What is Direct Tax?
A direct tax is imposed depending on a taxpayer’s income, meaning the higher the income, the higher the tax rate applicable3. A common example is income tax slab rates. The rules for direct taxes are designed to distribute money in the country by collecting taxes from people depending on their paying capacity. Hence, direct taxes are an important source of revenue for the government, which is utilised to fund many public welfare services and goods. This explains the direct tax meaning in simple terms.
Types of Direct Taxes:
When understanding what is direct tax, it’s important to note that the government imposes different types of direct taxes on individuals and entities. Some of the common types of direct taxes are listed below for better clarity.
1. Income Tax
As the name suggests, it is the tax applicable to a taxpayer's income. Any individual with income above the basic exemption limit must pay tax as per the applicable tax rate during a financial year. Tax rates are applicable depending on the income bracket of the taxpayer. The government decides these rates and income brackets. Failure to pay income tax results in penalties or even imprisonment. In case of entity/business, this tax is further categorised as:
2. Corporate Tax
This is a direct tax levied on the profits earned by a corporate body. In India, for the purpose of taxation, companies are categorised as domestic and foreign. The corporate tax rates are applied based on a slab rate system which depends on the type of corporate body and the revenue earned by the corporate body.
Capital Gain Tax
This tax is levied on the gain arising from the transfer of capital assets. The capital asset can be property, shares, bonds, ULIPs or any valuable material. Income from capital gains can be termed STCG, i.e. short-term capital gain and LTCG, i.e. long-term capital gain.
Securities Transaction Tax
This tax is levied on transactions of securities listed on stock exchanges in India, such as stocks, bonds and mutual funds. The tax rate depends on the type of security traded and the nature of the transaction, whether sale or purchase.
4. Gift Tax
Gift Tax in India refers to the tax levied on monetary gifts or property received without adequate consideration. While the Gift Tax Act, 1958, was repealed, such gifts are now taxed under the Income Tax Act if they exceed prescribed exemptions or limits.
5. Wealth Tax
Wealth Tax was a direct tax imposed in India on the net wealth of individuals, Hindu Undivided Families (HUFs), and companies. Abolished in 2016, it applied to assets like real estate, jewellery, and luxury cars exceeding specified exemption limits.
Who is Eligible to Pay Direct Tax?
Direct tax is payable by individuals who earn income during the financial year and whose taxable income is more than the threshold limit. The threshold limit under the old tax regime is Rs. 2.5 lakhs while under the new regime is Rs. 3 lakhs. The eligible entities who have to pay direct tax include the following –
| Type of Eligible Entity | Who They Are |
|---|
| Individuals | Residents, non-residents, and persons of Indian origin who earn income above the threshold |
| Hindu Undivided Families (HUFs) | HUF is treated as a separate tax entity, required to pay direct tax on its income |
| Partnership Firms & LLPs | Profits earned by the firm / LLP are taxed as per the income rules |
| Association of Persons (AOP) / Body of Individuals (BOI) | Groups of individuals or corporations with a common objective are taxed separately |
| Companies | Domestic & foreign companies earning taxable profits in India |
Difference between Direct Tax & Indirect Tax
| Parameter | Direct tax | Indirect tax |
|---|
| Mode of Payment | Direct tax is paid by the taxpayer directly to the income tax department. | Indirect tax is paid by the taxpayer to an intermediary who, then, deposits the tax to the relevant authorities. The tax is, thus, paid indirectly |
| Incidence / Transferability | The incidence of taxation is on the taxpayer himself. The tax cannot be transferred to another. | Indirect tax is transferred from one taxpayer to another. |
| Basis of Taxation | Direct tax is imposed on the income earned by an individual | Indirect tax is imposed on goods and services produced |
| Who Pays | Individuals, Hindu Undivided Families, businesses, trusts, Associations of Persons, Bodies of Individuals, etc. | Indirect tax is paid by the end-users of goods and services |
| Rate of Tax | The rate of tax depends on the income level | The rate of tax is the same for everyone |
| Nature of Taxation | Progressive form of taxation | Regressive form of taxation |
| Examples | Income tax, securities transaction tax (STT) | Goods and Services Tax (GST) |
Benefits of Direct Tax
1. Progressive form of taxation
Direct tax is a progressive form of taxation which promotes equality among individuals.
2. Source of government revenue
Direct tax forms a considerable source of revenue for the government.
3. Certainty for taxpayers
Direct tax is certain and helps taxpayers plan their taxes in advance.
4. Elasticity of tax rates
The tax rates are elastic and can be changed depending on the economic needs of the country.
5. Contribution to national development
By paying direct tax, you, as a taxpayer, can contribute to the development of the country.
Why are Direct Taxes Important?
Direct taxes are important as they are beneficial for nation-building.
- These taxes can maintain an economic and social balance because the taxes are applied according to a taxpayer's income.
- Taxes also help restrain rising inflation by reducing demand for goods and services.
- With an increasing workforce, the inflow of direct taxes also increases, thus generating more revenue for the government.
- These taxes enforce the equal distribution of wealth because people with high resources are required to make high contributions which are utilised to uplift the underprivileged sections of society.
- These taxes also enforce transparency as they are directly paid by the taxpayer to the government and thus play an essential role in the economy.
How Do I Pay Direct Taxes in India?
In India, paying direct taxes has become simple through digital and offline modes. Taxpayers can choose based on their convenience. Here are the main ways:
- Online through Income Tax e-Filing portal: Log in, generate a challan, and pay via net banking, debit card, or UPI.
- Authorised banks: Pay directly at designated bank branches using challans.
- Advance tax / Self-assessment tax: Pay before or while filing returns if liability exists.
- TDS/TCS credits: Employers or institutions deduct tax at source and deposit it on your behalf.
LTCG and its Impact on ULIPs
LTCG (Long Term Capital Gain Tax) is the tax charged on the profit earned from the sale of an asset that was held for longer than 2 years. Now let us understand how LTCG applies to a Unit Linked Insurance Policy (ULIP) with a lock-in period of 5 years. According to Budget 2021, a high-value ULIP, with aggregate annual premium of more than ₹ 2.5 lakhs, will be taxed as capital gain if purchased on or after February 1, 20215. A long-term capital gains tax is levied at applicable rate on the maturity/surrender/withdrawal value depending on investment in equity oriented or debt oriented ULIPs. However, ULIPs purchased before this date is tax-free subject to satisfaction of conditions as mentioned in Section 10 (10D) of Income Tax Act 1961. The only exception to this case is the death proceeds received by the nominee which will enjoy ULIP tax benefits.
Key Takeaways
- Understanding what is direct tax helps taxpayers know how income and profits are taxed directly without transfer.
- Direct taxes are progressive in nature, ensuring higher earners contribute more.
- They form a major source of government revenue for welfare and development.
- Eligible taxpayers include individuals, HUFs, companies, trusts, and other entities.
- Common types of direct taxes include Income Tax, Corporate Tax, Capital Gains Tax, and Securities Transaction Tax (STT).
Conclusion
It's important to note that tax laws and policies in India are subject to periodic changes, and staying updated is crucial for every taxpayer. Understanding the direct tax meaning helps individuals and businesses know how income and profits are taxed directly by the government . Consulting a tax professional is always advisable to plan better. Moreover, being aware of the different types of direct taxes, such as Income Tax, Corporate Tax, and Capital Gains Tax, ensures smarter financial decisions.
FAQs
1. What is a direct tax in India?
Direct tax is a form of tax which is levied on the income earned by taxpaying entities. It is levied on the taxpayer and paid by the same taxpayer.
2. Is GST a direct tax?
GST is an indirect tax. It is levied on the supply of goods and services but is ultimately paid by the end-user of such goods and services.
3. What are some of the investments that I can make to save on Income Tax?
Some of the investments which help you allow savings on income tax under old Tax regime are as follows –
- Life insurance policies
- Equity Linked Savings Schemes of mutual funds
- Public Provident Fund
- National Savings Certificate
- Sukanya Smariddhi Yojana
- Senior Citizens Savings Schemes
- 5-year fixed deposits with banks and post offices
- Home loans, etc.
4. What is TDS?
TDS stands for Tax Deducted at Source. It is a tax which is deducted from your income at a specified rate before the income is credited to you. TDS helps you take care of your tax liability. If, however, you have paid an excess TDS on your income, you can claim a refund by filing your income tax returns.
5. What is the disadvantage of Direct taxes?
Direct taxes eat into taxpayers’ income and reduces their disposable income. As such, it is not very popular.
6. What Are Examples of Direct Taxes?
Examples of direct taxes include income tax, real property tax, personal property tax, taxes on assets, corporate tax, capital gains tax, and gift tax. These are levied directly on individuals or legal entities.
7. Are direct taxes progressive in nature?
Yes, direct taxes are typically progressive, meaning the rate increases as income increases. Higher-income individuals pay a larger share than lower-income earners under such a system.
8. Can I save on direct taxes legally?
Yes, you can legally reduce direct tax liability by using deductions, exemptions, investment in tax-saving instruments under law (like in India: 80C, housing loan interest, etc.), and proper tax planning.
9. What happens if I fail to pay direct taxes on time?
If direct taxes are not paid on time, penalties, interest on unpaid amounts, legal repercussions, and possible notice or assessment by the tax authorities may follow, depending on jurisdiction.
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