Direct Taxes and Indirect Taxes

What is Direct tax?

It is the tax where the liability as well as the burden to pay it resides on the
same individual. Direct taxes are non-transferable taxes paid by the tax payer
to the government.
Example:
Income Tax: Levied on and paid by the same person according to tax brackets
as defined by the income tax department.
Corporate Tax: Paid by companies and corporations on their profits.
What is Indirect tax?
Indirect taxes are transferable taxes where the liability to pay can be shifted to
others.
GST is an indirect tax.
Customs Duty: Import duties levied on goods from outside the country,
ultimately paid for by consumers and retailers.
Indirect taxes are charged on GOODS AND SERVICES, while direct taxes are
charged on PROFITS AND INCOME.
Difference between Direct & Indirect tax?
Direct tax can help in reducing inflation, whereas indirect tax may enhance
inflation.
Direct taxes help in reducing inequalities and are considered to be progressive
while indirect taxes enhance inequalities and are considered to be regressive.
Indirect taxes involve LESSER ADMINISTRATIVE COSTS due to convenient and
stable collections, while direct taxes have many exemptions and involve higher
ADMINISTRATIVE COSTS.
Indirect taxes are oriented more TOWARDS GROWTH as they discourage
consumption and help enhance savings. Direct taxes, on the other hand,
REDUCE SAVINGS and DISCOURAGE INVESTMENTS.
Indirect taxes have a wider coverage as all members of the society are taxed
through the sale of goods and services, while direct taxes are collected only

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from people in respective tax brackets. Also, additional indirect taxes levied on
harmful commodities such as cigarettes, alcohol etc. dissuades over-
consumption, thereby helping the country in a SOCIAL CONTEXT.
THE GOVERNMENT NEEDS TO NEEDS TO KNOW WHAT IS ITS
OBJECTIVE/PURPOSE WITH REGARD TO TAXATION – DIRECT & INDIRECT.
Why Tax Income?
Importance of Income Tax flows from the fact that Income tax is the prime
source of fund to the government. It helps in removing inequalities of income
levels among people. Further, It helps in ERADICATION OF POVERTY, as the
government spends the amount collected through Income tax, FOR WELFARE
OF POOR PEOPLE.
Economics of Tax
Tax rates may be progressive, regressive, or flat. A progressive tax taxes
differentially based on how much has been earned. A tax system may use
different taxation methods for different types of income. The idea of a
progressive income tax has garnered support from economists of many
different ideologies from Adam Smith in the Wealth of Nations to Karl Marx.
Canons of Good Tax System
Canon - a general law, rule, principle, or criterion by which something is
judged. The characteristics or qualities of good tax system have been described
as canons of taxation. Taxes should be collected by the Government
like plucking flower without affecting the whole flowering plant.
Canon of Equality and Equity Taxation must ensure justice and the burden of
tax must be distributed equally based on the ability of tax payer.
Horizontal Equity: Individuals who are the same in all relevant aspects should
be treated equally.
Vertical Equity: Individuals who are better able to pay higher taxes should bear
a higher share of total taxes.
Canon of Certainty Tax payable by person should be certain and not arbitrary-
Presumptive taxation not permissible.
Promissory Estoppel: When one party had made a promise or assurance and
another person has acted to his prejudice on the faith of the same, the Person

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making the promise or assurance becomes bound thereby, due to the
application of the law of Estoppel.
e.g. Pournami Oils Mills case Vs State of Kerala and Sri Jagannath Roller Flour
Mills Vs State of Orrissa (Sales tax and octroi exemption cases)
In the above cases the Government(s) went back on the promise or assurance
of tax exemption and Court(s) held that it was improper.
Canon of Economy Complex and ever changing nature of tax law in India
require highly trained personnel involving high administrative cost and
inordinate delay in assessment and collection of taxes.
Canon of Economics : Which is a better Taxation – Direct or Indirect.
As per OECD average for direct tax collection in 2018 (close to India’s FY19)
was 67.3% of the total tax collection, while for India, it was 38.3% (for FY19).
Developed nations collect most tax revenues from direct tax. However, In India
indirect tax, like the GST, plays a dominant role in total tax revenue. The long-
term trend shows the annual average of direct tax revenue was 6.6% of the
GDP during the past decade of FY12-FY21. While during same period, the
annual average of indirect tax was far higher at 10.6% of the GDP.
Even for FY23 India's direct tax collection was at Rs.14.71 Lakh Crore till 10
January, 2023. While GST collection rises 11% to over ₹1.65-lakh crore in July,
2023.
Gross Goods and Services Tax (GST) revenue collected last month was
₹1,65,105 crore of which CGST was ₹29,773 crore, SGST ₹37,623 crore, IGST
₹85,930 crore (including ₹41,239 crore collected on import of goods) and cess
was ₹11,779 crore (including ₹840 crore collected on import of goods).
Revenues for the month were 11 per cent higher than the GST revenues in the
same month last year, the finance ministry said in a statement. During the
month, revenues from domestic transactions (including import of services)
were 15 per cent higher than revenues from these sources during the same
month last year. It is for the fifth time, gross GST collection has crossed ₹1.60
lakh crore mark, the ministry added. In June, GST collection was ₹1,61,497
crore.

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It can be observed from the above data that Personal Income Tax is much
higher than Corporate Income Tax.
It needs to be pondered over as to whether this situation needs to be revisited.
Generally, taxation should be based on ability to pay and it not clear whether
Personal Income Tax payers have a better ability to pay than Corporate tax
payers.
Canon of Economics
Further, high indirect tax collection is regressive because indirect tax does not
distinguish between the rich and poor (capacity to pay) as everyone pays the
same tax rates. On the contrary, direct tax is on the income levels/profits and
is thus based on the ability-to-pay principle of taxation. When direct taxes fall,
tax burden shifts to the poor.
FY21 will not only be remembered for historic high corporate profits but also
for falling behind income tax from non-corporate entities for the first time in
the 2011-12 GDP series.
The Budget documents show, in FY21 (RE), corporate tax collection fell to ₹4.5
lakh crore (23.5% of the gross tax revenue), while that of ‘tax on income other
than corporate tax’ went up to ₹4.6 lakh crore (24.2% of the gross tax
revenue).
This is problematic because it has pulled down the total tax revenue the
Government needs for higher fiscal spending. BESIDES, LOWER CORPORATE
TAX IS REGRESSIVE. Corporate entities are financially bigger entities with
more capacity to pay, while tax on income other than corporate tax is paid by

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relatively lesser mortals, like individuals (salaried or self-employed),
partnership firms, trusts etc.
Tax burden shifts to poor
Why high oil tax is a burden on the poor?
The poor not only use more petrol and diesel, they are also burdened with
inflation that high oil prices bring. This was revealed by a study conducted by
the PPAC (through Nielsen). The study showed (a) 99.6% of petrol is used by
the transport sector, of which 61.4% petrol is consumed by two-wheelers and
2.3% by three-wheelers, as against 34.3% by cars (B) 13% DIESEL IS CONSUMED
BY AGRICULTURE and (c) 70% of diesel is consumed by the transport sector.
While the first is a direct burden on the poor, the second (agriculture) and
third (transport sector) add to their cost of food and other essential items
(transported) and travel (by bus and train). To sum up, low corporate tax and
low direct tax means the tax burden shifts to the poor as the government
needs more resources for its fiscal spending. The pandemic has
disproportionately hurt the poor by way of higher loss of lives, jobs and
businesses and the impact is visible in low consumption demand in the
economy. Therefore, it makes immense economic sense to reverse the
regressive taxation regime in India, apart from other measures to tackle the
systemic slowdown.
Canon of Convenience
Tax should be collected in convenient manner.
Canon of Elasticity
Taxation should be elastic, more revenue is automatically fetched when
income of person rises, ie, it should have built-in flexibility.
Canon of Productivity
Tax must yield sufficient revenue collection & should not adversely affect
economic production.
Canon of Simplicity
Tax law should be simple & should not go beyond the understanding of
layman. This is lacking in Indian Income-Tax law.

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Bread vs Rusk
Two High Courts have conflicting views on whether rusk is actually bread; it is
now up to the SC to decide - Is it bread or biscuit, bread-sans-moisture or
simply rusk? The Himachal Pradesh High Court took 12 years to conclude that
rusk is actually bread-sans-moisture and as such, exempt from Value Added
Tax (VAT).
In Meghalaya, the High Court had earlier decided that rusk was different from
bread. Hence, there would be no exemption from VAT.
The distinctions are significant because VAT has been subsumed in Goods &
Services Tax (GST) and continues to be relevant in the present taxation regime.
Considering contrary rulings by different High Courts, the issue is expected to
be finally settled by the Supreme Court.
Meghalaya High Court
Bread vs Rusk
Meghalaya High Court, in a ruling in March this year, was emphatic that rusk
was not bread and as a value-added-product would not get exemption from
VAT. “The answer is obvious: bread is bread and rusk is rusk and never may the
twain (two) be equated,” the bench said, upholding the appellate judgment
about no exemption.
Applying the common parlance test, the court questioned whether a person
desirous of buying bread would ask for rusk at a shop.
Himachal Pradesh High Court
Himachal HC, however, has a different view.
Dictionary meaning -“As per the dictionary meaning of rusk, it would be
established that it is nothing but virtually a slice of bread dried and cooked
again in the oven,” a division bench of the court said recently while disposing
of a case filed by SS Food Kather in 2010. The petitioner had moved court after
being levied VAT at the rate of 13.5 per cent for rusk.
“The majority of the ingredients in rusk and bread are the same and the
difference of ingredients in the two products is minuscule and it is only the
duration of the baking which makes the difference between the two,” the HP
High Court said in its ruling.

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The bench took note of observations made by Allahabad High Court in a similar
matter where it was said that the word rusk had been defined in the Concise
Oxford English Dictionary to mean a dry biscuit or a piece of twice-baked
bread especially as prepared for use as baby food. Similarly, Collins Cobuild
Advanced Learner’s English Dictionary defines rusk as hard, dry biscuits that
are given to babies and young children.
The broader question is whether the economic development of the country is
to be considered while deciding the GST rates or should it be interpreted with
a narrow focus on the facts of the case alone. Assuming that a number of
multi-national companies are interested in investing in an emerging market
like India – it would be billion-dollar industrial investment.
Largest Bakery Companies : Arca Continental, Kraft Heinz, General Mills
(Behind some huge baked goods that everyone loves. Founded in 1866 as part
of a mill company, General Mills has since expanded into all kinds of foods but
has stayed rooted in grain-based products.), Conagra, Hershey, Bimbo,
Campbell, Post Holdings etc.
Largest Biscuit Companies : Nestlé, Mondelēz International, Kraft, Lotte, pladis
Global, Arnott’s, Lotus Bakeries, Burton's Biscuit Company etc.
The impact of the interments by these companies in the Indian economy is
perceptible. Not only FDI but also the possibility of jobs to millions and the
secondary effect of sale of goods and services, corporate taxes and personal
income tax. In addition, there is a possibility or The Organization for
Economic Cooperation and Development (OECD) bench mark - direct tax
collection mentioned above could also be achieved by encouraging investment
by MNCs. However, the protection to domestic industry of bread and biscuit
making companies has also to be kept in view. In other words, the
conversations on corporate taxation of India needs to be more strategic.
Canon of Diversity
In multiple tax system, tax payer will not be burdened with high incidence of
tax in aggregate.
Canon of Expediency
Levying tax on agricultural income lacks social, political or administrative
expediency in India and hence Government of India cannot tax agricultural
income.

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Other Canons
Administrative simplicity
The tax should be easy and inexpensive to administer.
Flexibility
The tax system should respond easily to changes in economic conditions.
Fairness
The tax system should be fair in its treatment of different individuals.
Transparency
Individuals should be able to ascertain their tax burdens so that burdens can
be politically tailored to what society considers desirable.

Some of the recent headlines in the financial newspapers include –

188 government companies and corporations racked up losses of Rs.1.75 lakh
crore: CAG report.
Of these, the net worth of 90 companies has been completely eroded.
India Post now biggest loss-making PSU, loses Rs. 15,000 crore in FY22.
Framework
Government needs financial resources for achieving the objectives of a welfare
state. Apart from corporate tax the Government financial resources include
both national and foreign (borrowings, divestment of stake in PSUs, donations,
NRI investments (deposits), dividends from PSUs etc). In this context the
contribution to the financial resources from the huge investments made by the
Government in PSUs can be improved a lot and to this extent the pressure on
corporate taxation (direct and indirect) could be considerably reduced.
Further, a diversified financial resource pool augurs well for an economy.
Probably to consider a strategic framework would be appropriate.
*******

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