Difference Between Direct and Indirect Taxes with Examples

Direct taxes are non-transferable taxes paid by the taxpayer to the government. These taxes are administered and governed by the Central Board of Direct Taxes (CBDT).

Here are some of the details about direct taxes:

1. Direct taxes are based on the ability to pay principle, requiring higher taxes from those with more resources and higher incomes.  Such fees aid in wealth distribution within the nation.
2. It is not possible to transfer direct taxes; so, it is up to companies and individuals to pay them.
3. There are penalties for failing to make timely payment of these kinds of tax where one can be fined or even jailed.
4. The brackets used in direct taxation may inhibit a drive for increased income when people limit productivity to avoid high tax rates.
5. Indirectly, individuals are charged indirect tax when they buy goods and services from businesses.
6. Retail traders and wholesalers pay indirect tax on their sales.

Who is eligible to Pay Direct Taxes?

Here is the list of entities who pays direct taxes:

1. Salaried individuals earning less than Rs 50 lakh annually from various sources should use the ITR-1 form.
2. Individuals and HUFs without income from business or professional gains should use the ITR-2 form.
3. Individuals and HUFs with income from business or professional gains should use the ITR-3 form.
4. Individuals, HUFs, and firms (excluding LLPs) with total income under Rs 50 lakh from business/profession as per Sections 44AD, 44ADA, and 44AE should use the ITR-4 form.
5. Entities and persons other than companies, individuals, and HUFs should use the ITR-5 form.

1. Companies not claiming exemptions under Section 11 should use the ITR-6 form.
2. Individuals and firms required to file under Section 139(4A), 139(4B), or 139(4D) should use the ITR-7 form.
3. Companies and other persons required to file under Sections 139(4A), 139(4B), 139(4C), or 139(4D) should use the ITR-7 form.

What is Indirect Tax?

Indirect taxes are transferable taxes where the liability to pay can be shifted to others. These taxes are administered and governed by the Central Board of Indirect Taxes and Customs (CBIC). Service tax and sales tax are examples of indirect tax.

It is not only a tax that is imposed by the government on an intermediary, say, a retailer or service provider to be passed on to the customer who finally pays it. While this type of fee is included in prices charged for goods and services, direct taxes are not.

Some of them include sales tax, customs duty, excise duty, value-added tax (VAT), and Goods and Services Tax (GST). As they are levied at different stages of production and distribution, their expenses are transferred to buyers. These indirect taxes are less visible to customers but add up to the total price of products and services.

Comparison of Direct and Indirect Taxes

Both the direct and indirect taxes are significant to the government. They provide a sizable portion of government revenue. Indirect and direct taxes, however, have different effects on society. To learn more, keep reading:

Types of Direct and Indirect Taxes in India

Major Types of Direct taxes are as follows:

• Wealth tax: The tax levied on an individual’s assets based on their value in a financial year is known as wealth tax. This tax is levied on HUFs, individuals, or companies.
• Corporation tax: This type of tax is levied on companies and businesses based on their income in a financial year. The taxation rate depends on whether the enterprise is in India or abroad.
• Income tax: This tax is levied on individuals on their annual income in a financial year.
• Capital Gains tax: The tax levied on profit earned from property sale are considered under this category of taxes.

Major Types of Indirect taxes are as follows:

• Service tax: This type of tax is paid to the government by all the service providers.
• Sales tax: This type of tax is levied by the government on movable goods.
• Value added tax: This is levied on products which are added at each stage from manufacturing till distribution.
•  Excise Duty: The tax collected from manufacturers by the government is called as excise duty tax.

Advantages and Disadvantages of Direct Taxes

Advantages of Direct Taxes

The key benefits of direct taxes are as follows:

1. Promotes Equality:
   1. Direct taxes, based on individuals' ability to pay, foster equality among taxpayers.
   2. Each person is taxed differently, depending on their income level.

1. Promotes Certainty:
   1. Direct taxes are predetermined and finalized before payment.
   2. For instance, income tax remains consistent annually unless salary changes occur.

1. Promotes Elasticity:
   1. Fluctuations in tax revenues correspond to changes in government earnings.
      1. These fluctuations can vary, either increasing or decreasing government earnings.

1. Saves Time and Money:
   1. Direct taxes are collected at the source of income, reducing the need for government spending on tax collection.
   2. Automatic payroll deduction systems employed by some companies further streamline the process, saving time and resources.

Disadvantages of Direct Taxes

Here are some of the drawbacks of direct taxes: 

1. Evasion: Self-assessment increases the risk of tax evasion.  
2. Administrative challenges: The cost of tax collection could exceed the tax amount.  
3. Potential deterrents: Higher tax rates may discourage individuals from fully disclosing their income or earning more.

Advantages and Disadvantages of Indirect Taxes

Advantages of Indirect Taxes

The following are the advantages of indirect taxes: 

1. Stability in Revenue:
   1. Indirect taxes provide the government with a stable and consistent revenue stream as they are collected at the point of sale. This ensures a reliable income source.
   2. Since these taxes are applied at the point of sale, all taxpayers, regardless of their income level, contribute to the economy. This broadens the revenue base and enhances financial stability.

1. Reduced Tax Evasion:
   1. Indirect taxes help reduce tax evasion because they are included in the price of goods and collected at the point of sale, making it difficult for taxpayers to avoid them.

1. Broad Revenue Base:
   1. Indirect taxes ensure that all consumers contribute to the economy's growth, promoting equal tax distribution and spreading the tax burden across the population, irrespective of income levels.

Disadvantages of Indirect Taxes

The following are the disadvantages of indirect taxes:

1. Reduced Consumer Spending:
   1. Indirect taxes can discourage consumer spending. Higher taxes on certain goods or services may lead consumers to buy less of those products, reducing overall demand and affecting businesses.

1. Unpredictable Revenue:
   1. Revenue from indirect taxes can be unpredictable due to changes in demand and economic conditions, posing challenges for the government in meeting its financial goals.

1. Impact on Basic Necessities:
   1. Taxes on essential goods and services, such as food, medicine, and utilities, can disproportionately affect lower-income groups, increasing financial strain and exacerbating inequalities between the rich and the poor.