1. INDIRECT TAX
An indirect tax is collected by one entity in the supply chain (usually a producer or retailer)
and paid to the government, but it is passed on to the consumer as part of the purchase price
of a good or service. The consumer is ultimately paying the tax by paying more for the
product.
Understanding Indirect Tax
Indirect taxes are defined by contrasting them with direct taxes. Indirect taxes can be defined
as taxation on an individual or entity, which is ultimately paid for by another person. The
body that collects the tax will then remit it to the government. But in the case of direct taxes,
the person immediately paying the tax is the person that the government is seeking to tax.
Excise duties on fuel, liquor, and cigarette taxes are all considered examples of indirect taxes.
By contrast, income tax is the clearest example of a direct tax, since the person earning the
income is the one immediately paying the tax. Admission fees to a national park is another
clear example of direct taxation.
Some indirect taxes are also referred to as consumption taxes, such as a value-added tax
(VAT).
Examples of Indirect Taxes
The most common example of an indirect tax is import duties. The duty is paid by the
importer of a good at the time it enters the country. If the importer goes on to resell the good
to a consumer, the cost of the duty, in effect, is hidden in the price that the consumer pays.
The consumer is likely to be unaware of this, but he will nonetheless be indirectly paying the
import duty.
Essentially, any taxes or fees imposed by the government at the manufacturing or production
level is an indirect tax. In recent years, many countries have imposed fees on carbon
emissions to manufacturers. These are indirect taxes since their costs are passed along to
consumers.
Sales taxes can be direct or indirect. If they are imposed only on the final supply to a
consumer, they are direct. If they are imposed as value-added taxes along the production
process, then they are indirect.
2. Regressive Nature of Indirect Taxes
Indirect taxes are commonly used and imposed by the government in order to generate
revenue. They are essentially fees that are levied equally upon taxpayers, no matter their
income, so rich or poor, everyone has to pay them. But many consider them to be regressive
taxes as they can bear a heavy burden on people with lower incomes who end up paying the
same amount of tax as those who make a higher income.3 For example, the import duty on a
television from Japan will be the same amount, no matter the income of the consumer
purchasing the television. And because this levy has nothing to do with a person's income,
that means someone who earns $25,000 a year will have to pay the same duty on the same
television as someone who earns $150,000 — clearly, a bigger burden on the former.
There are also concerns that indirect taxes can be used to further a particular government
policy by taxing certain industries and not others. For this reason, some economists argue that
indirect taxes lead to an inefficient marketplace and alter market prices from their equilibrium
price.
Features of Indirect Taxes
1. Taxable Event: The indirect taxes are levied on purchase/sale/manufacture of
goods and provision of services.
2. Incidence & Impact: In case of indirect taxes, the incidence and impact fall on two
different persons. It means the tax burden is shifted by the supplier to the buyer or
recipient of goods or services.
3. Regressive Taxation: The indirect taxes do not depend on paying capacity as tax
payable on commodity is same whether it is purchased by a poor man or rich person.
Therefore, indirect taxes are regressive in nature. There are exceptions to this
argument as higher taxes may be imposed on luxury goods.
4. Impact of Indirect Tax: The indirect tax on goods and services increases its price.
This leads to inflationary trend.
3. 5. Promotes Welfare: The harmful or sin products like alcohol, tobacco, etc. may be
taxed at higher rate. This practice not only discourages consumption of such goods but
also increases the revenue of the State.
6. Major Source of Revenue: In India, the contribution of indirect taxes to total tax
revenue is more than 50%. Therefore, it is a major source of tax revenue for the
Government.
Taxation Powers of union & State Government
In India, the constitution is Supreme and all laws and actions of the
Government are sub-ordinate to it. The constitution provides that no tax shall be
levied or collected except by authority of law.
The Structure of Government in India is federal in nature. As per article 1(1) of
constitution, India shall be union of States. There is a bifurcation of powers between
union and states. Government of India (Central Government) has certain powers in
respect of whole country. Each state (and union territory) has certain powers in respect
of that particular state (Union territory).
Indian constitution
India has a three-tier federal structure, comprising the following:-
(a) The Union Government
(b) The State Government
(c) The Local Government
The power to levy taxes and duties is distributed among the three tiers of
Government, in accordance with the provisions of Indian Constitution. The
constitution consists of a preamble, 25 parts containing 448 articles and 12 Schedules.
Provisions of constitution regarding taxation
The power to levy and collect taxes emerges from the constitution of India. The
following are the significant provisions of the constitution regarding taxation:
4. 1. Article 265: It states that no tax shall be levied or collected except by authority of
law. In fact, it prohibits arbitrary collection of tax.
2. Article 246: The authority to enact law and levy taxes and duties is given by
constitution vide Article 246. The Parliament may make laws for the whole of India or
any part of the territory of India, the State legislature may make laws for whole or part
of the State.
3. Seventh Schedule (to Article 246): The Seventh Schedule contains three lists which
enumerate the matters under which the union and the State Governments have the
authority to make laws.
(a) List I (Union List): The Central Government has the exclusive right to make laws
in respect of any matter covered in this list. Parliament makes law in this regard. Some
of the items in List I are defense of India, naval, military and air forces, atomic energy
and mineral resources, central bureau of intelligence and investigation, railways,
highways, currency, RBI, post office saving bank, taxes on income other than
agricultural income, duties of customs, corporation tax, etc.
(b) List II (State List): It contains the matters in respect of which the State
Government has the exclusive right to make laws. These matters include public order,
police, local government, public health and sanitation, hospital, burials and burial
grounds, cremation ground, libraries, water, fisheries, betting and gambling, etc.
(c) List III (Concurrent List): It contains the matters in respect of which both Central
& State Governments have powers to make laws. This list includes criminal laws,
criminal procedure, marriage and divorce, contracts including partnership, agency,
bankruptcy and insolvency, trust and trustees, trade unions, industrial and labour
disputes, etc.
Difference between Direct Taxes and Indirect Taxes:
Direct Taxes Indirect Taxes
Payer of tax and sufferer of tax one and
same (i.e. impact and incidence on the same
Payer of tax not sufferer of tax whereas
sufferer of tax is not paying directly to the
5. person) Government (i.e. impact on one head and
incidence on other head)
Income based taxes Supply based taxes
Rate of taxes are different from person to
person
Rate of duties are not differ from person to
person
Entire revenue goes to Central Government
of India
Revenue source to Central Government of
India as well as State Governments (i.e.
CGST and SGST)
Previous year income assessed in the
assessment year
There is no previous year and assessment
year concept
Central Board of Direct Taxes (CBDT) is an
important part of Department of Revenue.
Central Board of Excise and Customs
(CBEC) is an important part of Department
of Revenue.
The Central Board of Excise & Customs is
being renamed as the Central Board of
Indirect Taxes & Customs (CBIC), after
getting legislative approval.
Progressive nature. Regressive nature.
Advantages/Merits of Indirect Taxes
1. Convenient: Indirect taxes are imposed on production, sale and movements of
goods and services. These are imposed on manufacturers, sellers and traders, but their
burden may be shifted to consumers of goods and services who are the final taxpayers.
Such taxes, in the form of higher prices, are paid only on purchase of a commodity or
the enjoyment of a service. So taxpayers do not feel the burden of these taxes.
Besides, money burden of indirect taxes is not completely felt since the tax amount is
actually hidden in the price of the commodity bought. They are also convenient
because generally they are paid in small amounts and at intervals and are not in one
lump sum. They are convenient from the point of view of the government also, since
the tax amount is collected generally as a lump sum from manufacturers or traders.
6. 2. Difficult to Evade: Indirect taxes have in-built safeguards against tax evasion. The
indirect taxes are paid by customers, and the sellers have to collect it and remit it to
the Government. In the case of many products, the selling price is inclusive of indirect
taxes. Therefore, the customer has no option to evade the indirect taxes.
3. Wide Coverage: Unlike direct taxes, the indirect taxes have a wide coverage.
Majority of the products or services are subject to indirect taxes. The consumers or
users of such products and services have to pay them.
4. Elastic: Some of the indirect taxes are elastic in nature. When government feels it
necessary to increase its revenues, it increases these taxes. In times of prosperity
indirect taxes produce huge revenues to the government.
5. Universality: Indirect taxes are paid by all classes of people and so they are broad
based. Poor people may be out of the net of the income tax, but they pay indirect taxes
while buying goods.
6. Influence on Pattern of Production: By imposing taxes on certain commodities or
sectors, the government can achieve better allocation of resources. For example by
imposing taxes on luxury goods and making them more expensive, government can
divert resources from these sectors to sector producing necessary goods.
7. May not affect motivation to work and save: The indirect taxes may not affect
the motivation to work and to save. Since, most of the indirect taxes are not
progressive in nature, individuals may not mind to pay them. In other words, indirect
taxes are generally regressive in nature. Therefore, individuals would not be
demotivated to work and to save, which may increase investment.
8. Social Welfare: The indirect taxes promote social welfare. The amount collected
by way of taxes is utilized by the government for social welfare activities, including
education, health and family welfare. Secondly, very high taxes are imposed on the
consumption of harmful products such as alcoholic products, tobacco products, and
such other products. So it is not only to check their consumption but also enables the
state to collect substantial revenue in this manner.
7. 9. Flexibility and Buoyancy: The indirect taxes are more flexible and buoyant.
Flexibility is the ability of the tax system to generate proportionately higher tax
revenue with a change in tax base, and buoyancy is a wider concept, as it involves the
ability of the tax system to generate proportionately higher tax revenue with a change
in tax base, as well as tax rates.
Disadvantages/Demerits of Indirect Taxes
1. High Cost of Collection: Indirect tax fails to satisfy the principle of economy. The
government has to set up elaborate machinery to administer indirect taxes. Therefore,
cost of tax collection per unit of revenue raised is generally higher in the case of most
of the indirect taxes.
2. Increase income inequalities: Generally, the indirect taxes are regressive in nature.
The rich and the poor have to pay the same rate of indirect taxes on certain
commodities of mass consumption. This may further increase income disparities
among the rich and the poor.
3. Affects Consumption: Indirect taxes affect consumption of certain products. For
instance, a high rate of duty on certain products such as consumer durables may
restrict the use of such products. Consumers belonging to the middle class group may
delay their purchases, or they may not buy at all. The reduction in consumption affects
the investment and production activities, which in turn hampers economic growth.
4. Lack of Social Consciousness: Indirect taxes do not create any social
consciousness as the taxpayers do not feel the burden of the taxes they pay.
5. Uncertainty: Indirect taxes are often rather uncertain. Taxes on commodities with
elastic demand are particularly uncertain, since quantity demanded will greatly affect
as prices go up due to the imposition of tax. In fact a higher rate of tax on a particular
commodity may not bring in more revenue.
6. Inflationary: The indirect taxes are inflationary in nature. The tax charged on
goods and services increase their prices. Therefore, to reduce inflationary pressure, the
government may reduce the tax rates, especially, on essential items.
8. 7. Possibility of Tax Evasion: There is a possibility of evasion of indirect taxes as
some customers may not pay indirect taxes with the support of sellers.
