As a citizen of a country, an individual is responsible for funding various public expenditures like roads, military, education, public safety, healthcare, legal system, the functioning of government itself and more. This is where the concept of tax comes into the picture.
In order to upgrade a country’s infrastructure and overall development, the government taxes its citizens in return for public services. However, knowing how much tax you are paying on your income or property is not the only thing that’s important. As per the Central Government’s taxation laws, all taxes are divided into two categories, i.e., direct and indirect tax.
In this article, we will discuss direct and indirect tax in detail.
Direct Tax
The non-transferable taxes that are directly paid to the government by an individual or a legal entity are known as direct taxes. The amount to be paid depends upon the income and profit an individual makes within a financial year. This means that a person with greater sources or higher earnings must pay higher taxes.
Types of Direct Tax
- Income Tax: It is imposed on the income generated by an individual or a business.
- Corporate Tax: The companies and corporations pay this tax on their profits.
- Gift Tax: A gift tax is paid by an individual who sends something of value to another individual without getting something of similar value in return.
- Wealth Tax: This type of direct tax is imposed on the market value of an individual’s assets.
- Fringe Benefits Tax: Fringe benefits are the additional compensation given to employees apart from their salaries like company vehicles, reimbursements, tickets, and more. Employers are supposed to pay tax on these benefits that they provide to their employees.
Indirect Tax
Now, what is indirect tax? An indirect tax is collected by an intermediary such as traders, manufacturers, or a service provider, only to be paid to the government eventually. This tax is levied in addition to the original value of the products or services, which raises their prices. It is called an indirect tax because the bearer does not directly pay the tax to the government. Instead, another entity is bridging this gap.
Types of Indirect Tax
- Goods and Service Tax (GST)– It is the addition to a product at every point of the supply chain where value is added to it. The business adds this amount to the product’s price and charges the customer a price inclusive of
- Excise Duty– Excise duty is only applied to certain goods like alcohol, tobacco, and fuel. These are to be paid essentially by the manufacturers who push their burden on the consumers.
- Entertainment Tax: It is levied on any kind of commercial entertainment such as movie tickets, sports events, exhibitions and more.
- Customs Duty: Customs duty is the tax imposed on goods when they are transported to international geographic boundaries, i.e., when they are imported or exported from a foreign land.
Now, in order to get an even clearer understanding of direct and indirect tax, let’s look at the table below.
| Basis of Differentiation | Direct Tax | Indirect Tax |
| Imposition | Direct tax is imposed on the income or profit made by an individual or an organization. | Indirect tax is levied on goods and services consumed by the customers. |
| Payment System | As the name suggests, these taxes are directly paid to the government by every individual.
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There is an intermediary (retailers, manufacturers) included who collects the tax from the end consumers and gives it to the government. |
| Paying Body | These taxes are paid by individuals and businesses. | End-consumers are the bearers of these taxes. |
| Nature of tax | Progressive in nature, which means direct taxes increase with the increase of income and profits. | Regressive in nature, I.e., its rate diminishes as the income increases. |
| Rate of Tax | Under direct tax, the rate of tax depends upon the income and profits of an individual or entity. | Indirect taxes are the same for all taxpayers.
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| Transferability | The burden of direct tax cannot be shifted to others. | The burden can be shifted to the end consumers under indirect taxes. |
| Influence on Inflation | Direct taxes can be extremely useful in curbing inflation. This means that direct taxes can be increased whenever the economy is on the verge of a downfall.
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On the other hand, an increase in indirect tax can lead to inflation. |
Both direct and indirect taxes are set according to the taxpayer’s ability. On the one hand, direct tax helps the Government cool down the inflationary pressure on a country’s economy. While on the other hand, indirect taxes bring the Government stable and assured returns.
Direct and indirect taxes play a significant role in upgrading a nation’s economy and growth. They are collected by the central and state Governments depending on the type of tax levied.
