The Central Board of Direct Taxes, or CBDT, is the statutory body under the Central Board of Revenue Act, 1963, responsible for managing direct tax in India2. CBDT looks after the administration of direct tax laws and provides recommendations and inputs for planning direct taxes in India. Today, we will discuss direct tax meaning, its types and its benefits in detail.
What is Direct Tax?
A direct tax is imposed depending on a taxpayer’s income, meaning the higher the income, the higher the tax rate applicable3. A common example is income tax slab rates. The rules for direct taxes are designed to distribute money in the country by collecting taxes from people depending on their paying capacity. Hence, direct taxes are an important source of revenue for the government, which is utilised to fund many public welfare services and goods.
Types of Direct Taxes4:
There are different types of direct taxes imposed by the government. Some of the common types of direct taxes are given below.
1. Income Tax4-
As the name suggests, it is the tax applicable to a taxpayer's income. Any individual with income above the basic exemption limit must pay tax as per the applicable tax rate during a financial year. Tax rates are applicable depending on the income bracket of the taxpayer. The government decides these rates and income brackets. Failure to pay income tax results in penalties or even imprisonment.
In case of entity/business, this tax is further categorised as:
• Corporate Tax4
This is a direct tax levied on the profits earned by a corporate body. In India, for the purpose of taxation, companies are categorised as domestic and foreign. The corporate tax rates are applied based on a slab rate system which depends on the type of corporate body and the revenue earned by the corporate body.
• Capital Gain Tax4
This tax is levied on the gain arising from the transfer of capital assets. The capital asset can be property, shares, bonds, ULIPs or any valuable material. Income from capital gains can be termed STCG, i.e. short-term capital gain and LTCG, i.e. long-term capital gain.
2. Securities Transaction Tax4 -
This tax is levied on transactions of securities listed on stock exchanges in India, such as stocks, bonds and mutual funds. The tax rate depends on the type of security traded and the nature of the transaction, whether sale or purchase.
Difference between Direct Tax & Indirect Tax
The difference between direct and indirect tax can be highlighted in the following points6 –
Direct tax |
Indirect tax |
Direct tax is paid by the taxpayer directly to the income tax department. |
Indirect tax is paid by the taxpayer to an intermediary who, then, deposits the tax to the relevant authorities. The tax is, thus, paid indirectly |
The incidence of taxation is on the taxpayer himself. The tax cannot be transferred to another. |
Indirect tax is transferred from one taxpayer to another. While the incidence of tax can be on one taxpayer, the impact is on another who ultimately uses the goods and services |
Direct tax is imposed on the income earned by an individual |
Indirect tax is imposed on goods and services produced |
Individuals, Hindu Undivided Families, businesses, trusts, Associations of Persons, Bodies of Individuals, etc. pay direct tax on their income |
Indirect tax is paid by the end-users of goods and services |
The rate of tax depends on the income level and varies across taxpayers |
The rate of tax is the same for everyone. Tax rates are based on type of Goods/services. |
It is a type of progressive form of taxation since tax rates increase with increasing income |
The tax rates are common for everyone making it a regressive form of taxation |
The examples include income tax and securities transaction tax (STT) |
An example of indirect tax is Goods and Services Tax (GST) |
Who is Eligible to Pay Direct Tax?
Direct tax is payable by individuals who earn income during the financial year and whose taxable income is more than the threshold limit. The threshold limit under the old tax regime is Rs. 2.5 lakhs while under the new regime is Rs. 3 lakhs. The eligible entities who have to pay direct tax include the following7 –
- Individual taxpayers,
- Hindu Undivided Families,
- Partnership firms,
- Limited Liability Partnerships,
- Association of Person (AOP),
- Body of Individuals,
- Companies, and
- Any other artificial juridical entity.
Benefits of Direct Tax
Some of the benefits of direct tax are as follows8 –
- Direct tax is a progressive form of taxation which promotes equality among individuals. Individuals earning a higher amount of income pay a higher tax compared to those earning a lower income.
- Direct tax forms a considerable source of revenue for the government. The government uses the tax collected to fund the economic and social development of the country.
- Direct tax is certain and helps taxpayers plan their taxes in advance.
- The tax rates are elastic and can be changed depending on the economic needs of the country.
- By paying direct tax, you, as a taxpayer, can contribute to the development of the country. You get a sense of civic duty towards the government.
Why are Direct Taxes Important?
Direct taxes are important as they are beneficial for nation-building.
- These taxes can maintain an economic and social balance because the taxes are applied according to a taxpayer's income.
- Taxes also help restrain rising inflation by reducing demand for goods and services.
- With an increasing workforce, the inflow of direct taxes also increases, thus generating more revenue for the government.
- These taxes enforce the equal distribution of wealth because people with high resources are required to make high contributions which are utilised to uplift the underprivileged sections of society.
- These taxes also enforce transparency as they are directly paid by the taxpayer to the government and thus play an essential role in the economy.
LTCG and its Impact on ULIPs
LTCG (Long Term Capital Gain Tax) is the tax charged on the profit earned from the sale of an asset that was held for longer than 2 years9. Now let us understand how LTCG applies to a Unit Linked Insurance Policy (ULIP) with a lock-in period of 5 years. According to e Budget 2021, a high-value ULIP, with aggregate annual premium of more than ₹ 2.5 lakhs, will be taxed as capital gain if purchased on or after February 1, 20215. A long-term capital gains tax is levied at applicable rate on the maturity/surrender/withdrawal value depending on investment in equity oriented or debt oriented ULIPs. However, ULIPs purchased before this date is tax-free subject to satisfaction of conditions as mentioned in Section 10(10D) of Income Tax Act 1961. The only exception to this case is the death proceeds received by the nominee.
Conclusion
It's important to note that tax laws and policies in India are subject to change, so it's always a good idea to consult with a tax professional to understand the various types of direct taxes and tax implications of various financial products.
FAQs
1. What is a direct tax in India?
Direct tax is a form of tax which is levied on the income earned by taxpaying entities. It is levied on the taxpayer and paid by the same taxpayer.
2. Is GST a direct tax?
GST is an indirect tax. It is levied on the supply of goods and services but is ultimately paid by the end-user of such goods and services.
3. What are some of the investments that I can make to save on Income Tax?
Some of the investments which help you allow savings on income tax under old Tax regime are as follows –
- Life insurance policies
- Equity Linked Savings Schemes of mutual funds
- Public Provident Fund
- National Savings Certificate
- Sukanya Smariddhi Yojana
- Senior Citizens Savings Schemes
- 5-year fixed deposits with banks and post offices
- Home loans, etc.
4. What is TDS?
TDS stands for Tax Deducted at Source. It is a tax which is deducted from your income at a specified rate before the income is credited to you. TDS helps you take care of your tax liability. If, however, you have paid an excess TDS on your income, you can claim a refund by filing your income tax returns.
5. What is the disadvantage of Direct taxes?
Direct taxes eat into taxpayers’ income and reduces their disposable income. As such, it is not very popular.
Sources
1. https://economictimes.indiatimes.com/definition/direct-tax
2. https://incometaxmumbai.gov.in/about-us/organisation-and-functions/cbdt/
3. https://cleartax.in/g/terms/direct-tax
4. https://blog.saginfotech.com/definition-and-list-of-direct-taxes-in-india
5. https://economictimes.indiatimes.com/wealth/tax/how-capital-gains-on-ulips-will-be-calculated-cbdt-notification/articleshow/88996809.cms
6.https://www.forbes.com/advisor/in/tax/difference-between-direct-and-indirect-tax/#:~:text=Direct%20taxes%20are%20paid%20directly,purchases%20of%20goods%20and%20services.
7.https://incometaxindia.gov.in/pages/faqs.aspx?k=General+FAQs&c=6#:~:text=Who%20is%20supposed%20to%20pay%20Income%2Dtax%3F&text=Income%2Dtax%20is%20to%20be,as%20well%20as%20artificial%20persons.
8.https://byjus.com/question-answer/define-a-tax-explain-briefly-two-merits-and-two-demerits-of-direct-taxes/
9. https://groww.in/p/long-term-capital-gains-tax
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