Taxation: It refers to the process by which a government or taxation authority imposes or collects a tax from its citizens and businesses. Taxation is applied at all levels, from income tax to goods and services tax (GST). The Indian taxation system is divided into two parts: the central government and the state governments. Local governments, such as the municipalities and corporations, levy some modest taxes.

Money is essential to run a government and handle the affairs of a state. As a result, the government imposes a variety of taxes on individual and corporate earnings. In this article, we will discuss taxation in detail.

What is Taxation?

In India, the central and state governments play a crucial role in taxation. The state and federal administrations have implemented significant policy reforms to streamline the taxes procedure and enhance transparency in the country.

The Goods and Services Tax (GST) was one such development, as it simplified the tax structure on the sale and delivery of goods and services in the country.

Classification of Taxes

In general, there are two types of taxes:

1. Direct Taxes

A direct tax is paid directly to the imposing entity (generally government) by an individual or company. A direct tax cannot be transferred to another person or business. The person or entity subject to the tax is responsible for making sure the tax is paid.

The Central Board of Direct Taxes is responsible for levying and collecting direct taxes and formulating other direct tax policies.

Taxpayers, for example, pay income tax, property tax, asset tax, and gifts tax to the government directly.

Example of Direct Taxes

A person’s income tax is an excellent example of a direct tax. Income tax is usually reported once a year, while deductions from one’s wage might be made monthly. For example, if an individual pays \(\$ 30,000\) in tax per year on a \(\$ 120,000\) annual salary, the \(\$ 30,000\) is his direct tax.

Types of Direct Tax

1. Income tax – One’s income determines it. Depending on how much a worker earns, a percentage of their pay is deducted. The government is also keen on publicising credits and deductions that help reduce one’s tax liabilities, which is a positive thing.
2. Transfer tax – The estate tax is the most common type of transfer tax. This tax is imposed on a deceased person’s property taxable portion, including trusts and financial accounts. A gift tax is another type of tax that collects a particular amount from persons who are giving property to another person.
3. Entitlement tax – People benefit from social programmes like Medicare, Medicaid, and Social Security because of this form of direct taxation. The Federal Insurance Contributions Act is the umbrella term for the entitlement tax collected through payroll deductions.
4. Property tax – Property taxes are levied on real estates, such as land and buildings, and are used to fund public services such as police and fire departments, schools and libraries, and roads.
5. Capital gains tax – When an individual sells assets such as stocks, real estate, or a business, they must pay this tax. The tax is calculated by calculating the difference between the purchase price and the selling price.

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2. Indirect Taxes

Indirect tax is defined as the tax imposed by the government on a taxpayer for goods and services rendered. Unlike direct taxes, indirect taxes are not assessed on the taxpayer’s income, revenue, or profit, and they can be handed down from one person to the next.

The word indirect tax has several different meanings. An indirect tax, such as sales tax, a special tax, value-added tax (VAT), or goods and services tax (GST), is a tax collected from the person who suffers the tax’s ultimate economic cost via an intermediary as a retail store.

After that, the intermediary prepares a tax return and sends the tax proceeds to the government along with it. In this sense, an indirect tax differs from a direct tax, which the government collects directly from the individuals (legal or natural) who are subjected to it.

Example of Indirect Taxes

Let’s look at the example of VAT to see how an indirect tax is implemented. For example, suppose John goes to the outlet store to purchase a \(\$ 500\) refrigerator. When he approaches the salesperson, they will state the sale price, which is \(\$ 500,\) which is the correct response.

The refrigerator is worth less than that. But because a VAT (typically \(10\% \) to \(20\% \)) has been imposed, the sale price is now \(\$ 500.\) If John examines his receipt, he will see the refrigerator’s original price before the tax was applied. The tax is collected from the sale price and paid to the government by the unit or item’s producer.

Types of Indirect Taxes

1. Sales tax – When individuals go shopping in malls or department stores, they are already paying indirect taxes. Household goods, clothing, and other essential commodities are all subject to these types of levies. The final selling price is padded with a sales tax that the shop collects and pays to the government after payment at the counter.
2. Excise tax – Excise tax is also widely used. When a producer purchases raw materials for its goods, such as tobacco for cigarette manufacturers, they must pay indirect taxes on the items. Through a part of the ordinary course of business, the manufacturer can pass on the burden to the consumers by selling the cigarettes at a higher price.
3. Customs tax – Have you ever wondered why imported goods are so expensive? It is due to the customs duty. When a container of bananas from another country enters the United States, the importer must pay a tax (customs tax), which is subsequently passed on to the customer.
4. Gas tax – Yes, there is an indirect tax when purchasing gasoline for vehicles.

Taxation Principles

The criteria that a governing entity should employ when creating a taxation system are known as taxation principles. The following are some of these principles:

1. Broad application – The tax system should be applied to the widest possible population, ensuring that no single individual or company is overtaxed. Instead, the tax burden is shared by the entire population.
2. Broad tax usage – Only when there is a clear cause-and-effect relationship between the tax and the use taxes are targeted towards that use. Taxes are collected for general use in all other circumstances. Special interests, on the other hand, will receive preferred support.
3. Ease of compliance – The administration of taxation should be as straightforward as possible so that a taxpayer has little difficulty meeting the tax payment obligations. The taxation procedure should, in theory, be invisible to the taxpayer.
4. Expenditure matching – The level of taxes should roughly correspond to the amount of planned expenditures, ensuring that the governing organisation covers its costs prudently while not taxing excessively.
5. Fairness in application – The tax imposed on all taxpayers in the same economic situation should be the same. Furthermore, the tax should not favour one group over another, resulting in one group benefiting at the expense of another.
6. Limited exemptions – Any tax exemptions should only be granted for a limited time and a defined purpose, after which the exemptions should be removed. These exemptions are solely meant to encourage particular forms of conduct, most of which are related to economic development.
7. Low collection cost – The cost of collecting taxes should be as low as feasible so that the net receipts are as large as possible.
8. Understandability – A taxpayer should be able to understand how to calculate and pay a tax. Otherwise, the tax amount remitted could be wrong.

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Formulas to Calculate Tax

(i) Calculation of Goods and Service Tax
The \(4\) types of GST in India are:
SGST (State Goods and Services Tax)
CGST (Central Goods and Services Tax)
IGST (Integrated Goods and Services Tax)
UGST (Union Territory Goods and Services Tax)
Goods and services tax can be calculated using the following formula
\(GST\,Amount = \frac{{\left({{\text{The}}\,{\text{original}}\,\cos \,t\,{\text{of}}\,{\text{article}} \times {\text{GST}}\% } \right)}}{{100}}\)
Net price of an article \( = \) Original cost of an article\( + \)GST Amount
(ii) Calculation of Value Added Tax
VAT to be paid to Government \( = \) Output VAT \( – \) Input VAT
Output VAT \( = \) It is a tax charged on the sale of goods. It is set on the selling price of the goods.
Input VAT \( = \) It is the tax paid on the purchase of goods. It is paid at the cost price of the goods.
(iii) Net of Tax Formula
Net of Tax \( = \) Gross Income \( – \) Taxes on Gross Income
(iv) Taxable Income Formula
For individual,
Taxable Income Formula \( = \) Gross Total Income \( – \) Total Exemptions \( – \) Total Deductions
For Corporate,
Taxable Income Formula \( = \) Gross Sales \( – \) Cost of Goods Sold \( – \) Operating Expense \( – \) Interest Expense \( – \) Tax Deduction/ Credit.

Solved Examples – Taxation

Q.1. John is entitled to a gross salary of \(\$ 50,000\) annually, and he pays \(6\% \) interest on his son’s education loan of \(\$ 25,000.\) He is also eligible for a tax exemption of \(\$ 10,000.\) Calculate the taxable earnings.
Ans: Below is data for the calculation of John’s Taxable Earnings.

Gross Salary	\(\$ 50,000\)
Education Loan	\(\$ 25,000\)
Interest on Education Loan	\(10\% \)
Tax Exemption	\(\$ 10,000.\)

Taxable Earning \( = \) Gross salary \( – \) Interest on education loan \( – \) Tax exemptions
\( = {\text{\$ }}50,000 – 10\% \times {\text{\$ }}25,000 – {\text{\$ }}10,000\)
\( = {\text{\$ 37,500}}\)

Q.2. Assume a company earns a gross income of \(\$ 250,000\) in \(2020\) and is liable to pay corporate tax at a \(35\% \) rate. What will be the net income of the company after paying taxes?
Ans: Gross income \( = \$ 250,000\)
Corporate tax rate \( = 35\% \)
Tax payable on gross income \( = \$ 250,000 \times 35\% = \$ 87,500\)
Net income after tax \( = \$ 250,000 = \$ 87,500 = \$ 162,500\)

Q.3. A dealer in Bhopal (M.P.), say \(X,\) supplies goods and services worth \(₹8,000\) to \(Y\) a person in Indore (M.P.). If the rate of GST is \(28\% ,\) find:
a) Central GST (CGST)
b) State GST (SGST)
c) Integrated GST (IGST)
Ans: It is a case of intra-state supply as the goods and services are supplied within the same state (M.P.), so the tax will be shared equally by the central government as CGST and by the state government as SGST. Since, the GST rate is \(28\%, \) therefore CGST rate is \(14\% \) and SGST rate is also \(14\% .\)
a) Central GST (CGST) \(₹ 8,000 = \frac{{14}}{{100}} \times 8,000 =₹ 1120\)
b) State GST (SGST) \(₹ 8,000 = \frac{{14}}{{100}} \times 8,000 =₹ 1120\)
c) Integrated GST (IGST)\( = \) Nil

Q.4. The cost of some financial services in the same city, taxable under GST are given below. Cost of services: \(₹500,₹300,₹400\) and \(₹600.\) If the rate of GST is \(12\%, \) find the amount of GST on these services.
Ans: It is a case of an Intra-state transaction
The total cost of services \(= ₹500 + ₹300 + ₹400 + ₹600 + = ₹1800\)
CGST \( = 6\% \) of \(₹1800 = \frac{6}{{100}} \times ₹1800 = ₹108\)
SGST \( = 6\% \) of \(₹1800 = \frac{6}{{100}} \times ₹1800 = ₹108\) and IGST \( = ₹00\)
Therefore, the required amount of GST \(₹108 + ₹108 + ₹00 = ₹216.\)

Q.5. Kale buys an article for \(\$ 10000\) and pays \(7\% \) tax. He sells the same article for \(\$ 13000\) and charges \(9\% \) tax. Find the VAT paid by Kale.
Ans: Cost of the article \( = \$ 10000\)
Tax paid by Kale \( = 7\% \) of \( = \$ 10,000\)
\( = \$ \frac{7}{{100}} \times 10000\)
\( = \$ 700\)
The selling price of the article \( = \$ 13000\)
Tax charged at \(9\% = 9\% \) of \(13000\)
\( = \$ \frac{9}{{100}} \times 13000\)
\( = \$ 1170\)

Summary

In this article, we learnt about taxation and different types of taxation like direct and indirect tax. Also, we have discussed the taxation principles and some formulas related to tax along with the solved examples.

FAQs

Q.1. What is taxation and explain its types?
Ans: Taxation refers to the process by which a government or taxation authority imposes or collects a tax from its citizens and businesses. Taxation is applied at all levels, from income tax to goods and services tax (GST). The Indian taxation system is divided into two parts: the central government and the state governments. There are two types of tax: Direct tax and Indirect tax.

Q.2. What is the purpose of taxation?
Ans: It aids the government in constructing roads, schools, and health-care facilities, as well as the funding of law enforcement and the judicial system. Article \(246\) of the Indian Constitution details the various taxes levied by the country’s Central and State governments.

Q.3.What can be an example of taxation?
Ans: A person’s income tax is a good example of a direct tax. Income tax is usually reported once a year, while deductions from one’s wage might be made monthly. For example, if an individual pays \(\$ 30,000\) in tax per year on a \(\$ 120,000\) annual salary, the \(\$ 30,000\) is his direct tax.

Q.4. What is a tax on goods and services called?
Ans: Goods and services tax (GST), also known as indirect taxes, are consumption taxes levied on any value added to a product.

Q.5.Who started taxes in the world?
Ans: Over \(4500\) years ago, the first known tax was enacted in Mesopotamia, where individuals paid taxes in the form of animals throughout the year (the preferred currency at the time). There were also estate taxes and levies in the ancient world.

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We hope this detailed article on taxation helped you in your studies. If you have any doubts or queries, feel to ask us in the comment section. Happy learning!