Money is required to run a government and manage its affairs. For this, the government levies a variety of taxes on the earnings of individuals and businesses. Based on a broad classification, there are two types of taxes, namely, direct taxes and indirect taxes. In this article, we will look at these two types of taxes briefly. The types of taxes is an important topic for the UPSC IAS Exam Economy Syllabus.

What is Tax?

• Tax is a mandatory contribution to state revenue that the Indian government levies on worker income and corporate gains, as well as added to the cost of certain transactions, commodities, and services.
• The government collects taxes on citizens to generate revenue for business ventures that would improve the country's economy and raise citizens' living standards.
• In our country, the government's right to levy taxes is derived from the Indian Constitution, which grants the State and Central governments equal jurisdiction to impose taxes.
• Every tax imposed within the country must be accompanied by an accompaniment law passed by the State Legislature or the Parliament.

Classification of Taxes

Taxes are broadly classified into two types:

• Direct Taxes
• Indirect Taxes

Direct Tax

• A direct tax is one that is levied directly on the taxpayer and paid directly to the government by those who are subjected to it.
• The Central Board of Direct Taxes is responsible for levying and collecting direct taxes as well as formulating other direct tax policies.
• A taxpayer pays a government a direct tax for a variety of reasons, such as real property tax, personal property tax, income tax or asset taxes, Gift Tax, Capital Gains Tax, and so on.
• Direct Tax is one of the two main sources of revenue for the government. The indirect tax is the other.
• Every fiscal year, direct taxes account for roughly half of the government's revenue.
• To increase revenue, the government sets direct tax collection targets for each fiscal year.

Examples of Direct Tax

Income Tax

• Individuals, Hindu undivided families, unregistered businesses, and other groups of persons are all subject to income tax.
• The nature of income tax in India is progressive.
• Income from all sources is combined together and taxed according to the individual's income tax slabs.
• Different rates of income tax are charged based on the amount of net income. For instance, an income tax of 10% is charged if net taxable income is between Rs 5 to 7.5 lakhs.
• Where the total income exceeds Rs 50 lakh but does not exceed Rs 1 crore, there is a 10% surcharge on income tax.
• Note: Agricultural Income is not taxed

*Click here to read more about Income Tax.

Corporation Tax

• It is a tax placed on the profits of corporations and business firms. It is also called Corporate tax.
• A firm is recognised as a separate entity for tax reasons and hence must pay a separate tax from its owner's personal income tax.
• Companies that are registered in India under the Companies Act 1956, both public and private, are subject to pay corporate tax.
• As of January 2022, COrporation tax is at a rate of 22 per cent for all domestic companies.

*Click here to read more about Corporation Tax.

Minimum Alternate Tax

• The concept of Minimum Alternate Tax (MAT) was introduced to ensure that companies with large profits and substantial dividends to shareholders who were not contributing to the government through corporate tax by taking advantage of the various incentives and exemptions provided in the Income-tax Act paid a fixed percentage of book profit as minimum alternate tax.
• As a result, the government charges a Minimum Alternate Tax, or MAT, on these businesses as an advance tax. As a result, businesses are required to pay at least a certain amount of tax.
• According to the Income Tax Act, if a company's taxable income is less than a particular percentage of its booked profits, that portion of the book profits is automatically considered taxable income, and tax is due.
• As of January 2022, MAT is at a rate of 15 per cent.

*Click here to read more about Minimum Alternate Tax.

Capital Gain Tax

• A capital gain is any profit or gain derived from the sale of a capital asset.
• Profits from the sale of capital are subject to taxation.
• Land, buildings, houses, jewellery, patents, and copyrights are examples of capital assets.
• Short-term capital asset — A short-term capital asset is an asset that is held for less than 36 months.
• Long-term capital asset — A long-term capital asset is one that has been held for more than 36 months.
• From FY 2017-18 onwards, the 36-month requirement for immovable property (land, building, and house property) has been decreased to 24 months.
• For example, if you sell a house property after owning it for 24 months, any income you receive will be considered as long-term capital gain if you sell it after March 31, 2017.
• However, transportable goods such as jewellery and debt-oriented mutual funds are exempt from this adjustment. If held for more than 36 months, they will be classified as a long-term capital asset.
• The Capital Gains are charged differently for short term and long term gains based on the income gained.

*Click here to read more about Minimum Alternate Tax.

Securities Transaction Tax

• Securities transaction tax is a tax on gains made on the domestic stock exchange on securities such as equities, options, and futures.
• It is a direct tax levied and collected by the central government.
• P. Chidambaram, the former Finance Minister, proposed the Securities Transaction Tax (STT) in 2004.

*Click here to read more about Securities Transaction Tax

Commodities Transaction Tax

• The commodity transaction tax is charged on the buyer and seller of exchange-traded non-agricultural commodity derivatives in India.
• It is calculated based on the contract's size.
• Non-farm items such as metals (gold, silver, and copper) and energy products are among the commodities covered by CTT (crude oil and natural gas).

*Click here to read more about Commodities Transaction Tax

Alternate Minimum Tax

• What Minimum Alternate Tax (MAT) is to corporations, Alternate Minimum Tax (AMT) is to limited liability partnerships.
• Other types of commercial organisations, such as partnership businesses, sole proprietorships, and associations of persons, are not subject to this tax.

Estate Duty

• It was first introduced in 1953. It is imposed on all of a person's property when he or she dies.
• The deceased person's entire estate is considered his riches and is subject to taxation.
• Since 1985, the tax has been discontinued.

Wealth Tax

• It was first introduced in 1957.
• It was imposed on individuals, joint Hindu families, and businesses who had an excess of net worth.
• Wef 2015, the tax was abolished.

Gift Tax

• It was first introduced in 1958.
• All donations were subject to the gift tax, with the exception of those made by charitable institutions' government and private enterprises.
• Since 1998, the tax has been discontinued.

Fringe Benefits Tax

• Many corporations provide various bonuses to their employees and keep them beneath their input cost in order to lower the profit on booked entries.
• As a result, profit is reduced, resulting in lower government taxation.
• To counter this, the government enacted the Fringe Benefits Tax (FBT), which is essentially a tax that an employer must pay in lieu of the benefits provided to his or her employees.
• It was an attempt to impose a tax on all benefits that were evading the tax.
• In India's 2009 Union budget, the fringe benefits tax was repealed.

Advantages of Direct Tax

• Economic Balance: The government creates tax bands depending on an individual's wages and age to achieve economic and social balance. The tax rate is set according to the country's economic position. Individuals are excused in order to balance economic disparities.
• Ensures equality: Individuals and businesses with larger profits must pay higher taxes to the government in order for the government to assist the poor and vulnerable in society. This maintains economic equilibrium.
• Gives Certainty: The direct tax provides both the government and the taxpayers with a sense of certainty because the amount of tax that must be paid and collected is known to both the taxpayer and the government.
• Addresses inflation issues: During periods of high inflation, the government raises taxes in order to limit the demand for goods and services, resulting in a fall in inflation.
• Makes Government Accountable: Individuals are aware of the need to pay taxes. As a result, he or she is aware of his or her rights and is engaged in the government's use of taxes. This ensures that the government is held accountable.

Disadvantages of Direct Tax

• Can be easily evaded: Not everyone is eager to pay their taxes. To avoid paying taxes, some are willing to file a fraudulent tax return. Without being held accountable to the law of the state, these people can easily conceal their earnings.
• Tax slabs are arbitrary: Taxes are set arbitrarily by the Finance Minister if they are progressive. It places a significant burden on the poor if it is proportional.
• Obstructs growth: High taxes disincentivize people from saving and investing, causing the country's economy to suffer. It obstructs the growth of businesses and industries, causing them harm.
• Inconvenience: A direct tax has the significant disadvantage of pinching the taxpayer. When a lump sum is taken from his pocket, he feels a sense of his hard-earned money taken away. As a result, paying direct taxes is quite inconvenient.

Indirect Tax

• An indirect tax is a tax that is collected through a middleman from the person who suffers the tax's ultimate economic burden.
• It is possible for the taxpayer to transfer it to someone else.
• The intermediary prepares a tax return and sends the tax proceeds to the government along with it.
• In this sense, an indirect tax differs from a direct tax, which is collected directly by the government from the individuals (legal or natural) who are subjected to it.
• Indirect taxes are based on an individual's expenses rather than their income.
• Indirect taxes are levied on suppliers of goods and services, but the tax is passed on to the consumers, who are indirectly paying the tax.

Examples of Indirect Tax

Customs Duty

• When commodities are transferred across international boundaries, customs duty is applied as a tariff or tax.
• Its goal is to safeguard the country's economy.
• Various sorts of duties are imposed under customs rules, including Basic Duty, Countervailing Duty, Protective Duty, Anti-Dumping Duty, and Export Duty.
• Import duties are used not just to generate revenue for the government, but also to regulate commerce.
• In India, import duties are calculated on an ad valorem basis.

*Click here to read more about Customs Duty GST

• GST (Goods and Services Tax) is a national indirect tax applied on the manufacture, sale, and consumption of goods and services.
• It has supplanted all indirect taxes levied by the central and state governments on goods and services.

*Click here to read more about GST

Sales Tax

• In India, a sales tax is a type of tax levied by the government on the sale or purchase of a certain commodity within the country.
• Sales tax is levied by both the central and state governments.
• It has now been replaced by IGST.

Excise Duty

• Excise duty is a commodities tax in the proper sense because it is collected on the manufacturing of products in India rather than the sale of the product.
• Except for alcoholic drinks and narcotics, the central government imposes an explicit excise levy.
• It has now been replaced by CGST.

Service Tax

• In India, a service tax is levied on all services rendered.
• In 1994-95, a service tax was imposed on three services: telephone services, general insurance, and stockbroking.
• Every year since then, the service net has widened by adding more and more services. We now have a 'negative list' exclusion criterion, where some services are excluded from the tax net.
• In India, the current rate of service tax was 15% before it was replaced by the Goods and Services Tax.

Value Added Tax

• The VAT is constructed in such a way that it eliminates distortions.
• As a result, all states and union territories in India have implemented VAT (except UTs of Andaman Nicobar and Lakshadweep).
• The tax is imposed on a variety of commodities sold in the state, and the amount is set by the state.
• State VAT, which was in effect until July 1, 2017, had replaced the previous Sales Tax of States.
• It has now been replaced by SGST.

Dividend Distribution Tax

• A dividend is a payment made by a corporation to its stockholders from the company's profits in a given year. Dividends are income in the hands of shareholders, and they should ideally be subject to income tax.
• Dividend distribution tax is a tax levied by the Indian government on Indian corporations based on the amount of dividends paid to shareholders.
• DDT was first introduced in 1997, and it was regulated under Section 115 O of the Income Tax Act.
• The Finance Minister eliminated the Dividend Distribution Tax in Budget 2020.
• The burden of dividend taxation has now been shifted from corporations to individuals.

*Click here to read more about Dividend Distribution Tax

Advantages of Indirect Tax

• Everyone is able to contribute: Unlike Income Tax, which is paid by those in particular income groups but not others, Indirect Taxes are paid by everyone who buys a product. People who are not working in India, such as tourists and people from lower socio-economic groups, must pay it because they will purchase goods in some way.
• Indirect Taxes are convenient: When it comes to collecting indirect taxes, they are incredibly convenient. Taxes might be extremely low, and customers do not feel pressured while paying such modest sums. Moreover, they are a price of the cost of goods sold, hence, convenient to pay.
• They are unavoidable: Because indirect taxes are included in the price of the product, they cannot be avoided. As a result, anyone who purchases the commodity will be subject to the tax.
• They cover a wide range: Heavy taxation on any one feature of a service or item will be obvious to the consumer and will be a significant hardship. In this case, indirect taxes can be advantageous because they are spread out over a larger number of products and are paid in lower amounts.

Disadvantages of Indirect Taxes

• Indirect taxes have the potential to be regressive: Because both the rich and the poor pay the same indirect tax, it can be considered unjust to the poor. Anyone who makes a purchase is subject to indirect tax, and while the wealthy may afford to pay it, the poor will be charged the same amount. As a result, indirect taxes may be considered regressive.
• They are inflationary in effect: Sellers may not always be able to compute and collect the exact fraction of tax that applies to all of the goods they sell. As a result, they purposefully charge more than the tax amount in order to ensure that every buyer pays the indirect tax. However, this has a cumulative effect, raising commodity prices.
• They do not raise civic consciousness: Indirect taxes do not raise civic awareness because millions are not even aware that they’re paying a tax because it is hidden in the price.

Difference Between Direct and Indirect Taxes

Cess and Surcharge

Cess and surcharge are the taxes levied by the Union Government in order to raise funds for government operations. Though both Cess and Surcharge add money to the government’s revenue, these are different in many aspects.

Cess

• A cess is a tax on tax in basic terms.
• It is critical to remember that a cess must only be applied to the purpose for which it is levied.
• For example, the Indian government collects an education cess and uses it solely for that reason, namely, education.
• Furthermore, this tax is imposed on all taxpayers.
• Cess taxes are paid to the Consolidated Fund of India.
• Cess is generally expected to be charged until the government has sufficient purpose and becomes dormant after the purpose is fulfilled.
• A cess is different from other taxes such as excise duty and income tax as it is levied in addition to the current tax (tax on tax).
• For example, a 5% education cess on a 20% percent income tax will make the overall tax 21%. (20% base tax plus 5% (cess) of the 20%).
• Education cess, road cess, infrastructure cess, clean energy cess, Krishi Kalyan cess, and Swachh Bharat cess are the key cesses currently in place.

Surcharge

• In the case of individuals earning a net taxable salary of more than Rs 1 crore, a surcharge of 10% is levied on tax liability.
• Surcharge at the rate of 5% is levied on domestic corporations if net income is in the range of Rs 1 cr to Rs 10 cr. If the net income exceeds Rs 10 cr, a surcharge at the rate of 10% is levied.
• Surcharge at the rate of 2% is levied on foreign corporations if the net income is in the range of Rs 1 cr to Rs 10 cr.
• If the net income exceeds Rs 10 cr, the surcharge is increased to 5%. Marginal relief is given to both domestic and foreign companies in case the net income exceeds Rs 1 cr and Rs 10 cr.
• A surcharge on income tax is a substantial source of revenue for the government.
• This money is collected for whatever purpose the Union Government deems appropriate.
• It's worth noting that it only applies to the tax due, not the whole income.
• This money is paid to India's Consolidated Fund, which can be utilised for any purpose.

A 10 per cent surcharge on a 30 per cent income tax rate, for example, brings the tax burden to 33 per cent.

Benefits of Taxes

The goal of taxes is to provide funds to the government for spending without causing inflation. Tax is levied on a wide range of income, including salary, business profits, property rental, and so on. In addition, there are wealth taxes, sales taxes, property taxes, payroll taxes, value-added taxes, service taxes, and so on. The government uses taxes for a variety of purposes, including

• Infrastructure funding for the public sector
• Projects for development and welfare
• Defense spending
• Public insurance based on scientific research
• Employees of the state and government are paid a variety of salaries.
• The operation of the government's public transportation system
• Unemployment compensation
• Pension plans
• Enforcement of the law
• Public health, education, and water, energy, and waste management systems are examples of public utilities.

Conclusion

Thus, taxes have both advantages and disadvantages, but no one can deny that they are important to generate revenue. While direct taxes can be collected from the rich, indirect taxes give an opportunity to the poor to contribute in their own small way. The control of these taxation systems has a huge scope to bring about a change. For these reasons, the taxation of a country is critically important for the economy.