Taxes are essential for the effective governance of a nation, forming the backbone of its economy by providing vital funding for public services and infrastructure development. In India, the tax structure operates within a three-tier federal system comprising the Central Government, State Governments, and Local Municipal Bodies. This cooperative structure guarantees that the government possesses the financial means required to administer state matters efficiently. Article 265 of the Indian Constitution states, “No tax shall be levied or collected except by authority of law.” The legislative powers of the Union are in List I of the Seventh Schedule of the Constitution, and the powers of the states are described in List II, and List III outlines the concurrent powers.
Meaning of Tax
Tax is a mandatory payment representing a financial duty imposed on individuals or their assets to help sustain government operations. The government determines the applicable rates and specifies the categories subject to taxation, such as income tax and GST, among others. Who pays tax also varies depending whether a person is a consumer, salaried person earning beyond excepted limits, businesses earning a certain turnover, etc.
In essence, tax is a vital source of revenue for the government. The funds generated through the taxation system are utilized for financing various projects and initiatives by the governments focused on the country’s development.
Tax Structure in India
In India, taxes are divided into two broad categories: Direct and Indirect taxes. Direct taxes are levied and paid directly by individuals and corporations, whereas indirect taxes are levied on goods and services.
Types/Categories of Taxes
In India, the tax system is fundamentally categorized into two primary types: Direct Taxes and Indirect Taxes. This analysis will delve into these classifications, elucidating the distinctions between them and outlining the various subcategories associated with each.
TYPES/CATEGORIES OF TAXES
DIRECT TAXES INDIRECT TAXES
Direct Taxes
Direct taxes are imposed directly on the income or profits earned by individuals. Taxpayers meet their obligations to the government through several means, such as income tax and personal property tax. The responsibility for these taxes rests entirely with the individual, and this obligation cannot be transferred to another entity. The Central Board of Direct Taxes (CBDT) is responsible for overseeing and managing the administration of Direct Taxes.
Indirect Taxes
Indirect taxes are imposed by the government on various goods and services. This mechanism enables the transfer of the tax burden from one taxpayer to another. For instance, wholesalers may pass the tax on to retailers, who may pass it to the final consumers. As a result, consumers feel the effects of indirect taxes. The Central Board of Indirect Taxes and Customs (CBIC) oversees the regulation and management of these taxes.
All types of taxes can be grouped into two main categories. Thus, understanding the difference between direct and indirect taxes is crucial for compliance. Grasping their distinctions will improve your understanding of these two fundamental categories.
Difference between Direct Tax and Indirect Tax Table
| Particulars/Basis | Direct tax | Indirect tax |
| Meaning | Direct Tax is levied by government directly on the individuals or corporations. | Indirect Tax are levied by government on one entity (Manufacturer) but it is shifted to final consumer by the manufacturer. |
| Incidence | The incidence and impact of the direct tax falls on the same person. | The incidence and impact of the tax falls on two different persons. |
| Nature of Tax | Direct Tax is progressive in nature. | Indirect Tax is regressive in nature. |
| Governed by | Direct Tax is administered by the Central Board of Direct Taxes (CBDT). | Indirect Tax is administered by the Central Board of Indirect Taxes & Customs (CBIC), formerly known as Central Board of Excise & Customs (CBEC). |
| Taxable Incident | Taxable Income of the Person. | Purchase/sale/manufacture of goods or rendering of services. |
| Shifting of Burden | Tax burden cannot be shifted. | Tax burden is shifted to the final consumer. |
| Tax Evasion | Tax evasion is possible. | Tax evasion is hardly possible because it is included in the price of the goods and services. |
| Inflation | Direct tax helps in reducing inflation. | Indirect taxes promote inflation. |
| Collection of Tax | Difficult | Easy |
Types of Direct Taxes
Income Tax
- Income tax is governed by the Income Tax Act, 1961, and is administered by the Central Board of Direct Taxes (CBDT) under the Department of Revenue, Ministry of Finance. The Act lays down the rules, regulations, and guidelines for the collection, assessment, and enforcement of income tax.
- It is imposed on individuals, Hindu undivided families, unregistered firms, and other groups of people.
- India has a progressive income tax system, which means people with higher incomes pay more taxes as per the slab rate.
- There is a 10% surcharge on income tax in cases when total income is between Rs.50 lakhs to Rs.1 crore and 15% if income is above Rs.1 crore.
- For the calculation of total income, income from all sources is aggregated, and agriculture income is exempt.
- India offers two tax regimes. The old tax regime and the new tax regime. The new tax regime provides a lower tax rate but comes with fewer deductions. Currently, the new tax regime is the default regime but one can choose old regime by filing a 10-IEA form.
Corporation Tax
- A corporation tax is governed by the Income Tax Act, 1961, similar to individual income tax.
- A Corporation Tax is imposed on a company’s profits.
- A company must pay a separate tax from its owner’s income tax because the company is recognized as a separate entity for tax purposes.
- Both public and private companies that are registered in India under the Companies Act, 1956 are required to pay corporation tax.
- The Corporate Tax rate generally varies between 20% to 40% depending on the company’s structure.
Capital Gain Tax
- Capital Gain tax is dealt with as per the provisions of Sections 45 to 55A of the Income Tax Act, 1961.
- Any profit or gain realized from the sale of a capital asset is referred to as a capital gain.
- Taxation is imposed on capital sale profits.
- Capital assets include items like real estate, buildings, residential properties, jewelry, stocks, patents, copyrights, and other comparable assets.
- Long-term capital assets are those held for more than 36 months and then sold off. Immovable property sold after 24 months would be categorized as a long-term capital asset. In the case of equity shares, securities, mutual fund units, etc., however, the holding period of 12 months is applicable. If sold off after 12 months, they would be called long-term capital assets.
- As per the latest amendment, for any immovable property acquired before 23rd July 2024, the taxpayers will have the option to choose between two LTCG computation methods –
- 12.5% tax rate, without indexation
- 20% tax rate with indexation benefit.
However, there are certain exceptions to this amendment –
- Indexation benefit is only available on immovable property like land and buildings.
- It is available only to individuals and HUFs and not to firms or companies.
- It can be considered only for tax calculation and not for determining the amount of investment or loss to claim exemption or carry forward.
Minimum Alternate Tax (MAT)
- The concept of MAT was introduced to target companies that make huge profits and pay dividends to their shareholders but pay no/minimal tax under the general provisions of the Income Tax Act.
- The implementation of the Minimum Alternate Tax (MAT) requires companies to remit a predetermined percentage of their profits as tax.
- MAT applies to all companies, including foreign companies. The computation of MAT is regulated by Section 115JB of the Income-tax Act.
- MAT is equal to 15% with effect from AY 2020-21 (MAT was 18.5% before AY 2020-21) of Book profits (Plus surcharge and cess, as applicable).
- The term “book profit” refers to the net profit reflected in the profit and loss statement for the fiscal year.
Securities Transaction Tax (STT)
- Securities Transaction Tax (STT) is imposed on all transactions involving the purchase or sale of securities that are traded on recognized stock exchanges. This would include shares, derivatives, or equity-oriented mutual fund units.
- STT is a financial transaction tax akin to the Tax Collected at Source (TCS).
- STT is governed by the Securities Transaction Tax Act (STT Act).
- The implementation of the STT levy in 2004 led to the creation of a new Section 10(38) that was designed to offer benefits to taxpayers liable for STT.
Commodities Transaction Tax (CTT)
- The Commodities Transaction Tax (CTT) is levied on the value of trades involving non-agricultural commodities such as gold, silver, crude oil, and various metals and minerals conducted on commodity exchanges. This tax aims to both regulate speculative trading in commodity markets and provide a steady source of revenue for the government.
- The idea of taxing commodity transactions was first proposed in the early 2000s, around the same time the Securities Transaction Tax (STT) was introduced in the securities market. However, CTT was officially established in 2013 through the Finance Act, with its provisions coming into effect on July 1, 2013.
- CTT is typically collected by the commodity exchange at the time of the transaction and is then forwarded to the government. It applies to both buying and selling activities, impacting all participants in the commodities market.
- The CTT rate is set at 0.01% for futures contracts involving non-agricultural commodities and 0.05% for options contracts related to non-agricultural commodities, while agricultural commodities are exempt from this tax.
Alternate Minimum Tax (AMT)
- In the beginning, the concept of Alternative Minimum Tax was introduced for companies. However, the Finance Act 2011 and 2012 amendments extended the scope of AMT to LLPs, non-corporate taxpayers, and individuals.
- AMT applies to the following –
Association of Persons (AOP), Body of Individuals (BOI), Individuals, Hindu Undivided Family (HUF), or Artificial Judicial Person whose total adjusted income is more than ₹20,00,000 (Rs. 20 lakhs).
Types of Indirect Taxes
Customs Duty
- Customs Duty is imposed on the export and import of goods.
- The primary objective of customs duty is to ensure that all goods entering the country are subject to taxation.
- It is levied by the Union Government.
- Under Customs Regulations, several types of duties are levied, including Basic Duty, Countervailing Duty, Protective Duty, Anti-Dumping Duty, and Export Duty.
- Customs Duties are computed on a specific or ad valorem basis. In other words, it is calculated on the value of goods. Such value is determined in accordance with rules laid down in the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007.
Excise Duty
- Excise Duty is a tax levied on domestically produced goods. Generally, it is charged on their production and sale and is also known as CENVAT or Central Value Added Tax.
- It is different from customs duty because it is applicable only to items produced in India.
- Excise Tax is governed by two sets of Acts – The Central Excise Act, 1944, and The Central Excise Tariff Act, 1985. Ideally, the Central Board of Excise and Customs is responsible for the collection of excise duty.
- With the introduction of Goods and Service Tax (GST), several indirect taxes have been subsumed, including excise tax. Nonetheless, it is still applicable to a few items like petroleum, liquor, etc.
Service Tax
- Service Tax used to be imposed on services rendered within India prior to the introduction of GST.
- The Central Government was responsible for the collection and remittance of service tax on services offered by an organization, which was ultimately borne by the service recipient.
- Service Tax was first established in the fiscal year 1994–1995, initially covering three sectors: stockbroking, general insurance, and telecommunications.
- Since its inception, the scope of service tax expanded annually, incorporating a growing number of services. Currently, there exists an exclusion criterion based on a ‘negative list’, which delineated certain services that were exempt from taxation.
Value Added Tax (VAT)
- Value-Added Tax (VAT) is a form of indirect tax applicable on goods prior to the implementation of GST.
- This tax operates under a multistage system, allowing for the collection of tax on purchases at each point of sale, thereby eliminating the cascading (tax-on-tax) effect of taxation.
- Typically, the tax burden was transferred to the consumer or end-user.
- The VAT liability owed to the State Government for a specific month is calculated as the total output tax minus the input tax.
Goods and Service Tax (GST)
- The Goods and Services Tax Act was enacted by Parliament on March 29, 2017, and became effective on July 1, 2017.
- This type of indirect tax has replaced several other indirect taxes in India, including excise duty, VAT, and service tax.
- By consolidating the majority of indirect taxes, GST serves as a unified domestic indirect tax framework for the entire nation.
- In India, GST is a comprehensive, multi-stage, destination-based tax that is applied to every value addition.
- Under the GST framework, tax is imposed at each point of sale. For intra-state transactions, both Central GST (CGST) and State GST (SGST) are applicable, while inter-state transactions are subject to Integrated GST.
- Furthermore, GST is primarily driven by technology. All processes, including registration, return filing, refund applications, and responses to notices, must be conducted online through the GST portal, thereby streamlining these procedures.
Recent Reforms in Indian Taxation
Since independence, India has undergone several tax reforms, one of the most significant being the introduction of the New Tax Regime in 2020. This reform allows individual taxpayers to choose between the traditional tax regime, which includes various deductions and exemptions, and a simplified tax structure with lower rates and no exemptions. The goal of this initiative is to offer greater flexibility to taxpayers and to streamline the process of filing income tax returns.
Another major reform is the Goods and Services Tax (GST) Act of 2017. Before the implementation of GST, the taxation system was marked by multiple overlapping taxes on goods and services, leading to inefficiencies and tax evasion. The GST unified these taxes into a single tax framework, reducing cascading effects and simplifying compliance. This reform has improved tax collection and reduced evasion, resulting in significant economic benefits.
Conclusion
The taxation framework in India is fundamental to the development of the nation’s economy, facilitating the government’s capacity to deliver vital public services and infrastructure. The distinction between direct and indirect taxes illustrates the two primary sources for revenue generation, each possessing distinct features and consequences. Direct taxes, such as income tax and corporate tax, promote equitable contributions based on individual earnings, whereas indirect taxes, including the Goods and Services Tax (GST), streamline and consolidate the taxation process, influencing consumer behaviour.
Taxation legislation in India is a dynamic field, continuously evolving in response to the country’s socio-economic landscape. The implementation of reforms, including the introduction of the Goods and Services Tax (GST) and the New Tax Regime, has resulted in significant changes designed to improve compliance, reduce tax evasion, and streamline business operations. This ongoing transformation ensures that the tax system remains pertinent and effective in tackling the challenges posed by globalization, technological progress, and economic shifts.
The categorization of taxes into direct and indirect types not only elucidates the system but also underscores its flexibility in addressing diverse needs. Taxpayers must stay informed about these developments to ensure compliance and take advantage of the reforms implemented, as taxation remains an essential instrument for governance and economic stability.
The Indian Tax Structure and Types of Taxes in India has been compiled and explained by our intern, Ms Anjali Bajaj. She is assisting the team to bring the most informational and valuable legal blogs for the legal fraternity.
