Understanding Direct and Indirect Taxation in India: Categories, Benefits, and Drawbacks

Governments, both central and state, impose mandatory fees known as taxes on individuals and enterprises. These funds are crucial for supporting public expenditures and economic stability. Taxation is broadly divided into two primary categories: direct and indirect. Direct taxes are levied directly on an individual's income or profits, while indirect taxes are collected when goods or services are acquired.

Why Governments Collect Taxes Taxation serves as the principal financial resource for governmental bodies. These revenues are strategically allocated to cover essential public services such as national defense, educational institutions, healthcare provisions, and the development of critical infrastructure like roadways and dams.

Categories of Taxation

What is Direct Tax?

A direct tax is a fiscal charge imposed directly on an individual's earnings or profits. Examples include personal income tax, property tax, and fringe benefit tax (FBT). The liability for a direct tax rests solely with the individual or entity upon whom it is levied and cannot be shifted to another party. The Central Board of Direct Taxes (CBDT) is responsible for managing these taxes.

What are the Direct Taxes Imposed in India?

Some of the important direct taxes imposed in India include:

• Income Tax: This tax applies to individuals, with rates varying based on their income levels or total revenue, categorized into different tax brackets.
• Corporate Tax: Businesses operating or registered within India are mandated to pay tax on their operational profits. Unlike the progressive income tax slab rates for individuals, companies are subject to flat tax rates determined by the government.
• Securities Transaction Tax (STT): STT is a charge applied to transactions involving securities traded on recognized stock exchanges. This amount is added to the trade value, consequently increasing the total cost of the transaction.
• Wealth Tax (Abolished in 2015): Formerly, this tax was applied to net wealth surpassing a specific limit. It has since been replaced by an additional surcharge on high-income earners.
• Estate Duty (Abolished in 1985): This duty was previously imposed on the transfer of assets and wealth through inheritance.

Advantages of Direct Taxes

Direct taxes offer certain benefits for a nation's social and economic growth, such as:

• Curbing Inflation: Governments may raise direct tax rates during periods of monetary inflation. This action typically leads to a reduction in demand for goods and services, which can help in moderating inflationary pressures.
• Promoting Social and Economic Equity: To address income disparities, the government implements structured tax slabs and various exemptions, tailoring them to individual earnings and broader economic conditions.

Primary Disadvantage of Direct Taxes

Direct taxes come with a few notable disadvantages:

• A significant burden of direct taxes on individuals and businesses can reduce their disposable income, potentially hindering savings and investment activities.
• Due to the direct nature of these taxes, there is a tendency for individuals and businesses to seek methods of tax evasion or exploit legal loopholes to minimize their liabilities.

What is Indirect Tax?

In contrast to direct taxes, indirect taxes are governmental charges applied to goods and services. The financial burden of these taxes can be transferred from one payer to another; for instance, a wholesaler may pass it to a retailer, who then passes it to the final consumer. Therefore, it is often the end-users who ultimately bear the cost of indirect taxation. The Central Board of Indirect Taxes and Customs (CBIC) is responsible for the administration and governance of these taxes.

Historically, indirect taxes contributed to consumers paying more than the intrinsic value of purchased goods or services, with a diverse array of such taxes previously imposed. The Goods and Services Tax (GST) represents a current indirect tax in India, having consolidated numerous older indirect tax statutes. Some of the former indirect taxes levied in India included:

• Customs Duty: This was an import tariff imposed on goods entering the country, with the cost ultimately borne by domestic consumers and retailers.
• Central Excise Duty: Manufacturers were responsible for this tax, which they typically transferred to retailers and wholesalers.
• Service Tax: This tax was applied to the total sum charged by a service provider to the recipient of the service.
• Sales Tax: Retailers were liable for this tax, which they passed on to customers by including it in the price of goods and services.
• **Value Added Tax (VAT): This tax was levied on the incremental value added to goods or services at each phase of production or distribution, ultimately being absorbed by the consumer.

GST as an Indirect Tax

The implementation of the Goods and Services Tax (GST) has brought about significant positive changes within India's financial landscape. This reformed indirect tax has replaced numerous preceding mandatory taxes. Furthermore, GST aims to actualize the vision of "One Nation, One Tax, One Market" across the country. A key benefit of GST's arrival is the elimination of the 'cascading effect of tax,' also known as the 'tax on tax' problem. This phenomenon occurs when the final consumer faces an elevated or inflated cost due to taxes being applied on previously taxed amounts within the supply chain. However, with the GST framework, consumers are no longer burdened by the additional tax layers caused by this cascading effect.

Supply Types and Associated Taxes

Intra-state Supply

When goods and services are transacted within the boundaries of a single state, GST is imposed jointly and equally by both the Central and State governments. The taxes applied in this scenario include:

• Central Goods and Services Tax (CGST): The Central Government levies and collects this tax on the intra-state supply of taxable goods and services.
• State Goods and Services Tax (SGST) or Union Territory Goods and Services Tax (UTGST): This tax is imposed and collected by State Governments or Union Territories without legislatures on the intra-state supply of taxable goods and services.

Inter-state Supply

This refers to the provision of goods and services exchanged between different states and union territories. The tax levied in this instance is:

• Integrated Goods and Services Tax (IGST): IGST represents the combined total of CGST and SGST or UTGST, and is levied on inter-state supplies.

Benefits of Goods and Services Tax (GST)

There are several benefits associated with GST:

• Input Tax Credit: When remitting tax on a final product, businesses can deduct the tax previously paid on their inputs or purchases, thereby only paying the remaining balance. This mechanism, known as Input Tax Credit, significantly alleviates the overall tax burden.
• Composition Scheme under GST: The government has implemented a beneficial Composition Scheme for small businesses with an annual turnover below Rs. 1.5 crore (or Rs. 75 lakh for North-Eastern states and Himachal Pradesh). This scheme streamlines GST compliance, allowing eligible businesses to pay tax at a fixed rate based on their turnover, thereby simplifying tax procedures for small taxpayers.
• Zero-rated Exports: No GST is levied on the export of goods or services. Such transactions are classified as zero-rated supplies.
• Simplified Compliance: The introduction of various digital tools, such as new return forms, e-wallets, and e-invoicing, aims to enhance the ease and efficiency of tax administration.

Conclusion

India has advanced its taxation system by simplifying indirect taxes through GST and consistently refining direct tax regulations to boost efficiency. An effective tax framework strives to minimize tax evasion, promote equitable treatment, and foster economic engagement across all societal segments.

Frequently Asked Questions (from Source)

Several benefits stem from the Goods and Services Tax (GST):

• Streamlined Tax Structure: GST consolidates multiple indirect taxes, such as VAT, service tax, and excise duty, into a unified national tax framework.
• Elimination of Cascading Effect: The GST system removes the 'tax on tax' phenomenon, leading to a reduced overall tax burden on goods and services.
• Broader Tax Base: By incorporating a wider range of sectors, including many small and unorganized businesses, GST expands the tax base and increases government revenue.
• Consistent Tax Rates: GST ensures uniform tax rates and structures across all states, contributing to more stable pricing for goods and services.

Regarding differing payment rates for direct and indirect taxes, yes, direct tax rates are determined by an individual

’s income or profits, whereas indirect tax rates remain consistent for all consumers.

Individuals earning income in both India and other countries may encounter double taxation. To mitigate this, India has Double Taxation Avoidance Agreements (DTAA) with many nations, allowing taxpayers to claim credits or exemptions under these agreements.

Businesses can operate without GST registration only if their turnover remains below the specified threshold (e.g., ₹40 lakh for goods, ₹20 lakh for services, with lower limits in special category states). However, GST registration becomes mandatory irrespective of turnover for inter-state sales and e-commerce sellers.