Except for some countries with a lot of petroleum reserves, all countries impose some kind of tax on their citizens. This is because you need money to run the government, build roads and other infrastructure, impose law and order and so on. Sometimes taxes are of a redistributive nature, intended to reduce wealth inequalities and reduce poverty. Taxes can be of various types, and can be broadly divided into direct and indirect.
A direct tax is that which is imposed on either citizens or organisations directly. There are many types of direct taxes. In India, these include income tax, corporate tax, capital gains, property, inheritance tax etc. Direct taxes come under the jurisdiction of the Central Board of Direct Taxes (CBDT).
An indirect tax is imposed not directly on individuals but on goods and services. In India, this could be in the form of Goods & Services Tax (GST), customs duty, excise duty and so on. Individuals do not directly bear the burden of these types of indirect taxes, which are imposed on the organisations that provide goods or services. Ultimately, however, the burden is passed on to the end consumer, or the taxpayer.
The extent to which these types of indirect tax are passed on to the end consumer depends on many things, like the elasticity of demand for the product or service. Take for example, potato chips, demand for which is fairly elastic. That is, if prices are increased, consumers may buy less potato chips and go in for a cheaper alternative. If the GST on potato chips is increased from 10 percent to 20 percent, the manufacturer may choose to absorb the costs rather than raise prices so that consumers will continue buying them. Demand for cooking oil is fairly inelastic and any tax increase will be immediately passed on to consumers because most people cannot do without oil, unlike potato chips.
The share of the different types of direct tax and indirect tax varies from country to country. In India, direct taxes account for a little over half of tax collections, much of it (around 30 percent) accounted for by corporate tax, followed by income tax (23.5 percent). As far as indirect taxes go, the bulk of it is accounted for by GST (30 percent). Excise collected 11.5 percent and customs 8.5 percent. So, let’s now look at the different types of direct and indirect taxes.
This is a tax on the income of an individual. It is generally a progressive tax – that is, the higher the income, the higher the percentage of tax. It also tends to be unpopular among taxpayers because its effect is direct and immediate. The sight of a big chunk of your income eaten away by tax is enough to send the blood pressure shoots through the roof! No wonder that governments are keeping income tax rates on the lower side.
Income tax can be levied on income from profession or business, property or house, salaries, capital gains and other sources. The tax you have to pay depends on your income slab. Senior citizens eligible for lower rates.
However, taxpayers can reduce the burden of income tax by investing in certain specified instruments. For example, you can reduce taxable income by Rs 1.5 lakh by investing in certain instruments under Section 80C of the income tax act. These include equity linked savings schemes (ELSS), Public Provident Fund (PPF), National Savings Certificates (NSC) etc. Some of the other deductibles include insurance premiums, principal and interest on home loans etc.
Here are some of the investments through which you can reduce your income tax burden:
Public Provident Fund (PPF)
One of the most popular 80C deductions is PPF. This is very popular among risk-averse investors since it is backed by the government, so there is no risk of default. The tax advantages too are considerable, since PPF enjoys EEE tax treatment. EEE stands for exempt, exempt, exempt. What this means is that the initial investment is deducted from your taxable income, the interest earned is not taxed, and the ultimate proceeds too are not taxed.
The maximum amount that can be invested in a year is Rs 1.5 lakh. So, if your income is Rs 10 lakh, you can reduce it to Rs 8.5 lakh by investing in PPF. The benefits are higher for those in the higher tax brackets since the savings are more. So, PPF may not provide any great benefit if you are paying very little income tax.
Interest rates for PPF are fixed by the government from time to time. These are generally on a par with bank fixed deposits, or even marginally higher, but the tax advantages mean that your actual rate of return will be higher.
The disadvantage of PPF is that it’s not particularly liquid. There is a lock-in period of 15 years, and you will get the amount only after the end of the period.
Equity-linked savings schemes
Over the past few years, equity has outperformed most asset classes when it comes to returns. So, equity mutual funds must form a considerable chunk of your investments if you want to grow your savings. And if you want to grow your capital as well as reduce your tax outgo, there’s no better choice than equity-linked savings schemes, or ELSS.
Mutual funds offer ELSS funds that are eligible for Section 80C deduction. You can invest a maximum of Rs 1.5 lakh in these schemes and reduce your taxable income by that extent. This would mean a substantial savings in income tax, especially if you are in the higher tax brackets.
To avail of income tax benefits under ELSS, you need to stay invested in them for a period of three years. This might seem rather long, but it’s the shortest lock-in period among all the different kinds of instruments available for Section 80C deductions.
The benefit of investing in ELSS is two-fold – you get to save income tax, and you will see your capital grow at the same time.
National Savings Certificates
Another investment avenue that enjoys the benefit of Section 80C deductions is National Savings Certificates (NSC). NSC, like the PPF, is a government-backed scheme aimed at small investors. These are available at post offices around the country, and investments in them can be deducted from taxable income up to Rs 1.5 lakh.
NSC is very similar to PPF, and offers similar interest rates to investors. However, there are some crucial differences. One is that the maturity period is five years, instead of 15 as in the case of PPF. The interest earned on NSC is reinvested and the investor can claim the entire amount after five years.
The interest earned on NSC is fully taxable on maturity. It is added to your taxable income and taxed according to whatever slab you’re in.
Five-year bank deposits
If you prefer bank deposits, you can invest in them and also avail of Section 80C deductions. These are not applicable to all deposits, but only specified ones that have to be held for a minimum of five years. The advantage is that it is convenient. Many banks offer this kind of deposit, and you can open one in your own bank.
The interest rate will depend on the bank, but they are usually slightly lower than PPF. Interest rates earned on these deposits are fully taxable and taxes are deducted at source. However, since most banks calculate interest rates on a quarterly basis, the maturity proceeds could well be higher.
Like all other fixed deposits, interest earned from them will be added to your taxable income and taxed according to the bracket you’re in. So, you will have to pay more if you are in a higher tax bracket.
National Pension Scheme
National Pension Scheme (NPS) was introduced by the government to ensure post-retirement income to senior citizens. It was initially launched for government employees in 2004 and made available to everyone in 2009. Any Indian citizen between the ages of 18 and 60 can join the scheme.
Investments in this scheme are eligible for a reduction in taxable income to the tune of Rs 1.5 lakh under Section 80C. This scheme has two tiers for different types of investors, and tier I investors are eligible for an additional Rs 50,000 over and above the Rs 1.5 lakh of Section 80C, under Section 80CCD (1B).
Unit-Linked Investment Plan (ULIP)
A unit-linked investment plan or ULIP is an instrument that combines insurance with investment. While one portion of the premium is used to provide you with life cover, the remaining is invested in income-earning assets like equity, debt instruments and so on.
ULIPs offer some flexibility in that you can choose between debt and equity depending on your risk appetite and investment goals. Generally risk-averse investors choose debt since it is considered to be safer. Those who are prepared to take more risks will want to invest more in equity in exchange for higher returns.
The good thing about ULIPs from the income tax point of view is that they offer some benefits. Premiums paid on ULIPs are exempt from income tax under Section 80C up to a limit of Rs 1.5 lakh. But the premium amount must be less than 10 percent of the insurance cover provided by the company. Moreover, the returns on ULIPs are exempt from income tax under Section 10(10D) of the Income-Tax Act.
Among the different types of direct taxes, corporate tax contributes the most to the government’s coffers. Corporate tax is imposed on the profits made from business activity. In the past, corporate taxes used to be very high, almost punitive. But over the past few decades, governments have become much more business-friendly and have reduced these rates to encourage economic growth.
Income for the purposes of corporate tax include profits earned from the business, capital gains, income from property, income from renting property and from other sources like dividend, interest etc.
Companies with a gross turnover of up to Rs 250 crore have to pay 25 percent tax, while those whose turnover exceeds Rs 250 crore have to pay 30 percent, as of AY 2019-20. Companies are allowed various deductions like expenses and so on. There is also an investment allowance for new plant and machinery. However, all companies have to pay a minimum alternative tax (MAT) of 18.5 percent of book profits.
Another one of the types of direct tax is capital gains tax, which can be imposed on individuals as well as companies. Capital gains are made when an asset is sold for a profit. These assets can include equity, mutual funds, land, apartments, offices etc. There are two types of capital gains tax – long-term capital gains (LTCG) tax and short term capital gains (STCG) tax.
LTCG and STCG means different things for different assets. Let’s look at some of these assets
|Asset||STCG duration||LTGG duration||STCG Tax||LTCG Tax|
|Equity||Less than a year||Over a year||15 percent plus surcharge||10 percent for gains over Rs 1 lakh without indexation|
|Equity oriented mutual funds||Less than a year||Over a year||15 percent plus surcharge||10 percent for gains over Rs 1 lakh without indexation, or 20 percent with indexation|
|Debt funds||Less than three years||Over three years||Added to income and taxed according to slab||20 percent with indexation|
|House||Less than three years||Over three years||Added to income and taxed according to slab||20 percent with indexation|
We have mentioned the word `indexation’ here. Indexation means adjusting the purchase price of the asset for inflation. This raises the purchase price and so lowers your capital gains, and hence tax.
This is a type of direct tax imposed on transactions conducted on the stock exchange. Trading in equities, futures and options is taxed, and vary from 0.017 percent to 0.25 percent. This tax will increase the cost of transactions.
Goods and services tax (GST)
In order to reduce different types of indirect tax and makes things easier for taxpayers, the government introduced uniform GST for various goods and services across the country. While the same rates apply all over the country, different goods and services are charged differently. There are five slabs currently, ranging from 0 percent to 28 percent.
Tax rates are fixed by the GST council, which is headed by the Union finance minister. Members include finance ministers from all the states. Some governments prefer indirect taxes since they do not hit citizens directly, and so causes less outrage when rates are increased. However, indirect taxes tend to be regressive.
Though most indirect taxes now come under the GST umbrella, there are some exceptions. This has been made to benefit the states, to which excise revenues accrue. Some of the products that come under the excise umbrella are liquor for human consumption and petroleum products.
Customs duties are imposed whenever goods are brought into the country. These account for only a small portion of the total taxes collected. Customs duties are not just a source of revenue for the government; they may also be used to serve other purposes like discouraging the import of certain products or check anti-dumping. For example, there is an anti-dumping duty if products are imported at prices that may even be below production cost. Customs duty rates can vary between 0 percent and 150 percent.
As we have seen, there are different types of direct and indirect taxes that are imposed in India. Whether the government chooses direct or indirect taxes depends on its priorities. But generally most countries have a mix of both to maximise tax revenues. There are some who feel that direct taxes, since they are imposed on income, may act as a disincentive for individual effort and initiative and hence economic growth. Others say that indirect taxes are regressive, with the burden disproportionately more on poorer people. But in India, the government has the potential to increase direct taxes like income tax without raising rates or changing tax laws. More enforcement will probably swell the government’s coffers. But can anyone bell that cat?