Direct and Indirect Taxation: Know the Difference

Tax is a kind of fee/financial charge levied on individuals/legal entities by the government. Taxes are mandatory. An individual may be subject to hefty fines and penalties in case he fails to pay his due taxes. Taxes are intended to raise the revenue so as to financially fuel and support various public welfare programs such as building roads, creating jobs, improving transportation, funding military operations, launching educational initiatives, etcetera.

The contemporary tax system is complex and taxes can be classified in more than one ways. However, there are basically two forms of taxation – Direct Taxation and Indirect Taxation. Tax laws specify regulations regarding what is taxable directly and what is taxable indirectly. Let’s look at the key differences between the two:

Direct Taxation Indirect Taxation
Taxes are levied directly on individual/corporation by the government. Taxes are levied indirectly on consumers of goods and services by the intermediaries (manufacturers/service providers).
Direct taxes are imposed according to the individual’s financial ability. Indirect taxes are imposed irrespective of the consumer’s financial ability.
The tax is restricted to the person on whom it is imposed. It cannot be transferred further. These are actually the taxes that are initially borne by the intermediaries and subsequently shifted on to the final buyers.
Direct taxation precedes indirect taxation. Indirect taxation follows direct taxes.
Direct taxes are subject to tax evasion though evasion or non-payment can incur heavy penalty. Indirect taxes cannot be evaded.
A taxpayer files a tax return and then pays the taxes. The taxpayer has already paid his taxes when he buys any products/services.
Direct taxes are complex Indirect taxes are comparatively simple
Applicable to tangibles like income, interests, investments and property Applicable to intangible concepts like sales, expenditure and so forth
Types of Direct Taxes – Income Tax, Corporation Tax, Transfer Taxes, Capital Gains Tax, Inheritance Tax, etcetera. Types of Indirect Taxes – Sales Tax, Goods and Services Tax, Value Added Tax (VAT), etcetera.
Direct taxes are calculated as per the income tax slab released by I-T department for the particular year. Indirect taxes are calculated in two ways – Specific taxation (a fixed amount is imposed as tax) and ad valorem taxation (a fixed percentage on the selling price is imposed as tax).
Collection costs > Collection costs
Administrative costs > Administrative costs
Transparency > Transparency
It implies that the people are not so aware of, what and how much they end up paying as indirect taxes. In contrast, most of the people know well, what and how much are they paying as direct taxes.
Regressive > Regressive
It implies that the products/services demand decreases more significantly with increase in indirect taxes compared to increase in direct taxes.
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