Difference Between Direct and Indirect Tax

Direct taxes are recovered from the tax payer directly whereas indirect taxes are recovered from the tax payer via intermediatory at time of purchase. The taxes in both cases are still paid to the authorities levying the charges.

In this article on the difference between direct and indirect tax, we will discuss the two taxation types and the parameters that distinguish them. 

Table of Contents

• Difference between Direct and Indirect Tax
• What is Direct tax?
• What is Indirect tax?

Difference between Direct and Indirect Tax

In the following tabular format, we are going to discuss the differences between direct and indirect tax:

What is Direct Tax?

It is a type of tax that the taxpayer pays directly to the authority that imposes it. This type of tax is imposed according to the tax bracket in which they fall. It depends on the income and ability to pay principle. The more paying ability of an individual is directly proportional to more tax. Failure to pay taxes can cause penalties and imprisonment as per the rules. 

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Types of Direct Tax

Following types of direct tax 

1. Income Tax: In India, income tax is levied on non-agricultural income. Individuals, HUFs, firms, and juridical bodies are responsible for paying this tax. There are different tax slabs according to which tax is paid. Different rebates are offered for saving tax based on the income tax guidelines. 
2. Corporate Tax: It is also known as corporation or company tax. This is a tax levied on the profits of corporations and paid on the taxable income. It may be imposed at the central or state level. National as well as foreign corporations having permanent establishment in the country have to pay corporate tax. 
3. Wealth Tax: It is a tax based on the assets’ market value. This includes the total value of personal assets including real assets, ownership of financial securities, bank deposits, cash, etc. It aims at reducing the inequality in wealth accumulation. In 2015, surcharge replaced wealth tax in India. People with an annual income of ₹ 1-10 crore have to pay a surcharge of 2-12%.
4. Estate duty: It was imposed on the estate of the deceased in its entirety. This was paid in case of inheritance. It was levied when an asset is transferred after the death of the asset owner. The executor had to pay this estate tax to the government. As of now, there is no estate duty in India.
5. Custom duty: This is a tax imposed on import and export of goods when they are transported across international borders. The duty varies according to the country of origin, manufacturing material, weight and type of commodity. Government imposes the custom duty to regulate movement of goods, raising revenue and safeguarding domestic industries.  
6. Capital gain tax: This is the tax levied on investors when they sell a capital asset. Based on the duration, capital gains (profit from sale of assets), these profits can be categorized as income. This income is liable for taxation and is known as capital gains tax.

What is Indirect Tax?

This is a tax that has already been levied upon customers on purchase of goods and services. The indirect tax is included within the price of the product and service and the customer does not have to pay it separately. This tax is paid to the intermediary instead of the government directly. The intermediary files tax returns and forwards these tax proceeds to the government with a return. One of the drawbacks of indirect tax is that it raises the price of the product.  

Types of Indirect Tax

Following are the different types of indirect tax. As of July 2017,  service tax, sales tax and VAT have been replaced by GST in India.

• Sales tax: It is paid to the governing body for sales of goods and services. This is the amount of money calculated in percentage and is added to the cost of the product. Seller collects sales tax from the consumers at the final point of purchase. Whenever this tax is directly paid to a governing body, it is known as use tax. 
• Service tax: This tax is levied by either the government or the service provided on some services. Customers are required to pay tax on acquiring a service. It is charged to customers on a cash basis, whereas companies are charged on an accrual basis.
• Value-added tax (VAT): This is a consumption tax. It is levied on at every stage of supply chain from production to point of sale wherever value is added. VAT is calculated after subtracting the cost of materials that were already taxed at the previous stage from the cost of the product.
• Goods and Services Tax (GST): Except for a few states, GST has replaced almost every type of indirect tax in India. It is a multi staged tax as it is imposed at every step in the production process. Except for the consumer, every party in stages of production are refunded GST. Unlike previous taxes, it is only collected from point of consumption and not from anyone else in the production chain.

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Conclusion

Hope that this article has been able to help you understand the difference between direct and indirect tax. To learn more about these taxes, you should start with the basics of taxation that will help you gain in-depth insight on how these two taxation method work.

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