Direct Taxes and Indirect Taxes in India: Differences, Types

Direct taxes and indirect taxes in India are two main ways the government collects revenue to fund public services and development projects. Direct taxes are paid straight by individuals or businesses on income, profits, or wealth, such as income tax and corporate tax. 

Indirect taxes, on the other hand, are charged on goods and services, and their burden can be shifted from producers to consumers, with GST being the main example today. Understanding direct taxes and indirect taxes in India is essential for managing personal finances, business planning, and preparing for competitive exams in economics, finance, and taxation.

Enroll Now for BFSI Courses

Direct Taxes and Indirect Taxes in India Overview

Taxes fund public services, and understanding Direct Taxes and Indirect Taxes in India helps clarify how the government collects revenue. These notes simplify key concepts, types, mechanisms, and their impact on the economy for quick revision and exam preparation.

What is Direct Tax?

A direct tax is a tax levied on a person’s income or profits. The individual or company on whom the tax is imposed must bear its burden. This burden cannot be transferred to others. The Central Board of Direct Taxes (CBDT) oversees its administration in India.

Direct Taxes Imposed in India

Here are the major direct taxes under Direct Taxes and Indirect Taxes in India:

• Income Tax: Paid by individuals based on earnings. Tax slabs determine the payment amount.

• Corporate Tax: Paid by companies on their profits. Corporate tax rates are flat.

• Securities Transaction Tax (STT): Levied on transactions involving listed securities.

• Wealth Tax (Abolished 2015): Earlier charged on net wealth above a limit.

• Estate Duty (Abolished 1985): Applied on inherited wealth transfers.

Advantages of Direct Taxes

• Curbs Inflation: Higher rates reduce disposable income and demand.

• Social Balance: Progressive tax slabs help reduce income inequality.

Disadvantages of Direct Taxes

• High Burden: Reduces savings and investment.

• Tax Evasion: Individuals may attempt to hide income.

What is Indirect Tax?

Indirect tax is charged on goods and services. The burden can be passed from producer to consumer. CBIC administers indirect taxes.  Direct Taxes and Indirect Taxes in India include indirect taxes as a major source of consumption-based revenue.

Indirect Taxes Before GST

Before GST, several taxes formed the indirect tax system under Direct Taxes and Indirect Taxes in India: 

• Customs Duty: An import duty on goods entering the country. Consumers and retailers ultimately paid this.

• Central Excise Duty: Manufacturers paid this tax, shifting the burden to wholesalers and retailers.

• Service Tax: Imposed on the total amount charged by service providers.

• Sales Tax: Retailers paid this tax, then charged customers for it.

• Value Added Tax (VAT): Collected on the value added at each manufacturing or distribution stage.

GST as Indirect Tax

GST transformed Direct Taxes and Indirect Taxes in India by merging many taxes. It removed the tax-on-tax effect and created a unified national market.

Types of Supply and Taxes Levied Thereon

Direct Taxes and Indirect Taxes in India define GST under two broad supply types:

• Intra-state Supply: Supply of goods and services within the same state.

• Central Goods and Services Tax (CGST): Levied by the Central Government.

• State Goods and Services Tax (SGST) or Union Territory Goods and Services Tax (UTGST): Levied by the State Government or Union Territories.

• Inter-state Supply: Supply of goods and services between different states or union territories.

• Integrated Goods and Services Tax (IGST): This combines CGST and SGST/UTGST. It is levied on inter-state supplies.

Advantages of Goods and Service Tax (GST)

GST offers several key benefits to the Indian economy. It simplifies the tax structure and promotes business.

• Input Tax Credit: Businesses can reduce the tax paid on purchases from their final tax liability. This lessens the overall tax burden.

• Composition Scheme: Small businesses with turnover below specified limits can opt for a simpler tax scheme. They pay a fixed rate based on turnover.

• Zero-rated Exports: GST is not charged on the export of goods or services. Exports are treated as zero-rated supplies.

• Compliance: Digital tools and platforms simplify tax management. This makes compliance easier and more efficient.

Difference Between Direct and Indirect Tax

Direct and indirect taxes are two major types of taxes collected by the government. They differ in how they are imposed, who pays them, and how their burden is transferred. Understanding these Differences Between Direct and Indirect Tax helps taxpayers know how each tax affects income, expenses, and overall financial planning.

Key Mechanisms of Direct Taxes and Indirect Taxes in India

Direct taxes are collected from income or profits, while indirect taxes were added at multiple stages before GST. GST now works on a value-added system, letting businesses claim credits and consumers pay only the final tax without cascading effects.

Direct Tax Mechanism

Income tax is deducted at source for salaried workers. Companies pay corporate tax on profits. Direct Taxes and Indirect Taxes in India structure direct taxes to ensure transparency.

Indirect Tax Mechanism (Pre-GST)

Before GST, indirect taxes were added at various stages of production and sale. Each stage levied tax on the value including previous taxes, creating a cascading effect. This made goods and services more expensive for the end consumer.

GST Mechanism

GST operates on a value-added principle. Tax is levied at each stage of the supply chain. Businesses can claim Input Tax Credit for taxes paid on inputs. The final consumer bears only the GST charged by the last seller, without the cascading effect.