Direct Tax

Direct Tax: Overview

Broadly speaking, the government of India levies two types of taxes on the citizens of India – direct tax and indirect tax. The indirect taxes can be transferred to another person and its most common example is GST (Goods and Services Tax). The GST is levied on the manufacturers or service providers as a direct tax, which is then transferred to the consumers by levying it on the final price of the goods or services, thus, making it an indirect tax for the consumers. Whereas the direct taxes are the ones that cannot be transferred to another person such as Income Tax, which every individual is supposed to pay on their own directly to the government of India. Both the indirect and direct taxes are vital components that play an essential role in changing the course of the Indian economy.

To understand things better, let us first get our basics clear on the direct tax.

What is a Direct Tax?

As we have already mentioned, direct taxes are those which are paid directly by people or an organization to an imposing institution such as the government of India. These taxes are usually levied on a person’s income and wealth. The person or the organization in question cannot transfer this type of tax to another person or entity for payment. Some of the examples of direct tax include income tax and wealth tax.

What are the Benefits of Direct Tax?

Like everything, the direct taxation too has its share of benefits. Some of them are listed as follows:

  • Economic

The direct tax such as the income tax is collected annually and is mostly deducted at the source. For example, the income tax is deducted from an employee’s salary every month. This saves a great amount of administrative costs as here the employer acts as the tax collector. This system makes direct tax more economical than other types of taxes where a lot of administrative costs are involved.

  • Productive

The direct taxes are also very productive. The revenue generated from direct tax is directly proportional to the changes in the national wealth of the country. In simple words, the increase in a country’s population and/or prosperity will consequently increase the returns on direct tax.

  • Certain

In direct tax, the amount of tax to be paid is certain to the taxpayer. In addition, the tax authorities can also precisely estimate the revenue they can expect form the direct tax. There is no ambiguity in the tax amount as it is decided before the tax submission date. This certainty on the tax amount from both the sides helps in eliminating corruption from the tax collection system.

  • Equitable

The direct taxes are imposed on the basis of a taxpayer’s income. The taxpayers with high income need to pay taxes more than the taxpayers with lesser income. In other words, the rich pay more taxes than the poor. This is, however, applicable to all sections of the society. People belonging to similar economic conditions are taxed under the same rate. The equitable trait of the direct tax serves the purpose of equality and justice across all sections of population.

  • Progressive

The direct taxes play an important role in reducing the gap of financial inequalities across the country. These taxes are progressive as the government imposes tax on people according to their income. The money collected from these taxes is used to uplift the poor in the society, thus, leading to the aim of social and economic equality.

  • Anti-inflationary

Direct taxes can be used as an anti-inflationary tool to stabilize the price level in the market. It can be used to control the use and demand of products. The increase in demand of the product and services during inflation can be decreased by increasing the direct tax. Doing this will force people at large to spend less money to purchase the products and services, thus, reducing their demand and consequently the inflation rate. 

What are the Different Types of Direct Taxes in India?

The direct taxes are of three types, which are discussed as follows:

  1. Corporate Tax

Under the Indian Income Tax Act 1961, both Indian as well as foreign organizations are liable to pay taxes to the government. The corporate tax is levied on the profit of domestic firms that are different from the shareholders. Also, the foreign corporations whose profits appear or are deemed to emerge in India are also liable to pay taxes to the Government of India. The income of a company whether in the form of dividends, interest and royalties, is taxable. Corporate tax also includes the following:

  • Minimum Alternative Tax (MAT)

The MAT tax is imposed by the Government on Zero Tax companies. The accounts of these companies are made according to the Companies Act.

  • Fringe Benefits Tax (FBT)

The FBT tax is imposed on the fringe benefits such as drivers and maids that companies provide to their employees.

  • Dividend Distribution Tax (DDT)

An amount that is declared, distributed or paid as a dividend to the shareholders by a domestic company is taxed under the Dividend Distribution Tax. This tax is only applicable on the domestic companies; the foreign companies are exempted from this tax rule.

  • Securities Transaction Tax (STT)

The SST is imposed on the income which the companies get through taxable securities transactions. This tax is free of any surcharge.

  1. Wealth Tax

The wealth tax is imposed on the property owners. It does not matter if your property is generating an income or not. If you own a property, you are liable to pay wealth tax yearly to the Government on the basis of the current market value of the property. Individuals, Hindu Undivided Family (HUF) and corporate taxpayers are liable to pay wealth tax on the basis of their residential status. Not everything is taxable under the wealth tax law. The working assets are exempted from the wealth tax law. Some of the examples of working assets are as follows:

  • Gold Deposit Bonds
  • Stock Holdings
  • Commercial Complex Properties
  • House Property (rented for more than 300 days yearly)
  • House Property owned for business or professional requirement
  • House property held for business or profession
  1.  Capital Gains Tax

The capital assets for an individual refer to anything that is owned for personal use or to make an investment. For businesses, the capital asset is anything that can be used for more than a year and is not intended to be sold or liquidated during the course of business operation. Machinery, cars, homes, shares, bonds, art, businesses and farms are some of the examples of the capital assets. The capital gains tax is imposed on the income derived from the sale of investments or assets. On the basis of the holding period, capital tax is categorised under short-term gains and long-term gains.  The formula to calculate the capital gains is as follows:

Capital Gains = (Sale Value) – (Purchase Value)

Only those capital assets are liable to short-term gain, which are sold within 3 years of acquisition. The exception to this rule is securities. The capital assets that are sold after being held for more than 3 years are liable to long-term gains.

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