As is common knowledge, taxes are mandatory contributions levied on individuals or corporations by a government entity- whether local, regional or national. Taxes are collected by governments or taxing authorities to finance government activities.
A government is responsible to provide basic amenities to all its citizens, such amenities include proper transportation channels, sufficient good-quality health and education institutions, etc. In order to finance such activities, the government uses its fiscal budget generated by taxes and other sources.
Taxes are one of the most important factors that determine the wealth of individuals worldwide. Different countries might have different taxation regimes in place and most of them collect taxes from its citizens and businesses and utilize the tax money collected for several purposes.
The purpose of this blog is to categorize taxes into different categories based primarily on the nature of their collection- direct and indirect.
By the end of this blog, the reader would be able to broadly understand the different types of taxes. Even though the classification below is not an exhaustive one, it helps form a holistic view on taxation and serves as a critical step towards the development of a sense of personal finance.
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As implied by the name, a direct tax is paid directly to the government by the taxpayer. Essentially, direct tax can not be transferred by the taxpayer to someone else.
A few of the important categories of direct taxes include:
As implied by the name, income tax is the tax imposed by a government on income generated by individuals within their jurisdiction. As per the law, an entity needs to file an income tax return annually to determine its tax obligations.
In India, the Income Tax Act of 1961 imposes tax on the income of the Indian citizens. The inclusion of a particular income in the total incomes of a person for income-tax in India is based on his/her residential status (ordinary residents, not ordinary residents and non residents). Residents are taxed on the income outside India as well.
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Corporation tax is a direct tax imposed on the net income or profit that enterprises make from their businesses. Companies, both public and privately registered in India under the Companies Act 1956, are liable to pay corporation tax. This tax is levied at a specific rate according to the provisions of the Income Tax Act, 1961.
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Property tax, sometimes known as 'house tax,' is a local tax placed on owners of buildings and other residential land. The states have taxing authority, which is assigned to local governments by legislation, which specifies the valuation process, rate band, and collection mechanisms.
The property tax is based on the Annual Rental Value or Annual Rate-able Value (ARV). The ARV depends upon factors including the size of the property, proximity of the property to certain landmarks, local condition of the premises, amenities provided on the premises, etc.
Inheritance (Estate) Tax:
An inheritance tax, also known as an estate tax or death duty, is a tax imposed on a person's estate after he or she dies. It is a tax imposed on a deceased person's estate, or the total worth of his or her money and property. Estate tax was introduced in India in 1953 and was discontinued on agricultural land in 1984.
The Gift Tax Act, which was enacted on April 1, 1958, governs gift tax in India. Except for Jammu & Kashmir, it went into force across the country. All gifts in excess of Rs. 25,000 received in cash, draught, cheque, or other form from someone who was not related to the receiver by blood were taxed under the Gift Act of 1958.
Even though the gift tax was removed in 1988, it was reintroduced partially in 2004 and the Rs. 25,000 amount was increased to Rs. 50,000.
Capital Gain Tax:
The Capital Gains Tax is a type of tax that individuals must pay when they get a profit or gain from the sale of capital assets such as stock market investments or real estate.
Short-term Capital Gains (STCG) and Long-term Capital Gains (LTCG) are two types of capital gains, referring to gains from assets held for less than 36 months and gains from assets kept for more than 36 months, respectively.
The two main distinctions between STCG and LTCG in India are that STCG is computed depending on an individual's income bracket, whereas LTCG is taxed at a flat rate of 20%, and that STCG is not subject to indexation which is a benefit granted to adjust the capital asset’s value keeping inflationary rise in prices in mind.
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Contrary to direct taxes, indirect taxes can be shifted by the taxpayer to someone else. Basically, an indirect tax is collected by an intermediary (such as a retail store) and not by the governments directly, from the person who bears the ultimate economic burden of the tax (such as the customer).
An indirect tax may increase the price of a good so that consumers are actually paying the tax by paying more for the products. Additionally, different products have different tax requirements, for instance products like cigarettes and alcohol are more than grocery products.
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A few of the important categories of indirect tax include:
The Customs Act of 1962 was enacted in India for the primary purpose of prohibiting illicit import and export of various commodities.
Customs duty serves as an important type of indirect tax since it safeguards the business interest of indeginous businesses and secures the Indian currency’s exchange rate by restricting the imports to a minimum.
Customs duty can be further sub classified into several categories including the basic duty, additional duty or the countervailing duty, anti-dumping duty, protective duty, duty on bounty fed articles, export duty, cess on export, national calamity contingent duty, education cess, road cess, etc.
Excise tax is imposed by the central government under the Central Excise Act of 1944 and the Central Excise Tariff Act of 1985. The Central Excise Duty (CED) is a tax levied on excisable products (specified in the Central Excise Tariff Act 1985) made in India and intended for domestic use.
Most of the goods manufactured in India require excise duty to be paid. There are however certain exemptions specified by the Government. Such exemptions include products that are exported out of India.
Similar to customs duty, excise duty can be further sub classified into basic excise duty, special excise duty, road cess, surcharge (eg: surcharge on tobacco products), national calamity contingent duty, education cess, etc.
Under the terms of the Finance Act of 1994, service providers in India, with the exception of those in the state of Jammu and Kashmir, are required to pay a Service Tax. The Service Tax is imposed on the gross or total amount invoiced to the recipient by the service provider. In India, the government relies largely on service providers' voluntary cooperation to collect Service Tax.
In India, a sales tax is a type of tax levied by the government on the sale or purchase of a certain item inside the nation. Both the federal government (Central Sales Tax) and state governments (Sales Tax) levy sales taxes. In general, each state has its own Sales Tax Act that imposes varying rates of taxation.
Aside from sales taxes, several states levy extra fees such as labour contracts tax, turnover tax, and purchaser tax. As a result, sales tax serves as a key income source for state governments. Since April 10, 2005, most Indian states have added a new Value Added Tax to their sales tax (VAT).
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Value Added Tax (VAT):
The VAT practise carried out by state governments is implemented at each stage of the sale, with a specific credit system for the input VAT paid. In India, the VAT rate is 0% for basic commodities, 1% for gold ingots and valuable stones, 4% for industrial inputs, capital goods, and consumer goods, and 12.5% for everything else. (From)
Petroleum products, cigarettes, liquor, and other items are subject to variable rates (state-dependent). The Value Added Tax Act and the laws enacted thereunder administer the VAT levy, which is analogous to a sales tax.
VAT is essentially a multi-point taxation system on each of the entities in the supply chain. VAT can be computed using the subtraction method, addition method or the tax credit method.
Securities Transaction Tax (STT):
STT is a tax that is applied on all stock exchange transactions. On the acquisition or sale of equities shares, derivatives, equity oriented funds, and equity oriented mutual funds, STT applies. The current STT on an equity share acquisition or sale is 0.1 percent.
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Goods and Services Tax (GST):
The Goods and Service Tax, or GST, is the most significant change to India's indirect tax structure since the market opened up 25 years ago. Because it is charged where consumption occurs, the goods and services tax is a consumption-based tax.
The GST is levied on all value-added services and commodities at every point in the supply chain where they are consumed. The GST paid on the procurement of goods and services can be applied to the GST paid on the delivery of such goods and services. The seller must pay the GST at the relevant rate, but he can claim it back using the tax credit method.
Essentially , the GST encompasses Value Added Tax, Customs Duty and Excise Duty.
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This blog seeks to cover most of the categories of taxes in India by classifying them into direct and indirect taxes initially and then sub-classifying them accordingly.
Taxation forms a very important aspect of the day to day life of all entities in a country and plays a humongous role in determining the ability of an entity to accumulate wealth over longer periods of time. Even though this blog discusses the various categories of taxes with an Indian perspective, other countries worldwide follow similar classification procedures.
It is legally required for all entities to comply with the various types of taxes listed above. SInce, taxes can not be avoided, it is best to understand them in advance and be prepared to adhere to the same in a smart manner.