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Indirect Tax Definition
Indirect Tax Definition
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An Indirect Tax is a type of tax that is levied on goods and services before they reach the final buyer and it is this entity that ultimately pays the tax as a part of the final market price of the purchased goods or services. Alternately, if the entity that pays taxes to the collection authority does not suffer a corresponding income reduction, i.e., the tax and impact incidence are not on the same entity, and the tax is passed or shifted on, then the tax can also be termed as indirect. Thus, this type of tax is collected by an intermediary like a retail store from a consumer who pays it as an included price of a purchased item.
The concept of Indirect Tax, therefore different from a direct tax as the intermediary files a tax return at a later stage while depositing the tax proceeds to the government along with the return. Thus, an indirect tax is charged by the taxpayer to someone else while it is not so in the case of a direct tax. Hence, this type of tax makes up for a sizeable proportion of the total tax revenue that is generated by the government.
An importance of indirect tax stems from the fact that it allows governments to collect assured and stable returns through society. It also helps in raising significant government revenue, more so in developing countries like India, where direct tax is paid only by a minuscule of its population. However, apart from raising government revenue, it also helps in regulating the flow of imports and exports within and outside the country through the use of instruments like tariffs and import duties. Tariff imposition and import duties make imported goods costlier for domestic consumers and provide encouragement for domestic producers.
A prime example of indirect tax is the Value-Added Tax or VAT. It is a type of consumption tax that is levied on goods or services at each stage of the supply chain from the initial production point to the final point of sale. A user pays the final VAT amount based on a product’s cost minus the cost of materials which has been used for manufacturing the product and has already been taxed at a preceding stage. Thus, it is based on consumption rather than income.