Saturday, 11 March 2017

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Tax and Its Types | Why is Tax Taken? Direct and Indirect Tax


Tax- a word that can threaten any businessmen’s life! It could act both as a life saver or life taker. But, here comes the need for us to identify which role does tax actually play?
Tax, this term is highly misunderstood by many of us. Some take it as an unnecessary charge to be paid to government and some assume it to be a payment of earning well. Indeed it’s confusing. Tax is a wide term whose entire coverage is a single go is impossible & there arises many question if one is asked to define tax. In general if we discuss tax then following queries would arise:
  • What is tax?
  • Why is it levied?
  • How many types of taxes exists? (basically , in India )
  • Who needs to pay tax?
  • Who collects this tax?
  • Is it compulsory to pay?
  • On what tax is levied or paid?

Phew.. :-P and so many more questions attached to each of them! 

Since, tax is a wide term so, we shall proceed with the basic discussion, what does tax really mean?
In a layman’s term, tax is a fine for doing well. It is a charge, paid to the government of a country on a particular sum. But, this isn’t a perfect explanation. Lets’ just understand it a bit more comprehensively.

What is Tax?

Tax is a fee charged by a government of a country on the products purchased, income earned or any activity involving money.
It is a charge to be paid to the government of a country or its respective states, on the income earned by carrying out a trading activity, by an individual or an organization (say company), on the use of goods and services, expenditure on entertainment, buying or selling of properties etc.
And, tax on all of the above activity is different from each other.
Tax is basically an amount that an individual or an organisation has to pay for doing any activity involving money. For example: an individual or an organisation-
  • Earning an income (taxable income) shall be liable (responsible) to pay tax. (Income tax)
  • Earning business profit on trade. (Income tax)
  • Using or providing services. ( Service tax)
  • Engaged in import or export of goods and services ( export duty and customs duty)
  • Engaged in manufacturing of an article or a thing (Excise duty) etc…
From above examples, we conclude that there are different activities which falls under the purview of tax and different names are attached to the taxes paid on different activities. But, before moving on further, your mind must be querying: what is the need of tax or why tax is levied?

Why tax is levied & who collects the tax?

Ask your mind, why do you think, tax is levied? What’s the need of paying taxes? Before answering this question, we shall know that the tax that we pay, in whichever form, whether income tax, service tax or so on.. Where does this finally go? Who ultimately collects this tax? The answer is government!
The tax we pay reaches to our government. The central government and the state government collects these taxes. Few taxes falls under the control of central government and some to the state government. Now, what do u think these government do with this amount collected? (Ignoring corruption )
Keeping it serious, the amount which government receives by way of charging taxes from us, is used meeting expenditure of government like expenses on  infrastructure facilities ( building roads, canals etc.),  on education (building schools, providing uniforms, mid-day meals etc.) , on health care ( construction of hospitals), research and development, expenses on defense etc.
Tax acts as a revenue (income) generating activity for the government. Rather, it is the basic source of income for any government. Therefore, evasion (avoiding or stealing) of tax is a punishable offence.
So, here we conclude that tax is collected by the government of the country and it is levied since it creates revenue for the government and it is used for public expenditure by the government.

Let us now have a look at types of Taxes!


Now, there are many kinds of taxes charged in our country, India. For example: income tax, service tax, wealth tax, property tax etc. sometimes, an ordinary individual, himself does not know how many taxes he is paying and neither he seeks to know. Here, I am making an attempt to briefly explain kinds of taxes prevalent in India and how are they imposed!
Taxes in India is primarily divided into direct and indirect form.  Few taxes are called direct taxes and other taxes are called indirect taxes. Also, division of taxes in India is on the basis of tax levied by central government & Tax levied by state governments.

Tax Types: Direct and Indirect taxes 

Direct taxes

As the name suggests, direct tax is the tax directly payable to the central government of the country by an individual or an organization. Such kind of tax is directly imposed on the income earned by an individual or a company by way of salaries, business profit, capital gain (profit arising on sale or purchase of capital goods, Example: property, gold, government bonds or shares etc.) Or income from any other sources like prize money on winning a lottery or an income from winning a game show like KBC. Etc. 
In direct taxes. The burden of tax falls directly on to the individual. No intermediary is involved here. Also, direct taxes are progressive in nature, which means as the amount of tax increases with the increase in the ability of a person to pay i.e. a person with higher income pays higher tax!
Generally, following taxes falls under the head direct taxes –
  • Income tax.
  • Wealth tax
  • Corporate tax etc
Briefly let’s discuss some of the major direct taxes in India.

Income Tax- Income tax is the tax imposed on the total taxable income of the person earned during previous year. Here, a person includes- an individual, a company, a firm, a partnership firm, Hindu undivided family (HUF), an association of person (AOP) or a body of individuals (BOI) etc. Income tax act in India is governed by the “Income Tax Act, 1961.” 
Taxable Income is the net of total income taxable less of any deduction or exemption. Income tax is levied on the income above the minimum taxable limit as per the different rates applicable for each tax slab.
Under income tax, income earned by way of salary, income from house property (rental earning), any business income, income from capital gains & income from other sources are included. We shall be discussing them in detail in our later articles! 
For example: Mr. A earned an income of Rupees 10 lakhs by salary, Rs. 50,000 being business income, Rs. 10,000 as income from house property during the year 2015-2016. Therefore, the tax on this income (10 lakhs+50,000+10,000 = 10, 60,000) shall be assessed in the year 2016-2017.

Wealth Tax:  wealth tax is the tax on the assets possessed by an individual, HUF or a company in the previous year.  Assets includes land, property or gold etc. if the net value of such assets exceed rupees 30 lakh, then 1 % of tax is payable on the value of such assets.

Also, there are corporate taxes, gift taxes, dividend taxes etc. which we shall cover in next articles.

Indirect Taxes

Indirect tax, as the name suggests, is indirect in nature. Unlike, direct taxes, here the burden of tax does not appear to fall directly on to the person but ultimately it does.
For example: when we purchase any good, at the back side of the product we see batch details and MRP of the good. With MRP, it is well mentioned that price is inclusive of all taxes. This price that we pay for using or buying a commodity already includes a hidden tax in it. Such kind of tax that a consumer does not directly knows about, is called indirect taxes.
Indirect tax is a kind of tax where the liability of paying tax can be shifted from one person to another. The person who finally consumes the goods or uses services bears the tax, but the responsibility of paying such taxes to the government falls into the hands of the manufacturers or seller of the goods and services.
Unlike direct taxes, indirect taxes are regressive in nature, which means all the consumers equally bear the burden of tax, irrespective of their earning capacity.

For example: tax on a particular good say mobile phones, will be equal for all the  consumers purchasing same mobile phone.
Now, there exists wide range of indirect taxes in India based upon the nature of activities. Some of them are:
  • Service tax
  • Customs duty
  • Excise duty
  • Value added tax (VAT)
  • Central sales tax etc.

Service tax: Service tax is the tax imposed on the services provided in the taxable territory of India. The burden of such tax falls on the person using the services, who pays the amount of service tax along with the value of service used to the service provider, who in turn pays such service tax collected to the prescribed government of the country- state or central!

Service tax is not payable on all of the services. Government has drafted a negative list which prevents or defines few services which falls out of the purview of service tax, which means no tax is payable on the services mentioned in the negative list.
For example: courier services are taxable services in India. Therefore, tax is paid on using such service whereas Services by way of renting of residential property for use as residence is outside the ambit of service tax, since it is covered under negative list.

Excise Duty:  excise duty is the duty applicable on the manufacturing of an article or a thing in India. As soon as goods are manufactured, excise duty is paid by the manufacturer to the government. At the time of sale, manufacturer includes the excise duty paid on the goods in the cost of goods. When the consumer purchases such goods, indirectly he pays for the cost of goods as well as the excise duty paid.

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