Direct Tax

In modern economics, taxation is not merely a revenue-generating tool. It is a means of income redistribution, ensuring that economic justice is maintained in society. Taxes are collected by the government to carry out its essential responsibilities such as infrastructure development, social welfare, defense, education, and public health. Among the two major categories of taxes — Direct Tax and Indirect Tax, direct taxes are particularly important for assessing income levels and addressing inequalities.

Understanding the Basics: Incidence vs Impact of Tax

• Incidence of Tax refers to the initial point where the tax is levied or imposed.
• Impact of Tax refers to the actual burden or effect of the tax — who ultimately bears it.

These concepts help distinguish between direct and indirect taxes.

What is Direct Tax?

• A direct tax is the type of tax in which the incidence and the impact fall on the same person. In simple terms, the individual or entity who pays the tax to the government is the same person who bears its financial burden. It cannot be shifted to others.
• Examples: Income Tax, Corporate Tax, Capital Gains Tax.

What is Indirect Tax?

• An indirect tax is one where the incidence and impact fall on different people. The producer or seller pays the tax to the government but passes the burden onto the consumer.
• Examples: GST, Excise Duty, Sales Tax (before GST), Customs Duty.

Methods of Taxation in India

India follows multiple taxation methods to balance equity, simplicity, and efficiency.

Progressive Taxation

• The tax rate increases with an increase in income.
• Follows the ‘ability to pay’ principle.
• Example: Personal Income Tax in India.

Regressive Taxation

• Tax is uniform but impacts lower-income groups more severely.
• Example: Sales Tax or GST on basic goods can be regressive.

Proportional Taxation

• A flat tax rate irrespective of income levels.
• Less used in India’s direct tax system.

Specific and Ad-Valorem Taxes

• Specific Tax: Fixed per unit (e.g., ₹10 per litre).
• Ad-Valorem Tax: Based on the value of goods or services (e.g., 10% of transaction value).

Distribution of Taxation Powers in India

The Constitution of India has clearly divided taxation powers between the Centre and States under Article 246 and the Seventh Schedule:

• List I (Union List): Only Parliament can legislate (e.g., Income Tax, Corporate Tax, Customs Duty).
• List II (State List): Only State Legislatures can legislate (e.g., Land Revenue, Agricultural Income Tax).
• List III (Concurrent List): Both can legislate but Parliament prevails in case of conflict.
• Article 248: Parliament has residuary powers to make laws on matters not mentioned in any of the lists.

Five Principles of a Good Tax System

1. Fairness – Both vertical (rich pay more) and horizontal (equal treatment for equals) equity.
2. Efficiency – Should raise maximum revenue at minimum cost.
3. Administrative Simplicity – Easy to understand, collect, and comply.
4. Flexibility – Should adapt to changing economic conditions.
5. Transparency – The source and use of tax money should be open to public scrutiny.

Direct Taxes in India

Let’s look at the most significant types of direct taxes levied in India:

1. Income Tax

• Levied on individuals, Hindu Undivided Families (HUFs), firms, etc.
• Progressive in nature — as income increases, tax rate increases.
• Collected under the Income Tax Act, 1961.

2. Corporate Tax

• Paid by companies registered under the Companies Act.
• Separate tax slabs for domestic and foreign companies.
• Also includes:
  • Minimum Alternate Tax (MAT) – ensures tax payment even if book profits are high but taxable income is low.
  • Dividend Distribution Tax (DDT) (Now abolished in Budget 2020).
  • Securities Transaction Tax (STT) – on share market transactions.

3. Capital Gains Tax

• Imposed on profits from the sale of capital assets like land, buildings, stocks, patents, etc.
• Short-Term Capital Gains (STCG): Asset held for less than 36/12 months (depending on asset type).
• Long-Term Capital Gains (LTCG): Asset held beyond that period.
• LTCG has indexation benefits to adjust for inflation.

4. Fringe Benefit Tax (FBT) (Now Abolished)

• Introduced in Budget 2005–06, abolished in Budget 2009–10.
• Levied on employers for non-monetary benefits provided to employees (e.g., telephone, travel, health, canteen subsidies).

5. Securities Transaction Tax (STT)

• Introduced in Budget 2004.
• Levied on stock exchange transactions — buying/selling of shares, mutual funds, etc.
• Helps reduce tax evasion in stock market dealings.

6. Commodity Transaction Tax (CTT)

• Levied on commodity derivatives like agri-commodities, metals, etc.
• Similar in nature to STT.

7. Dividend Distribution Tax (DDT) (Now Abolished)

• Earlier paid by companies before distributing dividends.
• After Budget 2020–21, the burden is shifted to the shareholder who now pays tax as per their applicable income tax slab.

Advantages of Direct Taxation

1. Reduces Inequality: Since it is progressive, it aligns with the ability to pay principle and narrows the income gap.
2. Elastic in Nature: Revenue from direct taxes grows with economic growth.
3. Certainty and Transparency: Taxpayers know how much, when, and why they are paying.
4. No Inflationary Pressure: Unlike indirect taxes, direct taxes do not increase prices.
5. Effective Tool of Fiscal Policy: Government can increase or decrease tax rates to control inflation or boost demand.

Challenges or Demerits of Direct Taxation

1. Tax Evasion: Individuals often manipulate income, submit false returns or exploit loopholes.
2. High Compliance Burden: Complex paperwork, frequent assessments, and audits.
3. Disincentive to Work: High tax rates may reduce the motivation to work more or report full income.
4. Unequal Coverage: Agricultural income is tax-free, which creates imbalance. Rich farmers are legally exempt from income tax, unlike salaried individuals.
5. Litigation and Administrative Costs: Frequent disputes lead to pending tax cases, increasing the load on tribunals and courts.

Conclusion

The direct tax structure in India is designed to ensure social justice, revenue generation, and macroeconomic stability. Over time, reforms such as faceless assessments, reduction in corporate tax rates, and the removal of DDT have made the system more efficient and transparent. However, challenges like tax evasion, complex compliance, and inequitable exemptions still exist. Moving forward, digitalization, simplification, and expanding the tax base are key to making India’s direct taxation system more robust and equitable.

---

PDF File:

No PDF attached

---

Subject: Economics

← Back