Indirect Tax

March 7, 2009

Indirect tax is one which is collected by intermediaries who turn over the proceeds to the government and file the related tax return. Indirect taxes are imposed on goods and services. Unlike direct taxes, indirect taxes are not levied on individuals. An indirect tax such as sales tax, value added tax (VAT), or goods and services tax (GST) is a tax collected by an intermediary from the person who bears the ultimate economic burden of the tax. The intermediary later files a tax return and forwards the tax proceeds to government with the return.

For example, while purchasing goods from a retail shop, the retail sales tax is actually paid by the customers. The retailer eventually passes this tax to the respective authority. The indirect tax actually raises the price of a good and the customers purchase by paying more for that product. In other words, this charge is paid by one individual at the beginning, but the burden of this will be passed over to some other individual, who eventually holds the burden.

An indirect tax might result in increase in the price of a good as the 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.

Examples of indirect include: Excise tax, stamp duty, sales tax and expenditure tax. Excise tax is an indirect tax levied on the sale of a specific good produced within the country. Typical examples of excise duties are taxes on tobacco, alcohol and gasoline. Excise duty is a tax levied on the producer of certain goods, commodities and activities. It is a separate tax from VAT, and is different from it in that VAT solely affects the consumer. The motive for the implementation of excise is to curb the pursuit of goods and services harmful to our health and morals. The intension of this tax is to protect people from harming their health by abusing substances and engaging in illegal activities. The other motives are to punish any illegal activities and to provide monies needed for extra healthcare and for defense.

Stamp duty is an additional charge levied on documents, like promissory notes, bills of exchange, insurance policies and debentures. Sales tax is an indirect tax levied by the government at the point of sale on retail goods and services. Sales tax is collected by the retailer, which ultimately forwarded to the government.

Another vital indirect tax is Value Added Tax or VAT. Value added tax (VAT), or goods and services tax (GST), is a consumption tax levied on value added. In contrast to sales tax, VAT is neutral with respect to the number of passages that there are between the producer and the final consumer, where sales tax is levied on total value at each stage, the result is a cascade. Exports, since they are consumed abroad are not subjected to VAT. Businesses can recover VAT on the material and services but the personal end consumers cannot. Due to this, the total tax levied at each stage in the economic chain of supply is a constant fraction of the value added by the business to its products. This has another added advantage, i.e. the tax is collected by the business and not the government. The main reason for the invention of VAT was to discourage cheating and smuggling which was resulting from high sales taxes and tariffs.