The term indirect tax has more than one meaning. In the colloquial sense, an indirect tax (such as sales tax, a specific tax, value added tax (VAT), or goods and services tax (GST)) is a tax collected by an intermediary (such as a retail store) from the person who bears the ultimate economic burden of the tax (such as the consumer). The intermediary later files a tax return and forwards the tax proceeds to government with the return. In this sense, the term indirect tax is contrasted with a direct tax which is collected directly by government from the persons (legal or natural) on which it is imposed. Some commentators have argued that "a direct tax is one that cannot be shifted by the taxpayer to someone else, whereas an indirect tax can be."
An indirect tax may increase the price of a good so that consumers are actually paying the tax by paying more for the products. Examples would be fuel, liquor, and cigarette taxes. An excise duty on motor cars is paid in the first instance by the manufacturer of the cars; ultimately the manufacturer transfers the burden of this duty to the buyer of the car in form of a higher price. Thus, an indirect tax is such which can be shifted or passed on. The degree to which the burden of a tax is shifted determines whether a tax is primarily direct or primarily indirect. This is a function of the relative elasticity of the supply and demand of the goods or services being taxed. Under this definition, even income taxes may be indirect.direct taxexcise tax in the United States
- Indirect taxation is policy often used to generate tax revenue. Indirect tax is so called as it is paid indirectly by the final consumer of goods and services while paying for purchase of goods or for enjoying services.
- Indirect tax is broadly based since it is applied to everyone in the society whether rich or poor.
An indirect tax is imposed on producers (suppliers) by the government. Examples include duties on cigarettes, alcohol and fuel and also VAT
VAT is a tax placed on the expenditure / a tax set as a percentage of the price of a good)
A tax increases the costs of production causing an inward shift in the supply curve
The vertical distance between the pre-tax and the post-tax supply curve shows the tax per unit
With an indirect tax, the supplier may be able to pass on some or all of this tax onto the consumer through a higher price
This is known as shifting the burden of the tax and the ability of businesses to do this depends on the price elasticity of demand and supply
3. The merits of indirect taxes are briefly explained as follows :-
Indirect taxes are imposed on production, sale and movements of goods and services. These are imposed on manufacturers, sellers and traders, but their burden may be shifted to consumers of goods and services who are the final taxpayers. Such taxes, in the form of higher prices, are paid only on purchase of a commodity or the enjoyment of a service. So taxpayers do not feel the burden of these taxes. Besides, money burden of indirect taxes is not completely felt since the tax amount is actually hidden in the price of the commodity bought. They are also convenient because generally they are paid in small amounts and at intervals and are not in one lump sum. They are convenient from the point of view of the government also, since the tax amount is collected generally as a lump sum from manufacturers or traders.
2. Difficult to evade
Indirect taxes have in built safeguards against tax evasion. The indirect taxes are paid by customers, and the sellers have to collect it and remit it to the Government. In the case of many products, the selling price is inclusive of indirect taxes. Therefore, the customer has no option to evade the indirect taxes.
3. Wide Coverage
Unlike direct taxes, the indirect taxes have a wide coverage. Majority of the products or services are subject to indirect taxes. The consumers or users of such products and services have to pay them.
Some of the indirect taxes are elastic in nature. When government feels it necessary to increase its revenues, it increases these taxes. In times of prosperity indirect taxes produce huge revenues to the government.
5. Universality-Indirect taxes are paid by all classes of people and so they are broad based. Poor people may be out of the net of the income tax, but they pay indirect taxes while buying goods.
6. Influence on Pattern of Production
By imposing taxes on certain commodities or sectors, the government can achieve better allocation of resources. For e.g. By Imposing taxes on luxury goods and making them more expensive, government can divert resources from these sectors to sector producing necessary goods.
7. May not affect motivation to work and save
The indirect taxes may not affect the motivation to work and to save. Since, most of the indirect taxes are not progressive in nature, individuals may not mind to pay them. In other words, indirect taxes are generally regressive in nature. Therefore, individuals would not be demotivated to work and to save, which may increase investment.
8. Social Welfare
The indirect taxes promote social welfare. The amount collected by way of taxes is utilized by the government for social welfare activities, including education, health and family welfare. Secondly, very high taxes are imposed on the consumption of harmful products such as alcoholic products, tobacco products, and such other products. So it is not only to check their consumption but also enables the state to collect substantial revenue in this manner.
9. Flexibility and Buoyancy
The indirect taxes are more flexible and buoyant. Flexibility is the ability of the tax system to generate proportionately higher tax revenue with a change in tax base, and buoyancy is a wider concept, as it involves the ability of the tax system to generate proportionately higher tax revenue with a change in tax base, as well as tax rates.
Disadvantages / Demerits of Indirect Taxes ↓
Although indirect taxes have become quite popular in both developed & Under developed countries alike, they suffer from various demerits, of which the following are important.
1. High Cost of Collection
Indirect tax fails to satisfy the principle of economy. The government has to set up elaborate machinery to administer indirect taxes. Therefore, cost of tax collection per unit of revenue raised is generally higher in the case of most of the indirect taxes.
2. Increase income inequalities
Generally, the indirect taxes are regressive in nature. The rich and the poor have to pay the same rate of indirect taxes on certain commodities of mass consumption. This may further increase income disparities among the rich and the poor.
3. Affects Consumption
Indirect taxes affects consumption of certain products. For instance, a high rate of duty on certain products such as consumer durables may restrict the use of such products. Consumers belonging to the middle class group may delay their purchases, or they may not buy at all. The reduction in consumption affects the investment and production activities, which in turn hampers economic growth.
4. Lack of Social Consciousness
Indirect taxes do not create any social consciousness as the taxpayers do not feel the burden of the taxes they pay.
Indirect taxes are often rather uncertain. Taxes on commodities with elastic demand are particularly uncertain, since quantity demanded will greatly affect as prices go up due to the imposition of tax. In fact a higher rate of tax on a particular commodity may not bring in more revenue.
The indirect taxes are inflationary in nature. The tax charged on goods and services increase their prices. Therefore, to reduce inflationary pressure, the government may reduce the tax rates, especially, on essential items.
7. Possibility of tax evasion
There is a possibility of evasion of indirect taxes as some customers may not pay indirect taxes with the support of sellers. For instance, individuals may purchase items without a bill, and therefore, may not pay Sales tax or VAT (Value Added Tax), or may obtain the services without a bill, and therefore, may evade the service tax.
Capital ExpenditureThe most common type of capital expenditure occurs when you purchase or otherwise acquire any asset that will benefit your business for more than one year. New equipment, a car, computer, office furniture, or even business real estate are the things that most commonly come to mind when you hear the words "capital asset."
Expenses that add to the value or useful life of an item of property also are considered capital expenditures. If you have a capital expenditure that pertains to a particular asset in some year after the asset is purchased, you must treat the expenditure as a separate asset and depreciate it under the rules applicable to that type of asset in the year you place the expenditure into service.
Deciding whether a particular item should be classified as a capital expenditure or as a currently deductible expense is not always easy, particularly if it's debatable whether the expense represents a repair, or an improvement to a capital asset.
However, over time, the IRS and the courts have classified, on a case-by-case basis, some categories of items commonly considered to be capital expenditures, which we provide as a guide.
Some special rules. In some cases, the tax laws depart from the general deduct-or-capitalize analysis by providing specific rules that govern how you may or must treat certain expenditures.
For small business owners, the most commonly applied of these rules are:
- an expensing election that allows you to deduct rather than to capitalize a specified amount of your costs in acquiring certain business equipment
- amortization of startup costs, including those associated with organizing a corporation or a partnership
- an election to capitalize rather than deduct taxes and interest you pay to carry or develop real property or to carry, transport, or install personal property
Specific deductions: entertainment: introduction and contents
With certain exceptions, expenditure on business entertainment or gifts is not allowable as a deduction against profits, even if it is a genuine expense of the trade or business. This includes expenditure by:
- Individuals, partnerships and companies carrying on a trade, profession or vocation.
- Individuals, partnerships and companies carrying on a property business.
- Investment companies.
- Employees and directors (in certain circumstances).
- Any other person who carries on a trade or business.
Assets used for the purpose of business entertainment do not qualify for capital allowances.
Specific deductions: entertainment: gifts:
A gift is something that is given to a person without receiving anything in exchange. It is offered voluntarily and without any expectation of a return. An example of this would be gifts provided for potential customers who take a test drive in a new car - there is no obligation to buy the car and so nothing has been given to the trader in return for the gift.
Gifts may also arise where goods or services are supplied at less than the cost to the trader. For instance, a hotel might offer meals to its suppliers at a nominal charge. Here the difference between the cost of the meal and the price paid as a non-allowable gift. By contrast, if a baker reduces the price of fresh bread at the end of the day, this is a normal commercial transaction (as the bread will be worthless by the next day) and the cost is allowed in full.
Even if the recipient of the gift has provided a service to the trader, you should give no deduction unless it can be shown that the trader was under some contractual obligation to offer the gift. It is not unusual, for instance, for organisers of meetings or conferences to send small gifts, such as hampers or tokens, to speakers after the event. However, if the provision of a gift was not one of the conditions upon which the speaker agreed to attend, then the gift is treated as business entertainment expenditure, and the cost disallowed.
In some instances, something that appears to be a gift may actually be a part of a sale to a customer. A bunch of flowers presented to a customer who has just purchased a new car would effectively have been paid for by the customer - it is a part of the cost of the car. Similarly, gifts offered to customers who purchase a certain level of goods are really discounts on sale and not business gifts. Gifts of this nature are not disallowed under Section 577.
The legislation only refers to expenditure incurred. A trader may supply goods at a discount but, so long as the original cost has been covered, you should not treat the profit foregone as a business gift.