What is Direct Tax and What are Its Types?

A direct tax is imposed upon an individual person or property as a distinct type of tax upon transaction. Direct taxation is declarative in nature. The aim of direct tax is to promote equality and equity since it is based on the ability to pay of tax payer. In the case of direct taxation, the government and taxpayers know the amount that they will receive and pay, even before tax collection.

 

Table of Contents

• What is Direct Tax?
• Types of Direct Taxes
• Who has to pay direct taxes?
• Direct Tax Code

What is Direct Tax?

Direct tax is a type of tax that any person or organization pays directly to the authority that imposes it. Income tax, real property tax, taxes on assets, and real property tax are the types of direct taxes that are paid to the authority levying the tax. Direct tax is based on the ability-to-pay principle. It states that those who earn more or have access to several resources should bear a greater tax burden. This type of tax cannot be passed onto other individuals or business entities.  

Types of Direct Taxes

The following are the different types of taxes:

• Income Tax: Income tax must be paid depending on an individual's age and earnings. The government of India has categorised different tax slabs that determine the amount of Income Tax to be paid. Taxpayers must file Income Tax Returns (ITR) on an annual basis. Based on the ITR, individuals may receive a refund or have to pay tax. Heavy penalties are levied if an individual fails to file the ITR.
• Wealth Tax: This tax is paid on an annual basis and depends on the ownership of properties as well as the market value of a property. If an individual owns a property, he or she has to pay wealth tax regardless that property generates an income or not. Hindu Undivided Families (HUF), corporate taxpayers, and individuals need to pay wealth tax depending on their residential status. Payment of wealth tax is exempt for:
  • • Assets like stock holdings, gold deposit bonds, house property, and commercial property that have been rented for more than 300 days 
    • House property is owned for business and professional use.
• Estate Tax: Also known as Inheritance Tax, it is paid based on the estate value or the money left behind by an individual after his/her death.
• Corporate Tax: Domestic companies except shareholders need to pay corporate tax. Foreign corporations making an income in India also pay corporate tax. Income earned through technical service fees, dividends, by selling assets, royalties, or interest that is based in India are taxable. The following taxes are also included under corporate Tax:
  • Securities Transaction Tax (STT): This tax must be paid for any income earned via taxable security transactions.
  • Dividend Distribution Tax (DDT): DDT is levied on domestic companies that declare, distribute, or pay any amounts as dividends by shareholders. DDT is not levied on foreign companies.
  • Fringe Benefits Tax: Fringe Benefits Tax is levied on companies that provide fringe benefits for maids, drivers, etc.
  • Minimum Alternate Tax (MAT): For zero-tax companies that have accounts prepared as per the Companies Act, MAT is levied on them.
• Capital Gains Tax: It is a type of direct tax that is levied on earned income from sale of assets or investments. Investments in farms, shares, bonds, businesses, art, and home come under capital assets. Based on the holding period, tax can be classified into long-term and short-term. Any assets besides securities, that are sold within 36 months since the time they were acquired come under short-term gains. Long-term assets are levied in case the income is generated from the sale of properties held for a duration of more than 36 months.

Who Has to Pay Direct Taxes?

The following entities have to pay taxes:

Individuals:

• Salaried employees: Those earning income through employment typically have income tax deducted directly from their salaries by their employer.
• Business owners and freelancers: Individuals running their own businesses or working independently are responsible for calculating and paying income tax on their profits.
• Investors: Individuals earning income from investments like stocks, bonds, or real estate might need to pay taxes on their investment gains.
• Property owners: Owners of real estate might be subject to property taxes based on the value of property.

Business Entities:

• Corporations: Companies registered as corporations are subject to corporate income tax on their profits.
• Partnerships and limited liability companies (LLCs): These entities pass their income through to their owners, who then pay individual income tax on their share.
• Trusts and estates: Depending on their structure and purpose, trusts and estates may be liable for income tax or estate tax.
• Non-profit organizations: While exempt from income tax, some non-profit organizations might be subject to other types of taxes like property tax or payroll tax.

Direct Tax Code

The Direct Tax Code (DTC) refers to a proposal to revise, consolidate, and simplify the structure of direct tax laws in a country. It aims to replace existing tax laws, like the Income Tax Act, with something more straightforward and efficient. 

1. Simplification of Tax Laws: The DTC aims to simplify complex tax laws, making them more understandable for taxpayers. This can include reducing the number of exemptions, deductions, and categories of taxable income.
2. Broadening the Tax Base: By minimizing exemptions and deductions, the DTC seeks to broaden the tax base. This means more income becomes taxable, which can potentially lead to lower overall tax rates.
3. Enhanced Compliance and Reduced Litigation: Simplified laws are easier to comply with and enforce, which can reduce disputes between taxpayers and the tax authorities.
4. Lowering Tax Rates: One of the goals of the DTC can be to offer lower tax rates, thereby encouraging compliance and reducing tax evasion.
5. Elimination of Loopholes and Tax Evasion: The DTC often aims to close loopholes in the tax system that allow for tax avoidance and evasion.
6. Integrating Various Tax Laws: In some cases, the DTC might aim to combine various tax legislations under one umbrella, making the legal framework more cohesive.
7. Focus on Progressive Taxation: Ensuring that the tax burden is equitable and progressive, meaning higher earners pay a larger percentage of their income as taxes.
8. Addressing International Taxation: The DTC can also address aspects of international taxation to keep up with global trends and to prevent erosion of the tax base due to globalization.
9. Incorporating Technology: Utilizing technology for tax administration, easing compliance burdens, and improving enforcement capabilities.
10. Environmental Concerns: Sometimes, DTCs include provisions for environmental taxation or incentives for sustainable practices.