What Is Tax

What Is Tax

Tax is a compulsory financial contribution imposed by governments on individuals and businesses to fund public services and infrastructure.

Written by : Shipra Chaudhary

Reviewed by : Akanksha Gangvany

Akanksha Gangvany

2021-11-14

4317 Views

9 minutes read

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The government of every nation needs to collect taxes from its citizens to run the country. You pay taxes to your local authorities, state, and central government in almost every part of the world. Tax collection is essential to run a nation judiciously.

Countries collect taxes in many forms. The most common types of tax collections are direct tax, indirect tax, indirect tax,  and customs. This blog will provide you with details regarding what is tax, its types, and benefits.

Meaning of Tax

Tax meaning, the concept and purpose through which the government finances projects for the benefit of the larger population, public interest, and social welfare. These projects can be related to fundamental infrastructure, defence, and social welfare, like schools, bridges, satellites, etc. Taxes help fund many projects without huge commercial benefits, such as providing a regular supply of clean drinking water.

Tax in India is levied on all legal entities and individuals. Legal tax entities like corporations, development bodies, an association of individuals, and non-profit organisations are required to pay their share of direct and indirect taxes. Any taxpayer importing goods to India may also have to pay customs.

Listed below are a few things about taxation:

  • Tax can be levied annually or on each transaction
  • Local, state, and central authorities can levy taxes
  • All taxes must be deposited with the central or state tax authorities
  • Only state and central governments can reallocate the tax collection pool for investment and other purposes

How does Taxation Work?

The taxability of a person in India depends on that person's income slab for the financial year. Individual and corporate tax rates are different.

However, different types of incomes can be taxed at different rates or under distinct conditions. Indian tax system recognises the following types of income, otherwise known as heads of income under the Indian tax laws:

  • Income from Salary
  • Income from House Property
  • Income from Business & Profession
  • Income from Capital Gains
  • Income from Other Sources

Salary income covers any form of regular income. House property refers to the rental income received from a residential house. Interest income, dividend receipts, lottery winnings, and gifts are considered under income from other sources.

You also have the option of claiming deductions and exemptions from your income. Certain incomes and perquisites are exempt from tax. If you have these incomes, you can claim an exemption from tax on these.

Additionally, you can get deductions for certain investments and expenses. These deductions are applicable when you invest in tax-saving instruments or spend on eligible expenses. For example, tuition fees for school education are eligible for deduction from the gross total income.

Types of Tax

Whether you are an individual or a business owner, you need to pay taxes. Taxes in India are broadly categorised into two categories:

1. Direct Taxes: These are taxes that you directly pay to the government. A direct tax cannot be transferred to any legal entity or other individuals. It comes under the Central Board of Direct Taxes (CBDT). 

Examples of direct tax are Income Tax and Wealth Tax.

Direct Tax TypeDescription
Income TaxIt is levied on the annual income or the profit made. It is paid directly to the government. If your income is above the exemption limit, you have to pay income tax. If your age is below 60 years, the tax exemption limit is ₹2.5 lakh, and for senior citizens, it is ₹3 lakh.
Capital Gain TaxYou will pay capital gain tax if you have sold a property or stocks (mutual funds) and made a profit. These taxes can vary based on the years you held the investment. It could be short-term or long-term capital gain taxes. The definition of the short and long-term depends on the type of investment.
Prerequisite TaxYou may receive various perks from your company over and above the salary. It could be in the form of food coupons, fuel reimbursement, etc. These are taxed separately and come under Prerequisite Tax.
Corporate TaxThe taxes paid by the company come under the corporate tax. The tax rate depends on the company's revenue in a financial year. It applies to the net income that an investor receives from the investment.

2.Indirect Taxes: These are consumption-based and apply to goods and services sold or bought. The government collects indirect tax from the seller of goods or services. The seller collects the tax from the end-user - goods or service buyer. Hence, these are taxes that you pay but not directly to the government.

Examples of indirect tax include GST, VAT, etc.

Indirect Tax TypeDescription
Good and Service Tax (GST)GST is a consumption tax added to the final price of a product or service. Manufacturers pay GST on the raw material they purchase. Service providers pay GST on the amount paid for the product, while the retailers pay GST on the product purchased from the distributor.

3. Other Taxes: Apart from direct and indirect taxes, a few other taxes are levied in different forms, and they are listed below:

Several other taxes are levied on specified goods, assets, and activities in the country.

  • Examples of other taxes include property taxes, municipal taxes, professional taxes, entertainment taxes, etc.
  • Registration of property or transfer of asset ownership requires you to pay state and central taxes. These are Stamp Duty, Transfer Tax, and Registration Fees.
  • Cess is applied to your final tax liability towards the government. The government often uses this to collect taxes for a specific purpose.
  • Road and toll tax applies to vehicles plying on the road. Both taxes have become a critical part of maintaining and growing road infrastructure.

Did you know?

In the financial year 2020, the Budget exempted individual taxpayers with income up to ₹5 lakh from paying income tax.

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Benefits of Taxes

  • Now that you know tax meaning, let’s move forward to understand how paying taxes helps the government run the nation smoothly. Listed below are a few benefits of paying taxes:
  • Taxes help the state and central government provide public services and develop amenities such as parks and schools. Also, a part goes to enhance the defence sector of the nation.
  • It improves the living standards of citizens as taxation improves healthcare, education, and other sectors.
  • It allows the government to offer various public schemes like unemployment benefits, pension schemes, etc.
  • Taxation documents help you get loans and credit cards, as ITR serves as proof of income.
  • It also help citizens in their Visa application form as it is one of the proofs considered in the visa process.

Why Should You Pay Taxes on Time?

Every individual and business owner must pay taxes on time. If you fail, the government can impose penalties on you or your business. The tax penalty will depend on the category under which you have not paid the tax.

Below are some situations in which you havhave to pay a penalty and a corresponding penalty:

  • Income not Disclosed Completely: If you have not disclosed 100% of your income, you can be charged a penalty of 50% of tax payable on under-reported income. If under-reporting was because of misreporting, you have to pay 200% of the tax payable.
  • Penalty on Fake Documents: If you have shown falsified documents, such as a fake invoice or documentary evidence, in your returns, you need to pay a penalty of the amount equal to the sum of such false or omitted entries.
  • TDS: If a business fails to deduct Tax at Source, it will be liable to pay a penalty equal to the tax amount. You cannot avoid tax. However, you can plan your taxes and reduce your tax burden.  Section 80C, 80D, and other provisions under section 80 of the Income Tax Act, 1961, give you options to save tax. You can build your wealth, look after the financial safety of your family, incur other necessary expenses, and save tax.

Thus, you must calculate your income from different income sources, calculate your tax liability, and file your taxes on time.

Recent Reforms in Taxes

GST stands for Goods and Services Tax and is the primary indirect tax applicable in India from FY 2018-19. It has simplified the complicated web of indirect taxes applicable to goods and services earlier.

These included VAT, Service Tax, State Taxes, and more depending on the goods or service. Simplification has brought taxpayers into the ambit and has increased indirect tax collection dramatically in the last five years.

With an online filing and credit system, GST is one of the most successful indirect taxes in the world. It has also simplified goods transfer from one state to another, improving trade within the country.

Final Thought

Understanding what is tax is crucial for every citizen and business entity alike, as it forms the financial backbone of any nation. Taxes serve as the primary means for governments to finance public projects, infrastructure, defense, and social welfare initiatives that benefit society at large. Compliance with tax regulations ensures the smooth functioning of the economy and enables individuals to contribute responsibly toward national development.

Glossary

  • Customs Duty: A tariff or tax imposed on goods imported or exported from a country.
  • GST (Goods and Services Tax): An indirect tax levied on the supply of goods and services. The introduction of GST has replaced multiple indirect taxes across states.
  • Capital Gains Tax: It’s a tax on the profit from the sale of property or investments, and is categorised as short-term or long-term based on holding periods.
  • Corporate Tax: A corporation tax is a direct tax levied on profits earned by corporations or businesses during a fiscal year.
  • Tax Deduction: A reduction in taxable income due to eligible expenses or investments, reducing the overall tax liability.
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FAQs on Taxation in India

Applicable tax slabs will determine how much income tax you need to pay. You can know your tax liability by registering at https://eportal.incometax.gov.in/iec/foservices/#/login and completing your income details. You can check your applicable slab rates here.

Taxable income refers to earnings and other sources of income that are subject to taxation by the government. Exempt income, on the other hand, includes sources of income that are not taxable under specific circumstances, such as certain gifts, scholarships, or certain types of retirement income.

The term ‘Profession’ has been defined under the Income Tax Act as a word carrying a wider meaning which includes ‘vocation’. As per the court judgement, an occupation that requires intellectual skills and is different from the production or sale of commodities.

You can claim a refund for the excess amount of income tax paid to the government. But the option of refund is available only if you file your income tax return. You can file your annual ITR at https://eportal.incometax.gov.in/iec/foservices/#/login

Your taxable income should be more than ₹2.5 lakhs in the financial year for you to be liable to pay income tax. However, due to the rebate under section 87(A), you will only pay tax if your taxable income exceeds ₹5 lakhs.