What is Direct tax?
Direct tax can be defined as a type of tax in which the incidence and impact of the tax are levied on the same person. It can be further explained as a type of tax in which the liability of paying the tax cannot be shifted to someone else. It is directly paid to the government by the assessee and not to anyone else. Direct Taxes are charged on every source of income earned by any individual or business residing in the country. Income Tax, Wealth Tax, Estate Tax, Corporate Tax, and Capital Gain Tax are some examples of Direct Tax in India.
Direct taxation in India is imposed and regulated by the Central Board of Direct Taxes (CBDT). CBDT has all the authority to frame rules for the purpose of levying direct tax in the country. It also issues various circulars from time to time to clarify any specific problem or doubts.
History of Direct Taxation in India
The history of direct taxation in India can be traced back to ancient times. In ancient times, taxes were collected on land, produce, and imports. The Arthasastra, a treatise on statecraft written in 300 BC, outlined a sophisticated system of taxation. This system included income taxes, sales taxes, and customs duties. The fundamental philosophy of taxation was to provide for the needs of the state and the people, not to exploit the people.
The Mughal era saw the introduction of new taxes, such as the jizya (a tax on non-Muslims) and the land revenue. The British Raj introduced a more modern system of direct taxation, including the income tax, which was first introduced in February 1860 by Sir James Wilson.
After independence, the Indian government made a number of changes to the system of direct taxation. The most significant change was the introduction of the Hindu Undivided Family (HUF) system in 1956. The HUF system allowed families to be treated as a single tax unit, which reduced their tax burden.
In recent years, the Indian government has made a number of changes to the system of direct taxation in order to make it more efficient and equitable. These changes include the introduction of the Goods and Services Tax (GST) in 2017 and the reduction of the corporate tax rate in 2019.
Why are Direct Taxes Important?
Direct taxes play a Important role in India’s economy and hold significant importance for several reasons:
1. Revenue Generation: They are a stable and reliable source of government revenue, unlike indirect taxes which fluctuate with economic activity. This predictable income allows the government to plan and finance public services, infrastructure development, and social welfare programs effectively.
2. Promoting Equality: Direct taxes are typically progressive, meaning the tax rate increases as income rises. This helps reduce income inequality by ensuring higher earners contribute more to the public good. By analyzing direct tax data, the government can gain insights into income distribution and identify areas requiring additional investment. This helps allocate resources efficiently to address social and economic disparities.
3. Promoting Savings and Investment: The government can incentivize specific behaviors through direct taxes, such as offering deductions for saving or investing. This can help boost the national economy by promoting long-term financial planning and capital formation.
4. Controlling Inflation: When inflation rises, the government can increase direct tax rates to reduce disposable income and control excessive spending. This helps control inflation and maintain a stable economic environment.
5. Administrative Benefits: Direct taxes are generally easier to administer compared to indirect taxes, which involve multiple stages of collection. This reduces administrative costs and complexities.
6. Civic Responsibility: Paying direct taxes promotes a sense of civic responsibility among citizens. It encourages participation in the democratic process and contributes to nation-building.
Types of Direct Tax
1. Income Tax:
Income Tax is a direct tax that is levied on any individual’s or entity’s income. It is directly paid to the government like all the other direct taxes.
Income Tax is Calculated on?
The net taxable income is considered to calculate the tax liability of the individual or entity based on the income slabs provided by the Income-tax Department for the current financial year. The amount of tax paid depends on the money earned by the individual in that particular financial year. Income Tax for the financial year 2023-24 applies to all residents residing in the country whose annual income exceeds ₹2.5 lakh per year for old regime and ₹3 lakh per year for new regime Income Tax payment, TDS/TCS payment, and Non-TDS/TCS payments can be done to file income tax online.
Who Should Pay Income Tax?
Any individual whose gross total income is over Rs.2,50,000 in a financial year should compulsorily file Income Tax Return (ITR). For senior citizens, the limit is Rs.3,00,000 and for super senior citizens, it is Rs.5,00,000. These are required to pay taxes and file their income tax returns:
- Artificial Judicial Person
- Corporate Firms
- Association of Persons (AOPs)
- Hindu Undivided Families (HUFs)
- Local Authorities
- Body of Individuals (BOIs)
2. Wealth Tax:
The tax levied on the net wealth of super-rich individuals, companies, and Hindu Undivided Families is called Wealth Tax. It was introduced in the late 1950s, with the aim to reduce the inequality of wealth in the country. Wealth Tax was levied on all individuals and Hindu Undivided Families having net wealth above Rs. 30 Lakh. However, it was abolished in the budget 2015 by the government. Instead of Wealth Tax, the government increased the surcharge levied on the ‘super rich’ class by 2% to 12%. Any individual having an income of more than Rs. 1 Crore or higher and any company earning Rs. 10 Crore or higher are considered under the category of ‘super rich’. The market value of all the assets owned by the individual or any firm is considered to calculate wealth tax irrespective of whether they yield any returns or not.
3. Estate Tax:
The tax levied on the right to transfer the property owned by a deceased person on the day of death is called Estate Tax. It takes into consideration all the things that one possesses at the time of death. The properties that are included in calculating estate tax are cash and securities, real estate, insurance, trusts, annuities, business interests, and other assets.
4. Corporate Tax:
According to Income Tax Act, Corporations have to pay tax on the income earned by them. A corporation can be defined as an artificial person created under the jurisdiction of law having a distinct legal personality and its own signature referred to as the common seal. All companies either domestic or international are liable to pay tax on the income earned. Domestic companies have to pay coporate tax on their universal income and international companies working in India have to pay tax only on the income earned within India. Corporate Tax includes the following taxes:
- Securities Transactions Tax (STT): Any income earned through security transactions is taxable, and Securities Transactions Tax (STT) must be paid on it.
- Dividend Distribution Tax (DDT): DDT is levied on any domestic company who have declared, distributed, or paid any amount as dividends to shareholders. Foreign companies are exempted from this.
- Fringe Benefits Tax: It is levied on companies that provide fringe benefits for maids, drivers, etc.
- Minimum Alternate Tax (MAT): MAT is levied on companies having zero tax liability and whose accounts are prepared according to the Companies Act.
5. Capital Gain Tax:
Profit earned from the sale of capital assets is known as Capital Gain. Property, Plant and Equipment are all examples of capital assets. Gain on the sale of capital assets is categorised as an income, so they are liable for taxation. Capital Gain tax is levied on the capital gain. It is levied when such an asset is transferred from one owner to another.
Types of Capital Gain Tax:
- Short-term Capital Gain Tax: Short-term assets can be defined as an asset that is held for less than 36 months. For immovable properties, the duration is 24 months. Short-term capital gain tax is charged on profit generated from the sale of those short-term capital assets. The short-term capital gain is taxed at 20%.
- Long-term Capital Gain Tax: Long-term assets can be defined as an asset that is held for over 36 months. Long-term capital gain tax is charged on profit generated from the sale of those long-term capital assets. The long-term capital gain is taxed at 10%.
All capital gains are liable for taxation but the approach for long-term and short-term capital gain is different.
Who is Eligible to Pay Direct Tax in India?
Residents: Any individual who is considered a resident of India, regardless of their income source, is liable to pay direct tax on their income. This includes Indian citizens, foreign nationals who stay in India for 182 days or more in a financial year, and individuals with Indian work permits.
Non-Residents: Non-residents are only liable to pay direct tax on their income earned within India. This could include income from salary, business, property, or investments.
Types of Individuals:
1. Individuals below 60 years: They are eligible to pay direct tax if their income exceeds the basic exemption limit, which is currently ₹2.5 lakh per year for old regime and ₹3 lakh per year for new regime.
2. Senior Citizens (aged 60-80 years): They have a higher basic direct tax exemption limit of ₹3 lakh per year.
3. Super Senior Citizens (aged above 80 years): They have the highest basic exemption limit of ₹5 lakh per year.
All you need to know about Income tax in india.
1. Companies: All registered companies in India, regardless of their size or profitability, are liable to pay corporate tax on their net profit. A company is one of the most important and prominent forms of business organisation. It can be described as a voluntary association of individuals, having a common purpose, who agree to pool their funds and unite to achieve the said goals.
2. Limited Liability Partnerships (LLPs): LLPs are also subject to corporate tax on their net profit. LLP is a business structure that combines the limited liability benefits of a corporation with the flexibility of a partnership. Partners have limited personal liability for the debts and actions of the LLP. It is a cost-effective way to achieve economies of scale through cooperation. However, it’s important to analyze the legislation in your country and state before considering this business structure.
3. Hindu Undivided Families (HUFs): HUFs are treated as separate entities for tax purposes and are liable to pay direct tax on their income. According to Section 2(31) of the Income-Tax, 1961, a Hindu Undivided Family is recognised as a separate entity separate from the family members it consists of Hindu Undivided Family consists of members who are descendants of the same ancestors, including wives of the male members of the family and their unmarried daughters. HUF is not created under any law, but it is recognised under the act.
4. Associations of Persons (AOPs): These entities, such as clubs and societies, are also liable to pay direct tax on their income. An AOP is a legal entity formed by two or more entities with a common purpose of earning income, profits or gains. It may be registered or unregistered and is governed by the Income Tax Act, 1961. The taxability of an AOP depends on whether the shares of its members are determinable or not, and the tax rates are applied accordingly. BOI is similar to an AOP but comprises only individuals.
If you’re a startup in India, there are several direct tax benefits you can take advantage of to encourage entrepreneurship and support small businesses. Under the ‘Startup India’ program, the government provides Income Tax exemption. If you meet the definition as prescribed under G.S.R. notification 127 (E), you can apply for recognition under the program. As a recognized startup, you can get 100% tax exemption on your profit for 3 years in a block of 7 years. Additionally, angel investors who invest more than the company’s fair value are exempt from tax. The government has made several tax benefits available to startups over the last few years to boost the startup ecosystem.
Agriculturists: As per section 10(1), Income from agriculture is generally exempt from direct tax under certain conditions that are define under section 2(1A).
What is Direct Tax Code (DTC)?
The Direct Tax Code (DTC) is a proposed statute that aims to consolidate various direct tax laws into a single, comprehensive code in India. It is designed to replace the existing Income Tax Act, 1961, and other direct tax laws with a single, streamlined code. The main objectives of the DTC are to simplify the tax system and reduce complexity, broaden the tax base and improve tax compliance, and make the tax system more equitable and efficient. The first draft of the DTC was released in 2009, but it has not been implemented yet. Despite years of revisions and consultations, no final version has been presented to the Parliament, and the Income Tax Act, 1961, remains the primary legislation governing direct taxes in India.
The proposed DTC has several key features, subject to change. It combines various direct tax laws into one code, introduces new tax brackets and rates, simplifies deductions and exemptions for clarity, and encourages electronic filing and record-keeping. Another proposed change is the abolishment or revision of Minimum Alternate Tax (MAT).
The potential impact of DTC on individuals, businesses, and the economy is still debated and depends on the final version of the code. If implemented, some potential benefits include increased transparency and ease of compliance, improved tax administration and efficiency, and reduced tax disputes and litigation. However, concerns exist about potential drawbacks such as an increased tax burden on certain segments.
Advantages of Direct Tax
- Direct taxes provide a stable and dependable source of income for the government, unlike indirect taxes that fluctuate with economic activity. This allows for better planning and financing of public services, infrastructure development, and social welfare programs.
- Direct taxes are progressive, meaning the tax rate increases as income rises. This helps reduce income inequality by ensuring wealthier individuals contribute more to the public good.
- The government can incentivize desired behaviors through direct taxes. For instance, offering deductions for saving or investing can encourage long-term financial planning and capital formation, boosting the national economy.
- When inflation rises, the government can increase direct tax rates to reduce disposable income and curb excessive spending, contributing to controlling inflation and maintaining economic stability.
- Analyzing direct tax data provides insights into income distribution and identifies areas requiring investment, enabling efficient resource allocation to address social and economic disparities.
- Compared to indirect taxes with multiple collection stages, direct taxes are generally easier and less expensive to administer.
- Paying direct taxes promotes a sense of civic responsibility among citizens, encouraging participation in the democratic process and contributing to nation-building.
Disadvantages of Direct Tax
- High direct tax rates can discourage investment and entrepreneurship, potentially hindering economic growth. It is important to find a balance between generating revenue and not burdening taxpayers too much.
- Complex tax laws and procedures can create a significant compliance burden for taxpayers, especially small businesses and individuals with limited resources.
- The potential for tax evasion exists, leading to revenue loss for the government and undermining the fairness of the system. Continuous improvement in tax administration and enforcement is essential.
- High direct tax rates on capital gains can discourage risk-taking and innovation, potentially impacting economic growth.
- High direct tax rates can also encourage individuals and businesses to operate in the black market, further reducing revenue and undermining the Indian economy.
Difference Between Direct Tax & Indirect Tax
These are those taxes whose final burden falls on the person who makes the payment to the government.
These are those taxes that are paid to the government by one person, but their burden is borne by another person.
Incidence and Impact of Tax
When the incidence and impact of the tax lie on the same person, it is called direct tax.
When the incidence and impact of the tax lie on a different person, it is called an indirect tax.
Shift of Taxation
The impact of direct taxation can not be shifted.
The impact of indirect taxation can be shifted.
These are generally progressive in nature.
These are generally regressive in nature.
Effect on the Market Price
These taxes do not affect the market price of the product.
These taxes have a direct and positive effect on the market price of the product.
Income Tax, Wealth Tax, Corporation Tax, Capital Gain Tax, etc.
Goods and Services Tax (GST).
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