Differences between Direct and Indirect Taxes of India!
The basis of classifying taxes into direct and indirect taxes is “who ultimately bears the burden of a tax.”
(a) Direct tax:
When (i) liability to pay a tax and (ii) the burden of that tax falls on the same person, the tax is called a direct tax.
A direct tax is the tax whose burden is borne by the person on whom it is imposed, i.e., its burden cannot be shifted to others. For example, (i) Income tax is a direct tax because the person whose income is taxed is liable to pay the tax directly to the government and bear the burden of the tax himself. Other examples of direct tax are (ii) corporate tax—It is levied on profit of corporations and companies, (iii) Wealth tax—It is imposed on property of individuals depending upon the value of property. (iv) Gift tax—It is paid to the government by the recipient of gift depending on value of gift, (v) Estate duty—It is charged from successor of inherited property.
Similarly (vi) Expenditure tax and (vii) Fringe benefit tax (imposed by state govt.) are other examples of direct taxes. It is difficult to avoid direct taxes as they are levied directly on income and property of persons who pay directly to the government.
Merits of direct taxes:
(i) Direct taxes help in reducing disparities in income and wealth of people,
(ii) They are economical because cost of collection for government is relatively low,
(iii) Social and economic Justice is achieved to some extent because direct taxes are based on ability to pay.
Direct taxes are generally considered progressive taxes because they are based on the ability to pay. A progressive tax is one the rate of which increases with rise in income and decreases with fall in income.
(b) Indirect tax:
When (i) liability to pay a tax is on one person and (ii) the burden of that tax falls on some other person, the tax is called an indirect tax.
Thus, it is a tax whose burden can be shifted to others. For example,
(i) Sales tax:
It is an indirect tax because liability to pay tax is that of shopkeeper who in turn realises the tax amount from the customer by including it in the price of the commodity. Other examples of indirect tax are
(ii) Excise duty:
It is paid by the producer (manufacturer) of goods, who recovers it from wholesalers and retailers,
(iii) Custom duty:
It is charged from importer of goods from a foreign country which is recovered from retailers and customers,
(iv) Entertainment tax:
It is charged from cinema owners, who recover it from cinema viewers,
(v) Service tax:
It is imposed on selling services (like serving meals in hotels) to customers. Similarly,
(vi) Octroi (chungi) and
(vii) ‘Value added tax’
‘Value added tax’ is other examples of indirect taxes. In short, all taxes levied on goods and services in different forms (like on production, sale, transport, etc.) are called indirect tax.
Merits of indirect taxes:
(i) Indirect taxes are convenient to realise because they are Included in the price of the commodity.
(ii) They have wider coverage since every member (consumer) of society is taxed through price of the commodity.
(iii) Consumption of harmful commodities like wine, cigarettes, etc. is curtailed, thus serving social purpose.
Basis of Classification:
The basis of classifying taxes into direct tax and indirect tax is “Whether the burden of the tax is shiftable to others or not.” If it is not shiftable, i.e., when liability to pay and burden falls on the same person, it is a direct tax. If burden of a tax is shiftable, it is an indirect tax.