What is Difference between Direct and Indirect Taxes?

Fintown TeamTaxLeave a Comment

Direct taxes

Direct Taxes

Individuals, HUFs, companies, etc. pay direct taxes to the Central or State Government respectively. These taxes have fixed tax-slab rates based on the income earned. The types of direct tax in India are Income Tax, Wealth Tax, Corporate Tax, Estate Duty, Fringe Benefits Tax, Gift Tax, etc.

Indirect Taxes

Manufacturers and service and/or good providers pay indirect taxes. These manufacturers or service/good providers then shift the burden of the tax to the consumer by increasing the overall price of the good or service. The types of indirect tax in India are VAT, Excise Duty, Customs Duty, Service Tax, Sales Tax, Entertainment Tax, etc.

Note: Most Indirect Taxes have been or are being replaced with the Goods and Service Tax (GST)

Direct vs Indirect Taxes

  1. The incidence of Taxation – A direct tax is payable by a person or organization on whom the tax is levied. A person or organization collects indirect tax. But the incidence of tax is actually borne by another individual or organization. With direct tax, the incidence of tax does not shift, but with indirect tax, the incidence of tax shifts.
  2. Tax Levy – Direct taxes are levied on individuals, Hindu Undivided Families (HUF), companies, organizations, etc. and the tax burden cannot be passed on. Indirect taxes are levied on the end consumer. When an end consumer purchases a service or good, they have to pay indirect tax. This causes the price of that service or good to increase. For example, If A has to pay direct tax, then only A can and must pay that tax. If A pays indirect tax when selling goods or services, that tax can be passed on to the consumer.
  3. The rate of tax – Direct taxes are variable based on the tax slab rates. An individual will have a higher tax rate if they earn more and vice-versa. Indirect taxes have a fixed rate of tax on goods and services. All individuals will have to pay the same amount of tax to procure a good/service. For example, The direct tax rates are 10% (INR 3,00,000 – 5,00,000), 20% (INR 5,00,000 – 9,99,999) and 30% (above INR 10,00,000). Indirect tax rates are based on the good or service.

Other Differences Between Direct vs Indirect Tax

  1. Tax Evasion – It is relatively easier to evade paying direct taxes because of lack of administration. Indirect tax is payable on the purchase of services or goods. It is harder to evade paying indirect taxes. For example, Indirect taxes are collected at the source even though the incidence of taxation is passed on. One must pay direct taxes after income comes in.
  2. Purpose – The purpose of a direct tax is for the redistribution of wealth and to reduce inflation. Direct taxes is a progressive tax, although it reduces savings and investments. Indirect tax is regressive. The burden of tax is equally distributed irrespective of income. Indirect taxes also cause inflation. On the other hand, indirect taxes encourage taxpayers to save and reduce consumption. For example, The Government can use indirect taxes to increase the price of tobacco, alcohol, etc. This will discourage the consumption of such goods and/or services.

Leave a Reply

Your e-mail address will not be published.