Taxation in India: What is the importance of direct and indirect taxes?


For decades, taxation has been the key source of revenue for governments all across the world, including India. The country has a well-structured tax system that employs both liberal and progressive taxation depending on income and other criteria, with the national and state governments determining the rates. 

Tax income is the money received by the government and can be used for a variety of things, including infrastructure development (roads, trains, bridges, dam etc.), public healthcare and education, defense and civil services, to name a few. The primary role of taxes is to assist the government in achieving its development goals.

In India the tax structure is divided into the following two categories: 

  • Direct taxes: These taxes are levied on the taxable income earned by individuals and corporate entities and the burden to deposit taxes is on the individuals or companies themselves.  
  • Indirect taxes: These are taxes levied on the sale and production of goods and services, with the sellers bearing the responsibility of collecting and depositing the taxes rather than the assessees. 

As per the taxation system in India, these taxes are levied by the central and state governments and some minor taxes may even be levied by local authorities such as the municipality and local governments. In the recent past, the central and state governments have both taken a relook at taxation and undertaken a major revamp of the same with the introduction of new policies, reforms to existing policies, process simplification towards predictability, fairness and automation. 

What is the importance of taxation in India?

Now that we have understood the difference between direct and indirect taxes, let us discuss the importance of taxes in India. 

  • Importance of direct taxes:

Direct taxes, with their progressive tax system, demonstrate the relevance of taxes by eliminating income gaps. Citizens are taxed in proportion to their financial situation, promoting social and economic equality. Furthermore, with direct taxes, taxpayers know how much tax they can anticipate to pay in a given fiscal year and can plan ahead of time. Direct taxes can also serve to prevent inflation by managing demand and supply in the economy when their rates vary. 

  • Importance of indirect taxes:

When it comes to indirect taxation, they are an automatic function that occurs when people buy and sell goods and services across the country. As a result, they are simple to collect and convenient for both taxpayers and tax collectors. They also help to broaden the country’s revenue base by collecting donations from people who are otherwise excluded from paying direct taxes.

Now, let us take a brief look at the major central and state taxes in India: 

The central government taxes are as follows:

  • Income tax
  • Central goods and services tax (CGST)
  • Customs duty 
  • Integrated goods and services tax (IGST)

The state governments also impose certain taxes such as:

  • State goods and services tax (SGST)
  • Stamp duty and registration 

When we talk of taxation reforms within the country the one that stands out the most is GST. 

GST- This is a comprehensive tax that the government levies on manufacture, sale and consumption of goods and services at the national level. This tax has replaced all indirect taxes levied on goods and services by the state and central governments. GST became prevalent since July 2017and the country has opted for the dual GST model where both central and state governments levy GST. 

There are numerous benefits of GST the most obvious of them being:

  • Reduction in compliance cost due to the unification of indirect taxes
  • Minimal physical interference
  • Check over-tax evasion by way of a strong IT-based administration 
  •  A unified tax regime for both goods and services
  • There is no cascading of taxes

How income tax is planned and implemented in India’s economy? 

Individual – The tax incidence of every individual depends on their residential status which is defined on the basis of their physical presence in India as per the Income Tax Act. 

Company – The tax incidence of every company depends on the residential status of the company. For example, whether or not the company has been integrated in India or it is operational and managed from India. 

LLP Company – In the case of an LLP, the tax incidence depends on whether the company is operational wholly or partly from India and in such a case then the company is liable to be taxed at 30% of its global income. It must have a PAN and TAN and file an annual return of income each year. When an LLP distributes its profits to partners they are not taxed and upon dissolution, an LLP is not subject to additional taxes. 

Taxation on foreign entities: 

Liaison Office – A liaison office is not liable to income tax in India because it is unable to conduct business and earn profits due to Indian exchange control restrictions. It is also necessary for the liaison office to obtain an Indian tax registration number or a PAN and a withholding tax registration number or TAN. It is mandatory for the Liaison office to file an annual statement of its financial affairs and annual activity certificate or an AAC. Since it cannot generate any profits, the LO is not liable to pay repatriation taxes and in the event that there are any unutilized funds available at the time of its closure, they can be repatriated without any exit taxes. 

Project Office/Branch Office – This is considered to be an Indian Permanent Establishment (PE) of its foreign headquarters. It is therefore taxable at the rate of 40% of its profits. The project office or branch office is required to have a PAN and TAN and must file an annual return of income and an AAC. At the time of closure, any repatriation of surplus is not subject to additional taxation. 

Wholly Owned Venture/Joint Venture – Any company that is formed in India is treated as a resident of India and is taxed at 30% on its global income. It is necessary for the company to have a PAN and TAN and file annual income returns. 


In order to be able to understand the impact of direct tax on economic growth and ensure that one is filing tax returns correctly one must have some basic knowledge of how taxation in India functions. CoffeeMug is an AI networking platform outfitted with a highly qualified team of analysts, incubators, accelerators and mentors with diverse backgrounds. 

With the help of a vast global network and resources, CoffeeMug has successfully managed to support a number of startups and other companies through various stages of their business journey including providing access to multiple suitable candidates for C- suite positions. 


Q. What is the impact of taxation?

A. Taxes on products, income and wealth have an impact on economic behavior and resource allocation. Higher carbon taxes, for example, will increase producers’ costs, reduce demand and move demand to alternatives.

Q. How does direct tax benefit the country?

A. Direct taxes can help in inflation control. The government may raise the tax rate if inflation continues to rise. A rise in the tax rate may reduce consumption demand, which could help to lower inflation.

Q. How does indirect tax affect consumers?

A. Indirect taxes are levied on goods and services, raising the price and forcing the consumer to pay more for the product. State-imposed gasoline taxes are an example of this. 

Q. What are advantages of direct tax?

A. Persons are taxed at varying rates in the income tax legislation when it comes to direct taxes. Every individual is charged separately depending on their income. This gives the impression of not being overcharged, even if a person’s income is low. 

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