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Taxation System Of India

Taxation System Of India

The taxation system of any country falls into three main categories: regressive, proportional, and progressive taxes.

REGRESSIVE TAXES

  • Regressive taxes are those that have a greater impact on low-income individuals or entities than high-income earners.
  • Tax rates reduce with rise in income. Thus, marginal tax rates are lower than average tax rates. This system is not followed because it adversely affects the poor people of a country.

PROPORTIONAL TAXES | Taxation System Of India

  • A proportional tax, also referred to as a flat tax, impacts low, middle, and high income earners relatively equally. Under a proportional tax system, individual tax payers pay a set percentage of their income regardless of the total income earned. In this taxation system, the marginal tax rate is equal to the average tax rate.
  • For example, an income tax of 10% that does not increase or decrease as income rises or falls results in a proportional tax.

PROGRESSIVE TAXES | Taxation System Of India

  • A progressive tax has more impact on high income individuals and businesses, and less financial impact on low income earners. The current income tax is a progressive tax system; the proportion of tax liability rises as an individual or entity’s income increases.
  • Under a progressive tax system, taxes assessed on income and business profits are based on a progressive or increasing tax rate schedule. Marginal tax rates under a progressive tax system are often higher than the average tax rates.

DIRECT AND INDIRECT TAXES      | Taxation System Of India

  • A direct tax refers to any levy that is both imposed and collected on a specific group of people or organizations. An example of direct tax is the income tax collected from the people who actually earn their income.
  • Indirect taxes are imposed on one person or organization but collected from some other person or organization.
  • For instance, Goods and Services Tax (GST) is an indirect tax because the money is collected from merchants, not from the people who actually pay the tax (the consumers). When merchants sell commodities to consumers, they include the GST in the selling price of the commodities. They recover the GST from the consumers and deposits the tax with the government. Here, GST is levied on merchants but is collected from consumers.

 

BASIS FOR COMPARISON

 

DIRECT TAX

 

INDIRECT TAX

 

 

MEANING

 

Direct tax is referred to as the tax levied on a person’s income and is paid by the same person to the government.

 

Indirect tax is referred to as the tax levied on a person who consumes the goods and services and is paid by other person to the government.

NATURE Progressive in nature because tax slab rate increase with increase in income. Regressive in nature. A particular commodity is taxed at the same rate. A poor person with limited resources finds it difficult to purchase the commodity when compared to the rich.
INCIDENCE AND, IMPACT Falls on the same person Falls on different persons
EXAMPLES Wealth tax, income tax, property tax, corporate tax Goods and services tax (GST), security transaction tax (STT), excise duty, custom duty
EVASION Tax evasion is possible. Tax evasion is difficult because the taxes on commodity are included in the price of that commodity.
INFLATION Direct tax helps in reducing inflation. Indirect taxes promote inflation.
EVENT Taxable income or wealth of the person Purchase/sale/manufacture of goods and delivery of services

 

Conclusion

  • Both the direct and indirect taxes have their merits and demerits. If we talk about direct taxes, they are equitable because they are charged on the persons according to their paying ability. The direct tax does not cover every section of the society because these taxes are not levied on poor.
  • On the other hand, if we talk about indirect taxes, they are easy to realize as they are included in the price of products and services. In addition, they cover every section of the society.

What Is Marginal Tax Rate?

  • The marginal tax rate is applied to the last rupee added to your taxable income. For example, if you are earning ₹500,001 per year, then your 500,001st rupee will be taxed at the 20% tax rate.
  • The 20% tax rate is the marginal tax rate in this case. It is important to mention that not all the income will be taxed at the 20% rate.

What Is Average Tax Rate?

The average tax rate is calculated by dividing the total taxes paid by your total income.

Total income taxes paid

Average tax rate (ATR) =

Total income

The average tax rate incorporates taxes paid. t all levels of income, so it is obvious that it will be less than the marginal rate.

IMPORTANT TAXES IN INDIA | Taxation System Of India

Income Tax

  • Income tax is a direct tax levied on the income of individuals or organizations. When Income tax is levied on individuals, it is called income tax. When income tax is levied on organizations (such as partnership firms, companies, etc.), it is called corporate tax.
  • The various types of incomes covered under income tax are as follows:
    • Salary
    • Business or profession profits
    • Rental income from property
    • Gains arising from sale of asset (capital gains)
    • Interest income, etc.

Excise Duty

  • Excise duty is an indirect tax levied at the time of manufacture of any product. The manufacturer is liable to pay excise duty when the goods are taken out of premises. Excise duty is no longer applicable from 1 July 2017. It has been replaced by Goods and Services Tax (GST).

Customs Duty

  • Customs duty is an indirect tax paid on the import of any product into the country or export of any product from the country. Various types of custom duties have been covered in detail under chapter 20, Trade Barriers to International Trade.
  • Customs duty has not been replaced with GST. On the other hand, additional customs duty has been replaced by GST.
  • It is over and above the customs duty. It is levied by importing nation to increase the price of an imported commodity when the price is low because exporting nation is providing subsidy on exports.

Service Tax

  • Service tax is an indirect tax paid on the sale of services. In the case of goods, there are two separate events of production and sale, whereas in the case of services, the production and sale of services occur simultaneously.
  • In case of goods, excise duty is levied on manufacture, and sales tax is levied on sale of goods. In case of services, single tax is levied, namely, service tax.
  • Service tax is no longer applicable from 1 July 2017. It has been replaced by Goods and Services Tax (GST).

Sales Tax or VAT | Taxation System Of India

  • Sales tax is levied on the sale of goods. In India, sales tax on intra-state sale is called value added tax (VAT) and inter-state sale is called the central sales tax. VAT and central sales tax are no longer applicable from 1 July 2017. They have been replaced by Goods and Services tax (GST).

Distribution of tax revenues

  • Income tax and customs duty are levied by centre and distributed between Centre and States on recommendation of Finance Commission.
  • Excise Duty, Service Tax, Central Sales Tax and VAT are no longer applicable. They have been replaced by GST. Distribution of GST is discussed further in this chapter.

What is value added tax?

  • Although VAT is used as a term for intra-state sales tax in India, it is a methodology to levy indirect taxes.

Meaning of VAT

  • VAT is a multi-point levy of sales tax that enables the person to claim set off of tax (input credit), which he/she has already paid on the purchases. The system of VAT is so designed that the final levy and burden of the tax on the goods is borne by the final consumer of the goods.

Levy of VAT

  • VAT is levied at every stage of production. It is levied only on the value added by the last seller. The seller is accordingly liable to pay tax on the net value added to the existing value of goods. VAT means a tax on the sale of goods at every stage when it changes hands with the provision of credits for input tax paid at the time of purchase of goods.
  • The primary objective of VAT is to remove the cascading effect of taxes. The dealer is able to claim the tax paid on purchase against the tax payable on sales.
  • Tax evasion is also difficult because the dealer would not purchase goods on which tax has not been paid because in such a scenario, he would have to pay full tax on the whole value of item and not just on value addition.
  • VAT is a method used to charge indirect taxes including GST.
    Tax collection chart (value in ₹1000 crore)
Year       Centre   Centre   Centre   States:   States:   States:     Direct    Indirect                        Tax
                  (gross):                (gross):  (gross):  direct     indirect  total tax                  taxes    taxes                        revenues
                  direct   indirect  total tax                taxes      taxes      revenue

taxes  taxes      revenue

2015-16 798 646 1444 98 796 894 896 1442 2338
2014-15 706 540 1246 109 736 845 815 1276 2091
2013-14 638 496 1134 88 624 712 726 1120 1846

Source: Budget documents of the Government of India and the state governments

 

GOODS AND SERVICES TAX (GST): CHANGE IN INDIRECT TAXATION SYSTEM | Taxation System Of India

  • Goods and Service Tax or GST is a tax levied on the supply of goods and services. It has replaced various taxes from 1 July 2017 and brought them under one umbrella to make tax compliance easier.
  • Taxes previously levied and collected by the Centre:
    • Central Excise duty
    • Additional Duties of Customs (commonly known as Counter Veiling Duty)
    • Service Tax
    • Central Sales Tax and
  • Taxes previously levied and collected by the State:
    • State VAT
    • Entertainment and Amusement Tax
    • Taxes on lotteries, betting, and gambling
    • Luxury Tax
    • Octroi

Components of GST: SGST, CGST and IGST

  • The GST levied on the intra-state (within a state) supply of goods or services by the Centre is called central GST (CGST) and that by the states is called state GST (SGST). On inter-state (between states) supply of goods and services, integrated GST (IGST) is collected by Centre. IGST is also applicable on imports.

Composition of the GST Council

  • The GST Council has the following composition:
    • Union Finance Minister as the chairman
    • Union Minister of State in charge of revenue or finance.
    • One nominated member from each state who is in charge of finance or taxation.
  • The GST council will be empowered to take decisions on the following matters:
    • The taxes, cess, and surcharge levied by the Union, the States, and the local bodies which may be subsumed in the goods and services tax.
    • The tax rates on goods and services.
    • Laws to implement GST.
    • Apportionment of integrated goods and services tax.
    • Exemptions from GST based on minimum turnover.
    • Special provision with respect to North East and hilly area states.
    • Any other matter relating to the goods and services tax, as the Council may decide.
  • All decisions at the GST council will be based on voting. Every decision of the GST council needs to be taken with a three-fourth majority. While the central government’s vote will have a one-third weightage, the votes of all the state governments put together will have a two-third weightage, thus making a near-consensus between the centre and the states an imperative for any major decision.

GST Rate | Taxation System Of India

  • The GST rate has not been capped. It has been decided by the GST Council and will be reviewed by the council from time to time.

Commodities Outside GST

  • The Government of India will continue to charge the central excise duty on all petroleum and natural gas products, tobacco, and opium products. GST on the above products will be applicable at a later stage, which will be decided by the GST Council.
  • Only alcohol has been kept out of the purview of GST. Thus, existing central and state taxes will continue to apply on alcohol.

Compensation to States

  • The Parliament has agreed to compensate states for any loss of revenues, on account of change in taxation system to GST, for a period of 5 years.
  • A shift to new taxation system initially reduces tax compliance among the people and thus in the initial years, the revenue of state governments may reduce.
  • However, in the long run, GST will lead to increase in the revenue of state governments.

Implications of Introducing GST

  • As GST is a uniform taxation system applicable throughout the country, it will create a uniform market across the country and make taxation transparent and hassle free.
  • GST has subsumed many taxes, and thus it has made the taxation system simple and reduced the cost of complying the taxation system.
  • The earlier system of numerous tax departments hampered inter-department coordination and made tax evasion possible. GST will drastically increase the tax base and reduce tax evasion.
  • After introduction of GST, most of the goods will be cheaper. The rate of tax under GST is less compared to the tax rates existing earlier. In fact, the GST rate for essential commodities is 0%.
  • The reduction in tax burden will reduce the price of goods, lower the production cost, and improve exports. Thus, in the long run, implementation of GST will create a large number of jobs.
  • Services are presently taxed at 15%. The GST rate for most of the services is around 18%. Thus, services are expected to be costlier.

Administration of GST

  • As decided by the GST Council, the tax base will be shared between the assessment machinery of the centre and the states. A 90:10 formula was agreed upon for dual control of assesses.
  • As per the formula for dual control of assesses, 90% of those with a GST turnover of ₹1.5 crore or less will be assessed by the administrative machinery of the states, and 10% by the administrative machinery of the centre.
  • Those above a turnover of ₹1.5 crore would be assessed in the ratio of 50:50 between the centre and the states.
  • The territorial jurisdiction between the centre and the states was also decided. The states have been given the right to tax transactions up to 12 nautical miles. (1 nautical mile = 1.853 km)

Rates of GST | Taxation System Of India

The goods and services tax (GST) has goods and services categorized under the following slabs:

No tax

  • Goods: No tax will be imposed on items such as fresh meat, fish, chicken, eggs, milk, butter milk, curd, natural honey, fresh fruits and vegetables, flour, besan, bread, prasad, salt, bindi, sindoor, stamps, judicial papers, printed books, newspapers, bangles, handloom, etc.
  • Services: Hotels and lodges with tariff below ₹1000, grandfathering service has been exempted under GST.

5% GST

  • Goods: Items such as fish fillet, cream, skimmed milk powder, branded paneer, frozen vegetables, coffee, tea, spices, pizza bread, rusk, sabudana, kerosene, coal, medicines, stent, lifeboats will attract a tax of 5%.
  • Services: Transport services (railways, air transport), small restaurants will be under the 5% category because their main input is petroleum products, which is outside the GST ambit.

12% GST

  • Goods: Frozen meat products, butter, cheese, ghee, dry fruits in packaged form, animal fat, sausage, fruit juices, namkeen, Ayurvedic medicines, tooth powder, agarbatti, colouring books, picture books, umbrella, sewing machine, cell phones will be under 12% tax slab.
  • Services: Non-AC hotels, business class air ticket, fertilizers, work contracts will fall under 12% GST tax slab.

18% GST

  • Goods: Most items are under this tax slab, which include flavoured refined sugar, pasta, cornflakes, pastries and cakes, preserved vegetables, jams, sauces, soups, ice cream, instant food mixes, mineral water, tissues, envelopes, note books, steel products, printed circuits, camera, speakers, and monitors.
  • Services: AC hotels that serve liquor, telecom services, IT services, branded garments, and financial services.

28 % GST

  • Goods: Chewing gum, molasses, chocolate not containing cocoa, pan masala, aerated water, paint, deodorants, shaving creams, after shave lotions, hair shampoo, dye, sunscreen, wallpaper, ceramic tiles, water heater, dishwasher, weighing machine, washing machine, ATM, vending machines, vacuum cleaner, shavers, hair clippers, automobiles, motorcycles, and aircraft for personal use, will attract 28% tax, the highest under the GST system.
  • Services: Five-star hotels, race club betting, cinema will attract 28% tax slab under GST.

3% GST

  • Goods: Gold, silver, and diamonds are placed in the category of 3%, while rough diamonds would attract a nominal rate of 0.25%.
  • Note: The list of rates is only for understanding the slab rates under GST and is not required to — be learnt.

Input Credit Under GST

  • Input credit means at the time of paying tax on output, one can deduct the tax already paid on inputs.

Let us suppose a service provider delivers services on which the tax payable is ₹500 and consumes goods and services on which he has already paid tax of ₹370.Therefore,

  • Tax payable on output is ₹500
  • Tax paid on input (purchases) is ₹370
  • The service provider can claim input credit of ₹370 and is required to deposit only ₹130 in taxes.

Conditions for Claiming Input Credit 

  • Input credit can be claimed subject to the following conditions:
  • Supplier has filed GST returns: Input credit is only allowed if the supplier has deposited the tax that he/she has collected from the purchaser. Thus, every input credit that can be claimed shall be matched and validated before it can be claimed.
  • If the tax on purchases is higher than tax on sale, then some input credit will remain unclaimed. In such a case, one is allowed to carry forward or claim a refund.
    • If tax on inputs > tax on output carry forward input tax or claim refund
    • If tax on output > tax on inputs pay balance
  • No interest is paid on input tax balance by the government.
  • Since GST is charged on both goods and services, input credit can be availed on both goods and services.
  • Input tax credit is allowed on capital goods.
  • Input tax credit is not allowed for goods and services for personal use.

Challenges in Introduction of GST  | Taxation System Of India

GST is meant to simplify the Indian indirect tax regime by replacing number of taxes by a single unified tax. However, there are number of challenges for its successful implementation.

  • IT infrastructure and staff training: A huge chunk of tax compliance has shifted online with the implementation of GST, necessitating upgrading systems as well as staff’s skills. The government has launched the portal www.gst.gov.in to facilitate enrolment, registration and filing returns. Businesses are required to make investments to ensure that their tax compliance structure conforms to the GST system. Also, staff requires training not only to understand the tax implications of GST, but also on the procedural aspects like enrolling and uploading returns online.
  • Issue of casual taxable person: If a person registered in one state moves to another state for a short period for some business transaction such as to participate in a fair or exhibition, then that person would have to get himself registered in that state. The GST law requires the casual taxable person to pay taxes in advance by making an estimate of the sales.
  • Multiple registrations under states and centre: GST requires businesses operating in multiple states to obtain a separate registration number in each state and separate returns are to be filed. Such complexity is due to presence of state GST. Such requirement makes GST compliance a very cumbersome process.
  • Increase in tax rates for some commodities: One of the earlier expectation from GST was reduction in tax rates on goods and services. However, the peak rate under GST is 28 per cent (which can go up to 40 per cent) and there is a cess of 15 per cent over and above the peak rate for demerit goods.
  • Infrastructure for the collection process: Proper infrastructure is not yet in place to track the movement of goods and services between states, collection and monitoring of revenue, identify defaulters, etc.
  • Frequency of returns: The frequency and number of returns under GST system has significantly increased. Return filing is mandatory under GST. Even if there is no transaction, one must file a nil return. There are monthly and quarterly returns. One cannot file a return if previous returns are pending. Late filing of GST return has a cascading effect, leading to heavy fines and penalty

TAX-TO-GDP RATIO | Taxation System Of India

  • India needs to increase its tax—GDP ratio. India’s tax-to-GDP ratio is at 16.6% and is well below the emerging market economies, average of which is about 21%. The tax level of developed countries is even higher, at an average of about 34%. India’s overall tax to GDP is about 5.4 percentage points less than the level of other emerging economies.

LAFFER CURVE

  • The Laffer curve was developed by economist Arthur Laffer to show the relationship between tax rates and the amount of tax revenue collected by governments.
  • According to the curve, increase in tax rate up to a certain point leads to an increase in tax revenues. Beyond that point, any increase in tax rate leads to fall in tax revenues. This is due to the fact that high tax rates discourage economic activity.

MINIMUM ALTERNATE TAX |Taxation System Of India

  • The concept of minimum alternate tax (MAT) was introduced to tax companies making high profits and declaring dividends to their shareholders under the Companies Act but have no significant taxable income under the Income Tax Act because of exemptions, deductions and incentives provided under the Income Tax Act. The intent of introducing MAT was to ensure that no taxpayer with substantial income can avoid tax liability by using exclusions, deductions, and incentives.
  • Under the provisions of the Income Tax Act, where the income tax calculated is less than 18.5% of the book profits (as per the Companies Act), such book profits shall be deemed to the total income of the assessee and tax payable by the assessee shall be 18.5% on book profits.

Why Does It Arise?

Income tax is charged on income. There are two different ways to compute income:

  • Income as per Companies Law
  • Income as per Income Tax Law

What Are the Differences in These Two Incomes?

  • Mostly the two incomes are different because income tax has different rules for computing the income of a company. For example,
  • The amount of “depreciation” reduced from profit is different.
  • Sometimes, income tax allows for extra deduction of income (for example, if you have spent ₹100, then you can reduce ₹200 from your profit).

Finance Commission | Taxation System Of India

  • Article 280 provides for a Finance Commission as a quasi-judicial body. It is constituted by the President every fifth year or even earlier. It is required to make recommendations to the President on the following matters:
  • The distribution of taxes to be shared between the Centre and the States, and the allocation among the states, the respective share of proceeds.
  • The principles which should govern the grants-in-aid to the States by the Centre.
  • The measures needed to augment the Consolidated Fund of a state to supplement the resources of the panchayats and the municipalities in the state.
  • Any other matter referred to it by the President in the interests of sound finance.
  • Till date, 14 Finance Commissions have been appointed. The 14th finance commission is appointed for the period 2016-2020. It is headed by ex-RBI governor Dr. Y. V Reddy.
  • The 14th finance commission recommended that the share of States in central taxes be increased to 42% from existing share of 32%. This recommendation has been accepted in order to give more liberty to states to spend funds according to schemes drafted by themselves rather than schemes drafted by the Central government.

Impact on Role of Finance Commission with the Introduction of GST

  • Finance commission divides the pool of central taxes among the Centre and the States. Before introduction of GST, this divisible pool comprised corporation tax, income tax, excise duty, service tax, and customs duty. After the introduction of GST, the divisible pool is left with corporation tax, income tax, and customs duty only. Thus, introduction of GST has reduced the role of Finance Commission.

 

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