Direct and Indirect Taxes in India – Types, Benefits, Drawbacks & Rates

A tax is a mandatory charge collected by the Central and State Governments from individuals and businesses to meet public expenditure and sustain economic growth. Taxes are broadly categorized into two forms: Direct taxes and Indirect taxes. Direct taxes are charged on a person’s income or profits and are paid straight to the government. Indirect taxes, in contrast, are applied when goods or services are bought, and the payment is passed to the government through the seller or service provider.

Why Does the Government Collect Taxes?

Taxes serve as the primary source of income for the government. The money collected is utilized for essential services like defense, healthcare, and education, along with infrastructure development such as highways, bridges, and dams.

Types of Taxes

Direct Tax

A direct tax is levied on an individual’s income or profit. Examples include income tax, personal property tax, and fringe benefit tax (FBT). The responsibility to pay direct tax lies entirely on the taxpayer, and this burden cannot be shifted to someone else. The Central Board of Direct Taxes (CBDT) manages its regulation and collection.

Direct Taxes Applicable in India

Income Tax: Charged on individuals based on their income falling within prescribed tax slabs.
Corporate Tax: Paid by companies operating in India on their business profits. Unlike personal income tax slabs, corporate taxes are charged at fixed rates.
Securities Transaction Tax (STT): Levied on the purchase or sale of securities listed on recognized stock exchanges, added over the transaction value.
Wealth Tax (Abolished in 2015): Earlier charged on net wealth exceeding a set limit, now substituted with a surcharge on high-income groups.
Estate Duty (Abolished in 1985): Previously imposed on wealth transfers through inheritance.

Advantages of Direct Taxes

Direct taxes provide several benefits that contribute to a nation’s social and economic stability. Some key advantages include:

Helps control inflation: During inflationary periods, the government can raise tax rates, reducing the demand for goods and services. Lower demand helps bring inflation under control.
Promotes social and economic equality: With structured tax slabs and exemptions, individuals are taxed based on their income levels. This ensures a fair distribution of wealth and helps bridge income gaps.

Disadvantages of Direct Taxes

Despite their advantages, direct taxes come with a few drawbacks:

Heavy tax burden: High tax rates reduce disposable income, affecting savings and investments for both individuals and businesses.
Tax evasion risks: Since these taxes are collected directly, many taxpayers attempt to avoid them or exploit loopholes to minimize liabilities.

What is Indirect Tax?

Indirect taxes are imposed on goods and services and can be passed from one taxpayer to another. For instance, wholesalers shift the tax to retailers, and retailers ultimately pass it on to consumers. Thus, the final burden of indirect taxes falls on the end customer. These taxes are managed and regulated by the Central Board of Indirect Taxes and Customs (CBIC).

Earlier, multiple indirect taxes increased the overall cost of products and services. Today, the Goods and Services Tax (GST) has replaced most of them by unifying the system under a single law.

Examples of Indirect Taxes (Earlier Imposed in India)

Customs Duty: A tax on imported goods, eventually borne by retailers and consumers in India.
Central Excise Duty: Levied on manufacturers, who shifted the burden down the supply chain.
Service Tax: Charged on the total amount billed by service providers to recipients.
Sales Tax: Paid initially by retailers but passed on to customers when selling goods and services.
Value Added Tax (VAT): Collected at each stage of production or distribution, with the cost transferred to the consumer.

GST as an Indirect Tax

The introduction of the Goods and Services Tax (GST) has brought significant positive changes to India’s financial system. Many of the previous taxes have now become obsolete under this reformed indirect tax regime. GST is also helping turn the vision of “One Nation, One Tax, One Market” into reality.

One of the most notable benefits of GST is the elimination of the cascading effect of tax, or the “tax on tax” problem. This occurs when the final consumer ends up paying tax on previously applied taxes, increasing the overall cost of goods and services. Under GST, this extra burden is removed, providing relief to customers.

Types of Supply and Taxes Levied

Intra-State Supply
When goods or services are supplied within the same state, GST is levied equally by both the Central and State Governments:

Central Goods and Services Tax (CGST): Collected by the Central Government on intra-state supplies.
State Goods and Services Tax (SGST) / Union Territory GST (UTGST): Collected by the respective State Government or Union Territory without legislature on intra-state supplies.

Inter-State Supply
When goods or services move between different states or union territories, Integrated GST (IGST) applies. IGST combines CGST and SGST/UTGST to streamline taxation across states.

Advantages of GST

Input Tax Credit (ITC): Businesses can reduce the tax payable on the final product by claiming credit for taxes already paid on purchases, lowering the overall tax burden.
Composition Scheme: Small businesses with turnover below ₹1.5 crore (₹75 lakh for North-Eastern states and Himachal Pradesh) can pay tax at a fixed rate based on turnover, bypassing complex GST formalities.
Zero-Rated Exports: GST is not charged on exported goods or services, classifying them as zero-rated supplies.
Simplified Compliance: Digital initiatives like e-invoicing, e-wallets, and new return formats make tax management more efficient and less time-consuming.

GST Registration Services

Conclusion

GST has simplified India’s indirect tax system, reducing complexity and eliminating unnecessary tax burdens. At the same time, ongoing refinements to direct taxes aim to improve fairness, reduce evasion, and encourage wider participation in the economy. Together, these reforms create a more transparent and efficient taxation system for all.

FAQs

Q1. What is the difference between direct and indirect taxes?
Direct taxes are paid directly to the government based on income or profits, while indirect taxes are collected on goods and services and can be passed on to the consumer.

Q2. Is GST applicable on all goods and services?
Most goods and services are covered under GST, but some essential items like fresh vegetables, milk, and certain medicines may be exempt.

Q3. How does Input Tax Credit (ITC) work under GST?
Businesses can reduce the tax payable on their final product by claiming credit for taxes already paid on purchases, lowering the overall GST liability.

Q4. Can foreign income be taxed in India?
Yes, India taxes global income for residents. However, DTAA agreements help prevent double taxation for income earned abroad.

Q5. What happens if a business crosses the GST threshold?
Once turnover exceeds the threshold, GST registration becomes mandatory, and the business must comply with GST filings and payments.

Q6. Does GST affect pricing for consumers?
Yes, GST standardizes pricing by eliminating multiple indirect taxes, ensuring fair and uniform prices across states.