What is tax, and what is taxation? A primer on India's direct and indirect tax system

Tax means a part of income paid by individuals and business entities to the government or the tax authorities, by whatever name called. Taxation is the act of imposing taxes.

Tax systems vary widely among nations, and it is important for individuals and businesses to understand the tax structure of the place where they plan to do business. In India, the central and state governments both play a vital role in the structure.

The tax base

Direct tax

A tax where the incidence and the impact fall on the same person; the burden cannot be transferred. Currently prevailing direct taxes are income tax, corporate tax and property tax.

Indirect tax

A tax where the incidence and the impact do not fall on the same person. Currently prevailing indirect taxes are the goods and services tax, customs duties, central excise duty and VAT.

A short history of taxation in India

Ancient times. Taxation can be traced back to the Manusmriti and to Kautilya's Arthashastra, whose principle was to enable the king to discharge his duties and provide protection. Tax was levied on livestock, land and products such as bamboo, wheat, honey and salt.

Medieval times. The Delhi Sultanate introduced the jaghirdar or zamindari system, under which estates were governed and taxes collected locally. Under the Mughals, Sher Khan introduced a single price-list system, and Akbar's Zabti system fixed tax at one-third of produce, later converted at regional price schedules. Chhatrapati Shivaji abolished the zamindari system, fixed tax at two-fifths of produce and introduced the Chauth.

Modern times. The first Income-tax Act was introduced by the British Finance Minister James Wilson in 1860, and it has been the basic model of India's tax system since. It categorised income into four schedules: land and property; profession and trade; securities, annuities and dividends; and salary and pension.

Principles of taxation

1. Economic effect. Tax policy may be used to promote economic stability, since liabilities for taxes such as income tax respond strongly to changes in economic conditions.
2. Equity. Every state ought to contribute to the support of the government in proportion to the revenue enjoyed under its protection.
3. Cost effectiveness. Taxes should be established so as to minimise the real cost of collection.

Direct tax in India

Income tax is paid by taxpayers other than companies registered under the Companies Act, 2013, on the basis of slabs at different rates. Corporate tax is paid by registered companies on net profit, at the rate prescribed by the Income Tax Act, 1961 as amended by each Finance Act.

Due dates

• Companies: 31 October
• Non-companies whose accounts require audit: 31 October
• Individuals, HUFs and partnership firms not requiring audit: 31 July

Applicability and minimum alternate tax

A domestic company is taxed on its total income; a foreign company only on income earned, accrued or received in India. All companies incorporated in India must pay minimum alternate tax if the income tax payable is less than 15% of book profits, unless the company opts to pay tax under section 115BAA or 115BAB.

Double taxation and DTAA

Double taxation arises when the same income is taxed twice. Economic double taxation occurs when income is taxed twice in the same country in the hands of two persons; juridical double taxation occurs when income earned outside India is taxed twice in the hands of the same person, once abroad and once at home.

Unilateral relief

Section 91 of the Income Tax Act, 1961 provides relief irrespective of whether a DTAA exists, provided the taxpayer was resident in India in the previous year, the income accrued and was received outside India, the income was taxed in both countries, and tax was paid in the foreign country. The deduction is the lower of the Indian and the foreign tax rate.

Bilateral relief

Section 90 offers protection through a DTAA in two ways: the exemption method, under which income taxed abroad is not taxed again in India, and the tax credit method, under which tax paid outside India is credited against tax payable in India.