Direct and Indirect Taxes

Direct and Indirect Taxes


Direct Taxes

As the name suggests, are taxes that are directly paid to the government by the taxpayer. It is a tax applied on individuals and organizations directly by the government e.g. income tax, corporation tax, wealth tax, Estate Duty, Gift tax etc.


“A direct tax is really paid by the person on whom it is legally imposed.”


“Direct Taxes are those taxes which cannot be shifted and which,therefore,fall directly on the persons from whom the government extracts the payment.”

                                                                                                                                                     -Anatol Murad

Types of Direct taxes

 1.Income Tax

Income Tax is paid by an individual based on his/her taxable income in a given financial year. Under the Income Tax Act, the term ‘individual’ also includes Hindu Undivided Families (HUFs), Co-operative Societies, Trusts and any artificial judicial person. Taxable income refers to total income minus applicable deductions and exemptions.Tax is payable if the taxable is above the minimum taxable limit and is paid as per the differing rates announced for each tax slab for the financial year.

2.Corporation Tax

Corporation Tax is paid by Companies and Businesses operating in India on the income earned worldwide in a given financial year. The rates of taxation vary based on whether the company is incorporated in India or abroad.

 3. Wealth Tax

Wealth tax is applicable on individuals, HUFs or companies on the value of their assets in a given financial year on the date of valuation. Wealth tax payable is 1% of the net value of taxable wealth if it exceeds Rs 30 lakh as on valuation date for the financial year. The due date for filing wealth tax return is the same as for income tax return.

‘Net wealth’ here includes, unproductive assets like cash in hand above Rs 50,000, second residential property not rented out, cars, gold jewellery or bullion, boats, yachts, aircrafts or urban land. It does not include productive assets like commercial property, stocks, bonds, fixed deposits, mutual funds etc.

 4. Capital Gains Tax

The profits made on sale of property are taxable under Capital Gains Tax. Property here includes stocks, bonds, residential property, precious metals etc. It is taxed at two different rates based on how long the property was owned by the taxpayer – Short Term Capital Gains Tax and Long Term Capital Gains Tax. This deciding period of ownership varies greatly for different classes of property.


Merits of Direct Taxes

  1. The larger burden of the direct taxes falls on the rich people who have capacity to bear these and the poor people with less ability to pay have to bear less burden.
  2. Direct taxes are important instrument of reducing inequalities of income and wealth.
  3. Unlike indirect taxes, direct taxes do not cause distortion in the allocation of resources. As a result these leave the consumers better off as compared to indirect taxes.
  4. Revenue elasticity of direct taxes, especially if they are of progressive type is quite high. As the national income increases, the revenue on these taxes also rises a great deal.
  5. Collection of these taxes are not expensive.The tax payer himself has to deposit these taxes with the government.
  6. These taxes are based on the principle of certainty. The tax payer knows how much tax,when,where or how he has to pay.Even the government is certain to a large extent about the revenue collected from these taxes.

 Demerits of Direct Taxes

  1. In the direct taxation, people are aware of their tax liability and therefore they would try to avoid or even evade the taxes. The practice and possibility of tax evasion and avoidance is more in direct taxes than in case of indirect taxes.
  2. Direct taxes are generally payable in lump sum or even in advance and become quite inconvenient.
  3. Another demerit of direct taxes is their supposed effect on the will to work and save. It is assessed that work (given Income) and leisure are two alternatives before any taxpayer. If therefore, a tax is imposed say on income, the taxpayer will find that the return from work has decreased as compared with return from leisure. He therefore tries to substitute leisure for work.
  4. Sometimes the collection of these taxes is very expensive.If there is a great number of people who pay only small amounts as tax,the expenditure on the collection of the tax revenue will be enormous.For example,land revenue in India is adirect tax.Since this tax is collected from millions of farmers in small amounts of money,its collection is very expensive.
  5. Such type of taxes may discourage capital formation.If the rate of these taxes is very high,it affects saving adversely reducing the rate of capital formation.
  6. These taxes are not popular because the tax payer has to bear their burden directly.These taxes seem to be more oppressive.A lot of amount has to be paid in the form of these taxes.

Indirect Taxes

These are applied on the manufacture or sale of goods and services. These are initially paid to the government by an intermediary, who then adds the amount of the tax paid to the value of the goods / services and passes on the total amount to the end user.Examples of these are sales tax, service tax, excise duty etc.


“A indirect tax is imposed on one person,but paid partly or wholly by another’.


“AN indirect tax is demanded from the person in the expectation and intention that he shall indemnify himself at the expense of another”.

                                                                                                                                             -J.S. Mill

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