Direct and Indirect taxes

Get To Know About Direct and Indirect taxes In details

Online Legal India LogoBy Online Legal India Published On 30 Nov 2022 Updated On 06 Jan 2023 Category Income Tax

These are a few questions that grownups who make money in various ways frequently ask. But have you ever questioned what tax actually is? Why are we required to pay taxes to our government when it only serves our interests? What kind of tax does the government impose? The article itself has the answer to these queries.

A tax is a charge that the government levies against its people as well as different businesses or institutions. Every government typically levies two different types of taxes: direct tax and indirect tax. In contrast to indirect tax, which is imposed on a person but partially or entirely paid by another person, direct tax places the responsibility of payment on the person who is the target of the tax. The article focuses primarily on indirect taxes that people pay to their government. It also covers the state of indirect taxes now that the GST, the only indirect tax now imposed on citizens, has been implemented in the nation.

What is a tax?

The top levels of citizens initially used a systematic tax system under the Mauryan Empire, when they contributed a portion of their wealth and income as tax. Cash or products and materials were used to pay the levy. Feudalism was another name for this system in the past. But as new systems and time went on, the feudal system's outdated practices altered, and India officially adopted a tax system. Sir James Wilson introduced the first official tax system in the first union budget in the year 1860. This was done to help the government make up for the losses brought on by the mutiny of 1857.

The tax system has changed over the years as knowledge and technology have advanced. According to Article 265 of the Indian Constitution, any act imposing a tax on residents must be legitimate and not in violation of the Constitution's provisions. Additionally, the Union List in the Seventh Schedule of the Constitution grants the parliament the power to tax 

The tax collected by the government is their primary source of income and is used to pay for the amenities used by people in their daily lives, such as education, healthcare, housing, etc. Professor Seligman defines the term "tax" as "a compulsory contribution by a person to the government to provide revenue and money for the expenses that are borne by the government in the common interest and benefit of the citizens." The goal has altered as the state transformed into a welfare state. Protecting citizens' interests and working for their improvement is the goal of the welfare state. It collects taxes from people in order to achieve its goal, and these taxes are utilised for a variety of purposes, including

  • War spending,
  • Upholding justice, peace, and harmony,
  • Preservation of people's property,
  • An improved infrastructure,
  • Additional public works
  • Bolster educational infrastructure,
  • Creation of institutions and infrastructure for healthcare,
  • Offer men and women equal employment chances,
  • Avoiding the concentration of wealth in the hands of a select few,
  • Public transportation, generating energy and electricity, managing waste systems, and
  • Any country's economic growth and improvement.

Characteristics of a tax

The following are the various characteristics of tax:

Compulsory

A tax is a requirement that the government places on its subjects. Every citizen has a responsibility to pay taxes on time if their income is above the exemption threshold and they fit into one of the tax-paying categories. No one can object to paying taxes on the grounds that they do not receive any benefits from government services and facilities, as was previously indicated, as the tax money is exclusively utilised for people's wellbeing.

Public Benefit

The goal of government has shifted from being a welfare state to being one that prioritises the well-being of its people as a result of the state's changing nature. The government is required by Articles 37 and 38 of the Directive Principles of State Policy in the Constitution to work toward reducing income inequality and preventing the concentration of wealth in the hands of a select few, respectively. One strategy for doing this is to charge everyone a tax based on their wealth and income.

Imposed by the government 

A tax may only be levied by the authority of the law and no one else, according to Article 265. Thus, in accordance with Entry 85 and Entry 86 of List 1 provided in the Seventh Schedule of the Constitution, Parliament has the authority to impose corporate as well as wealth taxes on its inhabitants. This also implies that only the government may compel someone to pay if their income qualifies them to do so and impose a fine if they fail to do so.

Paid out of the income of a person 

The person who is subject to the tax is required to pay it from their income. The revenue was categorised earlier in the Act of 1860 as income from

  • Land assets,
  • Securities,
  • Occupation, trade, and
  • Pensions and salaries.

The definition of "income" is found in Subclause 24 of Section 2 of the Income Tax Return Filing Act of 1961. An assessee is an individual who pays the tax. In accordance with Clause 7 of Section 2 of the Act, it is further defined. "Assessee" encompasses the following:

  • A person who is required by the Act to pay tax or any other amount; or
  • A person for whom any Act-related proceedings are ongoing:
  • Based on the taxable income; or
  • Income from any other party that he is liable to tax; or
  • The loss suffered by him or someone else; or
  • Any reimbursement required by the Act to be made to him; or
  • A person who the Act deems to be a deemed assessee; or
  • An individual who is an Act assessee in default.

Types of taxes  

The government imposes two different sorts of taxes on its people, businesses, and other organisations and institutions. Which are:  

  • Direct tax 
  • Indirect tax

Direct tax

This kind of tax is placed on the person who must pay it and cannot be transferred to another person without having an adverse effect on them. This kind of tax contributes to reducing income inequality by prohibiting the accumulation or concentration of wealth in the hands of a small number of wealthy and powerful individuals. House tax, income tax, wealth tax, and other direct taxes are a few examples.

Indirect tax

This kind of tax is levied on one individual but paid in full or in part by any other person. Because they are not paid by the person who is generating the money, indirect taxes are so-called because the cost and impact of paying them can be transferred to another party. A person who provides commodities, products, or services to another person is subject to this kind of tax. Excise tax, customs tax, GST, VAT, and other types of taxes are a few examples.  

Difference between direct and indirect tax

Basis of comparison 

Direct tax 

Indirect tax 

Incidence and impact 

These are related to the same individual who is the subject of the tax.

Tax incidence is with the person who is subject to the tax, but tax impact is with the person who is subject to the tax.

The burden to pay tax 

Tax liability belongs to the person who earned the income; it cannot be transferred to another party.

Tax liability can be shifted since it falls on the party who utilises the goods or services provided by the party who is subject to the tax.

Viability 

Direct taxes are less onerous since they are levied on the wealth created and income earned.

Taxes are included in the MRP of a product, thus a person's income or wealth has no bearing on the price and is simply utilised to cover it.

Penalty in case of default

The assessee is responsible for paying any fines in the event of a default.

In this case, the supplier of the products and services bears the penalty rather than the taxpayer.

Paid to 

Direct payment is made to the government.

It is given to the providers of goods and services, who subsequently give it to the federal government. So, the government gets indirectly paid.

Examples 

Taxes on homes, wealth, income, etc.

Value-added tax, excise taxes, import duties, taxes on agricultural products, entertainment taxes, etc.

 

Indirect tax

Meaning of indirect tax

Any government's primary source of income is taxation. Many people would be shocked to learn that we pay taxes on everything we purchase or use on a daily basis. The government levies a tax on everything, including electrical devices, furniture, and biscuits. Additionally, this tax is used to fund essential public services including healthcare, education, and the construction of roads and bridges. An indirect tax is any type of tax that is imposed on a good or service.

In contrast to a direct tax, an indirect tax is imposed indirectly on the consumption of products and other services rather than directly on an individual's income. In the case of this kind of tax, the taxpayer first pays the supplier or service provider, who serves as a middleman between the taxpayer and the government, before paying the latter directly. Another person may take up more of the responsibility and incidence. VAT (value-added tax), excise tax, customs tax, GST, entertainment tax, service tax, etc. are a few examples of indirect taxes.

According to Article 265 of the Indian Constitution, only the government and no other entity within the nation have the jurisdiction to impose taxes. The Construction also outlines the topics that must be handled independently by the federal and state governments in the lists mentioned in the seventh schedule. The Constitution also lays forth the guidelines and protections for Indian taxes. For instance, Article 286(1) forbids the state from levying any form of taxes on the import and export of products outside of India as well as on the export of goods outside the state. As a result, the Constitution limits the government's ability to impose and collect taxes where it has granted that authority.

Features of Indirect Tax

The indirect tax has the following features:

Liability to pay tax

The consumer of products and services is either entirely or partially responsible for paying the tax. As intermediaries, the suppliers and service providers also pay the government's tax. This kind of tax is paid by the consumer of the good rather than the person making a profit. The clients buy the goods or services from the middlemen, such as retailers and service providers, and they pay for them. This price already includes a variety of indirect taxes.

Levied or paid on the purchase of goods and services

In contrast to direct taxes, which are assessed or paid on an individual's income earned or wealth accumulated, indirect taxes are assessed or paid on the goods and services the individual purchases. Direct taxes were levied against an individual's income, wealth, or earnings from things like real estate, wages, capital gains, and other sources of revenue. After making all the appropriate deductions from his income, a specified percentage of tax was applied and he was required to pay it. The amount of tax varies from person to person depending on the income received and deductions, but with indirect tax, he is unaware of the amount he is paying in taxes. Additionally, it is the same for everyone, regardless of income.

Regressive in nature

Everyone is subject to the same indirect tax. For instance, if a person purchases a packet of milk, he will pay the same indirect tax as someone else who purchases the same item. As a result of not being based on an individual's income, this sort of tax is also regressive in nature.

Multiple taxes

When there are several indirect taxes, the rates are high, which drives up the price of the good. A person with a moderate income must consider their options carefully before making a purchase and may decide to save their money rather than invest it in a pricey item. For instance, you can be required to pay service tax, excise or customs duty, depending on which is applicable, sales tax, etc. if you purchase furniture. In this case, there is a good chance that the price of the furniture will be greater than anticipated because it will take into account all applicable indirect taxes.

Current position of indirect tax in India 

In the past, the government assessed and imposed several forms of indirect taxes on its people. Depending on the kind of goods or service used, taxes change from one product to the next. Both the central and state governments levied taxes on goods. Sometimes the taxes levied by the state and federal governments were dissimilar, and consumers might easily see these differences in the prices of comparable goods. For instance, the state governments used to charge taxes on products like alcohol and narcotics, while the national government used to collect excise duty on all other goods. Service tax, on the other hand, is only levied and collected by the federal government.

But things have changed since the Goods and Services Tax, or GST, was put into place. This tax replaced all other types of indirect taxes when it was implemented nationwide in 2017. The GST currently includes all indirect taxes and applies to all states and regions equally. People now only needed to pay one type of indirect tax instead of the various types that were previously imposed on a single purchase thanks to the GST. The states levy the same tax, however, the amount may change based on the goods and services.

Types of indirect taxes that existed before the implementation of GST

Different types of indirect taxes were in place in India prior to the establishment of the GST. Which are:

Taxes imposed by the state government

The state governments imposed the following levies under the category of indirect tax on a variety of goods and services:

  • Extra excise tax and state excise tax,
  • Service fees,
  • Luxuries tax
  • Entry fee
  • Taxes imposed by the state, etc.

Taxes imposed by the central government

  • The central excise tax,
  • Additional excise taxes on textiles and self-importance items,
  • Customs duty,
  • Service fees,
  • VAT on entertainment
  • Sales taxes, etc.

Sales tax

The central government levied this type of tax on interstate product sales, or the selling of goods between states. The tax was further broken into the following 3 categories:

  • Interstate tax, 
  • Intrastate tax, and
  • Sale on the import and export of goods.

Service tax

Paid services including maintenance, banking, and health care were all subject to this type of indirect tax.

Value Added Tax (VAT)

Up until 1987, the government levied central excise on the gross value, which had a domino effect. The MODVAT system was developed to lessen this impact, and it was later superseded by the CENVAT Credit scheme. As technology advanced, it became necessary to impose VAT on local sales of necessities like commodities and services.

Excise duty and customs duty

Products that are produced in India are subject to an excise charge; however, those that are imported into the nation but were made outside are subject to a customs duty. The Central Value Added Tax has replaced the excise duty (CENVAT).

For instance, since tea is made in India, the government is allowed to charge an excise fee on its export, whereas branded clothing made outside and brought into India is subject to customs duties. This explains why certain branded clothing costs more money.

Entertainment tax

Entertainment services including movie theatres, cinema halls, gaming areas, amusement parks, etc. are subject to this type of tax. Using a movie theatre or PVR as an example will make this concept clearer. The cost of your movie ticket always includes the entertainment tax when you visit a PVR to watch a film. So going forward, keep in mind to make sure the government isn't applying this tax indiscriminately.

Need for a revised or new indirect tax scheme

The numerous economic variables that led to changes in India's taxation system. The former indirect tax system had a number of problems and difficulties that it did not address. Which are:

Numerous taxes

Numerous taxes were levied by various levels of government in the nation prior to the establishment of the GST. Which were:  

  • Central government-imposed taxes,
  • Customs taxes, central excise taxes, service taxes, etc. are a few examples.
  • State government levied taxes, and
  • VAT, CST, amusement tax, luxury tax, etc. are a few examples.
  • Taxes levied by the local government.
  • For instance, municipal body taxes, property taxes, etc.

Conclusion

A sort of tax known as an indirect tax is one that is paid to the government through middlemen like suppliers, service providers, manufacturers, etc. These taxes are imposed on both goods and services as well as on necessities that people utilise on a daily basis. There were several taxes under the previous indirect tax system, such as service taxes, luxury taxes, amusement taxes, etc., which led to many issues and confusion. All of this came to a stop with the implementation of the GST, which absorbed all previously in-place indirect taxes.

But there are still some issues to be resolved. One of the major issues is an increase in the price of raw materials and ultimately the finished product as a result of taxes being imposed on every transaction and manufacturing stage. Some commodities are now more expensive than others due to the various GST tax rates, making it challenging for the poor to buy them. This has made them even more afraid of paying greater taxes. All of these problems need to be solved. Additionally, the GST regulations must be adjusted in accordance with the growth of internet firms and e-commerce. However, one of the most significant contributions to the field of indirect tax is GST.


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