Taxation plays a pivotal role in a country's development, fueling government revenue and shaping economic policies. Taxes in India consists of two main categories: one directly linked to individuals' income or wealth, and the other applied to goods and services instead of individuals or businesses directly. Policymakers, businesses, and individuals must be aware of the details and effects of these tax categories, as they heavily impact economic trends and wealth distribution in societies.

India follows a three-tier taxation system, where taxes are collected by the local municipal bodies, the state government and the central government. Taxes in India are classified into two different categories - direct taxes and indirect taxes.

What is a direct tax?

Direct taxes are taxes levied on individuals and businesses, based on their income or wealth. It includes taxes such as income tax, property tax, Fringe Benefit Tax (FBT) and more. The responsibility to pay direct taxes falls on the exact earning member and cannot be transferred to another person. The Central Board of Direct Taxes (CBDT) manages and collects direct taxes in India.

What is an indirect tax?

Indirect taxes are levied on goods and services and, therefore, can be shifted from one tax payer to another. For example, a whole sale shop owner can pass it down to a retailer, and the retailer can in turn pass that on to the buyer. The Central Board of Indirect taxes and Customs collects indirect taxes in India.

Direct taxes vs Indirect taxes in India

Types of direct taxes

Income tax:

Income tax is a type of direct tax levied on individuals based on their earnings within a given financial year. It is mandatory for every individual to pay income tax if their income exceeds a certain threshold as stated by the government.

According to the budget in the year 2023, the new tax regime insists that if an individual earns an income between Rs. 300,001 to Rs. 6,00,000 then a 5% of tax will be applied. However, if the income is less than or Rs. 3,00,000 then no tax will be charged. For a person earning more than Rs. 15,00,000 the tax percentage is as high as 30%.

Corporate tax applies to the profits of companies and businesses operating in India, whether they are native or non-native. The Finance Act in India determines the rates, tax deductions, and exemptions. At present domestic companies are charged 30%  and foreign companies are charged 50% in India.

Securities Transaction Tax (STT) is a type of direct tax that buyers or sellers pay when they purchase or sell listed securities like shares, bonds, derivatives, and equity-oriented mutual funds. This was introduced in 2004 by the Finance Act to counter tax evasion via capital gains tax evasion. It clearly aimed at collecting taxes from financial market transactions happening within India.

Dividend Distribution Tax (DDT) is a tax levied on the dividends that companies give their shareholders. Before April 1, 2020 this tax was charged on the company distributing the amount and not the recipient. However, now, it is charged correctly on the person receiving the money.

Gift Tax is a direct tax applied on gifts from people other than the family. If the total value of the gift goes beyond Rs 50,000 then it is taxable. Unlike some types of income taxes where only the excess amount is taxed, gift tax is levied on the entire amount if the value goes beyond the said threshold.

Estate Tax also called inheritance tax, is a tax levied on the property inherited from a deceased person either inherited under will or personal law of the giver. Currently, India does not have a national provision for Estate Tax and it was abolished as early as 1985.

Minimum Alternate Tax, is a rule in direct tax laws that restricts the tax exemptions companies use. It ensures that they pay a minimum amount of corporate tax to the government. The main reason for implementing MAT is to guarantee that both domestic and foreign companies in India pay at least a minimum level of taxation.

Who should pay direct taxes? 

Qualifying Indian residents and NRIs should pay taxes in India. For Indian residents taxes are collected for their income earned from all over the world, whereas for non-resident Indians the tax is charged only on the income they generate from India. Every year, individuals must independently determine their residential status for calculating income and taxes, without considering their status in previous years.

A word from us!

The Indian tax system is a complex structure that includes both direct and indirect taxes, each of which has a certain function in terms of generating income and managing the economy. While indirect taxes are levied on products and services, direct taxes, which are managed by the Central Board of Direct Taxes (CBDT), are directed towards the income or wealth of specific persons. These taxes have a significant impact on how businesses and individuals make decisions, how the economy develops, and how wealth is distributed.