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What is tax? Tax concept, definition, and types in India
Every time you earn a salary, make a purchase, or invest in property, you’re contributing to the nation’s tax system. Tax is the backbone of a country’s economy, funding essential public services like healthcare, education, infrastructure, and national security.
This guide breaks down the concept of taxation in India, covering its definition, types, features, and benefits in simple terms. Whether you're a taxpayer or a business owner, this will help you navigate India’s tax system with confidence.
What is a tax?
A tax is a compulsory financial contribution imposed by the government on an individual’s income, business profits, goods, services, and transactions.
India follows a progressive taxation system, where high-income earners pay a larger share of their income as tax compared to low-income groups. This approach helps reduce income inequality and supports economic growth.
The taxation system helps the government generate revenue to finance nation-building activities such as infrastructure development, defense, healthcare, education, and other public expenditure programs.
Tax concept in India
The tax concept in India is based on two main categories: Direct tax and indirect tax. Direct taxes, such as income tax, are imposed on an individual’s or business’s earnings and paid directly to the government. Indirect taxes, like GST, are levied on goods and services and collected by intermediaries.
This dual structure maintains economic stability, controls inflation, and encourages investments through various tax incentives. Moreover, India's tax laws continue to evolve, ensuring a balanced and effective taxation framework that adapts to changing economic conditions.
Objectives of taxation
- Revenue generation: The primary purpose of taxation is to fund government expenditures.
- Wealth redistribution: Progressive taxation promotes a fair distribution of wealth across different economic classes.
- Control of inflation: Certain taxes help control inflation by regulating the purchasing power of individuals.
- Encouraging savings and investments: Tax incentives, such as exemptions on health insurance premiums, promote financial discipline and long-term investments for salaried individuals.
Administration of taxes in India
The administration of taxes in India is handled by multiple government bodies. These authorities oversee direct and indirect taxes, regulate tax policies, and facilitate taxpayer services.
- Central Board of Direct Taxes (CBDT): The CBDT operates under the Ministry of Finance and administers taxes, such as income tax and corporate tax.
- Central Board of Indirect Taxes and Customs (CBIC): CBIC governs the indirect taxes such as GST, customs duty, and excise duty. It regulates tax collection at various stages of production and consumption and manages customs enforcement at ports and airports.
- Goods and Services Tax Council (GST Council): This constitutional body determines GST rates, exemptions, and policy changes. It includes representatives from the central and state governments to ensure uniform tax implementation across India.
- State tax departments: State governments administer taxes such as State GST, stamp duty, and professional tax. Each state has its tax department responsible for local tax collection and compliance.
Types of taxes in India
The Indian taxation system is classified into two major categories:
- Direct tax - Levied directly on individuals and businesses.
- Indirect tax - Collected through goods and services.
Let's understand the types of direct and indirect taxes, along with their examples and key differences.
Concept of direct tax
Direct tax is imposed directly on individuals and businesses based on their income or profits, with taxpayers bearing the responsibility of payment.
Types of direct taxes
- Income tax
Income tax is levied on individuals, Hindu Undivided Families (HUFs), and businesses based on their earnings. Taxpayers are classified into different income tax slabs with varying rates. The tax is calculated on sources such as salary, business profits, and capital gains. Since the taxpayer pays this amount directly to the government, income tax is a direct tax.
- Corporate tax
Corporate tax applies to domestic and foreign companies operating in India. The tax rate varies based on turnover, industry type, and company structure.
- Tax Deducted at Source (TDS)
Tax Deducted at Source is a mechanism where a certain percentage of tax is deducted at the source of income before it is paid to the recipient. It applies to salaries, interest, commissions, and professional fees. Since TDS is deducted before payment is received, it is considered a direct tax.
- Securities Transaction Tax (STT)
Securities Transaction Tax is levied on transactions involving securities such as stocks, derivatives, and equity-oriented mutual funds. It is collected at the time of trade execution, ensuring ease of tax collection without requiring separate calculations during tax filings.
Features of direct tax
- Direct taxes are imposed on an individual’s or entity’s income, profits, or assets, such as income tax and corporate tax.
- The tax burden cannot be shifted to another person. The individual or company earning the income must pay it.
- Higher income groups pay a higher percentage of tax, ensuring fair wealth distribution.
- The collection, rates, and regulations are governed by laws such as the Income Tax Act, 1961.
- Taxpayers can reduce their tax liability through deductions like House Rent Allowance, 80C investments, and exemptions on capital gains.
- Direct taxes are collected annually or in advance through TDS and advance tax payments.
Examples of direct tax
The most common direct tax is income tax, where salaried individuals pay tax on their earnings based on the tax slab they fall under. Corporate tax is another direct tax levied on the net income of companies operating in India. Capital gains tax, also a direct tax, applies to profits earned from selling assets such as property, stocks, or bonds.
Concept of indirect tax
Indirect tax is imposed on goods and services rather than on income or profits. Unlike direct taxes, where the taxpayer bears the full responsibility, indirect taxes are collected by intermediaries such as manufacturers, retailers, or service providers and passed on to consumers. This means that the final tax burden is shared among buyers in the form of prices on goods and services.
Types of indirect taxes
- Goods and Services Tax (GST)
GST is a tax on the supply of goods and services, paid by consumers but collected and remitted to the government by businesses. These businesses add GST to their prices, collect it from customers, and pass it to the government. In return, they can claim a credit for the GST paid on their own purchases, reducing their overall tax burden.
- Customs duty
Customs duty is imposed on goods imported into India. It is collected by the government to regulate trade, protect local industries, and generate revenue. Customs duty varies based on the product category and country of origin.
- Stamp duty and registration fees
Stamp duty and registration fees are charged on property transactions and legal documents. Whenever a property is purchased or leased, the buyer must pay stamp duty to legalise the transaction. The rates vary across states and depend on the property’s value.
Features of indirect taxes
- Indirect taxes are included in the price of goods and services, making them easier to collect and reducing the risk of tax evasion.
- With the introduction of GST, indirect taxes have been streamlined into a uniform structure, eliminating multiple overlapping taxes and making compliance easier for businesses.
- Since businesses act as intermediaries for tax collection, they must maintain proper records, file returns, and remit taxes to the government.
Examples of indirect taxes
One of the most significant indirect taxes in India is the GST, which applies to nearly all goods and services at different tax rates. Customs duty is another example, levied on imported goods to regulate international trade and support domestic industries.
Difference between direct and indirect taxes
| Factors | Direct taxes | Indirect taxes |
| Definition | Levied directly on individuals and entities based on their income or profits | Levied on goods and services rather than on income or profits |
| Tax structure | Progressive, with higher rates for higher income brackets | The same rate applies to all income groups for specific goods and services |
| Basis of taxation | Income, wealth, profits, and capital gains | Consumption and sale of goods and services |
| Collection method | Collected directly from taxpayers by the government | Collected from consumers through intermediaries, such as sellers or manufacturers |
| Ease of collection | Relatively complex, as it considers multiple income sources | Simpler, using a point-of-sale mechanism imposed on the price of goods and services |
| Examples | Income tax, corporate tax, capital gains tax | GST, custom duty, stamp duty |
Concept of income tax
Income tax in India is a tax you pay on the money you earn. If your income crosses a certain limit, you must pay a portion of it to the government. It is governed by the Income Tax Act, 1961, and applies to various sources of income.
Your income can come from–salary, business profits, rent from property, or investments. The amount of tax you pay depends on how much you earn, with different tax slabs deciding the percentage.
The tax is collected in three main ways: Tax Deducted at Source, advance tax, and self-assessment tax.
- TDS is deducted directly from salaries, bank interest, or payments to professionals before the amount is credited to them, and the deducted tax is deposited with the government.
- Advance Tax follows a pay-as-you-earn system, where individuals with significant non-salaried income, such as business owners or freelancers, must pay tax in instalments if their total tax liability exceeds ₹10,000 in a year.
- Finally, any remaining tax after TDS and Advance Tax is settled through self-assessment tax, which taxpayers must pay before filing their Income Tax Return (ITR).
Common income tax exemptions
To reduce taxable income and encourage long-term savings, the Indian Income Tax Act provides various exemptions and deductions for individuals.
One of the most widely used deductions is Section 80C, which allows individuals to claim up to ₹1.5 lakh for investments in instruments like Public Provident Fund, Employees’ Provident Fund (EPF), and tax-saving fixed deposits. Section 80D provides deductions for health insurance premiums paid for self, family, and parents, with a maximum limit of ₹25,000 (₹50,000 for senior citizens).
House loan borrowers can benefit from Section 24(b), which allows a deduction of up to ₹2 lakh on interest paid for a self-occupied property. Additionally, House Rent Allowance is exempt under certain conditions, helping salaried employees reduce tax on rental expenses.
These exemptions and deductions significantly reduce tax liability, making tax planning an essential part of financial management.
Basic concept of GST
GST is a single tax that applies to the sale of goods and services across India. Before GST, businesses had to deal with multiple taxes like VAT, service tax, and excise duty. Now, this tax has replaced them all, making tax collection simpler and more transparent.
Introduced on July 1, 2017, GST follows a destination-based taxation system, meaning tax is collected at the point of consumption rather than at the point of production. GST is divided into three types:
- Central GST (CGST): Goes to the central government.
- State GST (SGST): Goes to the state government (for sales within the same state).
- Integrated GST (IGST): Goes to the central government (for sales between states).
One of the biggest advantages of GST is its input tax credit mechanism, which allows businesses to claim credit for taxes paid on purchases, reducing overall tax liability. With an online tax filing system through the GST Network, businesses can register, file returns, and make tax payments.
Common questions on taxes in India
What are the recent tax reforms in India?
India has undergone significant tax reforms in recent years to simplify compliance, improve transparency, and boost economic growth. Some of the most notable reforms include:
- New tax regime - Introduced as an alternative to the old tax regime in 2020, the new tax regime offers lower tax rates for salaried individuals but removes exemptions and deductions. The 2025 Union Budget amendment raised the rebate limit to ₹12.75 lakh, making it more attractive.
- Goods and Services Tax Act - Replaced multiple indirect taxes with a unified tax structure, reducing the cascading effect of taxes (tax on tax) and improving compliance through digital invoicing and e-way bills.
- Faceless assessment and appeals - Eliminated human interaction between taxpayers and tax officers, reducing corruption and bias in tax assessments.
- Corporate tax reduction - Lowered corporate tax rates to 22% from 30% for existing companies and 15% for new manufacturing firms, aimed at making the country a more attractive destination for investments.
What is the tax concept?
Tax is a mandatory financial charge imposed by the government on individuals and businesses to generate revenue for public services like healthcare, education, and infrastructure. It is broadly classified into direct and indirect taxes based on how they are collected.
Is income tax a direct tax or indirect tax?
Income tax is a direct tax because it is paid directly by individuals and businesses on their earnings to the government without any intermediaries.
Is TDS a direct tax or indirect tax?
Tax Deducted at Source is a direct tax as it is deducted from an individual’s income (such as salary or interest) at the source and paid directly to the government.