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Taxation System

IMPORTANT POINTS OF DISCUSSION

1. Introduction
2. Direct Tax
3. Kinds of Direct tax system
4. Indirect Tax
5. Kinds of Indirect tax system
6. Difference between Surcharge and Cess
7. India’s Tax Structure
8. Corporate Tax, Income Tax, Customs Duty
9. Goods and Services Tax
10. Angel Tax
11. Dividend Distribution Tax
12. Laffer’s Curve
13. Capital Gains Tax
14. Securities Transaction Tax

INTRODUCTION

When the Parliament or a state legislature enacts a new tax, the debate usually includes
some opinions about who should pay for running the government or for the particular
programme being supported by the tax. It is a means by which the governments finance
their expenditure by imposing charges on citizens and corporate entities.

Economists distinguish between those who bear the burden of tax and those on whom tax is
imposed. Taxes in India are imposed by the central government and the state governments.
Some minor taxes are also imposed by the local authorities, such as municipalities.

According to the Indian Constitution, Article 246 distributes legislative powers including
taxation, between the Parliament of India and the State Legislature. Article 265 of the
Constitution states that "No tax shall be collected or levied except by the authority of law".
The Central Board of Revenue is the apex body charged with the administration of taxes. It
comes under the Ministry of Finance and came into existence as a result of the Central
Board of Revenue Act, 1924.
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● Central Government levies taxes on income (except the tax on agricultural income,
which the State Governments can levy) and customs duty.
● State Government levies Value Added Tax (replaced by GST), stamp duty, state
excise duty, land revenue and professional tax.
● Local bodies are empowered to levy the tax on properties, tax for utilization of
resources like water supply, drainage, etc.

In the Indian taxation system, system is divided into two versions - Direct Taxation and
Indirect Taxation.

DIRECT TAX

Under Direct Taxes, the burden falls on the same person on whom it is imposed. Its burden
cannot be shifted. Its impact and incidence lie in the same person. Few examples of Direct
Tax:

Income Tax - According to the Income Tax Act 1961, every person who is an assessee and
whose total income exceeds the maximum exemption limit, shall be chargeable to the
income tax at the rate prescribed in the Financial Act. Such income tax shall be paid on the
total income of the previous year in the relevant assessment year.

Corporate tax - A corporate tax is also called a corporation tax or a company tax, which is
a direct tax imposed by a jurisdiction on the income or capital of corporations or analogous
legal entities.

KINDS OF DIRECT TAX SYSTEM

There can be three types of Direct tax systems according to the relationship between its
rate structure and income, wealth or economic power of the taxpayer. These are:

I. Proportional Tax System:- It is a system, in which, the tax rate remains constant
with an increase or decrease in income.
Example: If the tax rate is 10% and the annual income of a person is
Rs.10,00,000, then he will have to pay Rs.1,00,000 per year as tax. If income rises
to Rs.12,50,000 per annum, then the tax liability will rise to Rs.1,25,000 per year.
In this case, the burden of tax is more on the poor section as compared to the
rich section.

II. Progressive Tax System:- It is a system, in which, the tax rate increases with an
increase in the level of income of taxpayers.
Example: Tax rate of 5% for persons earning between Rs.50,000 and Rs.1,00,000
per annum and 10% for persons earning between Rs. 1,00,000 and Rs.2,00,000
per annum. In this case, the burden of tax is more on the rich section as
compared to the poor section. It reduces inequalities. India follows a progressive
tax system.
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III. Regressive Tax System:- It is a system, in which, the tax rate decreases with an
increase in the level of income of taxpayers.
Example: If a person pays Rs.1,000 as tax on income of Rs.10,000, then the tax
rate is 10%. If his/her income rises to Rs.15,000 and he/she is required to pay
Rs.1,200 as a tax, then the average tax rate will fall to 8%. In this case, the
burden of tax is more on the poor section as compared to the rich section. It
increases inequalities.

INDIRECT TAX

Under the Indirect tax regime, tax is imposed on someone but its burden falls on someone
else. Its burden can be shifted. The impact and incidence of the tax lie on different persons.
Few examples of Indirect taxes are:

Customs duty - Customs Duty is levied when goods are transported across borders between
countries. It is the tax that governments impose on export and import of goods. It regulates
the movement of goods in and out of the country and keeps a check on restricted items. The
rates of customs duties are either specific or on ad valorem basis.

Entertainment tax - Entertainment tax is also sometimes referred to as an "amusement

tax". It is any tax levied on any form of commercial entertainment, such as exhibitions,
movie tickets, sports occasions and more. The specified rules, such as the tax rate,
entertainment tax and cases of tax exemption, are subjected to the local authorities, as its
collection lies under their authority. With the implementation of the Goods and Services Tax
(GST), the entertainment tax is no longer applicable.

KINDS OF INDIRECT TAX SYSTEM

There are two types of Indirect tax systems; they are:

I. Specific tax:- It is the tax which is imposed on the basis of any specific feature of
a commodity like quantity, weight, length, width, etc. It is a set amount of tax per
unit sold; examples are the tax charged on the basis of length of a cigarette, the
tax charged on sugar is according to its weight, the tax charged on the purchase
of television is according to its size, etc.

II. Ad-valorem tax:- It is the tax which is imposed on the basis of price or value of a
commodity. The Latin phrase ad valorem means "according to value." So all ad
valorem taxes are based on the assessed value of the item being taxed. An ad-
valorem tax is a percentage tax based on the value-added by the producer.
Examples: GST, Property tax and sales tax

One advantage of ad-valorem taxes is that the tax revenue to the government can rise
automatically as the economy grows. This means that the tax rate does not need to be
adjusted frequently, as in the case of specific unit taxes, such as duties on cigarettes and
alcohol.
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The imposition of either type of indirect tax has an effect similar to a rise in production
costs.

DIFFERENCE BETWEEN SURCHARGE AND CESS

CESS SURCHARGE/SUPERTAX
A cess, charged by the Central Government A Surcharge is a tax on tax that is imposed
is a tax on tax, levied for some specific on incomes above a certain level with a
purposes. Generally, a cess is expected to view to reduce inequality and make the
be charged till the time government gets tax structure more equitable.
enough money for that purpose.
A surcharge is a charge on any tax,
A cess is somewhat different from the usual charged on the tax already paid. It is an
taxes like personal income tax and excise additional tax or charge.
duty. It is imposed as an additional tax
other than the existing tax. The main surcharges are that on the
personal income tax and on the corporate
An example is Swachh Bharat Cess income.

NOTE: The main difference between the surcharge and a Cess is that despite the fact that
they are not shareable with the State Governments, the surcharge can be kept with the CFI
and is spent like any other tax, the cess should be kept as a separate fund after allocating to
the CFI and can be spent only on for a specific purpose. It means that the cess can be spent
only for the specific purpose for which it was created. If the purpose for which the cess was
created is fulfilled, it should be eliminated.

INDIA'S TAX STRUCTURE

• Corporate tax
• Income tax
• Custom duty
• Goods and Services Tax

CORPORATE TAX

Corporate tax is a tax paid by the companies registered under the company law in India on
the net profit that it makes from the businesses. It is imposed on the net income of the
companies. The new effective tax rate, including cess and surcharge for domestic
companies, would be 25.17% and for the new domestic manufacturing companies would be
17.01%.
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Minimum Alternate Tax (MAT):- MAT was introduced to target the companies that make
huge profits and pay the dividends to their shareholders but pay minimal /no tax under the
normal provisions of the Income Tax Act by taking advantage of the various deductions and
exemptions allowed under the act.

All companies whether they are private or public, or whether they are Indian or foreign are
liable to pay MAT if the income tax payable (including cess and surcharge) as per the
provisions of the Income Tax Act is less than 15% of the book profit plus cess and surcharge.

INCOME TAX

An income tax is a tax that the governments impose on the income generated by individuals
within their jurisdiction. Income tax is a source of revenue for the governments. They are
used to fund public services, pay government obligations, and provide goods for citizens.

Income Tax Slabs:

Income Tax Slab (in lakhs) Tax rate as per old regime Tax rate as per new regime
Upto 2.5 Exempt Exempt
2.5 – 5 5% 5%
5 – 7.5 20% 10%
7.5 – 10 20% 15%
10 – 12.5 30% 20%
12.5 – 15 30% 25%
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Above 15 30% 30%

CUSTOM DUTY

Customs Duty is charged when the goods are transported across the borders between
countries. It is a tax that governments impose on import and export of goods. Customs Duty
is beneficial for many reasons. For instance, it ensures a country's economic stability, jobs,
environment, etc. It regulates the movement of goods in/out of the country. There are 3
main types of customs duty; these are:

1. Basic Customs Duty:- Basic customs duty is the tax that is calculated on the computation
value of the goods that is landed at the customs border of India. After being amended
time and again, it is currently regulated by the Customs Tariff Act, 1975. The Central
Government, however, holds the rights to exempt specific goods from this tax. BCD
depends upon the HSN code of the product and the Country of Import.

2. Anti-Dumping Duty:- The purpose of anti-dumping duties, in general, is to

eliminate dumping which is causing injury to the domestic industry and to re-establish a
situation of open and fair competition in the Indian market, which is in the general
interest of the country. For example – Imagine that there are two types of erasers, one is
of Nataraj (of India) and the other is of XYZ (of China). The cost of a packet of Nataraj
eraser is Rs.55, and the cost of XYZ eraser in China is Rs.55, and they are selling that
eraser in India for Rs.35, i.e., they are dumping it in India to harm our domestic
industries. So, India charges Rs.20 as Anti-dumping duty to equate the price of XYZ
eraser with Nataraj eraser to protect the domestic industries. Hence, this duty is based
on the dumping margin, i.e. the difference between the export price and the normal
price.

3. Countervailing Duty:- Countervailing Duty is an import duty imposed on imported goods

to neutralize some of the benefits enjoyed by the imported goods (from governments of
the exporter). For example - Subsidies provided by the government of China to their
products for selling it in India; So, this subsidy provided by China is countervailed in India
to protect the domestic industries. This type of duty imposed is called Countervailing
duty.

Composition of taxes in Gross Tax Revenue in 2019-20

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GOODS AND SERVICES TAX (GST)

The GST (Goods and Services Tax) is a unified indirect tax across the country on goods and
services.

Before GST- Tax was levied at each stage separately by the Central government and the
State government at varying rates. The system had a tax on tax exercise and also a good
scope of tax evasion.

After GST- The single tax levied on the value addition of goods and services, right from the
manufacturer to the end consumer, it has done away with tax-on-tax exercise, thus, not
only it brought down the effective tax incidence on the final consumer but also checked the
tax evasion.

GST replaced almost all the indirect taxes, which are-

At Central level

▪ Central Excise duty

▪ Duties of Excise (Medicinal and Toilet Preparations)
▪ Additional Duties of Excise (Goods of Special Importance)
▪ Additional Duties of Excise (Textiles and Textile Products)
▪ Additional Duties of Customs (commonly known as CVD)
▪ Special Additional Duty of Customs (SAD)
▪ Service Tax
▪ Central Surcharges and Cesses so far as they relate to supply of goods
and services
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At State level

▪ State VAT
▪ Central Sales Tax
▪ Luxury Tax
▪ Entry Tax (all forms)
▪ Entertainment and Amusement Tax (except when levied by the local
bodies)
▪ Taxes on advertisements g. Purchase Tax
▪ Taxes on lotteries, betting and gambling
▪ State Surcharges and Cesses so far as they relate to supply of goods
and services.

History of GST

● The first country to introduce the GST system in 1954 was France.
● In the year 2000, the NDA government constituted a committee headed by the
finance minister of West Bengal, Asim Dasgupta to design a GST model.
● In the year 2003, the NDA government formed a task force under Vijay Kelkar to
recommend tax reforms and Kelkar committee recommended rolling out GST as
suggested by the 12th Finance Commission.
● In 2007, an empowered committee was formed, comprising Finance Ministers of
every State, whose job was to convince all states to switch over to GST and bring a
consensus between Centre and States.
● The Constitution (One Hundred and First Amendment) Act, 2016, introduced a
national Goods and Services Tax (GST) in India from 1 July 2017.
● Nandan Nilekani (Infosys chairman) panel was set up to draw inputs from Canada
and New Zealand for a smooth transition to GST. The IT company has developed the
software for GST Network (GSTN), which provides the technology backbone for
Goods and Services Tax (GST).

GST Legislation

● Due to the introduction of the GST Act, the following major changes took place in the
Indian Constitution.
● Insertion of Articles 246A, 269A and 279A.
o Article 246A(1) gives the right to parliament, and the legislator of every state
can make the law in respect of goods and service tax to be imposed by
central or state government.
o Article no 246A(2) covers the provision of Interstate supply of goods or
services or both, in such circumstances, only parliament ( i.e. Central
Government) can make the law.
o As per Article 269A Goods and Service tax shall be levied and collected by
Government of India and apportioned between States in the manner as
provided in the law by parliament on the recommendation of GST council.
o Article 279A provides for constituting a Council called the Goods and Services
Tax Council.
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● Major Components of GST Act:

(a) Central Goods and Services Tax (CGST)- to be levied by Centre
(b) State Goods and Services Tax (SGST)- to be levied by state
(c) Integrated Goods and Services Tax (IGST)- On inter-state supply of goods and
services; it is levied and collected by the Centre and will be shared amongst the
Centre and the States.
(d) The Union Territories Goods and Services Tax (UT-GST)
(e) GST (Compensation to States) ACT, 2017.

Under the GST Act, the highest tax slab is pegged at 28%.

Implementation of GST

▪ The GST is governed by a GST Council, chaired by the Finance Minister of India.
Composition of GST council
1. Union Minister of Finance
2. Union minister of state in charge of revenue/finance
3. the Minister in charge of Finance or Taxation or any other Minister nominated by each
State Government.
▪ The quorum of the GST council consists of half of the members.
▪ Every decision of the GST Council should be taken by a majority, not less than 3/4th of
the weighted votes of members present and voting.
▪ GST council determines different tax rate slabs for different commodities. These rates
will be reviewed by the council from time to time.
▪ These rates are Zero (No tax)%, 5%, 12%, 18%, 28%.
Zero Percent - Mostly food items like curd, milk, buttermilk, flour etc., Newspaper,
handloom, etc.
Five Percent – The packaged food items, fertilizers, coffee, tea, spices, coal, medicines,
transport services, postage and revenue stamps, restaurant bills, e-waste etc.
Twelve Percent-Butter, Ghee, Namkeen in packaged forms, Cell phones will be under 12
% tax slab, Non-AC hotels, Business class air ticket, etc.
Eighteen Percent- (Most items will come in this slab), Ice cream, Biscuits, Mineral water,
steel products, Telecom services, IT services, etc.
Twenty Eight Percent-Pan Masala, Paints, shaving creams, ATM, Automobiles, Chocolate
not containing cocoa, Motorcycles, Five-star hotels, Cinemas, etc.
▪ There is a special rate of 0.25% on precious stones (Diamonds) and 3% on gold.

Note: Weightage of votes: Central Government – 1/3rd of the total votes cast, and

State Governments – 2/3rd of the total votes cast.

Features of GST:

● Destination based tax: The goods/services will be taxed at the place where they are
consumed and not at the origin. So, the state where they are consumed will have the
right to collect GST.
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● GST is a consumption tax: A consumption tax is a tax levied on consumption

spending on goods and services. The tax base of such a tax is the money spent on
consumption. The goods and services tax (GST) is a value-added tax levied on most
goods and services sold for domestic consumption. The GST is paid by consumers,
but it is remitted to the government by the businesses selling the goods and services.
● No cascading of taxes: "Cascading tax effect" means a tax on tax. This effect occurs
when a good is taxed on every stage of production. It is a situation wherein a
consumer has to bear a load of tax on tax and inflationary prices as a result of it.
With the imposition of GST, several taxes are merged into one single tax. So, when a
product is sold, each vendor in the supply chain is able to deduct the tax paid from
tax collected and remit it to the government. No matter how many times the
product changes hands, the final consumer pays the full tax rate but not a multiple
of it.

GSTN (GST Network)

▪ A special GST Network (GSTN) was created for GST implementation.

▪ It is a non-profit company, which is incorporated under section 8 of the Companies
Act 2013.
▪ Currently, Public shareholding (both Centre and various states) is 49%, and the rest
is held by Financial Institutions. However, the Government has decided to make it
100% Government owned with Centre increasing its share from 24.5% to 50% and
the rest by various states on a pro-rata basis.
▪ The GSTN will provide a shared IT infrastructure and services to Central and State
Governments, taxpayers and other stakeholders for the implementation of GST.
▪ Current Chairman of GSTN- Ajay Bhushan Pandey

Advantages of GST

The benefits of GST can be summarised as-

(1) Easy compliance

(2) Uniformity of tax rates and structures
(3) Removal of cascading effect- (Removal of inevitable and sometimes unforeseen chain)
(4) Higher revenue efficiency- (Due to increase in tax base)
(5) Transparency in the tax system

ANGEL TAX

⮚ An angel tax is a tax levied on such investments made by external investors in

startups or companies.
⮚ An angel investor is the one who provides the capital for business startups, usually in
exchange for convertible debt or ownership equity.
⮚ Currently, the funds from Angels are subjected to over 30% tax if they are more than
the fair market value.
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⮚ An angel Tax was introduced by the government in the Union budget of 2012 to
arrest the laundering of illegal wealth by means of investments in the shares of
unlisted private companies at extraordinary valuations.
⮚ Under certain conditions, an exemption to startups is offered under section 56 of the
Income Tax Act.

Note: An entity shall be considered a startup upto 10 years from its date of incorporation
and if its turnover for any of the financial years since its incorporation/registration hasn't
exceeded Rs 100 crore.

DIVIDEND DISTRIBUTION TAX

The dividend distribution tax is a tax imposed by the Indian Government on the Indian
companies according to the surplus paid to the company's investors. At present, the DDT is
removed by the government in financial annual statement 2020, according to the Union
Budget of India.

The companies have to deposit DDT within 14 days of declaration, payment or distribution
of dividend whichever is the earlier. In case of the non-payment within 14 days, the
company would have to pay interest @ 1% of the DDT.

As per the existing tax provisions, income from dividends is tax-free in the hands of
investors up to Rs.10,00,000 and tax is levied @10 Percent beyond Rs 10,00,000. Further,
the dividends from the domestic companies are tax-exempt, dividend from the foreign
companies are taxable in the hands of investors.

LAFFER'S CURVE

The Laffer's Curve is a theory developed by the supply-side economist Arthur Laffer to show
the relationship between the tax rates and the amount of tax revenue collected by the
governments. This curve is used to illustrate Laffer's argument that sometimes, cutting tax
rates can increase total tax revenue.

● It states that as the tax rate increases from the low level, tax collection also increases
but as the tax rate increases beyond a critical limit, tax collection starts falling.
● This can be due to lower profitability and higher incentive to cheat associated with
higher taxes.

Y-axis
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Tax Revenue X-axis

Tax Rate

The Laffer's Curve is based on this economic idea that people will adjust their behaviour in
the face of the stimulus created by income tax rates. Higher-income tax rates decrease the
incentive to work and invest compared to lower tax rates. If this effect is large enough, it
will mean that at some tax rate, and a further increase in the rate will actually lead to a
decrease in the total tax revenue. For each type of tax, there is a threshold rate above which
the stimulus to produce more diminishes, thereby reducing the amount of the revenues
which the government receives.

CAPITAL GAINS TAX

The Capital Gains Tax (CGT) is a tax on the profits realized on the sale of a non-inventory
asset.

● The most usual capital gains are realized from the sale of bonds, stocks, property,
and real estate.
● Capital gains tax can be payable on valuable items or assets that are sold at a profit.
Antiques, shares, precious metals, etc., could be all subject to the tax if you make
enough money from them.
● The amount of tax payable can differ. The lower boundary of a profit that is big
enough to have a tax imposed on it is set by the government. If the profit is lower
than this limit, it is tax-free. The profit is in most cases is the difference between the
amount (or value) for which an asset is sold, and the amount for which, it was
bought.

Capital gains can be categorized under two sub-headings, namely Short-Term Capital Gains
(STCG) and Long-Term Capital Gains (LTCG). The key differences are:

BASIS SHORT-TERM CAPITAL GAINS LONG-TERM CAPITAL GAINS

Meaning The profit arising out of the sale of a The profit arising out of the sale
short-term capital asset is known as of a long-term capital asset is
short term capital gains. known as long term capital gains.
Capital Asset For immovable property, it is less For immovable property, it is
than 24 months, whereas, for more than 24 months, whereas,
movable property, it is less than 36 for movable property, it is more
months. than 36 months.
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Financial Asset The holding period for Financial The holding period for Financial
asset is less than 12 months. asset is more than 12 months.
Rate of Taxation 15% 10% tax is applicable to the long-
term capital gains on the sale of
listed securities above rupees 1
lakh

SECURITIES TRANSACTIONS TAX

Securities Transactions Tax (STT) was originally introduced in 2004 by the Finance Minister,
P. Chidambaram, to stop tax avoidance of the capital gains tax. The securities transaction
tax is a direct tax.

● Securities Transaction Tax is collected and levied by the union government of India.
● Securities Transactions Tax (STT) is paid by the seller or the purchaser depending
upon the transaction.
● It is a tax payable in India on the value of the securities (excluding currency and
commodities) transacted through the recognized stock exchanges.
● As of 2016, it is 0.1% for delivery-based equity trading. This tax is not applicable to
off-market transactions or on currency or commodity transactions.

In this topic, we discussed the Indian taxation system including direct tax, kinds of direct tax
system, indirect tax, kinds of indirect tax system, the difference between surcharge and
cess, India’s tax structure, corporate tax, income tax, customs duty, goods and services tax,
angel tax, dividend distribution tax, laffer’s curve, capital gains tax and securities transaction
tax.
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