Taxation – Direct & Indirect Taxes
🟠 Topic 59: Taxation – Direct & Indirect Taxes
📖 Explanation (1000+ Words)
📌 Introduction
Taxation is one of the primary tools for mobilising government revenue to fund public services, promote economic development, and influence market behaviour. The tax system in India is divided into Direct Taxes (where the liability falls directly on the taxpayer) and Indirect Taxes (where the liability is passed on to the end consumer).
🔹 Constitutional Provisions Related to Taxation
| Article | Provision |
|---|---|
| Article 265 | No tax can be levied or collected except by authority of law |
| Article 246 | Division of taxation powers between Centre and States |
| Seventh Schedule | Lists taxation powers in Union, State, and Concurrent Lists |
| Finance Commission (Art 280) | Recommends distribution of tax revenues between Centre and States |
🔹 What is Direct Tax?
📖 Definition
A direct tax is a tax directly imposed on individuals and organizations, where the incidence and impact fall on the same person (the taxpayer).
Examples of Direct Taxes
| Tax Type | Description |
|---|---|
| Income Tax | Levied on individual and corporate income |
| Corporate Tax | Tax on profits of companies |
| Wealth Tax (abolished) | Previously levied on individuals’ net wealth |
| Capital Gains Tax | Tax on profits from sale of capital assets |
| Dividend Distribution Tax (abolished) | Tax on dividends distributed by companies (now taxed in hands of shareholders) |
Characteristics of Direct Tax
✔️ Progressive in nature — Higher income attracts higher tax rates.
✔️ Cannot be shifted to others.
✔️ Directly collected by government from taxpayers.
✔️ Helps reduce income inequality through progressive rates.
🔹 What is Indirect Tax?
📖 Definition
An indirect tax is levied on goods and services, where the incidence and impact fall on different persons — the tax is collected from the producer but passed on to consumers.
Examples of Indirect Taxes
| Tax Type | Description |
|---|---|
| Goods and Services Tax (GST) | Comprehensive indirect tax replacing multiple taxes |
| Customs Duty | Tax on import and export of goods |
| Excise Duty (merged with GST) | Previously levied on manufacturing |
| Service Tax (replaced by GST) | Previously applied to services |
Characteristics of Indirect Tax
✔️ Can be shifted to consumers.
✔️ Regressive in nature — Same rate applies irrespective of income level.
✔️ Collected by intermediaries (shops, companies) and deposited with the government.
✔️ Provides continuous revenue stream as consumption happens daily.
🔹 Key Differences Between Direct & Indirect Taxes
| Parameter | Direct Tax | Indirect Tax |
|---|---|---|
| Incidence | On taxpayer directly | Passed on to consumers |
| Progressive/Regressive | Progressive | Regressive |
| Example | Income Tax | GST |
| Evasion | Higher scope | Lower scope (collected at source) |
| Administration | IT Department (CBDT) | GST Council & CBIC |
🔹 Importance of Taxation
1️⃣ Revenue Mobilisation
- Taxes fund infrastructure, health, education, defence.
- Tax-to-GDP ratio is a critical indicator of fiscal health.
2️⃣ Redistribution of Wealth
- Progressive taxation reduces income inequality.
- Funds welfare programs for vulnerable sections.
3️⃣ Economic Regulation
- Sin taxes (tobacco, alcohol) discourage harmful consumption.
- Customs duties promote or restrict certain imports.
4️⃣ Economic Stability
- Fiscal policy uses taxation as a tool to manage inflation or recession.
🔹 GST – India’s Landmark Indirect Tax Reform
📖 Overview
Launched in 2017, Goods and Services Tax (GST) is a destination-based tax, replacing multiple indirect taxes levied by Centre and States.
| Tax Replaced | Example |
|---|---|
| Central Excise | On manufacturing |
| Service Tax | On services |
| VAT | State-level sales tax |
| Octroi | Entry tax at state borders |
Features of GST
✔️ One Nation, One Tax.
✔️ Comprehensive input tax credit system.
✔️ 4-tier rate structure: 5%, 12%, 18%, 28%.
✔️ GST Council ensures Centre-State coordination.
Benefits of GST
✔️ Simplified tax compliance.
✔️ Boosts ease of doing business.
✔️ Reduces cascading effect (tax on tax).
✔️ Increases tax base via improved compliance.
GST Council – Composition
| Member | Role |
|---|---|
| Union Finance Minister | Chairperson |
| State Finance Ministers | Members |
✔️ Decisions require 3/4th majority (Centre 1/3rd vote, States 2/3rd vote).
Challenges in GST Implementation
❌ Initial compliance issues (GSTN portal glitches).
❌ Frequent rate revisions causing uncertainty.
❌ Dependence on compensation cess for states.
❌ Exclusion of key sectors (petroleum, alcohol).
Tax Base & Tax Buoyancy
| Term | Meaning |
|---|---|
| Tax Base | Total entities and activities subject to taxation |
| Tax Buoyancy | Growth in tax revenue relative to GDP growth |
Direct Tax Reforms – Key Initiatives
| Initiative | Focus |
|---|---|
| Faceless Assessment | Eliminates direct interface between taxpayer and officer |
| Vivad se Vishwas | Settlement scheme for pending disputes |
| Corporate Tax Cut (2019) | Reduced corporate tax rate to 22% for domestic firms |
| New Tax Regime (2020) | Optional simplified slab system with lower rates, fewer exemptions |
🔹 Case Study – Direct Tax Reforms & Compliance
- Corporate Tax Reduction (2019) lowered rates to 22% for regular firms and 15% for new manufacturing firms.
- Resulted in: ✔️ Higher investments. ✔️ Improved tax compliance. ✔️ Boost to Make in India.
🔹 Tax-to-GDP Ratio
| Year | Direct Tax-to-GDP | Indirect Tax-to-GDP | Total Tax-to-GDP |
|---|---|---|---|
| 2022-23 | ~6% | ~5% | ~11% |
🔔 India’s tax-to-GDP ratio is lower than global peers (OECD average ~34%).
📚 Practice MCQ
1️⃣ Consider the following statements regarding Direct and Indirect Taxes:
- Direct taxes are regressive in nature.
- GST is an indirect tax.
- Direct taxes can be shifted from one person to another.
Which of the above statements are correct?
✅ Options:
(a) 1 and 2 only
(b) 2 only
(c) 1, 2, and 3
(d) 2 and 3 only
2️⃣ Which body administers Income Tax in India?
✅ Options:
(a) CBIC
(b) GST Council
(c) CBDT
(d) Finance Commission
3️⃣ Which of the following taxes were merged into GST?
- Excise Duty
- Service Tax
- Customs Duty
✅ Options:
(a) 1 and 2 only
(b) 2 and 3 only
(c) 1, 2, and 3
(d) 1 only
