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Taxation Overview

 

“Nothing Is Certain, Except Death and Taxes”

 

I couldn't start talking about taxes without quoting those remarkable infamous words.

 

What is tax?

 

A tax is a compulsory financial charge or some other type of levy imposed on a taxpayer by a governmental in order to fund government public expenditures.

 

And yes, that's the dictionary definition, but everyone knows what tax is, right?

I don't want to bore you with dictionary definitions, but there are still some basic differences that create some confusion.

 

Direct taxes vs. Indirect taxes

 

Although the actual definition may vary a little region to region, but the basic rule is:

 

• Indirect Tax: A tax levied on goods and services. (e.g. VAT)

• Direct Tax: A tax levied on the income or profits. (e.g. Income Tax)

 

In short: You can consider that direct taxes are taxes that you pay directly to the government and indirect taxes that you do not. Remember, this may vary from region to region.

 

Indirect Tax

 

Indirect taxes have various names around the world.

 

• Europe: VAT (Value-Added Tax)

• United States: Sales Tax

• Australia: GST (Goods and Services Tax)

• Japan: JCT (Japanese Consumption tax)

 

The process for collecting these taxes can vary significantly, but the outcome is the same: The end customer pays the tax.

 

Example:

 

Sales tax is collected by the retailer when the final sale in the supply chain is reached.

 

VAT is collected by all sellers in each stage of the supply chain (suppliers, manufacturers, distributors, and retailers all collect VAT on taxable sales). Similarly, all pay VAT on their purchases. (suppliers, manufacturers, distributors, retailers, and end consumers). Businesses must track and document the VAT they pay on purchases to receive a credit for the VAT paid on their tax return.

 

Potential advantages

• It is easier for the consumer to understand and acknowledge

• It is easier for firms to pay indirect taxes than consumers

• Countries can levy import duties to protect their domestic economy

• It is effective in reducing demand and overcoming market failures by adjusting social behavior (e.g. cigarette tax can contribute to reducing cigarette consumption)

 

Potential disadvantages

• Indirect taxes tend to affect those with lower incomes due to their regressive nature. That is, the tax paid will be the same for different income groups. (those with lower incomes will commit a higher percentage of their income than those with higher incomes)

• It can encourage tax evasion. (for example, cigarette taxes can increase the black market)

 

Direct Tax

 

Direct tax is based on the economic principle that whoever has more resources or earns higher incomes must pay a higher tax burden, and is also considered the unavoidable tax. In other words, there is no choice but to pay.