Difference Between Direct Tax And Indirect Tax: Lots or people usually confuse direct tax and indirect tax, this is not supposed to be so as they are two different kinds of tax. For clarity’s sake, we will be discussing these two kinds of taxes, their meaning, types and differences in this article.
Before going into the differences between direct tax and indirect tax, first of all we need to understand what those two mean (direct tax and indirect tax).
Direct tax is a tax paid by a tax payer which in no way is transferable. It is a non-transferable tax paid by a tax payer to the government. It can also be defined as the kind of tax where the burden and the liability to pay such solely resides on the individual.
Direct tax can be collected by the state government or the federal government as the case may be, also depending on the kind of tax that was levied. Indirect tax on the other hand is the kind of tax that can be transferred, the liabilities can be transferred to others. Income tax is a direct tax while a Value Added Tax (VAT) is an indirect tax.
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Types Of Direct Tax And Indirect Tax
The main types of direct taxes are:
1.Income Tax: This is the kind of tax that is imposed on a person and paid by the same person, it is being imposed according to the tax brackets as defined by the income tax department.
2. Corporate Tax: Corporate taxes are paid by corporations and companies from their profits.
3. Wealth Tax: This is paid when a person holds a property, a tax is imposed on the values of such properties.
4. Gift Taxes: This is paid when someone receives a taxable gift, the person is obligated to pay tax on the gift to the government.
6. Estate Duties: This is paid when a person inherits a property, he or she is obligated to pay an estate duty on the property.
7. Fringe Benefit Tax: This kind of tax is paid by the employer who provides fringe benefits for his or her employees and they are collected only by the state government.
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Types Of Indirect Tax
As we already know, indirect taxes are the kind of tax where the liability to pay such tax is shifted by the person whom the liability lies upon to another(s), who is the final consumer of the goods. Some of the types of indirect tax include:
1. Excise Duty: This is the kind of tax imposed by the government on the manufacture of a good which instead of paying them shifts the burden to the retailers and wholesalers, who in turn shifts them to the final consumers.
2. Sales Tax: Sales tax is paid by retailers and shopkeepers, and they in turn shift the burden of payment to the customers by charging them sales tax on goods and services.
3. Custom Duty: When goods are imported into a country, there are taxes which are being levied on them, in turn these taxes are being paid for by the retailers and the consumers.
4. Entertainment Tax: Owning a cinema comes with a liability of its own, however, when taxes are levied on cinemas, the liability lies on the cinema owners who then transfer the burden of payments to their customers the cinemagoers. They pay for it when paying for the cinema tickets.
5. Service Tax: Service tax as the name implies is the kind of tax which is being charged on the customers who services were rendered for, such service can be a food bill in a restaurant.
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Differences Between Direct Tax And Indirect Tax
The major difference between direct tax and indirect tax is that in indirect tax, the tax payer could shift his tax burden to others, while in direct tax, they cannot be transferred to anyone.
Direct tax is always imposed on an individual, family, company, firm, corporation, and so on while indirect tax on the other hand is always paid for before, during or after the consumption of goods and services. This can be paid by anyone and necessarily not the consumer of the goods, nor services.
It is very easy to record tax evasion in direct taxes, this is because of the lack of administration in the collection of administrative taxes, however, when it gets to indirect taxes, an evasion is very unlikely this is because the taxes are charged in the goods and services. To use any good or service, you must pay the tax.
Talk about inflation in a country, direct taxes help in reducing inflation while indirect tax increases inflation in the country.
Direct taxes are used to help reduce inequalities and is considered to be progressive, this is because it gets to deal with the individual directly while indirect taxes do increase inequalities, and it is considered to be regressive, this is because another could dumb their taxes one other and go free unaccountable.
Direct taxes has a better allocative effect than its counterpart (indirect Taxes), this is a result of the fact that direct taxes put less burdens on the collection of the amount than indirect taxes.
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Where the collections are scattered among parties or individuals, and the consumer’s choice of goods is changed from the price variations because of the indirect taxes on it.
a. Administrative costs: There are many exemptions involved in direct taxes and also high administrative costs which come from it whereas indirect taxes do not require high administrative costs because of the convenient and stable collections. Also as a bonus, indirect taxes do not come under an administration, it is just plain old goods and services.
Taxes can be used to reduce or regulate the consumption of goods and services, this is the work of an indirect tax. Indirect taxes imposed on harmful products and commodities such as alcohol, cigarettes and rest can discourage people from buying and reduce over-consumption, therefore helping the country with its social context. On the other hand, direct taxes cannot affect these changes.
b. Growth: When it has to do with the growth of the economy, and growth of the people as well, indirect taxes are more oriented towards achieving this growth and they strongly discourage the consumption of goods and services and therefore enhance individual saving, thereby helping the country at large.
Whereas direct taxes on the other hand, discourages and reduces individual or corporate savings and also discourages investment, thereby leading to poor growth of the tax payers (individuals, companies, HUF, corporations, and the rest).
c. wide coverage: When an indirect tax is effected, it touches every consumer of goods and services, however, when a direct tax is in effect, it only focuses on specific individuals. In other words, indirect taxes have a wider coverage of reaching people as every member of the society makes use of goods and services and these goods and services are taxed by the government. Whereas direct taxes are only focused on people in a respective tax brackets.
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In conclusion, taxes are a way to earn revenue for the government, so it is important that these taxes are paid. However it is not enough that just companies, establishments, businesses, corporations and the rest are made to pay as this may generate a little turn out considering other factors, hence the indirect tax where everyone is meant to pay.
It does not matter whether you know this or not but so long as you are consuming goods or receiving services, you are paying tax indirectly.
Edeh Samuel Chukwuemeka ACMC, is a Law Student and a Certified Mediator/Conciliator in Nigeria. He is also a Developer with knowledge in HTML, CSS, JS, PHP and React Native. Samuel is bent on changing the legal profession by building Web and Mobile Apps that will make legal research a lot easier.