Everyone talks about today how you can build the wealth, but as much important wealth building is as understanding the about how taxation works.
When we talk about taxing the citizens, then there are broadly two types of taxes: Direct Tax and Indirect Tax and to do a better financial planning you should be aware their meaning, how they work, what is the difference between direct and indirect tax, their types, etc.
Thus, I have prepared a in depth guide on it to simplify each topic.
So let’s get started!
Table of Contents
Direct tax is a kind of tax that is imposed on your profits and income of an individual that only you should have to pay and can’t pass on it’s burden to others.
In simple terms, all the taxes that you pay on your salary, income, property gains, selling any security or equities, etc. are fall under direct tax.
The word “Direct” signifies that this tax is collected by the Government of India directly through the Central Board of Direct Taxes (CBDT).
Imagine there is freelancing graphic designer named Anjali and she earns ₹12,00,000 annually from her design projects.
As a direct tax, she pays income tax based on her earnings.
Now, before paying the final income tax Anjali claims deductions under Section 80C for her contributions to a public provident fund (PPF) and under Section 80D for her health insurance premiums.
Finally after applying all these deductions, her final taxable income is reduced to ₹10,00,000.
Consequently, she pays income tax based on this adjusted figure and this illustrates how direct taxes are directly linked to individual income and you are forced to pay this tax else Government can take legal action on you.
There are different types of direct tax that you have to pay.
Income tax is a type of direct tax where an individual pay the taxes directly to the Government of India at the end of financial year based upon on their net taxable income after claiming all the deductions.
No matter if you do a job or business you are liable to pay the income tax if you are an individual or operating business on your name as the individual.
While the Investors can benefit from various deductions under Section 80C, 80D, and others, encouraging savings and investments.
Wealth Tax was once made to target the HNIs (high-net-worth individuals) based on their total wealth, including assets like property and luxury items but later on in 2015 this tax has got abolished.
Capital Gains Tax is again a type of direct tax that you have to pay whenever you made some capital gains like by selling properties, equities, mutual funds, etc.
While do note this capital gains tax are taxed based on whether it is a short term capital gain or long term capital gain and it can vary from assets to assets.
As per the budget FY2024-25 all the listed securities held for less then 12 months are categorised as short term capital gain while in the case of immovable property this time limit is 24 months.
This tax is imposed on a company’s profits, with various exemptions and incentives available to promote growth in specific sectors, such as manufacturing and startups.
Indirect tax is a kind of tax that you pay whenever you buy any goods and services and even you can pass your tax burden to other people.
The word “Indirect” signifies that Government of India collect this tax from you but indirectly through Central Board of Indirect Taxes and Customs (CBIC).
That means CBIC collect this tax from you and then finally transfer it to the Government.
Consider a local craft brewery in Rajasthan, which produces unique artisanal beers.
When customers purchase a bottle for ₹500, the 18% Goods and Services Tax (GST) is added to it, amounting to ₹90 and the final price or the MRP of the bottle becomes for the customer is ₹590.
Here, the brewery collects the GST on behalf of the government and remits it monthly.
Here you will observe that unlike in the case of direct taxes where only you have to pay the tax and can’t shift your burden to other.
In indirect taxes, that local craft brewery instead of paying tax from his pocket, he collected the tax from customer and paid that to the government and hence, shifted his tax burden to other.
This scenario illustrates how indirect taxes are included in the price of goods, impacting consumers without altering the brewery’s pricing strategy for the base product.
Now let’s checkout the different types of indirect taxes so that you can have a more clear understanding
GST or Goods and Services tax is the best example to represent the indirect tax system.
Earlier there was different indirect taxes like VAT, Excise Duty, etc. that made the system complex and reduced the ease of doing business.
Hence, back in 2017, Government of India introduced Goods and Service Tax to simplify the indirect tax system and to unify different taxes together making the system more effective.
Earlier in case of VAT, it is collected by the states only but now with the help of GST all the tax collected gets divided in into three segments: CGST (Central GST), SGST (State GST), and IGST (Integrated GST) for inter-state transactions.
GST is levied at multiple rates (0%, 5%, 12%, 18%, and 28%) based on the nature of goods and services.
Understanding these rates is crucial if you are doing a business or operating a manufacturing unit or working in retail sectors.
Custom duty is again an indirect tax type that you have to pay on importing the foreign goods to India. Investors dealing in international trade must stay abreast of changing customs regulations and rates.
Excise Duty is also an indirect tax, now after the GST introduction, it is usually applied on alcohol, tobacco products, or petroleum products like diesel, petrol, etc. only.
It is levied on the production or manufacturing of goods within the country and impact manufacturers that ultimately make the price of final products more expensive.
Here’s a quick comparison box highlighting the key differences between direct and indirect taxes:
| Feature | Direct Taxes | Indirect Taxes |
|---|---|---|
| Definition | Tax levied directly on income or wealth of individuals and corporations. | Tax levied on goods and services, passed on to consumers. |
| Taxpayer | Burden falls directly on the taxpayer. | Burden can be transferred to consumers. |
| Examples | Income Tax, Capital Gains Tax, Corporate Tax | Goods and Services Tax (GST), Customs Duty, Excise Duty |
| Collection Authority | Collected by the central and state governments. | Collected by various levels of government (central/state/local). |
| Impact on Prices | Does not directly affect the prices of goods/services. | Directly affects the prices of goods and services. |
| Tax Rate Structure | Progressive (increasing rates with income levels). | Multiple fixed rates (e.g., GST rates of 0%, 5%, 12%, 18%, 28%). |
| Compliance Complexity | Typically requires detailed income disclosures and filings. | Generally simpler compliance, often included in sales price. |
| Planning Opportunities | Opportunities for deductions and exemptions (e.g., Section 80C). | Limited planning options; focus on pricing strategies. |
Goods and Service Tax or GST is indirect tax as you don’t pay the tax directly to government and you can shift your tax burden to consumer.
Corporate tax is direct because corporate’s have to directly pay this tax every year as per the annual income.
TDS is a direct tax because the TDS got deducted from individual income or at the source of payment.
Well, no one like to pay the taxes but still if look at merits of direct taxes then we will see that tax money helps government to do economic development, it reduces the gap between a poor and rich.
While if see the demerits of direct tax then it reduces the net income of an individual due to which he is not able to spend more, higher taxation on high income discourages the people to do hardwork as they have to pay significant amount in tax.
Merits of Indirect tax – Unlike direct tax all people are forced to pay the indirect tax due to which government is able to collect large revenue from larger segment of the population, with that it provides stability in revenue.
While talking about the demerits of indirect tax so they increase the price of final goods, make the taxation system more complex for businesses, they are regressive in nature, etc.
That’s all! I hope now you have a clear understand in about direct vs indirect tax.
Both taxes affect our lives either directly or indirectly hence, we should plan our finance in such a way that we can save maximum on taxes.
While in case of indirect tax we can’t do much but if you are a businessmen then you can take the input credit or can claim the GST for so many items that you buy, showing that you have purchased those items for you business purpose.
Disclaimer: The Honest American provides financial education, investing strategies, & stock market news for informational purposes only and should not be construed as investment advice. Readers are encouraged to consult with a qualified financial advisor before making any investment decisions.
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