Difference between Direct and Indirect Taxes Last Updated : 17 Oct 2019

Direct taxes are non-transferable taxes paid by the tax payer to the government and indirect taxes are transferable taxes where the liability to pay can be shifted to others. Income Tax is a direct tax while Value Added Tax (VAT) is an indirect tax.

Direct and indirect taxes include all the different types of taxes levied by the government. Direct taxes include the taxes that cannot be transferred or shifted to another person, for instance the income tax an individual pays directly to the government. In this case, the burden of the tax falls flatly on the individual who earns a taxable income and cannot shift the tax to others.

Indirect taxes, on the other hand, are taxes which can be shifted to another person. An example would be the Value Added Tax (VAT) that is included in the bill of goods and services that you procure from others. The initial tax is levied on the manufacturer or service provider, who then shifts this tax burden to the consumers by charging higher prices for the commodity by including taxes in the final price.

Both direct and indirect taxes are critical components of governmental revenue and consequently the economy. The variations in the indirect taxes may come down in the future once the Goods and Services Tax bill is passed by the parliament, probably by next year.

Direct Tax Vs Indirect Tax:

Direct taxes are paid in entirety by a taxpayer directly to the government. It is also defined as the tax where the liability as well as the burden to pay it resides on the same individual. Direct taxes are collected by the central government as well as state governments according to the type of tax levied. Major types of direct tax include:

  • Income Tax: Levied on and paid by the same person according to tax brackets as defined by the income tax department.
  • Corporate Tax: Paid by companies and corporations on their profits.
  • Wealth Tax: Levied on the value of property that a person holds.
  • Estate Duty: Paid by an individual in case of inheritance.
  • Gift Tax: An individual receiving the taxable gift pays tax to the government.
  • Fringe Benefit Tax: Paid by an employer that provides fringe benefits to employees, and is collected by the state government.
  • Indirect tax, as mentioned above, include those taxes where the liability to pay the tax lies on a person who then shifts the tax burden to another individual.

    Some types of indirect taxes are:

  • Excise Duty: Payable by the manufacturer who shifts the tax burden to retailers and wholesalers.
  • Sales Tax: Paid by a shopkeeper or retailer, who then shifts the tax burden to customers by charging sales tax on goods and services.
  • Custom Duty: Import duties levied on goods from outside the country, ultimately paid for by consumers and retailers.
  • Entertainment Tax: Liability is on the cinema owners, who transfer the burden to cinemagoers.
  • Service Tax: Charged on services rendered to consumers, such as food bill in a restaurant.

Therefore, the prime difference between direct tax and indirect tax is the ability of the taxpayer to shift the burden of tax to others. Direct taxes include tax varieties such as income tax, corporate tax, wealth tax, gift tax, expenditure tax etc. Some examples of indirect taxes are sales tax, excise duty, VAT, service tax, entertainment tax, custom duty etc. However, this is not an exhaustive list of taxes and more types of taxes are levied by the government on specific cases.

Difference between Direct Tax and Indirect Tax:

There are different implications of direct and indirect taxes on the country. However, both types of taxes are important for the government as taxes include the major part of revenue for the government.

Key differences between Direct and Indirect Tax are:

  1. Direct tax is levied and paid for by individuals, Hindu undivided Families (HUF), firms, companies etc. whereas indirect tax is ultimately paid for by the end-consumer of goods and services.
  2. The burden of tax cannot be shifted in case of direct taxes while burden can be shifted for indirect taxes.
  3. Lack of administration in collection of direct taxes can make tax evasion possible, while indirect taxes cannot be evaded as the taxes are charged on goods and services.
  4. Direct tax can help in reducing inflation, whereas indirect tax may enhance inflation.
  5. Direct taxes have better allocative effects than indirect taxes as direct taxes put lesser burden over the collection of amount than indirect taxes, where collection is scattered across parties and consumers’ preferences of goods is distorted from the price variations due to indirect taxes.
  6. Direct taxes help in reducing inequalities and are considered to be progressive while indirect taxes enhance inequalities and are considered to be regressive.
  7. Indirect taxes involve lesser administrative costs due to convenient and stable collections, while direct taxes have many exemptions and involve higher administrative costs.
  8. Indirect taxes are oriented more towards growth as they discourage consumption and help enhance savings. Direct taxes, on the other hand, reduce savings and discourage investments.
  9. Indirect taxes have a wider coverage as all members of the society are taxed through the sale of goods and services, while direct taxes are collected only from people in respective tax brackets.
  10. Additional indirect taxes levied on harmful commodities such as cigarettes, alcohol etc. dissuades over-consumption, thereby helping the country in a social context.

Direct and indirect taxes are defined according to the ability of the end taxpayer to shift the burden of taxes to someone else. Direct taxes allow the government to collect taxes directly from consumers and is a progressive type of tax, which also allows for cooling down of inflationary pressure on the economy. Indirect taxes allow the government to expect stable and assured returns and brings into its fold almost every member of the society – something which the direct tax has been unable to do.

Both direct and indirect taxes are important for the country as they are intricately linked with the overall economy. As such, collection of these taxes is important for the government as well as the well-being of the country. Both direct taxes and indirect taxes are collected by the central and respective state governments according to the type of tax levied.

News About Direct and Indirect Tax

  • Indirect Taxes Collection up by 33.7 Percent and Direct Taxes up by 10.9 Percent

    Up to 31st January, 2016 the indirect taxes collection has grown by 33.7% and direct taxes collection has grown by 10.9%. Government has reached 73.5% of the Annual Budget Estimates target and has received Rs.10.66 lakh crore tax collection. The target by Annual Budget Estimates was set at Rs.14.49 lakh crore. The government may get more than Rs.40,000 crore extra over the Annual Budget Estimates’ target for indirect taxes. There might be a shortfall in the direct tax collection. These are the indications of high level of economic activities taking place in the economy.

    17 February 2016

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