The tax structure in India broadly consists of two types of taxes, namely indirect tax and direct tax. Understanding the basic framework and the components of these taxes can help you become more financially literate. In turn, that can assist you in managing your money and your investments better.
So, in this guide, we will be taking a closer look at direct tax in India. You may have come across the names of many direct taxes in your everyday life without realising their relevance. In fact, you most likely have also paid direct taxes to the government. Wondering how? Keep reading to find out.
What is direct tax?
Firstly, what is the meaning of direct tax? Well, as the name suggests, direct tax is simply a kind of tax that is levied directly on the person who has to pay it - or, in other words, the taxpayer. The taxpayer has to bear the burden of the payment themselves. And in this context, the taxpayer can be an individual, a Hindu Undivided Family (HUF), a partnership firm, a trust, or even a corporate entity.
So, that sums up the meaning of direct taxes. But to understand this component of the tax structure in India better, you will also need to get a closer look at the different types of direct taxes levied in the country. Check these out in the section below.
Types of direct taxes in India
The government of India collects different types of direct taxes. Broadly speaking, we can identify three kinds of direct taxes, namely:
- Income tax
- Capital gains tax
- Corporate tax
Let’s take up each of these one after the other and understand them better.
1. Income tax
In all likelihood, you are perhaps quite familiar with income tax. It is the tax that you pay on the income that you earn. Simple enough, isn’t it? This tax is calculated and levied as per the provisions of the Income Tax Act, 1961. Here are some important things to note about income tax - which is the most common kind of direct tax levied in India.
- Income tax is calculated on five main heads of income, namely salaries, income from house properly, income from business or profession, capital gains, and income from other sources.
- Income tax is not only levied on individuals. As per the provisions of the Income Tax Act, 1961, it is also levied on HUFs, companies, partnership firms and other persons.
- Income tax is calculated on the income earned by a person during a financial year (FY), which begins on April 1 of the current year and goes up to March 31 of the next year. For instance, FY 2021-22 starts on April 1, 2021 and ends on March 31, 2022.
- The income earned during a financial year is assessed during the subsequent year, which is called the assessment year (AY). So, the income you earn during FY 2021-22 is assessed in AY 2022-23.
- Income tax on individuals is levied at the slab rates specified in the relevant budget. The slab rate depends on the level of income an individual earns and their age.
- As a part of the assessment process, you will have to submit an Income Tax Return (ITR) to the Income Tax Department. There are different types of ITR as well. The ITR contains details of your income, the taxes paid thereon and the refund due, if any.
2. Capital gains tax
Capital gains tax, as you saw in the previous section, is a kind of direct tax. It is levied on any gains that you may receive when you sell a capital asset. A capital asset can be a house, a plot of land, equity shares or other financial instruments, gold and other precious metals, artwork, cars and other machinery.
Depending on how long you held the asset before making a sale, capital gains can be of two kinds: Long Term Capital Gains (LTCG) or Short Term Capital Gains (STCG).
• Long Term Capital Gains (LTCG)
LTCG refers to the gains on the sale of capital assets that have been held for a period of 24 months or longer. In the case of equity shares alone, the LTCG period is 12 months instead of 24. In case of debt oriented mutual fund holding period is 36 months.
• Short Term Capital Gains (STCG)
STCG refers to the gains on the sale of capital assets that have been held for less than 24 months. In the case of equity shares alone, the STCG period is 12 months and in case of debt mutual fund STCG period is 36 months instead of 24 months. So, if you sell equity shares within 12 months of buying them, the gains you make are taxes as STCG.
3. Corporate tax
Corporate tax is also a kind of income tax - and therefore, a kind of direct tax. Like capital gains tax, corporate tax also falls under the purview of the Income Tax Act, 1961. This tax is levied on the net profits made by companies established in India. As for foreign companies with operations in India, they generally have to pay corporate tax on the profits that arise from such operations.
In addition to the tax levied on the profits made by corporate entities, there are also other taxes that they may have to pay, based on other terms in the governing laws. Let’s take a look at these taxes, so you can understand the direct tax structure in the country better.
• Minimum Alternative Tax (MAT):
MAT is a kind of direct tax levied on the companies that declare little or no income in a financial year. These are known as ‘zero tax companies.’
• Securities Transaction Tax (STT):
SST is a kind of tax that is payable on the value of securities in transactions executed through a stock exchange.
Benefits of direct tax
The structure of the direct tax in India has been developed and implemented to offer several benefits to the country as a whole, and to further development. Let’s take a closer look at some of the key benefits of direct taxes.
1. Easier administration
Since direct tax is levied and collected from the taxpayer directly, administration is easier and more economical.
2. Great degree of clarity
Estimating and calculating the revenue or income is clear cut. Therefore, calculating direct taxes has a great degree of clarity.
3. Scalable taxation
Direct taxes levied on the income of persons increase as the income increases. This makes it very scalable.
4. Deductions for taxpayers
The direct tax framework also gives option of many deductions to taxpayers, to reduce the burden of taxes.
FAQs on direct taxes
1. What is advance tax?
Advance tax is simply tax that is paid in advance, on the income that you expect to earn during a particular financial year. It is paid prior to actually earning the income. And unlike regular income tax, which you pay as a lump sum amount at the end of the financial year, advance tax is paid in installments as specified by the Income Tax Act, 1961. Following is the summary of advance tax dates and liability to be paid:
Income Tax Slab
Rates for Income Tax Slab FY 2020-21 & FY 2021-22 (New Regime)
₹0.0 – ₹ 2.5 Lakhs
₹ 2.5 Lakhs- ₹ 3.00 Lakhs
5% (Tax rebate permissible under section 87A)
₹ 3.00 Lakhs – ₹ 5.00 Lakhs
5% (Tax rebate permissible under section 87A)
₹ 5.00 Lakhs- ₹ 7.5 Lakhs
₹7.5 Lakhs – ₹ 10.00 Lakhs
₹10.00 Lakhs - ₹12.50 Lakhs
₹12.50 Lakhs - ₹ 15.00 Lakhs
> ₹15.00 Lakhs
2. How does direct tax differ from indirect tax?
Direct tax is levied on and paid by the taxpayer directly. Indirect tax, on the other hand, is levied on one party and paid by another. So, the burden of tax is borne directly by the taxpayer in case of direct taxes. In indirect taxes, the tax burden is borne by the end user.
3. Can I claim any deductions from my income to reduce my direct tax liability?
Yes, the Income Tax Act, 1961, allows for many deductions and exemptions, so the burden of income tax on your finances is reduced. From FY 2020-21, you can choose between the old tax regime or the new one. The new tax regime has lower tax rates but does not allow for any deductions. On the other hand, the old tax regime comes with higher tax rates, but allows for the deductions such as:
- Children education allowance
- Conveyance allowance
- Daily expenses in the course of employment
- Deduction under Chapter VI-A
- Helper allowance
- House Rent Allowance (HRA)
- Interest on housing loan (Section 24)
- Leave Travel Allowance (LTA)
- Other special allowances [Section 10(14)]
- Professional tax
- Relocation allowance
- Standard deduction on salary
4. Do I have to pay direct tax on my life insurance benefits?
If the policy is exempt under Section 10(10D) of Income Tax Act 1961, any proceeds received from policy will be tax exempt. If policy is not exempt u/s 10(10D) of Income Tax Act 1961, gain from policy will be subject to income tax.
5. What is the rate of STCG and LTCG?
The following points will help you understand this better.
- STCG is taxed at the income tax slab rate applicable to you if no STT is applicable.
- In case STT is applicable, STCG is taxed at 15%.
- LTCG in general is taxed at 20%.
- LTCG on equity funds - if over Rs. 1 lakh - is taxed at 10%.
Disclaimer: Readers are suggested to seek independent professional advice from tax consultants on applicable income-tax provisions before making any investment decisions.