Direct Tax & Indirect Tax | Definition & Key Differences In Between

INTRODUCTION

As they say, the only things certain in this world are death and taxes. Since death has been our obsession since the time immemorial, let’s talk about taxes.

Taxes come in many forms – income tax, sales tax, corporate tax, service tax and so on. There are so many types of taxes that an average person pays that chances are you pay a tax without even knowing that you’re actually paying it!

You will be surprised to know exactly what taxes you end up paying in your day to day lives, both knowingly and unknowingly? So here goes!

DIRECT & INDIRECT TAXES – The Definition

Who collects the taxes from the taxpayer is what determines the most fundamental classification of taxes.

Direct Taxes, as the name implies, are taxes that the taxpayer pays the government directly. It is a tax enforced on individuals and organizations directly by the government e.g. income tax, corporation tax, wealth tax etc.

Indirect Taxes are free from the extent of individuals. This type of taxes is enforced on the manufacture or sale of goods and services. An intermediary, who then adds the amount of the tax paid to the value, initially pays these to the government.

Both direct and indirect taxes play an important role in the country. It is because the two types of taxes are intricately connected with the overall economy. As such, collection of these taxes plays an important role for the government as well as the well-being of the country. The central and respective state governments according to collect both direct taxes and indirect taxes.

And, the value can be determined by the goods/services. And, the value is passed as per the total amount to the end user.

Examples of these are sales tax, service tax, excise duty etc.

An individual pays Income Tax based on his/her taxable income in a given fiscal year. Under the Income Tax Act, the term ‘individual’ has a broad meaning. It also includes Hindu Undivided Families (HUFs), Trusts, Co-operative Societies, and any artificial judicial person.

Taxable income is accumulated from total income minus applicable deductions and exemptions.

Tax is to be paid if the taxable exceeds the minimum taxable limit. Then, the tax is payable as per the rates. The rates differ as announced for each tax slab for the financial year.

Difference between Direct Tax and Indirect Tax:

The meanings of direct and indirect taxes differ according to the domestic regulation. However, both types of taxes are important to the government. It is because the taxes include the major part of revenue for the government.

Key differences between Direct and Indirect Tax are:

  1. The direct tax is applied and paid for by individuals. The individuals include the Hindu Undivided Families (HUF), firms, companies etc., whereas indirect tax is ultimately paid for by the end-consumer of goods and services.
  2. The burden of a tax can’t be substituted in case of direct taxes. However, the burden can be exchanged for indirect taxes.
  3. Lack of administration in a collection of direct taxes is imperative for tax evasion. It makes tax evasion possible. Individuals cannot evade taxes. Indirect taxes as the taxes are applied to goods and services.
  4. The direct tax is important in reducing inflation, whereas indirect tax may contribute to the enhancement of inflation.
  5. Direct taxes have better effects on local bodies than indirect taxes. It is because direct taxes put lesser burden over the collection of amount than indirect taxes. Tax collection derived indirectly is scattered across parties. And, consumers’ preferences of goods is altered from the price variations due to indirect taxes.
  6. Direct taxes contribute to the reduction of inequalities and are regarded to be progressive while indirect taxes augment inequalities and are considered regressive.
  7. Indirect taxes require lesser administrative costs. The costs are minimized due to convenient and stable collections, while direct taxes have many exemptions. And, direct taxes require higher administrative costs.
  8. Indirect taxes are oriented more towards growth as they depress consumption and help improve savings. Direct taxes, on the other hand, decrease savings and depress investments.
  9. Indirect taxes have a wider exposure as all members of the society have to pay taxes through the sale of goods and services, while direct taxes are collected only from people in particular tax brackets.
  10. Additional indirect taxes enforced on harmful commodities such as cigarettes, alcohol etc. deter over-consumption, thus helping the country in a social context.

SUMMARY

The definition of direct and indirect taxes varies according to the ability of the end taxpayer. The ability may shift the burden of taxes to someone else. Direct taxes allow the government to accumulate taxes directly from consumers and are a progressive type of tax, which also takes the impact of inflationary pressure on the economy.

Indirect taxes forecast stable and assured returns. The government formulates policies in order to ensure stable and assured returns. And, bring into its fold almost every member of the society – something which the direct tax has been unable to do.

Share Your Thoughts Here