Indirect Taxes and Customs (CBIC).

Difference Between Direct and Indirect Taxes

Types of Direct Taxes

Income Tax

Income tax is charged on the income or profits earned by individuals or business entities during a financial year. It is calculated based on the income tax slabs and rates applicable to that particular financial year.

When paid by a business entity or company, it is referred to as corporate tax.  

Capital Gains Tax

The government directly imposes capital gains tax on the profit or gain arising from the sale of a capital asset.

These can include land, residential property, jewellery and more. The tax is based on the investment tenure and is payable in the year the transaction occurs.

Securities Transaction Tax

Securities transaction tax is charged on the sale or purchase of financial securities listed on authorised stock exchanges in India. It also applies to unlisted shares in an IPO that are subsequently listed on stock exchanges.

The tax is applicable to equities, units of equity-oriented mutual funds and derivatives and is charged on every transaction.

Others

There are also other taxes, such as the property tax that is imposed on a property or land owner by the respective local government or municipal corporation. It includes any type of real estate property, such as residential properties and office buildings.

Types of Indirect Taxes

Goods and Services Tax (GST)

Goods and services tax is now the unified domestic indirect tax that replaced several previous indirect taxes in India, such as VAT, excise duty and services tax.

GST is imposed on goods and services and is calculated based on its type, composition and location at multiple stages. It is charged on every value addition throughout the supply chain.

Customs Duty

It is an indirect tax levied on goods transported across international boundaries. It is determined by the origin of the goods and their composition.

Customs duty is charged on all imported goods and certain goods exported out of the country.

Others

GST subsumed most of the indirect taxes applicable to a wide range of products. There are a few exceptions, such as the tax charged on petrol, diesel and alcohol.

Benefits of Direct Tax

• Promotes Equality- Direct taxes are levied based on income. Therefore, people with lower incomes pay lower taxes, while those with higher incomes pay higher taxes.
• Controls Inflation- The government can influence the demand for goods and services by revising the income tax slab rates. Higher direct tax rates can reduce the demand for goods and services, controlling inflation.
• Helps in Development Initiatives- By collecting higher income taxes from people with higher income levels, the government can engage in development projects benefitting the economically weaker sections of Indian society.
• Higher Degree of Certainty- As direct taxes are predetermined, certain and consistent to an extent, the government can make planned infrastructural developments.

Disadvantages of Direct Tax

• Tax Evasion- Since taxpayers are responsible for paying direct taxes rests with the taxpayers, they can engage in fraudulent practices to report lower income and avoid paying the tax.
• Can Disrupt Financial Growth- A higher tax rate on income or capital gains can discourage people from making investments for future financial growth.
• Complex Procedures - Applying the income tax exemptions and deductions, calculating income tax liability and preparing the documentation can be complicated and time-consuming.
• Administrative Challenges- The cost of collecting taxes can exceed the actual amount in certain cases.

Benefits of Indirect Tax

• Collective Contribution- By imposing an indirect tax on goods and services, every individual is contributing to the country’s growth, regardless of their income.
• Unavoidable- The indirect tax is paid by the consumers at the time of purchase. Hence, it cannot be avoided.
• Easy Collections and Payments - The tax is collected at the time of the product’s delivery of the products, so there is less documentation involved.
• Fair Distribution- Essential products are imposed with a lesser tax rate than luxurious products.

Disadvantages of Indirect Tax

• Increase in Overall Price- As the indirect tax is applied to the base price of the goods and services, it increases the overall cost for consumers.
• Lack of Awareness- Since the indirect tax is added to the price of products, the consumers may not be entirely aware of the exact amount of tax they are paying.
• Unpredictable Revenue- The revenue generated from indirect taxes can be unpredictable due to the change in demand and supply, creating challenges in government initiatives.
• Not Equitable- Indirect taxes on products remain the same for all consumers, regardless of their income. This can disproportionately affect people with lower income.

Difference Between GST and Income Tax

Paying Taxes: A Fundamental Responsibility Beyond Moral Obligation

Contribution to the Social Cause

By ensuring the payment of applicable direct and indirect taxes, you help support various developmental initiatives in India. This includes essential services, such as education and infrastructure.

Maintain Public Services

Tax payments fund the maintenance of essential public services, such as transport,  sanitation and healthcare.

• Legal Compliance

Paying taxes is legally mandatory. Non-compliance can result in high penalty charges.

How to Reduce Your Income Tax Liability?

The Income Tax Act 1961 provides various income tax exemptions and deductions to help you reduce your taxable income. Section 80C and Section 80D are the two common provisions used by salaried taxpayers.

While Section 80C provides tax deductions for the payments made for a wide range of savings and investment plans, Section 80D is exclusive to health insurance premium payments.

Section 80D provides a tax deduction* of up to ₹1 lakh for the health insurance premium paid for yourself, including your spouse and dependent children and parents.

Explore Reliance General Insurance and our health insurance policies online to secure financial support for your healthcare requirements while also saving on taxes.

Frequently Asked Questions About Direct vs Indirect Taxes

• Is GST a direct or indirect tax?

GST (Goods and Services Tax) is fixed and charged on goods or services and is an indirect tax. It is based on the type and composition and varies across the different states in India.

• Who is liable to pay direct tax?

Individuals and business entities earning an income or profits, which are taxable under the Income Tax Act 1961 are liable to pay direct taxes.

• How do I know which is direct or indirect tax?

Direct taxes apply to income or capital gains earned and are paid directly by the taxpayer to the government. On the other hand, indirect taxes are charged on goods or services. End consumers pay them to retailers or wholesalers, who then remit them to the government’s account.

• Is custom duty direct or indirect tax?

Customs duty is an indirect tax on goods transferred across international borders. It is charged on all imported goods and certain other products exported out of the country.

• What type of tax is corporate tax?

Corporate tax is a form of direct tax as it is charged on a business entity’s income.

• What is TDS?

TDS refers to Tax Deducted at Source. It is the process of deducting tax at the source by the payer when making a specific payment. It applies to salaries, interest amounts, rent, etc.

• Is TDS a direct or indirect tax?

Tax Deducted at Source (TDS) is a form of direct tax. It is deducted directly from the source of income and paid to the government.​

Disclaimers:

*T&C Apply. For more details on risk factors, terms conditions, brochure, and exclusions, please read the policy wording and CIS carefully before concluding a sale.

Tax benefits are subject to conditions under the Income Tax Act and amendments thereof. The tax laws are subject to amendments/changes from time to time. Please consult your tax advisor for details.