Budget Terms Explained I : Direct Taxes

- Team Orbis Economics

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Tax announcements are perhaps the most keenly awaited aspect of the annual budget every year by individuals and businesses alike. This is because they directly impact either the income in hands of people and enterprises or increase the prices they pay for products and services. In this edition of budget related concepts we look at direct taxes. These taxes – like income tax and corporate tax – affect the incomes directly. As a result direct taxes can impact the profitability for businesses and potential demand from consumers as well as disposable incomes for the income tax payers.

What are direct taxes?

Tax heads can be divided into two parts – direct and indirect. Direct taxes are called so because their impact on an individual or esnterprise’s income is exactly that- direct. An increase in direct tax rate results in less income in the hands of the payee and a decrease in the direct tax rate results in higher income in the hands of the payee.  

Direct taxes are divided under various heads like income tax, corporation tax, property tax and capital gains tax among others. However, the two most important direct taxes are income tax and corporation tax.

What is income tax and why is it important?

Income tax is the tax on the total income earned by an individual. All salaried people with an income above a threshold limit pay an income tax, it is also the only direct tax liability for businesses that function as sole proprietorships. As per the last Union Budget (2012-13), income tax was payable for a level of income above Rs. 2 lakh. It is divided into various slabs, with 30% as the rate for all with an income over Rs. 10 lakh.

Changes in income tax rates thus determine the money in hand for salaried individuals and sole proprietors. As a second round effect, they impact the spending decisions of consumers that buy goods and services produced. Discretionary consumer spending on goods and services i.e. that, which is not compulsory - like entertainment, beauty and health care and luxury goods, for instance, are most likely to get impacted by tax rate changes. So as an individual, income tax changes will determine how much you can spend and save, and as a business, it will help you plan for demand for your products and services in the next year.

What is corporation tax, who pays it and why is it important?

Corporation tax or corporate tax, as it is often called, is the tax levied on all registered companies in India. These can be both Indian and foreign companies present in India. While Indian companies have to pay corporate tax on their overall income, even if it is earned outside the country, foreign companies only need to pay tax on their income earned in India. Corporate tax rates are important because they can impact the net incomes of companies and also impact the B2B demand for various products and services. At present the effective corporate tax rate for Indian companies is at 30%.