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Direct and Indirect Tax – Differences & Similarities

With so many taxes going around, it becomes a daunting task for a new taxpayer or a start-up to worry about them all. Knowing them individually and how they apply to you personally can help understand their significance in our lives. For instance, do you know that while income tax is a direct tax, an excise duty is not, and it comes under indirect tax? And, while customs duty is put as an indirect tax, the corporate tax is a direct tax paid by a person or a company?

To cut the matter short, we need to understand what taxes go under which category and are there any similarities between a direct and an indirect tax.

Direct Taxes:

Direct taxes are those individual taxes which cannot be transferred to another taxpayer. The burden of a direct tax falls completely on the shoulders of the person who is paying it. Example of a direct tax is an income tax paid at the end of each financial year. Direct taxes are paid directly to the government, and the liability of it is completely on the individual who needs to pay for it.

Let us look at some of the examples of direct taxes:

  • Income Tax – This is levied on a person who falls under the tax bracket set by the government. The burden is completely on the individual and he or she cannot transfer it to anyone else.
  • Wealth tax – Wealth tax again is an entity that needs to be borne by an individual who owns a property. Here again, the owner or the owners are liable to pay the tax
  • Corporate tax – Although not an individual, the joint owners or corporations need to pay the tax directly to the government. Liability falls on the owners of the companies.
  • Gift Tax – This is again an individual tax liable to be paid by a person who receives a ‘taxable’ gift.
  • Estate Duty tax – When a person or persons receive an inheritance, they need to pay a percentage as applicable to the government – directly. Liability again lies on the person inheriting the property

Other direct taxes include the Fringe benefits tax, where the owner or the employer pays the tax directly to the government for the benefits given to the employees.

Indirect Taxes:

Indirect taxes are those taxes which are not paid by an individual but can be shifted from one person to another. The VAT comes under an indirect tax, where the initial tax is paid by the manufacturer of the goods and then transferred to the sellers to the customers who pay the final and high tax on the commodity. These are called indirect taxes because they are not paid by one individual directly, but a series of persons paying them up at each level.

  • Sales Tax – Sales taxes are paid by the retailer, who collects it from the customers by charging them for the goods sold.
  • Customs Duty – The imported goods, when sold in India, are levied with a customs duty which the customers or the retailers who sell them pay at the end.
  • Entertainment Tax – Entertainment tax is levied on the theatre owners and other persons running similar such entertainment premises. However, the tax although paid by the owner is actually collected from the people who buy the tickets.
  • Service Tax – The service tax is an indirect tax which is paid by the hospitality industry owners to the government, although they collect it from their customers. Restaurants, eateries and so on, are examples of industries that pay service tax.

Although there has been a change in the tax models because of the introduction of GST, which again is an indirect tax where there are several taxpayers involved. However, before going into GST and all that it implies, let us look at some differences between an indirect and a direct tax.

Direct and Indirect taxes – what are the differences between them?

Although both go to the government, there are some differences between the two taxes, who pays them, how they calculate and so on. Here are some of the very explicit distinctions between the two taxes:

  • Direct taxes are individual taxes, while the indirect taxes are borne by the end-consumers
  • Inflation is enhanced by an indirect tax since the consumers need to pay more for what they buy, while direct taxes collected can help curtail inflation
  • Indirect taxes have a series of people involved and therefore, the burden gets shifted from one person to another, while a direct tax is the sole responsibility of the person who pays it
  • Income tax evasions are a very common occurrence in our society – so evasions are common in collecting direct taxes due to the large population. Indirect taxes are collected at each stage, and therefore, evasions are not common
  • Direct tax collection evokes a huge administrative cost due to so many exemptions and multiple levels of calculations involved for each individual. Indirect taxes evoke comparatively lesser administrative cost
  • With the introduction of GST, the indirect taxes have become streamlined and easier to collect while direct taxes are still on an individual basis and therefore vary sufficiently to put pressure on the collectors
  • Indirect taxes are common for all and not based upon the salary brackets – either poor or rich, the cost of a biscuit does not vary. Direct taxes, however, are salary or income based

Now, although there are many other differences in both these taxes, there is one very essential similarity between the two – both the taxes collected go to the State coffers, and are used for good governance and other nation-building projects. Our overall economic growth and prosperity depends upon the taxes collected by the government and also the number of people paying them up at the right time. Also, the direct and indirect taxes are collected by the Central and the State governments, as applicable.

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About the Author: Praveen Unnikrishnan

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