Direct and Indirect Taxes

What is tax?

Taxes are generally an involuntary fee levied on individuals or corporations that is enforced by a government entity, whether local, regional or national in order to finance government activities. In economics, taxes fall on whomever pays the burden of the tax, whether this is the entity being taxed, like a business, or the end consumers of the business’s goods. (Source: Investopedia). It is a monetary burden laid upon individuals or property owners to support the government. It is not a voluntary payment or donation, but an enforced contribution towards the government.

Why are taxes levied:

The prime reason for levy of taxes is that they are the basic source of revenue to the government which can be utilised by the government for its expenses like defence, healthcare, education, different infrastructure facilities like roads, dams, highways etc.

Two forms of taxes:

There are mainly two forms of taxes namely Direct and Indirect taxes. These 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 the consumers while indirect taxes allow the government to expect stable and assured returns through the society.

Direct Taxes:

A Direct tax is imposed directly on the taxpayer and paid directly to the government by the ones on whom it is imposed. It cannot be shifted by the taxpayer to someone else.

Some important direct taxes imposed in India are as under:

1. Income Tax: It is levied on and paid by the same person according to the different tax brackets as defined by the income tax department. It is imposed by the government on all the income that is generated by various entities within their jurisdiction. All individuals and businesses have to file an income tax return every year to determine whether they owe any taxes or are eligible for any tax refund.

2. Corporate Tax:It is also known as the corporation tax. It is the tax on all the income or gains generated by corporations. It is generally levied on the profits earned. The companies and business organizations are taxed on the income under the provisions of Income Tax rules.

3. Inheritance (Estate) Tax: An inheritance tax which is also known as an estate tax or death duty is a tax which arises on the death of an individual. It is a tax on the estate, or total value of the money and property, of a person who has died.

4. Gift Tax: It is the tax that an individual receiving the taxable gift pays to the government.

Advantages of Direct Taxes:

1. Social and economic equity

This form of taxation indicates social justice as it is based on the ability to pay. The economic situation of persons determines the rate at which they are taxed. Also the progressive nature of direct taxation can help reduce income inequalities. This is well depicted by the slabs and exemption limits for different sections like women, individuals and senior citizens.

2. Certainty of tax to be paid

The tax payer is certain as to how much tax is to be paid, as the tax rates are decided in advance. The same implies for the government where it can estimate the tax revenue from direct taxes.

3. Economical and lower cost mechanism

Collection of direct taxes is generally economical. Like in the case of personal income tax, the tax can be deducted at source (TDS) from the income or salaries of the individuals. So, the government does not have to spend much in tax collection as far as personal income tax is concerned.

4. Relatively Elastic

Increase in the income of individuals and companies, leads to increase in the yield from direct taxes also. An increase in tax rates would increase the tax revenues. Thereby, direct taxes are relatively elastic.

5. Controls inflation

Direct taxes can help control inflation. When the inflation is on the uptrend, the government may increase the tax rate. With an increase in tax rate, the consumption demand may decline, which in turn may help reduce inflation.

Disadvantages of Direct Taxes

1. Tax Evasion

We have higher tax evasion in our country due to high tax rates, poor documentation and corrupt tax administration. This helps in suppressing the correct information about incomes easily and thereby with manipulating accounts, evasion on tax is encouraged.

2. Impacts capital formation

Direct taxes can affect savings and investments. Due to tax implications, the net income of individuals reduces, in turn reducing their savings. Reduction in savings results in low investment, affecting the capital formation in the country.

3. Arbitrary rate of taxation

The direct taxes are arbitrary. There is no objective defined for determining the tax rates of direct taxes. Also, the exemption limits in personal income tax, wealth tax, etc., are also determined in an arbitrary manner. Therefore, direct taxes may not always fulfill the requirement of equity.

4. Inconvenient

Direct taxes are inconvenient owing to the lengthy procedure of filing returns. For most people payment of direct tax is a task to convince oneself to pay a part of their income as tax to the state. This is a boost to evade tax further. It is also inconvenient in terms of maintaining accounts in a proper form.

5. Imbalance in Sectoral taxation

In India, there is sectoral imbalance as far as direct taxes are concerned. Certain sectors like the corporate sector is heavily taxed, whereas, the agriculture sector is 100% tax free.

Indirect Taxes:

An indirect tax is a tax collected by an intermediary from the person who bears the ultimate economic burden of the tax. It can be shifted by the taxpayer to someone else. An indirect tax may increase the price of a good so that consumers are actually paying the tax by paying more for the products.

Some important direct taxes imposed in India are as under:

1. Customs Duty:

Customs Duty is a tariff or tax imposed on goods when transported across international borders. The purpose of it is to protect the country’s economy, jobs by controlling the flow of goods, especially the restrictive and prohibited goods, in and out of the country. Hence, simply put, it is the tax imposed on imports and exports of goods.

Under the custom laws, the various types of duties are levied:

  • Basic Duty: It is levied on all imported goods.
  • Additional Duty or Countervailing Duty (CVD): Countervailing Duty (CVD) is charged on import of specific goods listed by the government of importing country as per their Foreign Trade Policy. It is imposed to balance the price of the same product of domestic producers and the price of foreign producers based on the export subsidy they avail from their exporting country.
  • Anti-dumping Duty: Dumping is basically when foreign sellers may export into India, goods at prices below the amounts charged by them in their domestic markets with the intention to capture the Indian markets. That is why, in order to prevent dumping, the Central Government may levy additional duty equal to the margin of dumping on such articles.
  • Protective Duty: The Central Government may levy protective anti-dumping duties at the rates recommended on specified goods.
  •  Export Duty:  Such duty is levied on export of goods. The main purpose of this duty is to restrict exports of certain goods.

2. Central Excise Duty:

It is the tax which is charged on excisable goods that are manufactured in India and are for domestic consumption. It is mandatory to pay Central Excise duty on the goods manufactured, unless if they are exempted.

3. Service Tax:

The Service Tax is levied on the gross or aggregate amount charged by the service provider on the receiver.

4. Sales Tax:

Sales Tax in India is a form of tax that is imposed by the Government on the sale or purchase of a particular commodity within the country. Sales Tax is imposed under both, Central and State Government Legislation. Generally, each state follows its own Sales Tax Act and levies tax at various rates.

5. Value Added Tax (VAT):

It is a tax on the estimated market value added to a product or material at each stage of its manufacture or distribution, ultimately which is passed on to the consumer. It is a multi-point levy on each of the entities in the supply chain.   

6. Securities Transaction Tax (STT):

STT is a tax levied on all transactions done on the stock exchanges. STT is applicable on purchase or sale of equity shares, derivatives and equity oriented mutual funds. A person becomes investor after payment of STT at the time of selling securities (shares). Selling the shares after a period of 12 months comes under long term capital gains and one need not have to pay any tax on that gain. In the case of selling the shares before 12 months, one has to pay short term capital gains @10% flat on the gain.

Difference between direct and indirect taxes:

DIRECT TAXES INDIRECT TAXES
Direct taxes are paid entirely by a taxpayer directly to the government Indirect tax is ultimately paid for by the end-consumer of goods and services.
Burden of taxes cannot be shifted Burden of taxes can be shifted
It can help reduce inflation It enhances inflation
Tax evasion can be possible These cannot be evaded as are charged on goods and services
Higher administrative costs are involved Lesser administrative cost involved
Direct tax is progressive Indirect tax is regressive

Conclusion:

Both direct and indirect taxes are important for our country as they are linked with the overall economy. Both are collected by the central and respective state governments according to the type of tax levied and are important for the government as well as growth perspective of the country.


GST Bill and its importance in India

What is GST bill?

Goods and Services Tax (GST) is defined as the tax levied when a consumer buys a good or service. It is proposed to be a comprehensive indirect tax levy on manufacture, sale and consumption of goods as well as services. GST aims to replace all indirect levied on goods and services by the Indian Central and State governments. GST would subsume with a single comprehensive tax, bringing it all under a single umbrella, eliminating the cascading effect of taxes on the production and distribution prices of goods and services.

GST Bill

Current Scenario: cascading effect of taxation

The current multi-staged tax structure has charges from the State and Union governments separately, leading to cascading effect of taxes. There are taxes at different rates and at multiple points. The Centre has taxes like Income tax, service tax, central sales tax, excise duty and security transaction tax while at the State level it includes VAT or sales tax, octroi, state excise, property tax, entry tax and agriculture tax. These taxes lead to increased tax burden on the Indian products affecting the prices and sales in the domestic as well as international markets.

How will GST be a remedy?

Remedy to the above scenario of multiple taxes and its cascading effect which is a burden on common man is GST. The framework of proposal has dual GST which means it will have a federal structure. GST will basically have three kinds of taxes namely Central, State and one called integrated GST that will help to tackle inter-state transactions. Under the current GST tax reform, all forms of supply of goods and services like transfer, sale, barter, exchange and rental will have a CGST and SGST.

GST Bill and its consequences

What is the need for GST?

One can explain the impact of cascading taxes with an example. Say A sells goods to B after charging sales tax, and then B re-sells those goods to C after charging sales tax. In this case while B was computing its sales tax liability, it also included the sales tax paid on previous purchase, which is how it becomes a tax on tax. This is also referred to as taxes on taxes. This is where the need for GST arises to do away with the phenomenon.

What are the challenges in the implementation?

India is adopting a dual GST, namely the Central GST (CGST) and state GST (SGST). The main hurdle in the implementation will be the coordination among different states. The Centre and States will have to come to consensus on the uniform GST rates, inter-state transaction of goods and services, infrastructural requirements to implement the new tax reform, all of which needs to be worked upon for the smooth transition into GST pattern.

Other factors to be considered:

  • Since GST is a destination based tax, there should be clarity on where the goods are going. Proper methodology should be chalked out as it would require proper management in terms of services provided.
  • There has to be uniformity in the implementation of GST in all states at the same time and the same rates or else it would be difficult to comply with the law provisions.

Features of GST:

  • GST will have two components namely Central GST levied by the Centre and State GST levied by the states.
  • Petroleum products, alcohol for human consumption and tobacco have been kept out of the purview of the GST.
  • The final consumer will have to bear only the GST charged by the last dealer in the supply chain.
  • The tax collected would be divided between the Centre and the States in a manner that would be defined by the parliament, as per the recommendations of the GST Council.
  • The bill proposes an additional tax not exceeding 1% on inter-state trade in goods, to be levied and collected by the Centre to compensate the states for two years, or as recommended by the GST Council, for losses resulting from implementing the GST.

Advantages of implementing GST:

Introduction of GST is considered to be a significant step in the reform of indirect taxation in India. Amalgamating several Central and State taxes into a single tax would help mitigate the double taxation, leading to a common national market. From the consumers point of view, the advantage would be in terms of a reduction in the overall tax burden on goods, which is currently estimated at 25%-30%. (Source: Wikipedia)

The other advantages include:

  • Reduction in prices: Manufacturers or traders would not have to include taxes as a part of their cost of production, which would lead to reduction in prices.
  • Lower compliance and procedural cost: There would be reduction in the load to maintain compliance. Also keeping record of CGST, SGST and IGST separately would not be required.
  • Move towards a Unified GST: Although India is adopting dual GST, it is still a good move towards a Unified GST which is regarded as the best method of Indirect Taxes.
  • GST rollout can help boost India’s GDP growth by 100-200 bps or (1 to 2%) as this will help faster and cheaper movement of goods across the country with a uniform taxation structure.
  • GST’s successful implementation would give a strong signal to the foreign investors about India’s ability to support business.
  • GST will be beneficial with more transparency, efficient compliance, ramp up in GDP growth to the Centre, states, industrialists, manufacturers, the common man and the country at large.

What if India launches GST?

The long awaited GST bill if passed by India should have the following benefits, a few to mention:

  • Will help in reducing tax evasion:

All the distributors will prefer purchase with invoices, because that would give them better profit margins as the distributor will get credit of all the taxes paid at the previous stage. Currently, it is the distributor who has to bear the burden of the excise duty. So if the customer insists on taking the bill, we can presume that the tax evasion should fall. This will indeed be the biggest advantage of GST.

  • Removal of location bias approach:

GST would help to even out the tax structures across various states, omitting location bias. As taxes should not be a hindrance to the investment decision of an individual, introduction of GST would help an investor to put up business units in any state without the worry of tax difference. This would boost the business in undeveloped locations as well.

  • Lesser incentive for tax evasion:

Currently, taxes are being paid on the entire underlying value of a product or service, but with GST, companies will have to pay tax only on the value-addition. This would lead to reduction in the actual tax paid and also decrease the incentive for evasion.

  • Unified market:

With the implementation of GST, there will be cut down of individual taxes imposed by the central government as well by the states. This would lead to a unified market and would boost the movement of goods across states with drop in the business costs.

  • Increase in State revenues:

GST will expand the tax base and thereby lead to increase in the revenues available at the states’ and centre’s disposal. This would thereby help in increasing the resources of the poorer / consumer states like, Bihar, Uttar Pradesh and Madhya Pradesh will increase substantially.

  • Improvement in tax governance:

GST would improve tax governance in two ways. One it is related to self-policing incentive inherent to a valued-added tax that can work very powerfully in the GST. The second relates to the dual monitoring structure of GST, one by the States and the other by the Centre.

Impact of GST on the ‘Make in India’ initiative

The current indirect tax regime is a hindrance in the growth of the domestic manufacturing sector as well as flow of foreign investment to the sector. Introduction of GST is important as it would help alleviate the situation. There would be reduction in cost of manufacturing both from a tax view as well as compliance front. Inspite of being one country, India has more than 30 markets which would be transformed into a single market with GST. Since it will also be applicable on imports, the tax factor working against ‘making in India’ will disappear, further boosting the production and in turn the exports as well.

RECENT POSITIONING:

The Monsoon session of the Parliament that has begun recently will go on till August 12. The bill has already been cleared in the Lok Sabha. Once again, hopes are high that the Goods and Services Tax Bill will get passed in the Rajya Sabha, making way for this reform to become legislation and eventually get implemented next year.

Roadblock to the introduction of GST

GST still has a long way to go before it is finally implemented. After the Bill is passed in both the Houses of Parliament by two thirds majority, it will be sent to the State Legislatures for ratification. At least 50% of the State Legislature approval will be required before the proposed Constitution amendments are brought into effect. After this, the Parliament would be required to legislate laws pertaining to CGST and IGST.

Conclusion:

GST will bring in transparent and corruption-free tax administration, removing the current shortcomings of the supply chain owing to the multi-layered policies. GST is not only investor or business friendly but also consumer friendly. GST is the need of the hour and any hindrance to its enactment is clearly unjustified and not in national interest. Critics argue about the feasibility of implementing GST. But one should always remember that there is no reform that is perfect. It is important that we start with the current bill and gradually improvise the same in due course.