Taxation in India - Direct taxes & Indirect Taxes

Taxes are essential for any country’s economic development. In India, taxes fund infrastructure, social services, education, defense, and numerous welfare programs. The Indian taxation system is broadly classified into Direct Taxes and Indirect Taxes, based on who ultimately bears the burden and how the tax is collected.

Let’s dive into what these two types of taxes mean, how they differ, and their relevance in everyday life.

What Are Direct Taxes?

Direct taxes are levied directly on individuals or entities and are paid straight to the government. These taxes are non-transferable, meaning the person or organization on whom the tax is levied is responsible for paying it.

Examples of Direct Taxes

Income Tax: This is the most common form of direct tax. It applies to individuals, Hindu Undivided Families (HUFs), companies, and other entities based on their income. Income tax is calculated according to specific slabs and rates set by the government, which are updated every financial year.

Corporate Tax: Paid by companies on their net profits. The rates vary depending on whether the company is domestic or foreign and on their annual turnover.

Capital Gains Tax: This tax is applicable on profits earned from the sale of capital assets like real estate, shares, or mutual funds. It's divided into short-term and long-term capital gains, with different tax rates and holding period criteria.

Securities Transaction Tax: Levied on transactions made on stock exchanges. It’s deducted automatically when you buy or sell equity shares, mutual funds, or derivatives.

Previously, there was also Dividend Distribution Tax, which was levied on companies paying dividends to shareholders. This was abolished in 2020, and now dividends are taxed in the hands of the recipients.

What Are Indirect Taxes?

Unlike direct taxes, indirect taxes are collected by intermediaries (like sellers or service providers) from consumers. The burden of paying the tax is passed on to the end-user as part of the product or service price.

Examples of Indirect Taxes

Goods and Services Tax (GST): Launched in 2017, GST unified various indirect taxes such as VAT, service tax, and excise duty into a single tax structure. GST is applied at every stage of the supply chain but allows for an input tax credit to avoid cascading taxation.

Customs Duty: Imposed on goods imported into India and, in certain cases, on exports. Customs duty helps regulate trade, protect domestic industries, and generate revenue.

Excise Duty: Once a major tax on the manufacturing of goods in India, it now applies primarily to products like alcohol and petroleum, which are excluded from GST.

Stamp Duty: Levied on legal documents related to transactions involving property, shares, or other financial instruments. Though not a tax on goods or income, it is collected by state governments and classified as an indirect tax.

Key Differences Between Direct and Indirect Taxes

While both tax types are vital to government revenue, their mechanism of collection and impact on individuals differ significantly: