Direct and Indirect Tax in India: Differences, types

If you're seeking clarity about the differences between income tax and GST, you're in the right place. Explore the difference between direct and indirect tax

By Forbes India

Published: Oct 16, 2024 04:00:16 PM IST

Updated: Oct 16, 2024 04:08:32 PM IST

“There are two things certain in life, said Benjamin Franklin once, “death and taxes”.

Taxation is an essential part of our lives, shaping how governments function and providing the resources needed for public services. In India, there are two main types of taxes: direct and indirect. But what exactly are these taxes, and how do they differ? In this blog, we'll take a closer look at the difference between direct and indirect tax. We'll break down the concepts in simple terms, exploring their roles, implications, and how they affect individuals and businesses nationwide.

Direct tax and indirect tax

Before we delve into the differences between direct and indirect taxes, you must familiarise yourself with the basic differences between the two:

Direct taxes

The government levies These taxes directly on individuals or entities based on their income or profits.

They are paid directly by the taxpayer to the government.

The most common example of a direct tax in India is the income tax, where individuals and businesses are required to pay a percentage of their earnings to the government.

Indirect taxes

Indirect taxes, on the other hand, are not directly imposed on individuals or businesses but are instead levied on goods and services.

These taxes are passed on to the end consumer as part of the price of the goods or services purchased.

In India, the most talked-about indirect tax is the Goods and Services Tax (GST), which subsumes many indirect taxes like service tax, excise duty, and value-added tax (VAT).

Difference between direct and indirect tax

We have compiled all the differences between direct and indirect taxes in this comprehensive table:

Point of Differentiation	Direct Taxes	Indirect Taxes
Imposition of Tax	Levied directly on income or profits of individuals.	Imposed on the purchase or consumption of goods and services.
Tax Incidence or Tax Collection	Taxpayer is responsible for paying the tax to the government.	Tax is collected by the seller or service provider and passed on to the government.
Tax Impact	Falls on the taxpayer. Both tax incidence and tax impact fall on the same person.	Falls on the consumer. Tax impact is on the consumer, while tax incidence is on the seller of goods and services.
Method of Collection	Collected by government agencies such as the Income Tax Department.	Collected by businesses at the point of sale or provision of service.
Rate of Tax Payment	Based on the income or profit of individuals or businesses.	It is uniform for all taxpayers.
Nature of Tax	Progressive as higher incomes are taxed at higher rates.	Regressive, as both poor and rich are taxed the same amount, resulting in a larger percentage of income from the poor.

Types of direct tax and indirect tax in India

Here's an overview of the different types of direct and indirect taxes in India:

Types of direct tax

There are four direct taxes: income tax, wealth tax, corporate tax, and capital gains tax. Let’s understand what they mean:

Income tax

This tax is levied on the income earned by individuals, Hindu Undivided Families (HUFs), partnerships, associations of persons, companies, and trusts.

The income tax rates vary based on the income slab in which the taxpayer falls.

Individuals have to file income tax returns annually to declare their income and pay the applicable tax.

Wealth tax

Wealth tax was levied on the net wealth of individuals, Hindu Undivided Families (HUFs), and companies in India until it was abolished in 2015.

Net wealth included assets like land, buildings, cars, jewellery, cash in hand, etc., minus any liabilities.

The tax was levied on the net wealth exceeding a specified threshold at a fixed rate.

Corporate tax

This tax is levied on the income earned by companies and corporate entities operating in India.

The tax rates for domestic companies, foreign companies, and certain specified entities may vary.

Corporate tax rates are usually higher than individual income tax rates.

Companies have to file annual tax returns disclosing their income and paying the applicable tax.

Capital gains tax

It is levied on the profits earned from the sale of capital assets, such as real estate, stocks, bonds, and mutual funds. The tax is applicable only when the capital asset is transferred, resulting in a capital gain.

It is classified as short-term or long-term based on the asset's holding period.

The tax rates for short-term and long-term capital gains differ, and certain conditions may allow for exemptions or concessions.

Also Read: How to pay income tax challan due: Complete step-by-step guide

Types of indirect tax

Here's an explanation of some of the main types of indirect taxes in India:

Goods and services tax (GST)

GST was introduced in July 2017 to replace numerous indirect taxes, such as excise duty, service tax, and value-added tax (VAT).

GST is levied at multiple stages of the supply chain and applies to goods and services.

It is a destination-based tax, meaning it is collected where the final consumption of goods or services occurs.

GST has various tax rates depending on the category of goods or services, with exemptions and concessions for certain essential items.

Sales tax

This tax is levied on the sale of goods within the country.

The state governments impose it, and it varies from state to state.

Sales tax is typically applied as a percentage of the sale price of goods and collected by the seller at the time of sale.

The introduction of the GST has largely replaced the traditional sales tax system, bringing uniformity and streamlining tax administration across the country.

Service tax

Service tax was a tax levied by the central government on specified services provided by service providers.

It applied to a range of services, such as banking, insurance, telecommunications, transportation, and hospitality.

Service tax was charged on the value of services rendered and was collected by the service provider from the service recipient.

Like central excise duty, service tax was also subsumed under GST.

Value-added tax (VAT)

This was a state-level tax imposed on the sale of goods within a state.

It was levied at each stage of the production and distribution process, but unlike GST, it did not apply to services.

VAT was based on the value added at each stage of production or distribution, with businesses allowed to claim credit for VAT paid on inputs.

VAT rates varied across states and product categories, with some essential goods exempted or taxed at lower rates.