Direct v/s Indirect Taxes

As a student of tax law, I’ve often been asked to distinguish ‘direct’ and ‘indirect’ taxes. I confess, I’ve never been quite sure myself.

A common explanation is that “a direct tax is a tax paid directly by the taxpayer to the government and cannot be shifted, like an income tax. An indirect tax, like a tax levied on goods and services, can be passed on to another entity or individual.”

But the truth is these terms are amorphous and susceptible to different meanings in different jurisdictions and contexts.

The Indian Constitution doesn’t refer to ‘direct’ or ‘indirect’ taxes. It speaks only of taxes. Rather, the Central Board of Revenue Act, 1963, draws this distinction (ostensibly for the purpose of allocating administrative jurisdiction between the Central Board of Direct Taxes and the Central Board of Indirect Taxes and Customs (formerly, the Central Board of Customs and Excise)).

The CBRA defines direct taxes as including a plethora of taxes, including the income-tax, and the erstwhile gift, estate and wealth taxes.

But remarkably, and somewhat counterintuitively (to an India-trained lawyer), in the United States, income, gift and estate taxes are considered indirect taxes. As the U.S. Supreme Court explains in Moore v United States, “generally speaking, direct taxes are those taxes imposed on persons or property… [B]y contrast, indirect taxes are the familiar federal taxes imposed on activities or transactions. That category of taxes includes duties, imposts, and excise taxes, as well as income taxes.” The distinction assumes importance in the United States because the U.S. Constitution requires that direct taxes be apportioned among the several States. Indirect taxes are not subject to such a requirement.

This little comparative law quirk stood out to me. Sometimes, labels help us understand things better. Sometimes they can confuse.

Moore itself is about whether the transitional, one-time, 'Minimum Repatriation Tax' enacted by the 2017 Tax Cuts and Jobs Act was constitutional. By a 7-2 , majority, SCOTUS said yes. It's worth a read to understand how the U.S. taxes its citizens and corporations on the foreign-source income of their foreign corporations.