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Difference Between Direct And Indirect Taxes 

11 Sep 2023

In India, it makes no difference whether you earn a living or purchase products and services in terms of taxation. You may be an individual or a corporate entity and you have an obligation to pay your taxes. Tax is a sort of mandatory fee which has a recurring nature. It is paid to the state and the central Government of India. Additionally, knowing about aspects of taxation including the difference between direct and indirect tax is essential for your own taxation. Taxation is the primary revenue source for the Indian government and this aids in the development of the Indian economy. 

A Broad Categorisation of Taxes: Indirect and Direct Taxes

If you have been around in financial circles, and even if you have not, you must have heard of how everyone dreads that time of year when tax returns have to be filed. Needless to say, if you open a demat account today and go ahead and invest in the stock market, you will probably think of taxation at some point. If you earn returns, for instance, you have to file these. Your returns may be taxed, depending on the category of tax which you fall under aligned with your yearly income. 

Looking at taxes from a broad point of view, taxes are categorised as indirect and direct taxes. So, what is the difference between direct and indirect tax? It is worth looking at each kind of tax individually to grasp differences between the two. 

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Direct Tax Explained

Plainly put, direct tax refers to a tax which the taxpayer must directly pay to any authority which is imposing the said tax. In this case, the taxpayer must bear the brunt of the tax and cannot transfer such a liability to any other entity. The Central Board of Direct Taxes (CBDT), in India, has the responsibility of collecting and administering direct taxes. The Department of Revenue is the governing body of the CBDT. It provides the Indian government with inputs related to direct tax implementation. 

In case you invest in an upcoming IPO, and you get a number of shares allotted to you, you may sell these and earn a profit. Then you have to pay a direct tax on the profit you earn. It is vital for taxpayers to understand what direct taxes are and the types that exist. Knowing this will help to grasp the difference between direct tax and indirect tax, and consequently, learn how taxation impacts taxpayers in India. 

Direct Taxes: Types

The following are the kinds of taxes in the category of “direct tax” in India: 

  • Income Tax - This is, perhaps, the most common of all direct taxes which people and other entities pay to the Indian government. Income tax is levied on any income that is earned in a financial year. The Income Tax Department of India has determined certain tax slabs depending on the income earned, and amounts of tax are paid aligned with this. 
  • Capital Gains Tax - In case anyone makes capital gains, a tax on those gains/returns is imposed. The tax, again, is paid to the Indian government. Capital gains can be generated from property (when you sell and make profits) or from any investments like equities. Depending on the duration of holding of the investments, capital gains tax is levied as either long-term capital gains (LTCG), or STCG (short-term capital gains). 
  • STT or Securities Transaction Tax - In case you are engaged in trading in securities, you have to pay tax known as securities transaction tax, whether you make gains or do not make gains. 

While learning about the difference between direct and indirect tax, if you know the pros of each, you can decipher differences better. The pros of direct taxation is that it curbs inflation and is considered an equaliser between different classes of individuals. For the government, the advantage is that it is a revenue source. 

Indirect Tax - What is it?

Whereas direct taxes are imposed on the income of any taxpayer and the profits earned by them, indirect taxes are those levied on products and services. Taxpayers must pay indirect taxes to the Indian government through an intermediary, and so, these taxes are referred to as “indirect”. The CBIC or the Central Board of Indirect Taxes and Customs collects and administers this tax, also governed by the Revenue Department, as is the case with the CBDT. 

The Types of Indirect Taxes

Are you clear about the difference between direct tax and indirect tax? You will get more clarity once you know the types of indirect taxes in India. These are mentioned below: 

  • The GST or Goods and Services Tax - This is the most common of all indirect taxes, and has successfully replaced other Indian indirect taxes like excise duty, service tax, purchase tax and other taxes. Unified and single, the GST is a comprehensive indirect tax imposed on goods and services, based on the tax brackets specified by the GST authorities in India. 
  • Customs Duty - In case you buy any goods and services from abroad, a customs duty is levied as a tax. Every product or service that enters India from overseas is taxed via the customs duty. 

The advantages of indirect taxes are that every person contributes to paying taxes, and payment is easy for people, plus the government can collect taxes in a convenient manner. 

The Difference Between Direct and Indirect Tax - A Summary

The table below shows the differences between direct and indirect taxes: 
 

Variables of Difference

Direct Tax

Indirect Tax

Description/Meaning

Paid to the government directly

Paid to the Indian government through an intermediary

Taxpayer 

Individuals, businesses and HUFs

End-consumers of services and goods

Tax Imposed On 

Income and profits

Goods and services

Rate of Tax

Directly dependent on profits and income

Identical for everybody

Collection of tax 

Tedious and complex

Convenient

Kinds of tax

Income Tax and STT

GST

Evasion probability 

Probable and possible

Not possible


Know Your Taxes

Once you open a demat account and begin investing in the stock market, you should know what potential taxes you may have to pay. While direct taxes are connected to your investment in the share market or any upcoming IPO, indirect taxes are not. Direct taxes have a lot to do with your own earnings and gains so they are directly related to the investments you make. Indirect taxes are levied on the products and services you purchase and have nothing to do with profits or returns. 

 

Related Articles: What are tax-free bonds and how they work | Tax implications on a Mutual Fund and SIPs (Systematic Investment Plans) | How are capital gains on equity and debt funds taxed?

 

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