Lesson

Direct Tax at a Glance

1

KEY CONCEPTS
n Taxes n Direct Tax n Indirect Tax

Learning Objectives
To understand:
 Genesis & Meaning of Taxes
 Key Definitions of Tax
 Rationale to levy Tax
 Types of Taxes
 Characteristics of Taxes
 Objectives of Taxation
 Direct vs. Indirect Tax
 Background of Indian Taxation System and its structure
 Tax Administration

Lesson Outline
 Taxes – An Introduction
 Characteristics of Taxes
 Objectives of Taxation
 Direct vs. Indirect Taxation
 Background of Taxation System of India
 Tax Structure
 Tax Administration
 Lesson Round-Up
 Test Yourself

 List of Further Readings

 Other References

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EP-TL&P Direct Tax at a Glance

REGULATORY FRAMEWORK
l Income Tax Act, 1961 (the Act)
l Income Tax Rules, 1962 (the Rules)

TAXES - AN INTRODUCTION

Genesis of Tax
The word tax is based on the latin word taxo which means to estimate. Taxation has existed since the birth of
early civilization. In ancient times taxes were either material or money like goods or services in the primitive
society. The subjects used to pay a share of their income to the head of a tribe or to the King who in return
provided them with the administration security from foreign aggression and other civic amenities.
In the medieval centuries feudalism was founded, so the origin of modern tax system was also founded. Feudal
market dues, tolls for protection and use of road, bridges, ferries, land rent, and other payment in goods and
services were gradually transferred into money payment with the rise of money economy, Kings liked to receive
money and the people preferred to pay money instead of goods and services. Step by step the old feudal
revenue system changed into taxation.
Thereafter, with the development of economic sciences and with the passage of time, the functions of modern
state appeared and taxation gradually became a tool of usage with more than one goal and became important
source of revenue. During 19th and 20th centuries, there has been both qualitative and quantitative change in
the public expenditures. Taxation has passed through the stages with passage of time, and tax’s functions and
objectives also have changed from the ancient communities to medieval societies and modern societies also,
so the tax system has evolved with the evolution of the functions of the modern state.

Meaning of Tax
A tax is a financial charge or other levy imposed upon a taxpayer (an individual or legal entity), collected by a
state or the functional equivalent of the same, such that failure to pay, or evasion of or resistance to collection
of tax, is punishable by law. The principle reason for taxation was to pay for government expenditures.

A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer (an individual
or legal entity) by a governmental organization in order to fund government spending and various public
expenditures (regional, local, or national), and tax compliance refers to policy actions and individual
behaviour aimed at ensuring that taxpayers are paying the right amount of tax at the right time and securing
the correct tax allowances and tax reliefs.

Key Definitions
There is no precise and accurate definition for the term tax and the concept of tax has been defined differently
by different economists. Some definitions are as follows.
“A tax is compulsory contribution from the person to the government to defray the expense incurred in the
common interest of all without reference to special benefits conferred”. - Prof Seligman
“A tax as a share of the income of citizens which the state appropriate in order to procure for itself the means
necessary for the production of general public services”. - Deviti. De Marco
“A tax is a compulsory charge imposed by a public authority irrespective of the exact amount of service rendered
to the tax payer in return and not imposed as a penalty for legal offence”. - Hugh Dalton
“A tax as a pecuniary burden imposed for support of the government, the enforced proportional contribution of
persons and property of the government and for all public needs”. - Jom Bouvier

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Direct Tax at a Glance LESSON 1

From the above definitions we may conclude that a tax is compulsory contribution, levied by government from
owner of income without direct benefit but for public benefit, and taxes should be arranged by the law.

Rationale to levy Tax

The taxes collected have been used by the government to carry out many functions. Some of these include:
l Expenditures on war,
l The enforcement of law and public order,
l Protection of property,
l Economic infrastructure (such as roads, legal tender, enforcement of contracts, etc.),
l Public works,
l Social Engineering,
l The operation of Government itself, and
l To fund welfare and public services such as education systems, health care systems, pensions for
the elderly, unemployment benefits, and public transportation, energy, water and waste management
systems, common public utilities, etc.
Modern social security systems are intended to support the poor, the disabled, or the retired person by taxes
on those who are still working. In addition, taxes are applied to fund foreign aid and military ventures, to inflate
the macroeconomic performance of the economy or to modify patterns of consumption or employment within
an economy, by making some classes of transaction more or less attractive. Thus, there is no doubt that most
government expenditures must be paid through the taxation system and it is reasonable to see this as the
principle function of taxation. Yet there have always been a variety of subsidiary objectives of taxation.
In the present time, taxation is not just a means of transferring money to the government to spend it for meeting
the public expenditures or raise revenue to the government, but taxes have become beside that, a tool for
reduced demand in the private sector, redistribution of income and wealth in the societies in the countries.
It is also a means for economic development and for playing very important role in the case of stabilization
of income, protection of domestic industries from foreign ones. Taxation helps to find out solutions for some
economic problems that face the state, like unemployment, inflation, and depression. Countries practice
sovereignt authority upon citizens, through levy of Taxes.

CHARACTERISTICS OF TAXES

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EP-TL&P Direct Tax at a Glance

1. Tax is Compulsory and not Voluntary – A tax is imposed by law. So tax is compulsory payment to the
Governments from its citizens. Tax is duty of every citizen to bear his share for supporting the government.
The tax is compulsory payment, refusal or objection for paying tax due leads to punishment or is an
offence of the Court of law.
2. Tax is Contribution – Contribution means in order to help or provide something. Tax is contribution from
members of community to the Government. A tax is the duty of every citizen to bear their due share
for support to government to help it to face its expenditures. Some wants are common to everybody in the
society like defence and security, so these wants cannot be satisfied by individuals. These social wants
are satisfied by Governments, hence it is the duty of the people to support government for these social
wants.
3. Tax is for Public Benefit – Tax is levied for the common welfare of society without regard to benefit to
any special individual. Government proceeds are spent to extend common benefits to all the people.
4. Tax is paid out of Income of the tax payer – Income means money received, especially on regular
basis, for work or through investment. Tax is paid out of income as long as the income becomes realized,
here the tax is imposed. Income owner has profit from any business, so he should pay his share to
support the Government.
5. Government has the power to levy Tax – Governments are practicing sovereign authority upon the
citizens through levying of taxes. Only government can collect tax from the people.
6. Tax is not the cost of the benefit – Tax is not the cost of benefit conferred by the government on
the public. Benefit and taxpayer are independent of each other, and payment of taxation is of course
designed for conferring of benefits on general public.
7. Tax is for the economic growth and public welfare – Major objective of the government is to maximize
economic growth and social welfare. Developmental activities of the nations generally involve two
operations, the raising of revenue and the spending of revenue, so the government spends taxes for
economic benefit, for entire community and for aggregate welfare of the society.

OBJECTIVES OF TAXATION
The primary purpose of taxation is to raise revenue to meet huge public expenditure. Most governmental
activities must be financed by taxation. But it is not the only goal. In other words, taxation policy has some non-
revenue objectives. In today’s scenarios, taxation besides being the main resource for supporting government
has became a tool for economic growth, social welfare; attract foreigner investment, economic stability, and
income distribution. The Objectives of taxation in brief are as under:-
l Source of Revenue to Government: Taxes are imposed so as to produce the necessary amount of
revenue to meet the requirement of the government, as the public expenditure is increasing in scope
and size day by day. Therefore, the main objective of taxes is to raise revenue to meet the government
expenditures adequately.
l Redistribution of Income and Wealth: Income differs from one person to another in the society. Inequity
in income leads to many evils, and the government aims to reduce inequalities between members of
the society, to secure social justice. Tax is a means of ensuring the redistribution of income and wealth
in order to reduce poverty and promote social welfare. For achieving these goals, government adopts
the following:
i. Imposition of high rate tax upon luxury commodities.
ii. Applying progressive tax system when levying taxes from taxpayers.
iii. Imposition of tax exemption to basic goods.

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Direct Tax at a Glance LESSON 1

l Social welfare: Social welfare is the basic need of the society in the modern age. The government
functions have become very important to the society, because the society needs saving, protection,
education, health, and so on. All these functions are necessary to make social welfare, so the
government receives revenue from tax, and expends it for those functions. Therefore revenue from
taxes is fuel to the government for social welfare.

l Safety of society from bad and injurious customs: Fighting the bad customs in the society is the
primary task of the government, so tax is a tool for fighting some of those customs. From this angle tax
imposition of very high percentage on the goods like tobacco and alcohol is an effort to reduce these
habits.

l Economic Significance of Taxes: Taxes are used from economic point of view, so taxation helps to
encourage some economic activities, and as a tool to solve some economics problems. Tax is also a
means for directing of scarce economic activities. Taxation helps to accelerate economic growth, and
taxation plays very important role in case of economic stability.

l Economic growth: Taxes are considered as a tool for economic growth and it helps to accelerate growth
of economic development. Economic development has placed considerable emphasis on objectives of
taxation policy. Economic development is the main objective in all the countries of the world. Economic
development depends on mobilization of resources and efficient use of such resources between
different sectors of the economy activities. Tax policy must be designed so as to mobilize the internal
resources and use these resources in productive manner.

l Enforcing Government Policy: Government policy can easily be enforced by adoption of suitable tax
policy. The Government can encourage investment, saving, consumption, export, protection of home
industry, employment, production, protection of society from harmful customs, and economic stability
through suitable tax policy.

l Economic Stability: Maintaining economic stability is one of the tax objectives. Economic stability is
a very important factor for the sustained economic growth. Government can effectively use taxes in
the case of inflation and depression. These may be increased in inflationary situations. Increase in
the rates of existing taxes and the imposition of new taxes would check consumption, decrease the
level of effective demand and therefore help in bringing up stability in prices. Heavy taxation transfer
purchasing power from the hand of people to the government which if used for productive purpose will
increase the level of economic activity and employment.

In the case of depression taxes play an important role. Purchasing power in the hands of people is reduced
and they are able to spend less and the demand for commodities and services is reduced. All these lead to a
shrinkage of business activity and employment. In this case government should increase the purchasing power
in the hands of public through reducing the burden of taxation on the people and impose tax upon saving so
that people may be encouraged to spend more and thus help to create more demand for goods and more
business activity and employment.

DIRECT VS. INDIRECT TAX

Taxes are usually classified into two categories. These are direct tax and indirect tax. A direct tax is “one which
is demanded from the very persons who, it is intended or desired, should pay it. Indirect taxes are those which
are demanded from one person in the expectation and intention that he shall indemnify himself at the expense
of another.”

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EP-TL&P Direct Tax at a Glance

Direct Taxes: Taxes which are directly levied on Income of the person and its burden cannot be shifted. For
example - Income Tax.
Indirect Taxes: Indirect taxes are imposed on price of goods or services. Person paying the indirect tax can
shift the incidence to another person. For example - GST or Customs duty.

Differences between Direct Tax and Indirect Tax

Point of Direct Tax Indirect Tax

Difference
Meaning Direct tax is a tax wherein the levy of tax is In this the levy of tax is made on one person
made on a person and the responsibility of and the responsibility of paying the tax to the
paying such tax is fixed on that person. Government is fixed on some other person.
Levy Direct tax is levied on person. Indirect tax is levied on goods and services.
Transfer of Tax The burden of direct tax cannot be The burden of indirect tax can be transferred
Burden transferred to other person. to the end users.
Effect The purpose of direct tax is to redistribute Indirect tax increases the price of goods or
the wealth of a nation. services.
Example Income Tax. Goods and Services Tax.
Penalty It is levied on the Assessee. It is levied on supplier of Goods & Services.

Merits of Direct Tax

1. Equity: Direct taxes have equity of sacrifice, depend upon the volume of income. They are based on the
progressive principle, so rates of tax increase as the level of income of a person rises.
2. Elasticity and productivity: Direct taxes have elasticity because when the government faces some
emergency, like earthquake, floods and famine, the government can collect money for facing those
problems through the mode of Direct tax.
3. Certainty: Direct tax has certainty on both sides ‘tax-payer’ and ‘government’. The tax-payers are
aware of the quantity of tax. They have to pay and rate, time of payment, manner of payment, and
punishment from the side of government is also certain about the total amount they are getting.
4. Reduce inequality: Direct taxes follow progressive principles so it is taxing the rich people with higher
level of taxation and the poor people with a lower level of taxation.
5. Good instrument in the case of inflation: Tax policy as fiscal instrument plays important role in the
case of inflation, so government can absorb the excess money by raising in the rate of existing taxes or
imposition of new taxes.
6. Simplicity: The rules, procedures, regulations of income tax are very clear and simple.

Demerits of Direct Taxes

1. Evasion: Direct tax is lump sum therefore tax payers may try evasion.
2. Uneconomically: Expenses of collection are higher in the case of direct taxes, because they require
widel - spread staff for collection.
3. Little incentive to work and save: In Direct taxes, rates are of progressive nature. A person with higher

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Direct Tax at a Glance LESSON 1

earning is taxed more, in turn he is left little with amount. So the tax payer feels disincentive to work
hard and save money after reaching a certain level of income.
4. Not suitable for a poor country: Direct taxes are not enough to meet its expenditure.
5. Arbitrary: Due to absence of logical or scientific principle to determine the degree of progression in the
taxation, the direct taxes are arbitrary.

Merits of Indirect Taxes

1. High revenue production: Nature of indirect taxes is imposition on the commodities and services. Here
indirect taxes cover a large number of essential goods and luxurious goods which are consumed by the
mass both rich and poor people, these help in collecting large revenue.
2. No evasion: Nature of indirect tax is that, it is included in the price of commodity, so tax evasion or tax
avoidance is difficult.
3. Convenient: Indirect taxes are small amount and indirect taxes are hidden in the price of goods and
services, hence the burden of these taxes is not felt very much by the tax-payers, and not lump sum like
direct taxes.
4. Economy: Indirect taxes are economical in collection and the administrative costs of collection are very
low. Also the procedure of collection of these taxes is very simple.
5. Wide coverage: Indirect taxes cover almost all commodities like essential commodities, luxuries, and
harmful ones.
6. Elasticity: Since a large number of commodities and services are covered by indirect taxation there is
great scope for modifying of taxes, goods and tax rate, much depends on nature of goods and on their
demands.

Demerits of Indirect Taxes

1. Regressive in effect: Essential commodities are used by all members of community. When taxing these
commodities the burden would be equal, and no distinction is made between the rich and poor people.
2. Uncertainty in collection: Discourage savings and Increase inflation. Indirect taxes are payable when
people spend their income or when people buy goods and services, so tax authorities cannot accurately
estimate the total yield from different indirect taxes.
3. Discourage savings - Increase inflation: Indirect taxes are included in the price of commodity, so
people have to spend more money on essential commodities, when levied indirectly. That means the
customers cannot save some of their money.
4. Increase inflation: Indirect taxes increase the cost of input and output, increase in production cost, push
the price of goods. These reflect an increase in the wages of the workers.

BACKGROUND OF TAXATION SYSTEM OF INDIA

Taxation in India during Ancient Times

It is a matter of general belief that taxes on income and wealth are of recent origin but there is enough evidence
to show that taxes on income in some form or the other were levied even in primitive and ancient communities.
The origin of the word “Tax” is from “Taxation” which means an estimate. Nearly 2000 years ago, there went
out a decree from Ceaser Augustus that all the world should be taxed. In Greece, Germany and Roman Empires,
taxes were also levied sometime on the basis of turnover and sometimes on occupations. For many centuries,
revenue from taxes went to the Monarch. In Northern England, taxes were levied on land and on moveable
property such as the Saladin title in 1188. Later on, these were supplemented by introduction of poll taxes, and
indirect taxes known as “Ancient Customs” which were duties on wool, leather and hides. These levies and

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EP-TL&P Direct Tax at a Glance

taxes in various forms and on various commodities and professions were imposed to meet the needs of the
Governments to meet their military and civil expenditure and not only to ensure safety to the subjects but also
to meet the common needs of the citizens like maintenance of roads, administration of justice and such other
functions of the State.
In India, the system of direct taxation as it is known today, have been in force in one form or another even from
ancient times. There are references both in Manu Smriti and Arthasastra to a variety of tax measures. Manu, the
ancient sage and law-giver stated that the king could levy taxes, according to Sastras. The wise sage advised
that taxes should be related to the income and expenditure of the subject. He, however, cautioned the king
against excessive taxation and stated that both extremes should be avoided namely either complete absence
of taxes or exorbitant taxation. According to him, the king should arrange the collection of taxes in such a
manner that the subjects do not feel the pinch of paying taxes.
He laid down that traders and artisans should pay 1/5th of their profits in silver and gold, while the agriculturists
were to pay 1/6th, 1/8th and 1/10th of their produce depending upon their circumstances.
The detailed analysis given by Manu Smriti and Arthasastra on the subject clearly shows the existence of
a well- planned taxation system, even in ancient times. Taxes were paid in the shape of gold-coins, cattle,
grains, raw- materials and also by rendering personal service. Most of the taxes of Ancient India were highly
productive. The admixture of direct taxes with indirect taxes secured elasticity in the tax system, although more
emphasis was laid on direct tax. The tax-structure was a broad based one and covered most people within its
fold. The taxes were varied and the large variety of taxes reflected the life of a large and composite population.

Income Tax in Modern India

Income Tax Act, 1860 Income Tax Act, Income Tax Act, 1918 Income Tax Act, 1922
1886
Consequent upon the The Act of 1886 levied The Act of 1918 brought The organizational history of
financial difficulties a tax on the income under change also the income tax department
created by the events of residents as well receipts of casual or dates back to the year
of 1857, Income Tax was as non residents in non recurring nature 1922. “One of the important
introduced in India for the India. The Act defined pertaining to business aspects of the 1922 Act
first time by the British agricultural income or professions. Although was that, it laid down the
in the year 1860. The and exempted it from income tax in India has basis, the mechanism of
Act of 1860 was passed tax liability in view of been a charge on net administering the tax and
only for five years and the already existing income since inception, the rates at which the tax
therefore it lapsed in land revenue a kind it was in the Act of 1918 was to be levied would be
1865. It was replaced of direct taxes. The that specific provisions laid down in annual finance
in 1867 by a licence Act of 1886 exempted were inserted for the acts. This is the procedure
tax on professions and life insurance first time pertaining to brought in much needed in
trades and the latter premiums paid by business deductions adjusting the tax rates in
was converted into a assessee policies of for the purpose of accordance with the annual
certificate tax in the his own life. Another computing net income. budgetary requirements
following year. It was important provision and in securing a degree of
The Act of 1918 remained
latter abolished in 1873. of this Act were that elasticity for the tax system.
in force for a short period
Licence tax traders the Hindu undivided Before 1922 the tax rate
and was replaced by
remained in operation family was treated were determined by the
new Act (Act XI of 1922)
till 1886 when it was as a distinct taxable Income Tax Act itself and
in view of the reforms
merged in the Income entity. to revise the rates, the Act
introduced by the Govt.
tax Act of that year. itself had to be amended.
of India Act, 1919.
The Income Tax Act, 1922

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Direct Tax at a Glance LESSON 1

gave for first time a specific

nomenclature to various
income tax authorities
and laid the foundation
of a proper system of
administration as per
provisions of Income Tax Act
1922 thus, it is the Income
Tax Act, 1961, which is
currently operative in India.

Income Tax Act, 1961

The present law of income tax in India is governed by the Income Tax Act, 1961 which is amended from time
to time by the Annual finance Act and other legislations pertaining to direct tax. The act which came into
force on April 1, 1962, replaced the Indian Income Tax Act, 1922, which had remained in operation for around
40 years. Furthermore, a set of rules known as Income Tax Rules, 1962 have been framed for implementing
the various provisions of the Income Tax Act, 1961.

TAX STRUCTURE

Constitution of India
The roots of every law in India lies in the Constitution, therefore understanding the provisions of Constitution is
foremost to have clear understanding of any law. Let us first understand what it talks about tax:
l Article 265: no tax shall be levied or collected except by the Authority of Law.
l Article 246: distributes legislative powers including taxation, between the parliament of India and the
State Legislature.
l Schedule VII- enumerates powers under three lists
l Union List: Powers of Central Government
l Legislative List: Powers of State Government
l Concurrent List: Both Central and State Government have powers, in case of conflict; law made by
Union Government prevails.
Some of the major taxes under respective lists are:

Central l Customs including export duties

Government
l Excise on Tobacco and other goods manufactured in India except alcoholic liquors for
human consumption, opium, narcotic drugs
l Corporation Tax

l Taxes on inter-state trade of goods other than newspapers

l Taxes on inter-state consignment of goods

l Any other matter not included in List II or III

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EP-TL&P Direct Tax at a Glance

State l Taxes on agricultural income

Government
l Excise duty on alcoholic liquors, opium and narcotics

l Octroi or entry Tax

l Tax on intra state trade of goods other than newspapers

l Tax on advertisements other than that in newspapers

l Tax on goods and passengers carried by road or inland waterways

l Tax on professionals, trades, callings and employment

TAX ADMINISTRATION
The Central Board of Revenue or department of Revenue is the apex body charged with the administration of
taxes. It is a part of Ministry of finance which came into existence as a result of the Central Board of Revenue
Act, 1924.
Initially the Board was in charge of both direct and indirect taxes. However, when the administration of taxes
became too unwieldy for one Board to handle, the Board was split up into two, namely the Central Board of
direct Taxes (CBDT) and Central Board of Indirect Tax and Customs (CBIC).

Central Board of Direct Taxes

The Central Board of Direct Taxes (CBDT) provides essential inputs for policy and planning of direct taxes in
India and is also responsible for administration of the direct tax laws through Income Tax department. The CBDT
is a statutory authority functioning under the Central Board of Revenue Act, 1963. It is India’s official Financial
Action Task force (FATF) unit.

Organizational Structure
The CBDT is headed by CBDT Chairman and also comprises six members. The Chairperson holds the rank of
Special Secretary to Government of India while the members rank of Additional Secretary to Government of
India.
l Member (Income Tax)
l Member (Legislation and Computerization)
l Member (Revenue)
l Member (Personnel & Vigilance)
l Member (Investigation)
l Member (Audit & Judicial)
The CBDT Chairman and Members of CBDT are selected from Indian Revenue Service (IRS), a premier civil
service of India, whose members constitute the top management of Income Tax department.

Income Tax Department

Income Tax department functions under the department of Revenue in Ministry of finance. It is responsible for
administering following direct taxation acts passed by parliament.
l Income Tax Act, 1961

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