How Your Taxes Work ?? | Regressive Vs Proportional | Direct Tax | Indirect Tax | GST

We know that our house cannot run without sufficient money. If our parents stopped getting their income, it would be really difficult for us to manage our day-to-day expenses, maintain our standard of living, and save money for a rainy day. There is no doubt that we need money to survive and to run our homes.

Just like how we need money to run the house, the Government also needs money to run the country. The Governments’ job in any country is to improve the standard of living, reduce inequalities and promote economic growth of the country. For all these activities, the government needs money.

Once the Government gets these funds, it can then spend it on various things like welfare projects, development projects, administration costs, and on public infrastructure.

One of the methods that the Government uses for collecting revenue is taxation. Taxation is a mandatory fee that is paid by all of us to the Government for the smooth functioning of our country.

In India, the Central and the State Governments have the right to collect taxes according to the Indian Constitution.

When we hear the word tax, we automatically think of money getting deducted from our salaries. We assume that people are talking about income tax when they mention the word tax.

While it is true that income tax is a popular method for the Government to collect funds, it is not the only method. There are other different types of taxes.

Let us study some of these types of taxes.

Types of taxes

We can broadly classify the Indian tax system into two broad categories, i.e., Direct Tax and Indirect Tax. These two categories of taxes have various subcategories as well. Let us discuss them in detail.

What is direct tax?

The meaning of direct tax is evident from the name itself. It is the tax that is paid directly by the taxpayer or legal, business entity to the government. Here the person who owes the tax to the government cannot pass it on to someone else.

Central Board Of Direct Taxes looks after the direct tax workings in India. There are different types of direct taxes. They are Income tax, Securities Transaction Tax, Prerequisite Tax, Corporate Tax and Capital Gains Tax

1] Income Tax: This is the tax that is charged to an individual taxpayer or a legal entity on their income earned. There are different income tax slabs based on an individual’s income. The current Income Tax Rate for the year 2021-2022 are :

  •  Nil for income for upto Rs. 2.5 lakh;
  •  5% for income between Rs. 2.5 lakh to Rs. 5 lakh;
  •  10% for income between Rs. 5 lakh to Rs. 7.5 lakh;
  • 15% for income between Rs. 7.5 lakh to Rs. 10 lakh;
  • 20% for income between Rs. 10 lakh to Rs. 12.50 lakh;
  •  25% for income between Rs. 12.5 lakh to Rs. 15 lakh;
  • 30% for income above 15 Lakh

2] Securities Transaction Tax (STT): This is the tax that is imposed on traders and investors who participate in the stock market. This tax is imposed on the securities that are traded in the stock market. The intraday equity trading current rate of STT is 0.025% whereas STT for future and options are 0.01% and 0.017%

3] Prerequisite Tax: Prerequisite Tax is the tax that is imposed on the various benefits companies provide to their employees like rent-free accommodation and paying medical expenses. The current Prerequisite Tax rate is 30% of the value of benefits enjoyed by the employees.

4] Corporate Tax: This is the tax that is charged on a company’s profits. Corporate Tax has sub categories as well.  This includes Dividend Distribution Tax, Fringe Benefit Tax and Minimum Alternative Tax. The current Corporate Tax rate for domestic companies with an annual turnover of upto Rs.250 crore is 25%, for domestic companies with an annual turnover of more than Rs.250 crore is 30%, and for foreign companies is 40%.

a]Dividend Distribution Tax is imposed on the dividends that a company pays to its investors. The dividend distribution tax rate is 15% as per section 1150. However, in the Union Budget of 2020, Dividend Distribution Tax has been abolished.

b]Fringe Benefit Tax, that is tax imposed on the benefits given to employees in a company like travelling allowance. When Fringe Benefit Tax was still valid the tax rate was 30% on the value of benefits provided by the company to its employees. It was abolished in the year 2009 after much debate in the parliament.

c] Minimum Alternative Tax, where the government forces companies to pay the minimum tax in order to avoid tax evasions by companies. The current Minimum Alternative Tax rate is 15% for all companies in India.

5] Capital Gains Tax: The tax that is imposed on the sale of property or returns on any investment made by a person is the capital gains tax. It can be short-term or long-term. The short term Capital Gains Tax is 15% whereas the long term Capital Gains Tax is 20%

What is Indirect Tax ?

Indirect Taxes are different from Direct Taxes. Direct taxes are imposed on our income, profit or revenue from the stock market. Indirect taxes are taxes that are charged on the goods and services that we buy.

There are different types of indirect taxes like sales tax, central excise tax and value added tax. However, with the start of the Goods and Services Tax, all these other forms of indirect tax have been replaced.

Indirect taxes can be shifted by one person to another person. The government receives the payment of the tax from the seller of a good and service.  In Indirect Taxes, tax is added to the product or service bought by the customer. The seller of the product collects the tax.

What is goods and services tax? (GST)

All other forms of indirect taxes were replaced in India with the introduction of the Goods and Services Tax in 2017. Earlier, due to the presence of various indirect taxes like Central Excise Duty, Value Added, Central Govt Tax and State Govt Tax, the system of paying taxes was highly complicated. 

With GST, the system has been simplified. GST is imposed on all goods and services consumed in the country. Goods and Services Tax has made tax administration easier with its motto ‘one nation, one tax.’ It has also brought more people under the tax umbrella and has been helpful in eliminating tax evasion.

What are the types of increasing or decreasing taxes?

Every country has a ‘tax rate’ system that they follow based on their policy framework.

Tax rate is the amount of tax that a person has to pay. This amount of tax is based on their tax base. A tax base can be income, property, consumption of goods and services, etc.

This tax rate can be Proportional, Progressive, or Regressive Taxation.

1] Proportional Taxation

Proportional Taxation is a system that is based on the idea of equal sharing of tax burden. According to Proportional Taxation, everyone irrespective of their income has to pay the same tax.

Let us say there are three people with incomes INR 1,000; INR 2,000; INR 3,000. We can say they are Person A, Person B, and Person C respectively. We will assume that the country has a Proportional Tax System with a tax rate of 10 percent.

This means that all the above three people will have to pay 10 percent of their income for taxes. Their tax amount will be INR 100 for Person A; INR 200 Person B; INR 300 Person C respectively.

However, this taxation is not fair as it charges the same tax rate to both rich and poor.

2] Progressive Taxation

Progressive Taxation is a system where the tax rate increases with increase in income. According to Progressive Tax system, the responsibility of paying tax should increase with an increase in income

We can use the same example above and say that three people are having incomes INR 1,000; INR 2,000; INR 3,000. We can say they are Person A, Person B, and Person C respectively.

 Let us say the country has a Progressive Tax System with a tax rate of 10% for Person A; tax rate of 15% for Person B; tax rate of 30% for Person C.

Here we can see that the tax rate rises with an increase in income. So the tax amount paid by each will be INR 100 by Person A; INR 300 by Person B; INR 900 by Person C respectively.

Progressive taxation is popular now because of the rise of democracy and the need for social welfare.

3] Regressive Taxation

Regressive taxation is a system where the tax rate falls as the income increases. According to Regressive Taxation, as a persons’ income rises, they have to pay less taxes.

Again we use the same example as above. We assume that three people are having incomes INR 1,000; INR 10,000; INR 1,00,000. We can say they are Person A, Person B, and Person C respectively.

Let us say the country has a Regressive Tax System with a tax rate of 10% for Person A; tax rate of 1% for Person B; tax rate of 0.1% for Person C.

Here, we can see that the tax rate decreases with an increase in income. So the tax amount paid by each will be INR 100 by Person A; INR 100 by Person B; INR 100 by Person C respectively.

The Regressive Tax system is unjust to the poor as they are burdened more with the tax.

Conclusion

Tax is a compulsory fee that the government charges on its citizens, legal or business entities. It is broadly classified as Direct and Indirect Taxes. In Direct Taxes the tax is paid directly by the individual and in Indirect Tax the tax burden is shifted by the seller to the consumer.

The tax rate imposed on various individuals in a country depends on the tax rate the country follows. This tax rate can be Progressive, Regressive and Proportional. Most countries being democratic and welfare oriented follow the Progressive system, including India.

Frequently Asked Questions Related to Taxation

  1. What is taxation?

Taxation is the mandatory fee imposed by the government on its citizens to collect revenue for spending on various activities like building public infrastructure, raising standard of living, etc.

  • What are the two categories of taxation?

In India, taxes are of two broad types: direct tax and indirect tax. Direct taxes are those that are charged directly to an individual, and indirect taxes that are imposed on consumption of goods and services.

  • What are the types of Direct Tax?

Income Tax, Capital Gains Tax, Securities Transaction Tax, Prerequisite Tax and Corporate Tax are the different types of direct tax.

  • Why were the Value Added Tax, Sales Tax and Central Excise Tax replaced?

Value Added Tax, Sales Tax and Central Excise Tax were replaced by a better and efficient indirect tax system called the Goods and Services Tax (GST). GST has bought all the indirect taxes under one umbrella.

  • What are the different types of tax rate systems?

Proportional Tax, Regressive and Progressive Tax are the different types of tax rate systems.

  • Which Tax Rate System does India follow?

India follows the progressive tax rate system. In the Progressive Tax rate system, the more income a person earns, the more they are taxed.

  •  What is the retrospective tax system?

 The word retrospective means’ looking back.’ In the tax world, it means charging tax on transactions that happened way before the law was framed. These transactions mostly involved sale of assets by foreign entities in India.

  •  What are the current GST slabs?

The government has introduced a four tier tax structure for all goods and services. The current slabs of the Goods and Services tax are divided into four groups with the slab rates : 5%, 12%, 18% and 28%.

  •  How is Income Tax calculated?

We calculate Income Tax with the help of different tax slabs. Tax slabs are the range of income based on which different rates of tax are imposed.

  1. Why does the government collect taxes?

The government requires funds for carrying out various activities like development of public infrastructure, sponsoring schemes that reduce inequality and boost economic growth. One way of collecting these funds is through taxes imposed on citizens in the country.

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