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Understanding the Process of Direct Tax in India

Tax is the charge levied upon the citizens by the government to generate income which will then be invested in various schemes and projects for the overall development of the country. The Constitution of India allocates the authority to impose and collect the tax to central and state government. According to Article 265 of the Indian Constitution, no tax shall be levied or collected by anyone but by the authority of law. Hence, every tax charged from citizens should have the backing of law either passed by Parliament or State Legislature.

There are two types of taxes levied by the government:

  • Direct Tax: Direct taxes are taxes that are paid directly to the government by the taxpayer. These taxes are directly imposed by the government on the citizens and entities and must be paid by the individual taxpayer himself/herself.

The Income Tax Act of 1961 and Wealth Tax Act of 1957 govern direct taxes. These two legislations were proposed to be replaced by a new legislation, Direct Tax Code. The proposition was, however, dropped and Wealth Tax Act was repealed in 2015.

Ever since 2015, Income Tax Act has been the major source of Direct Tax excised from citizens apart from Wealth Tax, Corporation Tax, and others.

  • Indirect Tax: These are the taxes which are not directly payable to the government by the citizens but are imposed on the goods and services provided by a service provider. These taxes are collected by an intermediate entity selling the product which is then submitted to the government. Some common examples of indirect taxes are sales tax, goods and services tax etc.

The Central Board of Direct Taxes in India

Central Board of Direct Taxes or the CBDT oversees the direct taxation system in India. CBDT was formed by Central Board of Revenue Tax, 1924 and it is responsible for administering direct tax laws under the Department of Revenue in the Ministry of Finance.

CBDT provides input and suggestion on the policies related to direct taxation and it also governs the execution of the policies in India. CBDT is headed by a chairman and consists of six members who act as Special Secretary to the Indian Government.

Various Acts that Govern Direct Tax are as follows:

  • Income Tax Act:

    The Income Tax Act (IT Act) of 1961 is the law that governs income tax in India. As per this act, the taxable income of an individual can be earnings from any source such as; salary, business, property gains etc. This tax also defines the tax benefit on fixed deposit and life insurance premium. Income Tax Act provides parameters under which one can save on their income by investing and determining one’s income tax bracket.

  • Wealth Tax Act:

    The Wealth Tax Act was introduced in 1957 and it administers the taxation on the net wealth of individual, company or Hindu United Families (HUF). As per this act if the net wealth exceeds Rupees 30 Lakhs, then 1% of that excess amount will be payable. This Act was repealed in Budget of 2015 and was not leviable from the assessment year 2016-17. This was replaced with an extra charge of 12% on the income of the taxpayer earning more than Rupees 1 crore per annum as well as companies with an annual turnover of Rupees 10 crore or more. This resulted in a drastic increase in the fund of the government.

  • Gift Tax Act:

    The Gift Tax Act was introduced in 1958. According to this act, 30% tax was levied on any valuable or monetary gift received by an individual. This act was abolished in 1998. As per the new rules any property, jewellery, shares etc. which is given as a gift or inherited from family members like parents, grandparents, siblings, spouses, uncles, aunts or is gifted by local authorities is exempted from tax. Apart from the exempted entities any gift received with a value more than Rupees 50,000 is taxable.

  • Expenditure Tax Act:

    Expenditure Act came into existence in the year 1987 and it is applicable all over India except in Jammu and Kashmir. This act deals with any expenses an individual may procure while availing services provided by a hotel or restaurant. According to this act certain expenses, if they exceed the amount of Rupees 3,000 are taxable in case of a hotel and all the expenses incurred in case of the restaurant are chargeable.

  • Interest Tax Act:

    The Interest Act came into action in 1974. According to this act, the interest earned under a specific situation is taxable. This tax is applicable to the whole of India, including all the Union Territories. This tax was abolished in 2000, and thus the tax on the interest is no more chargeable.

What are the Types of Direct Taxes Paid by Taxpayers?

Direct taxes are of various types. The different direct taxes that are paid by a citizen directly to the government are listed below:

  • Income Tax:

    Income tax is the most important tax that every eligible citizen in India is liable to pay. This tax is charged directly by the Government of India on the taxable income of a citizen. Every individual, co-operative society, firm, company, Hindu United Family (HUF), trust and the artificial judicial person has to pay this tax. The rate at which the tax is charged varies with the income and tax slab of the assesse. The income tax is charged differently for people with different residency status.

    The taxable income of an individual assessee is calculated as:

    Taxable income = Total income (from every eligible source) in a year – deductions and exemptions available on it.

    Income tax is chargeable under the following:

    • Income from salaries of an employee.
    • Income from any business or other professions like lawyer, doctor etc.
    • Income from house property.
    • Income from capital gains on the sale of an asset.
    • Income from other sources.
  • Corporate Tax:

    Corporate tax is levied on the companies that work as separate entities from their shareholders. In the case of foreign companies, the income that is deemed taxable is the income that is generated or predicted to be generated in India. It is charged for technical services and dividends on the sales, royalties, interest, and gains from the sale of capital assets in India.

    There are three sub-taxes under Corporate Tax:

    • Minimum Alternative Tax (MAT): MAT came into action in the year 1987 as a part of Finance Act, vide Section 115J of the Income Tax Act, 1961. This tax was essentially introduced to bring the ‘Zero Tax’ companies under the purview of income tax. The accounts of these companies were made with respect to the Companies Act.
    • Fringe Benefits Tax (FBT): FBT was introduced in the Financial Act, 2005. This is the tax that the companies must pay on the fringe benefits provided to the employees by the employer.
    • Dividend Distribution Tax (DDT): DDT is payable by companies since it was introduced in Finance Act of 1997. It is the tax levied on the amount declared, distributed or paid as a dividend by any domestic company. This tax does not apply to foreign companies.
  • Capital Gains Tax:

    Capital gain tax is a tax levied on the income received from the sale of a capital asset or investment. The capital investment or assets include house property, farms, businesses, artifacts, jewellery etc. Capital gains tax is of two types: Long-term capital gains and short-term capital gains.

    Capital gains can be calculated as; Capital gains = money received from sale – cost of capital investment .

  • Securities Transaction Tax:

    Trade in security is a very good method of making money. The money earned from this is taxable under different tax called Securities Transaction Tax, which was introduced in 2004 by the Finance Minister. This tax is charged by adding the payable tax to the price of shares. It implies that on every trade of shares, an individual pays tax.

  • Perquisite Tax:

    Perquisite refers to all the benefits and perks that an employer may decide to share with the employees. Under these privileges, a company may decide to provide a house, a car, or other compensations like phone bill and fuel bill reimbursement to the employees. This tax is levied by deciphering how the benefit is acquired by the company or how it is utilized by the employee. For example, if the company provides a vehicle to the employee for official use, it is not taxable. But if the vehicle is given for both personal and official use, then tax will be levied on it.

Tax Rates for Different Types of Direct Taxes

  • Income Tax:

    Income Tax in India is charged according to different tax slabs for a different range of income.

    Following are the tax brackets for the income tax levied on the individuals:

    • Income of (>=) Rs. 2,50,000 – NIL
    • Income from Rs. 2.5 Lakhs to 5 Lakhs – 5%
    • Income from Rs. 5 Lakhs to 10 Lakhs – 20%
    • Income from Rs, 10 Lakhs (or <) – 30%

    For residents between 60 and 80 years of age:

    • aIncome up to Rs. 3 Lakhs – NIL
    • bIncome from Rs. 3 to 5 Lakhs – 5%
    • Income from Rs. 5 to 10 Lakhs INR – 20%
    • Income from Rs. 10 Lakhs (or <) – 30%

    For the residents of more than 80 years of age:

    • Income of (>=) Rs. 2,50,000 – NIL
    • Income up to Rs. 5 Lakhs – NIL
    • Income from Rs. 5 Lakhs to 10 Lakhs – 20%
    • Income from Rs. 10 Lakhs (or <) – 30%

    10% of surcharge is taxed on the income between 50 Lakhs and 1 core INR and 15% of income tax on the income of more than 1 crore INR.

    Cess is charged at 3% on the income tax + surcharge.

    Amounts invested in specific schemes like EPF, PPF, NSC, Tax Saving FDs, etc. are eligible for a deduction of up to Rs. 1,50,000 per year under Section 80C.

  • Corporate Tax:

    The rate of corporate tax levied on domestic companies:

    • Any domestic company with an annual turnover of over Rs. 1 crore has to pay corporate tax at 30%. A company generating less than Rs. 1 crore is exempted from the tax.
    • If the net income of the company is more than Rs. 10 crores then a surcharge of 5% is levied on it.
    • If the income of the company exceeds Rs. 10 crores then a surcharge of 10% is applicable on it.

    Corporate Tax on International Companies:

    • For companies earning less than Rs. 1 crore, the tax is levied at 41.2%.
    • Companies with a yearly turnover of more than Rs. 10 crores are levied a tax of 42.024%.
    • Companies with a yearly turnover of more than Rs. 10 crores are levied a surcharge of 5% on the net income.
    • MAT is charged at 19.05%.
    • DDT is charged at 16.995% on dividends declared.
  • Capital Gains Tax:
    • Short-term capital gains are taxed as per the normal income tax slab.
    • Long-term capital gains are charged at 20% with indexation and at 10% without indexation.

Benefits of Direct Taxation

  • Equitable: Because the direct tax is collected directly from every citizen and cannot be transferred to another for its payment, an equal tax is paid by every section of the society.
  • Economical: Income tax and other forms of direct tax can be collected by the government easily since taxation is done at source using TDS (Tax Deduction at Source).
  • Certainty: There is a sense of certainty in the taxpayer as well as the government as each party knows the amount of tax to be paid and collected respectively.
  • Productivity: Direct taxes in terms of productivity grow as the working population and community grow.
  • The consciousness of duty: The taxpayers have the right to know how their money is collected as tax and being spent by the government.
  • Creates equal distribution of wealth: More tax is collected from people that can afford them which is utilized by the government for the upliftment of the poor or lower section of the society.