Understanding Taxes in India: Types and Benefits

Tax is fees levied on products and services by an individual, an organization, or a government to generate revenue. The amount accumulated through tax is used for executing public welfare programs. Penalty charges apply to those evading tax if a tax notice goes unacknowledged by the taxpayer, if the taxpayer provides false information regarding their income to evade tax, or those who refrain from paying tax or default on payments. There are provisions in the IPC to take strict actions against tax evaders and defaulters.

Different Types of Taxes in India

Taxes may be broadly classified into direct and indirect taxes. This classification is based on the mode of payment.

• Direct taxes are those that the taxpayer pays directly to the government.
• Income tax comes under the classification of direct taxes.
• Indirect taxes are fees/charges levied on goods and services when they are bought and sold.
• The end consumer of the product/service pays the tax on the product he/she consumes to the seller of the given product/service. The seller pays the fee to the government as an indirect tax.
• Therefore, the end consumer is indirectly paying the fee to the government as an indirect tax through the medium of the seller. GST, Value Added Tax, excise duty are all examples of indirect taxes.

Types of Direct Taxes:

*Tax rates differ for different tax slabs.

Advantages and Disadvantages of Direct Tax

Advantages

• Progressive nature: Direct taxes are structured so that individuals with lower incomes pay lower taxes than those with higher incomes. 

• Inflation control and reduction of inequalities: By adjusting tax rates, the government can curb inflation and reduce economic disparities among citizens. 

• Certainty: Both the government and the taxpayer are aware of the exact amount and timing of tax payments. 

Disadvantages

• Potential for tax evasion: Complex tax regulations may lead to fraudulent practices, where taxpayers attempt to lower taxes or avoid them altogether. 

• Complex documentation process: The process of filing direct taxes can be intricate and time-consuming as there are numerous tax documents required to file income tax returns and other returns.

• Non-transferable burden: The responsibility of paying direct taxes cannot be shifted to others; the individual or entity liable must bear the burden themselves. 

Understanding Income Tax and its Features

Income tax is governed by the Income Tax Act of 1961, it serves as a primary source of revenue for the government, funding various developmental and welfare activities across the country. 

• Income tax Assessee: An income tax assessee refers to any individual taxpayer or entity liable to pay taxes and falling within the taxable income bracket as defined by the government. 

• Income Tax Slabs: To ensure fairness, the government employs income tax slabs to determine the rate at which each assessee is liable to pay tax. The general principle is progressive- the higher the income, the higher the tax rate. 

• Income Tax Deductions: Taxpayers can reduce their taxable income through various deductions. Sections 80C and 80D of the Income Tax Act provide avenues for tax-saving investments, such as Equity-Linked Savings Schemes (ELSS), Public Provident Fund (PPF), Employees’ Provident Fund (EPF), and tax-saver fixed deposits. 

• Tax Deducted at Source (TDS): TDS is a mechanism where the payer deducts tax from certain payments, such as salaries or interest on fixed deposits, and remits it to the government on behalf of the payee.

• Tax Evasion laws and Implications: The Government of India has established stringent laws to curb tax evasion. Non-compliance can lead to severe penalties under various sections:
  • Section 140A (1): If an assess fails to pay the taxes, either partially or wholly, they are considered a defaulter. The assessing officer can levy a fine equal to the arrear as per Section 221 (1).
  • Section 271 (C): Failure to disclose actual income can result in a fine ranging from 100% to 300% of the tax evaded.  
  • Sections 142 (1) and 143 (2): Under these sections, an income tax notice is sent to the defaulter. Non-compliance can lead to the assessing officer demanding the assessee to file the return or furnish detailed information about assets and liabilities. 

Types of Indirect Taxes:

Advantages and Disadvantages of Indirect Tax

Advantages

• Universal contribution: Every individual contributes to nation-building through indirect taxes, as they are levied on goods and services consumed by all, regardless of income level. 

• Ease of collection: Indirect taxes are easily collectable from the end consumer at the point of sale, simplifying the tax collection process. 

• Fair distribution: Essential goods are charged at lower tax rates compared to luxury items, ensuring a fair distribution of the tax burden.  

• Transferable burden: The burden of paying indirect taxes can be transferred to the end consumer, as businesses include these taxes in the price of goods and services. 

Disadvantages

• Price inflation: Indirect taxes can lead to an increase in the overall price of goods and services, affecting consumer purchasing power. 

• Regressive nature: Indirect taxes are considered regressive, as they take a larger percentage of income from low-income individuals compared to high-income earners. 

• Lack of consumer awareness: Consumers often lack knowledge of the taxes paid, leading to a lack of transparency in the actual cost of goods and services. 

• Unpredictable revenue: The amount received from indirect taxes is often unpredictable. It depends on consumer purchasing behaviour and demand for goods and services. 

Other Taxes:

Paying tax basically ensures that the government has sufficient funds to execute various public welfare programs and infrastructural improvements. Other benefits include funding for the following:

• Public welfare projects
• Public infrastructure development projects
• Public health & education
• Public utilities, including water, electricity, and sewage systems
• Public insurance
• Defence weaponry
• Scientific research
• Pension schemes
• Unemployment benefits
• State government employees’ salary

Budget 2025 Update

In the Union Budget 2025, significant changes were introduced by the Income Tax Department to the tax structure. One of the key announcements was the increase of the tax exemption limit. Individuals earning up to Rs. 12,00,000 annually are now exempt from paying income tax under the new tax regime. 

The revised tax slabs under the new regime FY 2025-26 (AY 2026-27) are as follows:

With these revised tax slabs, individuals earning up to Rs. 12,00,000 will have zero tax liability due to the increased rebate of Rs. 60,000. For salaried individuals, the tax liability will be zero for incomes up to Rs. 12,75,000, considering the standard deduction of Rs. 75,000. You can also use an income tax calculator to calculate your returns. 

Note: 

• Marginal relief on rebates is still applicable.
• The rebate is not available for income that is taxed at special rates (e.g., capital gains under section 112A). 

Advantages of Paying Tax:

There are several advantages of paying taxes that the taxpayer gets to enjoy. For instance, it is possible to use tax return form or other relevant documents of income tax as a proof document to apply for a loan/financial assistance.

• Loan approvals:  While applying for bigger loans like home and vehicle loans, a copy of ITR from the previous 3 years is requested by banks. If you attach a copy of your income tax returns filing from the last 3 years, you can apply for a higher loan amount or reapply if your application got rejected the first time. The reason for this being the banks calculate your repaying ability and credit risk based on your income. ITR is a document that can be used as proof of your income to receive bigger loans quickly.
• Visa: Foreign consulates request for your ITR returns at the time of visa interview to ensure that you are not escaping your country to evade paying taxes. If you are traveling abroad, especially to countries like UK, US, Canada, Middle East and European countries, it is advisable to keep your ITR receipts with your passport.
• For self-employed/freelancers/consultants: If the annual income is above the exemptions limit, ITR receipts may be used as proof of their income for any financial/business transactions.
• Government tenders: ITR receipts are used as proof of income while applying for government tenders.
• Tax refunds:  You can claim tax refunds only if you have filed your Income Tax Returns. If your income is below the exemption limit, you can claim refunds from savings instruments like fixed deposits.
• Life insurance: If you have a life insurance policy worth a larger amount, like 50L or 1 crore, you have to furnish your IT returns to avail of the benefit.
• Compensations for accidents: In the case of a vehicle accident, self-employed individuals must furnish Income Tax Return receipts for claiming compensation.

You can easily file government tax online by logging on to e tax filing portal. Alternatively, you can file your return by taking the assistance of tax companies who file on behalf of you when you provide the relevant information. 

Conclusion

A comprehensive understanding of India’s taxation system, encompassing both direct and indirect taxes, is essential for effective financial planning. Recognising the tax benefits and tax implications associated with various sources of income empowers you to make informed decisions for your taxes, ensuring compliance and optimising your tax liability. 

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Taxes in India FAQs: