Direct taxes

1. Meaning, incidence and fiscal significance

A direct tax is assessed on the income, profits or wealth of a person or entity that is legally responsible for paying it. Personal income tax and corporation tax are the leading Indian examples. Unlike GST, which is collected through suppliers on taxable supplies, income tax is assessed with reference to the taxpayer’s taxable income. The familiar distinction is that direct taxes are ordinarily borne by the assessed taxpayer, whereas indirect taxes can be passed to consumers.

This distinction is not economically absolute. Tax impact refers to the initial legal burden, while tax incidence refers to the ultimate economic burden. A corporation may partly shift its tax burden through higher prices, lower wages or reduced returns to shareholders. Incidence depends on competition, market conditions and the responsiveness of supply and demand.

Direct taxes finance public expenditure and can redistribute resources through progressive rates. A progressive tax takes a larger proportion of income as income rises; proportional taxation applies a constant rate, while regressive taxation imposes a relatively heavier burden on lower-income groups. Progressive income taxes also act as automatic stabilisers: collections generally rise during expansion and fall during downturns without fresh legislative changes.

• Horizontal equity: taxpayers with similar ability to pay should face similar burdens.
• Vertical equity: taxpayers with greater ability to pay should contribute more.
• Buoyancy measures revenue responsiveness to GDP, including policy changes; elasticity attempts to exclude their effects.

2. Constitutional powers and tax administration

India’s Constitution distributes taxation powers through specific entries in the Seventh Schedule. Parliament taxes income other than agricultural income under Union List Entry 82 and corporation tax under Entry 85. States can tax agricultural income under State List Entry 46. Taxes on lands and buildings fall under State List Entry 49. Consequently, property tax collected by municipalities should not be confused with Union income tax; municipal taxing powers operate through state legislation and the constitutional framework of Article 243X.

Article 265 requires legal authority for both the levy and collection of a tax. Annual Finance Acts commonly amend tax provisions following the Union Budget. For financial year 2025–26, the relevant framework is the Income-tax Act, 1961, as amended. The Income-tax Act, 2025 is scheduled to take effect from 1 April 2026; aspirants should distinguish an enactment date from its commencement date.

The CBDT administers Union direct taxes through the Income Tax Department. PAN identifies taxpayers, while TAN is relevant to entities deducting or collecting tax at source. Advance tax, self-assessment tax and TDS are mechanisms for collecting liability. Under Article 270, eligible Union taxes enter the divisible pool shared with states. Union surcharges and cesses levied for specific purposes are excluded from this pool.

• Agricultural income is not entirely outside constitutional taxation powers: states possess the relevant power.
• Agricultural income may affect the rate applied to non-agricultural income through partial integration where prescribed conditions are met.
• The Finance Commission recommends the distribution of the divisible pool; it does not itself levy taxes.

3. Personal income tax and capital gains

For financial year 2025–26, taxable income is organised under five heads: salaries, income from house property, profits and gains of business or profession, capital gains, and income from other sources. Tax liability also depends on residential status and the source or receipt of income. Residence is determined through statutory conditions, not simply citizenship. Residents ordinarily resident generally face taxation on worldwide income, subject to applicable provisions and treaty relief.

India offers an old regime with several deductions and exemptions and a default new regime with revised slabs but fewer concessions. Under the new regime for financial year 2025–26, the slabs are: nil up to ₹4 lakh; 5% from ₹4–8 lakh; 10% from ₹8–12 lakh; 15% from ₹12–16 lakh; 20% from ₹16–20 lakh; 25% from ₹20–24 lakh; and 30% above ₹24 lakh. Higher rates apply only to income within the respective slabs.

For eligible resident individuals under this regime, the Section 87A rebate can eliminate tax on total income up to ₹12 lakh, excluding the benefit for tax on specially rated income. The ₹75,000 salary standard deduction can make ordinary salary income up to ₹12.75 lakh tax-free, subject to conditions. This is not a ₹12 lakh basic exemption limit. Capital gains arise from transfers of capital assets; rates and holding-period rules depend on the asset and applicable law.

• An exemption, deduction and rebate operate at different stages of tax computation.
• Surcharge is an additional charge on tax; health and education cess is 4% of income tax plus applicable surcharge.
• Capital gains tax forms part of income taxation, rather than being a tax on every sale’s gross proceeds.

4. Corporation tax and related instruments

Corporation tax is charged on taxable company profits, not gross turnover. Taxable profits may differ from accounting profits because tax law specifies allowable deductions, depreciation and other adjustments. A domestic company choosing Section 115BAA is generally taxed at a 22% base rate after foregoing specified incentives. Including the prescribed surcharge and cess, the effective rate is 25.168%.

Section 115BAB provides a 15% base rate for qualifying new domestic manufacturing companies satisfying incorporation, commencement and other conditions. The manufacturing commencement deadline was 31 March 2024. Its effective rate, including surcharge and cess, is 17.16%. Therefore, neither 22% nor 15% is a universal rate for every Indian company. Minimum Alternate Tax addresses cases in which certain companies report book profits but have low normal tax liability; companies opting for these concessional regimes are exempt from MAT.

Securities Transaction Tax applies to specified securities transactions and is distinct from capital gains tax. Wealth tax was abolished from assessment year 2016–17, and estate duty was abolished in 1985. These historical changes do not mean that income generated by assets or gains from their transfer are necessarily untaxed.

• Distinguish a base tax rate from an effective rate including surcharge and cess.
• Tax incentives can encourage investment but create revenue costs, complexity and unequal treatment.

5. Compliance, avoidance and policy challenges

Tax evasion involves illegal concealment or misreporting, such as suppressing receipts or claiming fictitious expenses. Tax avoidance generally uses legal arrangements to reduce liability, but abusive arrangements can be challenged through anti-avoidance provisions. Legitimate tax planning uses benefits in accordance with legislative intent. India’s General Anti-Avoidance Rules became applicable from assessment year 2018–19 and target impermissible avoidance arrangements, subject to statutory safeguards.

International taxation addresses income crossing national borders. Double Taxation Avoidance Agreements allocate taxing rights and provide relief; they do not promise that income will remain untaxed everywhere. Transfer-pricing rules require covered related-party transactions to satisfy the arm’s-length principle. The OECD/G20 Base Erosion and Profit Shifting project tackles strategies that artificially shift profits away from jurisdictions where economic activity occurs.

Digital returns, the Annual Information Statement, third-party reporting and faceless procedures can improve compliance and reduce direct interface. Nevertheless, a wider information network must be accompanied by data security, effective grievance redressal and timely refunds. India’s challenges include informality, litigation, narrow effective coverage and balancing revenue mobilisation with investment incentives. More return filers do not necessarily mean an equal increase in persons with positive tax liability.

• A sound direct-tax system combines equity, certainty, administrative simplicity and predictable enforcement.
• Tax expenditure refers to revenue forgone through concessions relative to a benchmark tax structure.

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