What Is a Direct Tax?

direct tax

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What Is a Direct Tax?

Direct taxes are based on the ability-to-pay principle. This economic principle states that those who have more resources or earn a higher income should pay more taxes. The ability to charge taxes is a way to redistribute the wealth of a nation.

Understanding a Direct Tax

Direct taxes are based on the ability-to-pay principle. This economic principle states that those who have more resources or earn a higher income should pay more taxes. The ability to charge taxes is a way to redistribute the wealth of a nation.

Direct taxes cannot be passed onto a different person or entity; the individual or organization upon whom or which the tax is levied is responsible for the fulfillment of the full tax payment. Direct taxes, especially in a tax-bracket system, are thought by some to be a disincentive to work hard and earn more money because the more money a person earns, the more taxes they pay.

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A direct tax is the opposite of an indirect tax, where the tax is levied on one entity, such as a seller, and paid by another—such as a sales tax paid by the buyer in a retail setting. Both taxes are equally important to the revenue generated by a government and, therefore, to its economy.

The History of Direct Taxes

The modern distinction between direct taxes and indirect taxes came about with the passing of the 16th Amendment in 1913. Before the 16th Amendment, tax law in the United States was written so that any direct taxes were required to be directly apportioned to the population. A state with a population of only 75% the size of another state’s, for example, would only be required to pay direct taxes equal to 75% of the larger state’s tax bill.

This antiquated verbiage created a situation in which the federal government could not impose many direct taxes, such as personal income tax, due to apportionment requirements. However, the passing of the 16th Amendment changed the tax code and allowed for the levying of numerous direct and indirect taxes.

The Central Board of Direct Taxes in India

The Central Board of Revenue as the apex body of the Department, charged with the administration of taxes, came into existence as a result of the Central Board of Revenue Act, 1924. Initially the Board was in charge of both direct and indirect taxes. However, when the administration of taxes became too unwieldy for one Board to handle, the Board was split up into two, namely the Central Board of Direct Taxes and Central Board of Excise and Customs with effect from 1.1.1964. This bifurcation was brought about by constitution of two Boards u/s 3 of the Central Board of Revenue Act, 1963.

What is the Central Board of Direct Taxes (CBDT)?

  • It is a statutory body established as per the Central Board of Revenue Act, 1963.
  • It is India’s official financial action task force unit.
  • It is administered by the Department of Revenue under the Ministry of Finance.

Composition and Functions of CBDT

The Central Board of Direct Taxes consists of a Chairman and following five Members:

  • Chairman
  • Member (Income Tax & Revenue)
  • Member (Legislation)
  • Member (Admn.)
  • Member (investigation)
  • Member (TPS & system)
  • Member (Audit & Judicial)

The Chairman and Members of Central Board of Direct Taxes are assisted by Joint Secretaries, Directors, Deputy Secretaries, Under Secretaries and ministerial staff to carry out their day-to-day functions.

CBDT Structure

The Central Board of Direct Taxes consists of a Chairman and six members that deal with the following:

  • Income Tax
  • Revenue
  • Legislation and Computerisation
  • Audit and Judicial
  • Investigation
  • Personnel and Vigilance

The Members of the CBDT are selected from the Indian Revenue Service (IRS). The members constitute the top management of the Income Tax Department.

Functions of CBDT

  • It deals with matters related to levying and collecting Direct Taxes.
  • Formulation of various policies.
  • Supervision of the entire Income Tax Department
  • Suggests legislative changes in Direct Tax Enactments
  • Suggests changes in tax rates 
  • Proposes changes in the taxation structure in line with the Government policies.

Advantages of Direct Taxes

Though it is strictly implemented on every individual who does not qualify for an exemption, there are actually numerous advantages of paying taxes directly. They include:

Curbs inflation:

The Government will often increase tax when there is inflation. This reduces the demand for goods and services and as a result of descending demand, inflation is bound to compress.

Social and economic balance:

On the basis of every individual’s earnings and overall economic situation, the Indian Government has well-defined tax slabs and exemptions in place so that the income inequalities can be balanced out.

Certainty:

There is a sense of certainty with respect to direct taxes from the taxpayer and the government, as each know how much to pay and how much to expect to collect respectively.

The good thing about direct taxes is that they are determined and made final before they are even paid. In the case of income tax, the annual tax is the same every year as long as the salary does not change.

Productivity

Direct taxes are considered to be very productive, the reason being, as the working population and community grows, so do the returns from direct taxation.

Saves time and money

The government does not need to spend on the collection of taxes because they are already taken right at the source of the income. Some companies use automatic payroll deduction systems, which help save time and money.

Promotes elasticity

Taxes are the earnings of the government, and when they fluctuate, the earnings also change. They can go higher or lower.

Creates equal distribution of wealth:

The money is equally distributed as the Government charges more taxes from the ones who can afford and this money is used for the benefit of the lower and poorer sections of the society.

Promotes equality

Since direct taxes are based on the ability of a person to pay, it promotes equality among payers and citizens. Every person is charged a different amount, depending on how much they make.

The Direct Tax Code

The DTC or Direct tax code has been drafted to replace the existing Indian Income Tax Act of 1961. This was done to establish a more efficient, effective and equitable direct tax system. The aim was to stabilize, amend all laws relating to the direct taxes in order to ease voluntary compliance and increase the tax-GDP ratio. With 319 sections and 22 schedules in it, the DTC aims to replace the old Income Tax Act and provide a more stable, well organized and overall better code for taxation.

History of Implementation of Direct tax Code

The government published a discussion paper on Direct Tax Code in 2009 and issued the Direct Tax Code (DTC) bill in parliament in 2010.

Like all technical bills, this bill too was referred to the standing committee on finance headed by Mr Yashwant Sinha. The government wanted to implement DTC from 1 Apr 2012 but due to delay in the report being submitted by the standing committee, it was not possible. It is not a very controversial bill as state governments are not involved in it.

Objectives of the Direct Tax code

The objectives of the Direct Tax Code are mentioned below:

  • To simplify and consolidate all direct tax laws of the central government
  • To make the tax system more effective and efficient.
  • To bring the consolidated law relating to direct taxes, that is, income-tax, dividend distribution tax, fringe benefits tax and wealth-tax
  • To bring horizontal equity among different classes of taxpayers in line with best international practices.
  • To improve compliance further, tax laws need to be simple, stable and robust.
  • To phase out the multiplicity of tax exemptions and deductions in order to widen and deepen the tax base.

What is simplification and consolidation of Direct tax Laws?

Simplification of direct tax laws can be stated as follows:

  • Tax laws would be re-written in simple language
  • Exemptions and reductions would be reduced
  • Cross-references will be reduced
  • Explicit Language will be used.

Consolidation of tax laws can be stated as follows:

  • All tax laws dealing with direct taxes would be merged. E.g. Income Tax Act, 1961; Wealth Tax Act, 1957; Gift Tax Act, 1958.

Direct Tax Code (DTC) Proposals

  • Increase in Income tax slabs. (Government adopted the proposed tax slabs in the financial year 2012 – 2013)
  • Corporate Income Tax or Corporate Tax – For both domestic and foreign firms, the tax rate should be 30% and no surcharge will be applicable. Currently, there is a 5% surcharge that is applicable for domestic firms and for foreign firms, tax is 40% along with 2% surcharge is also applicable.
  • Minimum Alternate Tax rate should be 20%. Currently, the tax rate of MAT is 18.5%.
  • Savings Scheme should be under EET. Presently these schemes are under EEE.
  • Few schemes like PF, Gratuity, pension funds etc would still come under EEE.

Following are the Direct Tax Codes explained with examples

Here, the Direct Tax code is explained in this section by delving into its key features. Examples of income tax, corporate tax, wealth tax, and Capital Gains Tax are given below.

  • A Single code for direct taxes: A single unified taxpayer reporting system can be facilitated by bringing all direct taxes under a single code with unified compliance features.
  • Flexibility: The law has been created in such a way that can accommodate the changes and requirement of a growing economy without having to constantly resort to amendments.
  • Stability: With reference to the current system, the taxes are formed in the Finance Act of the relevant year. The rates of taxes under Direct tax code are proposed to be prescribed in the First to the Fourth schedule of the DTC itself. Also, any amendments to the same will be brought before the Parliament as an Amendment Bill.
  • Eliminates the problem of constant litigation: Special care is taken to avoid ambiguity and contradiction in the code in order to avoid misinterpretation and misuse.
  • Eliminates regulatory functions: The regulatory functions are to be carried out by other regulatory authorities.
  • Fringe benefits tax: These are charged to the employee than charging it to the employer.
  • Political contributions: There are political contributions of up to 5% of the gross total income that will be eligible for deduction.

Types of Direct Taxes in India

The following taxes are imposed directly and applicable to all Indian citizens.

Income Tax

It is based on one’s income. A certain percentage is taken from a worker’s salary, depending on how much he or she earns. The good thing is that the government is also keen on listing credits and deductions that help lower one’s tax liabilities.

  • This comes across as the most important and common tax that every Indian must pay.
  • This tax is directly charged on the income of the person.
  • The rate at which income tax is charged depends on the level of income.
  • Income Tax is chargeable to individuals, corporate houses, firms, companies, trusts, Hindu Undivided Families (HUF’s), and any artificial judicial person.
  • Income tax is chargeable on taxable income

ie: Taxable income = (total income) – (applicable deductions and exemptions)

Also, the different heads of Income under which income tax is chargeable are as follows:

  • Income from a profession or business
  • Income from property or house
  • Income from salaries
  • Income that is in the form of capital gains
  • Income from other sources

Note: Income Tax is levied differently for different people depending on their residency status.

Wealth Tax

  • This tax is charged on the benefits derived from property ownership.
  • The same property is taxed every year depending on its current market value.
  • There is no difference for a tax that is levied on the Individuals, HUF’s and companies.

Note: Income tax on wealth is chargeable depending on the residential status

Corporate Tax

  • Corporate tax is applicable to companies who exist as separate entities from their shareholders.
  • Foreign companies are also taxed on the income that arises or that is considered to arise in India.
  • This type of tax is charged on gains from the sale of capital assets located in India, royalties, interest, fees for technical services and dividends.
  • Corporate tax includes Minimum Alternative Tax (MAT) which was introduced to bring Zero Tax companies under the income tax bracket and whose accounts were made as per the Companies Act.
  • Fringe benefit (it is an extra benefit supplementing an employee’s salary) is included in Corporate tax that is paid by the companies on the fringe benefits provided (or deemed to have been provided) to employees.
  • Lastly, it also includes Securities Transaction Tax (STT) which is a tax levied on taxable securities transactions. However, there is no surcharge applicable to this.

Capital Gains Tax

  • Capital gains tax is taxed on the income derived from the sale of assets or investments.
  • Capital investments will cover farms, businesses, homes, work of arts etc.
  • Capital Gains = (money received from sales) – (cost of capital investment).
  • Capital Gains are categorized as short term gains (ie: gains on assets sold within 36 months of acquisition) and long-term gains (ie: gains on assets sold after 36 months of acquisition and holding). Also, Voluntary tax is paid by the taxpayer when the asset is sold.

Transfer taxes

The most common form of transfer taxes is the estate tax. Such a tax is levied on the taxable portion of the property of a deceased individual, including trusts and financial accounts. A gift tax is also another form wherein a certain amount is collected from people who are transferring properties to another individual.

 Entitlement tax

This type of direct tax is the reason why people enjoy social programs like Medicare, Medicaid, and Social Security. The entitlement tax is collected through payroll deductions and is collectively grouped as the Federal Insurance Contributions Act.

Property tax

Property tax is charged on properties such as land and buildings and is used for maintaining public services such as the police and fire departments, schools and libraries, as well as roads.

How is the direct tax collected?

Tax Deducted at Source (TDS):

  • Tax Deducted at Source is the collection of income tax directly from the individual’s source of income periodically or occasionally.
  • All entities in India, including foreign representative offices and Indian setups like wholly-owned subsidies, should withhold tax on employees’ salaries on behalf of the IT department.
  • The employer may also deduct TDS on various other payments like rent, interest, dividend and royalty.
  • The Finance Act of each financial year specifies the rates in force for deduction of tax at source according to the IT Act, 1961.

Tax Collection at Source (TCS):

  • TCS is the tax payable by a seller, which he collects from the buyer at the time of sale.
  • IT Act governs the goods on which the seller has to collect taxes.

Voluntary payment by taxpayers:

  • Every taxpayer, who earns taxable income, must pay income tax in India.
  • An individual who has an independent income can deposit self-assessment tax or advance tax to the credit of government by using a tax payment form.

Direct Taxes vs. Indirect Taxes

There are basically two types of taxes – direct and indirect taxes. The following are the differences between the two:

  • Direct taxes refer to taxes that are filed and paid by an individual directly to the government. Indirect taxes, on the other hand, are taxes that can be transferred to another entity. Therefore, the burden of paying them can be put on another person’s shoulders.
  • Direct taxes can be evaded in the absence of proper collection administration. Indirect taxes cannot be escaped from because these are charged automatically on goods and services.
  • Direct taxes can help address inflation while indirect taxes can lead to inflation.
  • Direct taxes lessen the savings of earners, but indirect taxes encourage the opposite because they make products and services more expensive and unaffordable.
  • Direct taxes are imposed only on people that belong to various income brackets. Indirect taxes, on the other, can be felt by everyone who buys goods and avails services.

Disadvantages of Direct Taxes

Direct taxes also have some drawbacks such as 

  • Considered a Burden- As taxpayers are required to pay direct taxes like income tax in a single lump sum every year, they are considered a burden. Moreover, even the documentation process is generally complex and time-consuming.
  • Evasion is Possible- While the government has made tax evasion very difficult now, there are still many fraudulent practices through which individuals and businesses can avoid or pay lower taxes than they should.
  • Restrains Investments- Due to the imposition of direct taxes like securities transaction tax and capital gains tax, a lot of people avoid investing. So, in a way, direct taxes restrain investments.

Paying Taxes is Your Responsibility

As you can see, direct as well as indirect taxes have their pros and cons, but both are abundantly important for the economy. While taxes are generally considered to be an unnecessary burden, it is from the taxes you pay that the government builds the nation, invests in defence, healthcare, infrastructure, launches welfare initiatives, and prospers. Our dream of seeing our country become a global superpower can only be achieved if the citizens continue to pay taxes with complete honesty.

Now that you’ve understood the different types of direct and indirect taxes in India, fulfil your responsibility of paying taxes and being a responsible citizen of the country. Make use of the available tax deductions as much as possible but do pay the remaining tax liabilities on time every year as this will ultimately help the citizens and make the country more prosperous.

Article submitted by:

CVBAY is an ITR, GST AND Finance management Platform helping businesses for finance and tax related services. For any query, please email us : ccvbayaccountservicee@yahoo.com Or visit : https://www.cvbay.co.in Or call us: +91 8341000081


What is Direct Tax?

direct tax

A direct tax is a tax an individual or organization pays directly to the imposing entity. A taxpayer, for example, pays direct taxes to the government for different purposes, including real property tax, personal property tax, income tax, or taxes on assets.





What is Income Tax?

It is based on one’s income. A certain percentage is taken from a worker’s salary, depending on how much he or she earns. The good thing is that the government is also keen on listing credits and deductions that help lower one’s tax liabilities.


How Income will be calculate for tax?

Income tax is chargeable on taxable income
ie: Taxable income = (total income) – (applicable deductions and exemptions)


what is Property tax?

Property tax is charged on properties such as land and buildings and is used for maintaining public services such as the police and fire departments, schools and libraries, as well as roads.


How is the direct tax collected?

Tax Deducted at Source (TDS)
Tax Collection at Source (TCS)
Voluntary payment by taxpayers


What is Tax Deducted at Source (TDS)

Tax Deducted at Source is the collection of income tax directly from the individual’s source of income periodically or occasionally.


What is Tax Collection at Source (TCS)

TCS is the tax payable by a seller, which he collects from the buyer at the time of sale. IT Act governs the goods on which the seller has to collect taxes.

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