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Direct Tax vs Indirect Tax

As they say, nothing is certain except death and taxes. Since we would like to focus on the more cheerful of these two options, lets’s talk of taxation.

Taxes come in various avatars. They include sales tax, income tax, service tax, corporate tax and many others. In fact there are so many taxes that an average person often doesn’t even know that he/she is paying for one.


The 2016 Union Budget is just round the corner, and like all years, there’s a lot of noise regarding taxes. Well, taxes don’t merely mean your income tax. While income tax is an example of direct tax, the ones that we really don’t see are indirect taxes.

The most fundamental classification of direct and indirect taxes in based on who collects them from the tax payer.

Here’s how the two differ.

Direct Tax vs Indirect Tax Infographics

Direct vs Indirect Tax

Direct taxes

This levy is payable directly by a person or a company who is obliged to pay the same. Direct taxes can’t be transferred to anybody else. Income tax, as already said, is the commonest form of direct tax. It’s payable by individuals, cooperative societies, Hindu undivided families (HUFs), trusts, and similar organizations, on the total income earned. It may include income from salary, house property, professional or business income, capital gains, as well as income from other sources, like savings account or recurring deposit interests. The tax liability depends on the gender and residential status of a person subject to tax.

Companies are similarly taxed on their earned income. For any Indian company, the tax is mandatory on the income earned within the country and overseas, while in the case of non-resident companies, tax must be paid on the money earned in India.

House owners have to pay property tax that is applied according to the rules in the state. Lastly, tax has to be paid on gifts that exceed ₹50,000 per annum.

The responsibility to declare income for the purpose of calculating the direct tax liability is on the individual. Non-payment or evasion could lead to heavy penalties.

Indirect taxes

These are levied by the government and collected by an intermediary authority from the person who shoulders the ultimate burden of the tax. This means that if you are buying some goods or services from somewhere and if you are the final consumer, the tax levied on the manufacturer will be passed on to you. Indirect taxes increase the total amount you have to pay for some products or services. Sometimes, it could be shown separately from the price of the product or could be included in the price. For instance, service tax paid on food bills, is shown separately, while the tax paid on petrol is included in the price of the product.

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There are many other forms of indirect taxes. For instance, customs duty is a tax imposed on imported and exported goods to and from the country. Besides, the government charges excise duty on goods and services produced within India for domestic consumption. Service tax is levied on services like travel and recreation, food and beverages, and similar items by the provider, while the value-added tax (VAT) is applied on each stage of the sale of an item in a piecemeal system. The last VAT part is borne by the final consumer. Lastly, there’s a securities transaction tax charged on all transactions carried out in a stock exchange. All these taxes are called indirect taxes because unlike a direct tax, the person paying the tax can pass it on to another party. These taxes are first levied at the manufacturer-level and are passed to the final consumer, which is you.


The gist of distribution of direct and indirect tax lies in the shifting. A tax which can’t be shifted is direct, and the one which can be shifted is indirect. While the conventional distinction between a direct and indirect tax is logical enough, it’s very difficult to apply in practice, and calls for a fair knowledge of the behaviour of people on tax payment.

Unless you know whether the tax has shifted from an immediate payer to someone else, you can’t categorise it as indirect or direct. Besides, difficulties may arise when the tax is partly shifted and partly borne by the individual on whom it’s imposed.

Does it then mean that a tax can be partly indirect and partly direct? Surely not. It’s better to put it this way that a possibility of shifting to any degree may be regarded as a condition for indirect tax. Lack of shifting, on the other hand, could be regarded as a direct tax.

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Several economic experts, however, distinguish between indirect and direct tax on the basis of assessment, instead of the point of assessment. Taxes, direct or indirect, are assessed on expenditure incurred or income earned.

A major criticism of indirect taxation, often mooted, is that they may be regressive. These taxes are collected regardless of the financial position of either party. Indirect taxes therefore hit lower-income families harder, especially when imposed on medicine, food, or other essentials, because taxes are based on what a person spends, instead of what he/she earns.

Proponents of indirect taxes, on the other hand, argue that direct taxes penalise success by compelling a higher income household to pay a higher percentage on their income tax. The high rate prompts many people adopt extraordinary measures for shielding their income from the tax authorities. They also contend that people have a discretion over the sales tax amount they pay by controlling consumer spending.

Important direct taxes

Here are some of examples of key direct taxes.

  • Income tax: Every so often, the working population of a country, jointly celebrates the freedom, power and liberty that come with being rewarded for a job well done. The gut-twisting excitement and warmth of achievement usually comes at different times, via different channels, for different sections of the society. But there are two things that unite all categories of earners; the feeling of success and achievement, as well as the slight tinge of sadness, noticing that the amount you actually earned, isn’t what you signed for or expected. And that’s because of the income tax you’re supposed to pay.

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An income tax is paid by individuals based on their stable income during a specific financial year. According to the Income Tax Act, “individuals” also include HUFs, trusts, cooperative societies and all artificial judicial persons. Taxable income means the total earned income minus all applicable exemptions and deductions. Income tax is payable when the net income crosses the minimum taxable limit and paid according to the differing rates announced in the Union Budget for every slab in a financial year.

  • Corporation tax: This tax is paid by businesses and companies operating within the country, on the income earned from all its operations at home and abroad, during a particular financial year. The taxations rates vary, depending on whether the company is incorporated in India or elsewhere.


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  • Wealth tax: This tax is levied on individuals, HUFs and companies, on the value of assets owned in a particular financial year and on the valuation date. It’s taxed at 1% of the assessee’s net wealth, over ₹30 lakhs. Here, net wealth includes unproductive assets like cash in hand over ₹50,000, any residential property not let out, bullion or gold jewellery, cars, yachts, aircrafts, boats, or urban land. Wealth tax doesn’t include productive assets like bonds, stocks, commercial property, mutual funds, fixed deposits etc.
  • Tax on capital gains: Profits earned from the sale of property fall under capital gains tax. Here, property means precious metals, residential building, bonds, stocks etc. Capital gains tax is charged at two different rates, depending upon how long a property was owned by a taxpayer i.e. long term capital gains and short term capital gains. Deciding period of ownership greatly varies among various classes of property.

Important indirect taxes

Following are some examples of key indirect taxes.

  • Sales tax: This tax is levied on sale on movable goods. It’s collected by the Union government, in case of inter-state sales i.e. Central Sales Tax (CST), or by state governments for all intra-state sales i.e. Value Added Tax (VAT). The tax rates vary depending upon the type of product.
  • Service tax: This tax is a part of the Central Excise in India. It’s a tax imposed on services provided in the country, except in Jammu and Kashmir. The Central Board of Excise Customs (CBEC) has the responsibility to collect the service tax. It’s a type of indirect tax levied on some specific services known as “taxable services”.  Over the past several years, the service tax ambit has been expanded to include new services. A list of negative services has also been recently introduced.

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The object behind imposing service tax is to lessen the degree of taxation on both manufacturing and trading units, sans forcing the government to compromise on revenue. To levy service tax, the value of a taxable service must be the gross amount charged by a service provider for services rendered.

  • Excise duty: It’s applicable on manufacture of goods sold within India. Once the goods are produced, the excise duty is originally paid directly to the Union government by the manufacturer. When the goods reach the buyer from the manufacturer, the tax is bundled by the latter along with the cost of the goods, and passed over to the buyer.
  • VAT: It’s the tax on the value added to a particular product and a multi-point tax, imposed on every stage of a sale. VAT is collected at the manufacture/resale stage and contemplates the rebating of tax paid on purchases and inputs.

Highlights of direct tax

  1. Helps to reduce disparities in the wealth and income of people.
  2. Economical because the collection cost is very low for the government.
  3. Some extent of economic and social justice is achieved because direct taxes are based on the ability to pay.

Direct tax is often considered as progressive taxes because of the ability to pay. The rates of progressive taxes increase with a rise income and decreases with a fall in income.

Highlights of indirect tax

  1. Indirect taxes can be easily realised because they are already included in the price of the commodity.
  2. Indirect taxes have a greater coverage because every consumer is taxed via the price of the commodity.
  3. Consumption of harmful commodities like cigarette, alcohol etc. can be discouraged, thus serving a social purpose.


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Why are taxes necessary?

A government needs resources for running the administration of a country. Taxes have been levied ever since public administration came into being with the rule of kings. It’s a system to collect and distribute the surplus held by the rich to the poor. In the present day, taxes are required to fuel a country’s development and to provide various civic amenities. They are often the rider for a country’s growth. In fact, a country’s progress can be measured by how effective and efficient the administration is, rather than by the volume of taxes collected from its citizens and business enterprises. There are any countries that levy a plethora of taxes but spend the money in populist schemes instead for the real welfare of its people.

In the end

Both direct and indirect taxes have their own set of purpose. Direct taxes are equitable because they are levied on individuals, according to their ability to pay. They are also economical because of a lower collection cost. However, direct tax doesn’t cover all sections of the society.

Indirect taxes, on the other hand, are easy to realise because they are comprised in the price of products and services and also has a better coverage of the society. The good thing is that the tax rate is high for harmful products to dissuade people from using them.

Government policies change with time and it affects the taxation system of a country. Tax structures are guided by public welfare demands and the need to foster growth. Authorities, at the same time, must ensure that taxes serve their intended purpose.

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Direct Tax vs Indirect Tax


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