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Difference between Direct and Indirect Tax

Difference between Direct and Indirect Tax
February 23, 2024

 

Taxation mechanism is a highly intricate and complex affair and as responsible taxpayers, you must be aware of the clear distinctions between the taxes. In the course of our financial journey, every individual or an entity is supposed to pay taxes, whether one is earning an income or purchasing a product or service. 

The very basic classification of taxes is the division of taxes as “Direct tax” and “Indirect Tax”. As a responsible taxpayer in India, direct taxes are to be paid to the Government for income through employment, business, assets or profits. Whereas, one has to bear indirect taxes while buying goods and services, which in turn reaches the Government through the seller. These broad categories of taxes constitute the major source of revenue for the Central and State Governments and are utilised to build the economy. 

Direct Tax and Indirect Tax

For a better understanding of direct and indirect tax, let us first focus on the formal definitions.

Direct Tax

Direct tax is the tax levied directly on the taxpayer’s income by the Government. An individual, a HUF or an entity is responsible for payment of these taxes upon the income or wealth generated and accumulated. This liability cannot be shifted or transferred to someone else or another entity under any circumstances. In India, the planning and imposition, collection and administration of these taxes is done by the Central Board of Direct Taxes (CBDT), governed by the Department of Revenue of the Central Government. Income Tax,  Corporate Tax and Capital Gains Tax fall into this category. 

Indirect Tax

Indirect tax is payable on the purchase of goods and services. Here, the end consumer pays the taxes as a percentage of the price, which reaches the Government through the seller, who acts as an intermediary. Thus, taxes like Goods and Services Tax (GST), VAT, Customs Duty, etc. are paid indirectly to the Government by the buyer of the product or the service. The responsibility for the collection and administration of these taxes lies upon the Central Board of Indirect Taxes and Customs (CBIC). Like CBDT, CBIC is also governed by the Department of Revenue. 

Difference between Direct and Indirect Tax

There are certain points of difference between the two broad categories of taxation – Direct and Indirect Tax. The following table illustrates the same. 

Context

Direct Tax

Indirect Tax

Imposition

Levied on income, wealth or profit

Levied on goods and services

Payer

Paid by individuals, HUFs and business entities

Paid by end- consumers

Mode of payment

Paid directly to the Government by the taxpayer

Paid by the customer to the Government through the seller, who acts as an intermediary

Rate of tax

Based on the tax slabs of individual, HUF or entity’s income, wealth and profit

Same for everyone but differs product-wise.

Nature of burden

Progressive, higher tax payable for higher income 

Regressive as all income classes are treated as equals

Transfer of liability

Not transferable

Transferable

Method of collection

Needs complex documentation

Convenient as included in price

Evasion

Possible

Not possible

Types of Direct Tax in India 

Direct tax is levied upon income, profits and wealth, based on which it can be classified into the following categories: Income Tax, Corporation Tax, Wealth Tax and Capital Gains Tax. 

Following are the examples of direct tax in India

1. Income tax:

Income Tax is paid by an individual based on his/her taxable income in a given financial year. Under the Income Tax Act, the term  ‘individual’  also includes Hindu Undivided Families (HUFs), Co-operative Societies, Trusts and any artificial judicial person. Taxable income refers to total income minus applicable deductions and exemptions. The income tax is decided as per various slabs which are subject to variation in each fiscal year.

2. Corporation tax:

This is the tax that is levied on businesses and companies operating in India. It is levied on the basis of earnest income in worldwide operations in a given fiscal year and the rates depend on the physical location of the concern (whether based in India or abroad).

3. Wealth tax:

This is a form of direct tax that is levied on individuals, HUFs or companies on the value of their assets in a given financial year on the date of valuation. It does not include productive assets like commercial property, stocks, bonds, fixed deposits, mutual funds etc. and is currently taxed at the rate of 1% of the net wealth of any individual exceeding
Rs 30,00,000.

4. Capital Gains tax:

This form of direct tax is levied on the sale of property and consequent profit. Property here includes stocks, bonds, residential property, precious metals etc. It is taxed at two different rates based on how long the property was owned by the taxpayer – Short Term Capital Gains Tax and Long Term Capital Gains Tax.

Types of Indirect Tax in India 

  • Goods and Services Tax (GST)

GST is a single, comprehensive indirect tax that has subsumed multiple indirect taxes such as VAT, central excise duty, service tax, etc. It is levied on the supply of goods and services throughout the country. GST has different rates based on the type of goods or services.

  • Excise duty

Excise duty is a tax levied on producing or manufacturing goods within the country. It is primarily levied on goods like petroleum products, alcohol, tobacco, and certain luxury items.

  • Customs Duty

When goods are imported from a foreign country, you are required to pay customs duty on it. Irrespective of whether the product has come to India by air, land, or sea, you will have to pay the customs duty on it. The customs duty rates vary depending on the goods type and the country of origin.

  • VAT

It was a consumption-based tax imposed on a product, which was added at each stage of its manufacture or distribution. It is imposed by State government while mainly decides its percentage on various goods. While GST has mostly eliminated VAT, it is still imposed on some products such as items that contain alcohol.

Pros of Direct and Indirect Tax

Both direct and indirect taxes come with their own set of benefits. Let us delve into the details one by one. 

Pros of Direct Tax

  • Cuts down inflation: When the economy is reeling under monetary inflation, rates of direct taxes are increased to battle it out. Paying higher tax rates forces taxpayers to cut down on their consumption and demand for goods and services. In turn, it pulls down the inflation level. 

  • Balances the economy: The well-defined direct tax structure and exemptions make’s people with higher incomes, pay higher taxes and vice versa. This helps in balancing the income inequalities and subsequently, the economy as a whole. 

  • Redistribution of Wealth amongst the Individuals: Direct Tax promotes a progressive taxation system, where higher tax rates apply to the wealthy and lower rates apply to comparatively less wealthy individuals. This approach addresses wealth inequality among citizens, aligning with its non-revenue objectives.

  • Revenue Generation for Economic development: The primary objective of levying tax is to generate revenue for government so that it carries out the social welfare activities such as building public infrastructure, healthcare, schools, colleges, providing subsidies, defence etc. benefitting the overall development of the society in large.

Pros of Indirect Tax

  • No Tax evasion possible: Indirect taxes are included in the price itself for a product or a service. So, there’s no scope to evade it if the purchase is made. 

  • Equal tax burden: The same tax rate holds for everyone, irrespective of income level. Each individual shares the same tax burden, however small or big it is, and pays it to the government.  

Cons of Direct and Indirect Tax

There are certain drawbacks of both direct and indirect tax. Let’s go through them in detail. 

A. Cons of Direct Tax

  • Complex and burdening: Direct taxes, payable yearly in hefty lump sums, are often considered a burden by the taxpayer. In addition, the documentation involves a lot of calculations and paperwork, making it a complex process. 

  • Can be evaded: Though income tax is a mandatory payment, there are scopes of evading it. Fraudulent practices can be applied to pay lower taxes than the actual amount or skip it altogether. 

B. Cons of Indirect Tax

  • Regressive nature: Indirect tax rates are fixed for everyone alike. So, people from the lower-income group need to bear the same tax burden as those of the high-income group. This makes the tax structure regressive. 

  • Higher price: Indirect tax is included in the prices of goods and services. Thus, the price level increases, pulling down the purchasing power of individuals and households. 

Who collects Direct Tax in India?

Direct taxes are calculated upon income, wealth and profit of individuals, HUFs and businesses. In India, the collection of direct taxes like the income tax or corporate tax is done by the Department of Revenue of the Central Government. It is the responsibility of a statutory body - the Central Board of Direct Taxes (CBDT), governed by the Revenue department. 

What is the difference between GST and Direct Tax?

The two major taxes payable by the Indian taxpayers are the Direct Tax and the Goods and Services Tax. Following are the key points of differences between the two, represented in the table:

GST

Direct Tax

Payable by an individual or a business on consumption of goods and services

Payable by individuals, HUFs and businesses on annual income earned.

It’s an indirect tax and transferable within stages of the supply chain

It’s a direct tax and not transferable

Can be charged by registered entities only as the intermediary

The taxpayers pay the tax directly to the government

Tax rates are same for  end consumers.

Tax rate is determined based on the Applicable Slab rates for individuals and HUFs and for businesses. 

Every member of a supply chain is charged for a product

Only  individual, HUF or entity is charged for the corresponding income

Rate of GST varies based on types of product and services

Slab rates or flat rates are based on the type of taxpayer 

Monthly/Quarterly returns are filed by supplier’s along with annual returns upon crossing of the threshold limit. 

Only annual returns are filed

FAQs on Direct and Indirect Tax

Q. What are direct and indirect taxes?

Direct taxes are levied on the income, wealth and profit of individuals, HUFs and entities, payable directly to the Government. Whereas, indirect taxes are payable on consumption of goods and services by end consumers.. 

Q. Is GST an indirect tax?

Yes, GST is included in the price of products and services and is an indirect tax. 

Q. What are the types of direct tax?

The types of direct taxes are income tax, corporation tax and capital gains tax. 

Q. Who is liable to pay direct tax?

Any individual, HUF or business is liable to pay direct tax for the income, profit and wealth. 

Q. What are the types of indirect taxes?

The types of indirect taxes include Goods and Services Tax (GST), Value Added Tax, and Customs Duty. 

Q. Do indirect and direct taxes need  to be collected separately?

Yes, indirect and direct taxes must be collected separately. Indirect taxes are charged on goods and services, while direct taxes are charged on profits and income.

Q. Is the tax rate different for direct and indirect taxes?

Yes, tax rate charged are different for direct and indirect taxes. Direct tax is charged on the "Income” of the person. While Indirect tax is charged on the "Purchase of goods and services”.

Summing up

Understanding different types of direct and indirect taxes as well as the benefits and drawbacks of direct and indirect taxation helps you in differentiating direct and indirect taxes in India. However, irrespective of its nature, taxes paid to the Government are meant for the development and welfare of the economy. So, as a responsible taxpayer, it remains the duty of every income earner to pay the taxes properly and on time. Here,  tax saving strategies for salaried individuals based on provisions of the Income Tax Act,  1961 can be useful in lowering the burden.   

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Francis Rodrigues Francis Rodrigues

Francis Rodrigues has a decade long experience in the insurance sector, and as SVP, E-Commerce and Digital Marketing, HDFC Life, manages the online sales channel, as well as digital and performance marketing. He has had hands-on experience in setting up sales channels and functional teams from scratch over a career spanning 2 decades.

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Vishal Subharwal Vishal Subharwal

Vishal Subharwal heads the Strategy, Marketing, E-Commerce, Digital Business & Sustainability initiatives at HDFC Life. He is responsible for crafting and ensuring successful implementation of the overall organisation strategy.

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