Difference Between Direct Tax and Indirect Tax

byDilip PrasadLast Updated: March 12, 2024
Difference Between Direct Tax and Indirect Tax

Taxes constitute a significant source of earnings for the government of India. Whether you are earning a salary or watching a movie in a theatre, you may have to pay taxes to aceess various products and services. These taxes are either paid to the state or central government depending on the tax levied on the individual. Broadly, the Indian taxation system is divided into two subcategories: direct tax and indirect tax. 

As a rational citizen of India, every individual must have a firm understanding of the type of taxes that the government levies. Both types of taxes are subdivided into several types, which we will discuss in this article. Read on to learn the difference between direct and indirect tax in complete detail.

Direct Tax vs Indirect Tax

What is Direct Tax?

A direct tax is a type of tax liability where the taxpayer has to pay the taxes directly to the imposing authorities. An individual paying direct taxes cannot transfer his/her tax liability to another entity or individual. These direct taxes are collected and administered by CBDT (Central Board of Direct Taxes). The Department of Revenue manages CBDT and governs the implementation of several types of direct taxes.

Types of Direct Taxes 

In India, direct taxes are classified into three types: income tax, capital gains tax, and securities transaction tax (STT). A detailed explanation of all these major types of taxes is given below:

  1. Income tax

It is the most common direct tax levied by the government of India on an individual’s income. It is directly paid to the government on the basis of the different income slabs suggested by the IT (Income Tax) department of India. 

  1. Capital gains tax

It is the tax levied on any individual making capital gains in the country. Such gains may arise from investments in land, equities, and more. These taxes are generally charged based on the time period for which such investments are being held.

  1. Securities transaction tax

If any individual is involved in security trading in India, then he/she is liable to pay the securities transaction tax. Such taxes are to be paid regardless of the gains made out of them. 

What is Indirect Tax?

Indirect taxes are levied by the government of India on goods and services. These taxes are first paid to the intermediaries before they are directly paid to the government. Thus, they are referred to as indirect taxes. CBIC (Central Board of Indirect Taxes and Customs) administers and collects indirect taxes in India. Like CBDT, CBIC is also governed by the Department of Revenue.

Types of Indirect Taxes

Indirect taxes are a significant source of revenue for the government in India. Majorly, there are two types of indirect taxes as discussed in detail below:

  1. GST (Goods and Services Tax) 

GST is the most common indirect tax that has replaced a series of indirect taxes like value-added tax (VAT), service tax, purchase tax and excise duty. GST serves as a comprehensive indirect tax that is levied on goods and services based on various tax slabs as suggested by the GST Council of India. 

  1. Customs duty

It includes the charges paid by any individual who purchases goods and services from abroad. You have to pay customs duty regardless of the mode of receipt of the order (land, air, or sea). Therefore, this tax is levied on every good coming to India from foreign countries.

Also Read: Advance Tax: Definition, How to Calculate & More

The Benefits of Direct Tax and Indirect Tax

Benefits of Direct Taxes

  • Establishes economic and social balance by implementing progressive tax slabs.
  • Helps in reducing the rate of inflation by increasing tax rates during inflationary periods.

Benefits of Indirect Taxes

  • Ensures equal contribution as every individual pays some amount of indirect tax on goods and services.
  • Indirect taxes are unavoidable as they are charged on consumed goods and services.

Drawbacks of Direct Tax and Indirect Tax

Drawbacks of Direct Taxes

  • Tax evasion and fraudulent practices undermine the effectiveness of direct tax collection.
  • Direct taxes are often considered burdensome as they are paid in a lump sum annually, and the documentation process can be extensive and time-consuming.

Drawbacks of Indirect Taxes

  • Indirect taxes are the same for all economic classes, which can be perceived as unfair for individuals with lower incomes.
  • Indirect taxes increase the cost of goods and services, making them more expensive for consumers.

We learned about the two main taxes that add to the major revenue of the Indian government: direct tax and indirect tax. By learning about these taxes, you may know why the government charges them and how you are contributing to the country’s development. A direct tax is a tax levied by the central government on the income and capital gains of a taxpayer. On the other hand, indirect taxes are the tax levied on goods and services and are paid to indirect intermediaries. As a rational citizen of India, everyone must have a firm knowledge of the taxes they are paying and clarity of the differences between them.


What are the benefits of Direct and Indirect Taxes?

Direct taxes ensure a progressive system where higher earners contribute more, promoting income redistribution and social equity. Direct taxes also provide a stable source of government revenue, allowing for funding of essential public services, infrastructure, and welfare programs. Additionally, they encourage fiscal responsibility and accountability as individuals have a direct stake in the tax system. Indirect taxes, on the other hand, have their own advantages. They are easier to administer and collect, minimizing compliance costs and administrative burden. Indirect taxes also offer a broad tax base, capturing revenue from a wide range of economic activities. They are generally considered less disruptive to economic behavior as they are not directly linked to individual income. Indirect taxes can also be designed to incentivize certain behaviors, such as promoting environmentally friendly products through lower tax rates.

What are the disadvantages of Direct and Indirect Taxes?

Direct taxes have certain drawbacks such as they can discourage investment and economic growth by burdening high-income earners and businesses. High tax rates on individuals and corporations may also incentivize tax evasion and avoidance, leading to reduced revenue collection. Direct taxes can be complex and require significant administrative resources, resulting in compliance costs for taxpayers. Indirect taxes also have their disadvantages. They tend to be regressive, as low-income individuals may bear a disproportionate burden. Indirect taxes can increase the cost of goods and services, potentially impacting consumer purchasing power. They may also lead to unintended consequences, such as creating black markets or encouraging smuggling. Additionally, indirect taxes can be seen as less transparent, as the final tax burden is often hidden within the price of goods or services.

Does Goods and Service Tax (GST) fall under direct or indirect tax category?

The Goods and Service Tax (GST), implemented in India on 1st July 2017, serves as an indirect tax that replaced numerous previous levies like excise duty, VAT, and services tax. The GST Act was enacted in the Parliament on 29th March 2017.

How would I know which tax is direct or indirect?

Direct taxes are taxes that individuals or businesses pay directly to the government, based on their income or profits. On the other hand, indirect taxes are paid to the government when individuals make purchases of goods and services.

Is the rate of payment different for direct and indirect taxes?

No. The rate of payment is the same for direct and indirect taxes.

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