Taxation in India: Direct and Indirect Taxes, Income-tax Act 2025 and GST for RBI Grade B Finance
Last updated: 2026-11-13 · MockMentor
Taxation forms part of the Union Budget line of the RBI Grade B Finance syllabus, since taxes are the main source of government revenue and the main tool of fiscal policy. Questions ask about the types of tax, tax buoyancy and elasticity, the features of GST and the GST Council, and terms such as reverse charge, inverted duty structure, equalisation levy, Pigovian tax and Tobin tax. With the new Income-tax Act, 2025 in force from April 2026 and GST rates simplified in September 2025, this is also a current topic. This chapter covers the principles of taxation, India's direct and indirect taxes, GST in detail and the key terms.
In one line: India raises most of its revenue from direct taxes on income and profits and from GST, a destination-based tax on consumption shared between the centre and states; recent reforms have cut corporate tax rates, made a simpler income tax regime the default, replaced the 1961 Income-tax Act and reduced GST to two main slabs.
Basic concepts
- Tax: a compulsory payment to the government without any direct benefit in return. Under Article 265, no tax can be levied or collected except by authority of law.
- Direct tax: a tax whose burden cannot be shifted to someone else, such as income tax. The person who pays it bears it.
- Indirect tax: a tax whose burden can be shifted, usually to the consumer, such as GST. The seller pays it to the government but collects it from the buyer.
- Impact and incidence: impact is on the person who pays the tax first; incidence is on the person who finally bears it.
- Tax base: what is taxed, such as income, profits, consumption or property.
- Tax-to-GDP ratio: total tax revenue as a share of GDP; a measure of a government's ability to raise revenue.
Why in News?
- The Income-tax Act, 2025 came into force on 1 April 2026, replacing the Income-tax Act, 1961, with simpler language, fewer sections and a single "tax year" in place of "previous year" and "assessment year".
- GST rates were rationalised from 22 September 2025 into two main slabs of 5% and 18%, with a special rate of 40% for a small set of luxury and sin goods, in a reform often called "GST 2.0".
- Under the new tax regime, which is the default, income up to ₹12 lakh (₹12.75 lakh for salaried taxpayers, after the standard deduction) became effectively tax-free from 2025-26 because of a larger rebate.
- The Goods and Services Tax Appellate Tribunal (GSTAT) started functioning in 2025, giving taxpayers a dedicated forum for GST appeals.
Why taxes are needed
- To raise revenue for public goods such as defence, roads, health and education.
- To reduce inequality through progressive taxes and spending on the poor.
- To stabilise the economy, by raising or cutting taxes in different phases of the business cycle.
- To discourage harmful activities, such as through taxes on tobacco and pollution.
- To encourage desirable activities, such as through deductions for savings or exports.
Principles of taxation
Canons of taxation (Adam Smith)
| Canon | Meaning |
|---|---|
| Equality | People should pay in proportion to their ability |
| Certainty | The amount, time and manner of payment should be clear |
| Convenience | Taxes should be collected at a time and in a way convenient to the taxpayer |
| Economy | The cost of collection should be low |
Later economists added productivity, elasticity, flexibility, simplicity and diversity.
Types of tax by rate
| Type | Meaning | Example |
|---|---|---|
| Progressive | The rate rises as income rises | Personal income tax |
| Proportional | The same rate at all incomes | A flat tax |
| Regressive | The burden falls more heavily on lower incomes | Many indirect taxes, since the poor spend a larger share of income |
| Degressive | Progressive up to a point, then proportional | Some tax schedules with a top flat rate |
Tax buoyancy and tax elasticity
| Measure | Meaning |
|---|---|
| Tax buoyancy | Percentage change in tax revenue ÷ percentage change in GDP, including the effect of changes in tax rates and policy |
| Tax elasticity | The same ratio, but excluding the effect of discretionary changes in rates and policy; shows how revenue responds to growth alone |
A buoyancy above 1 means revenue grows faster than GDP. Example: if GDP grows 10% and tax revenue 12%, buoyancy is 1.2.
Laffer curve
The Laffer curve shows that tax revenue rises with the tax rate up to a point, then falls, because very high rates discourage work and investment and encourage evasion. It is often used to argue for lower rates.
Direct and indirect taxes compared
| Basis | Direct taxes | Indirect taxes |
|---|---|---|
| Burden | Cannot be shifted | Can be shifted to consumers |
| Equity | Can be progressive | Usually regressive |
| Evasion | Easier to evade | Harder to evade, as collected at each stage |
| Inflation | Can curb demand and inflation | May raise prices |
| Collection cost | Higher | Lower |
| Coverage | Only those with taxable income | Everyone who buys goods and services |
| Examples | Income tax, corporation tax, securities transaction tax | GST, customs duty, excise duty on petroleum and tobacco |
Direct taxes in India
Direct taxes are administered by the Central Board of Direct Taxes (CBDT), set up under the Central Boards of Revenue Act, 1963.
Personal income tax
The Income-tax Act, 2025 continues two regimes:
- New regime (default): lower rates with few exemptions or deductions.
- Old regime: higher rates but deductions for savings, home loans, insurance and others.
Under the new regime for 2025-26 onwards, income up to ₹4 lakh is not taxed, followed by rates of 5%, 10%, 15%, 20% and 25% on successive slabs of ₹4 lakh, and 30% above ₹24 lakh. A rebate makes income up to ₹12 lakh effectively tax-free, and salaried taxpayers get a standard deduction of ₹75,000.
Corporation tax
- Domestic companies can choose a concessional rate of 22% (about 25.2% with surcharge and cess) without most exemptions, introduced in September 2019.
- The minimum alternate tax (MAT) does not apply to companies under the concessional regime.
- Foreign companies pay tax on income earned in India at a higher rate.
Capital gains
From July 2024, short-term capital gains on listed equity and equity mutual funds are taxed at 20%, and long-term gains at 12.5% above an annual exemption of ₹1.25 lakh. Indexation benefits were withdrawn for most assets.
Other direct taxes
- Securities Transaction Tax (STT): on purchase and sale of shares and derivatives on exchanges; rates on futures and options were raised in 2024.
- Tax Deducted at Source (TDS) and Tax Collected at Source (TCS): collected at the point of payment, which widens the tax net.
- Wealth tax: abolished from 2015-16 and replaced by a surcharge on the super-rich.
- Gift tax and estate duty: abolished; gifts above ₹50,000 from non-relatives are taxed as income.
International tax
- Double Taxation Avoidance Agreements (DTAAs): treaties to avoid taxing the same income in two countries.
- General Anti-Avoidance Rule (GAAR): in force since April 2017, allows tax authorities to deny benefits of arrangements whose main purpose is avoiding tax.
- Base Erosion and Profit Shifting (BEPS): the OECD and G20 project to stop multinational firms from shifting profits to low-tax places. Its Pillar Two sets a global minimum corporate tax of 15% for large multinationals.
- Equalisation levy: a tax on payments to foreign digital companies. India introduced a 6% levy on online advertising (2016) and a 2% levy on e-commerce supplies (2020). The 2% levy was removed from August 2024 and the 6% levy from April 2025.
Indirect taxes in India
Indirect taxes are administered by the Central Board of Indirect Taxes and Customs (CBIC).
Customs duty
Levied on imports (and a few exports) under the Customs Act, 1962. It includes basic customs duty and the Agriculture Infrastructure and Development Cess. Integrated GST is also charged on imports.
Excise duty
After GST, central excise applies mainly to petroleum products (crude, petrol, diesel, aviation turbine fuel and natural gas), which are outside GST for now, and to tobacco products.
Goods and Services Tax (GST)
History
| Year | Step |
|---|---|
| 2000 | Empowered Committee of State Finance Ministers set up |
| 2004 | Kelkar Task Force on implementation of the FRBM Act recommended a comprehensive GST |
| 2006 | Budget speech proposed GST from 2010 |
| 2014 | 122nd Constitution Amendment Bill introduced |
| 2016 | Constitution (101st Amendment) Act passed |
| 1 July 2017 | GST launched |
| 22 September 2025 | GST rates rationalised into two main slabs ("GST 2.0") |
Structure
GST is a destination-based tax on the supply of goods and services, levied at each stage with credit for tax paid on inputs.
| Component | Levied by | On |
|---|---|---|
| Central GST (CGST) | Centre | Supplies within a state |
| State GST (SGST) | State | Supplies within a state |
| Union Territory GST (UTGST) | UTs without legislature | Supplies within the UT |
| Integrated GST (IGST) | Centre, shared with the destination state | Supplies between states and imports |
Taxes subsumed
GST replaced central excise, service tax, additional customs duties, central sales tax, state VAT, entry tax, octroi, luxury tax, entertainment tax (except by local bodies) and several cesses.
Items outside GST
- Alcohol for human consumption (taxed by states).
- Petroleum crude, petrol, diesel, aviation turbine fuel and natural gas: within the constitutional scope of GST, but to be taxed only from a date the GST Council recommends.
- Electricity.
- Stamp duty and property taxes.
Rate structure after GST 2.0
| Rate | Items (examples) |
|---|---|
| Nil | Fresh food, milk, education and health services, many essentials, and individual life and health insurance from September 2025 |
| 5% | Most daily-use goods, many food items, medicines, fertilisers, some services |
| 18% | Most goods and services, including small cars, electronics, cement and financial services |
| 40% | A small set of luxury and sin goods, such as large cars, high-end motorcycles and aerated and sugary drinks; tobacco products move to this rate once the compensation cess ends |
| Special rates | 3% on gold and jewellery; 0.25% on rough diamonds and precious stones |
The GST compensation cess, levied from 2017 to pay states for revenue loss for five years and then extended to repay loans taken during COVID-19, was ended for most goods with GST 2.0, and continues on tobacco products only until the loans are repaid.
GST Council
The GST Council is a constitutional body under Article 279A.
| Feature | Detail |
|---|---|
| Chair | Union Finance Minister |
| Members | Union Minister of State for Finance and the finance (or other nominated) ministers of all states and UTs with legislatures |
| Quorum | Half of the total members |
| Voting | Decisions need at least three-fourths of the weighted votes of members present and voting; the centre has one-third of the weight and the states together two-thirds |
| Role | Recommends rates, exemptions, thresholds, model laws and dispute resolution |
In Union of India v. Mohit Minerals (2022), the Supreme Court held that the Council's recommendations are persuasive, not binding, on Parliament and state legislatures, which reflects cooperative federalism.
Benefits of GST
- One nation, one tax: a common national market, ending check posts at state borders.
- Removes the cascading effect (tax on tax) through input tax credit.
- Simpler compliance through a common online system.
- Wider tax base and better tax compliance through digital records.
- Boost to manufacturing and exports, as taxes are refunded on exports.
- Transparency, with tax shown separately on invoices.
Problems and criticisms
- Multiple rates and frequent changes in the early years, which GST 2.0 has reduced.
- Fuel, electricity and alcohol are still outside GST, which breaks the credit chain.
- Compliance burden for small firms, and delays in refunds.
- Fake invoicing frauds to claim input tax credit.
- Loss of fiscal autonomy for states, and disputes over compensation.
Important GST terms
| Term | Meaning |
|---|---|
| Input Tax Credit (ITC) | Credit for GST paid on inputs, set off against GST payable on output |
| Composite supply | Two or more naturally bundled supplies with one principal supply, taxed at the rate of the principal supply (a train ticket with a meal) |
| Mixed supply | Two or more separate supplies sold together for one price, taxed at the highest rate among them (a gift hamper) |
| Zero-rated supply | Exports and supplies to Special Economic Zones: no tax on output and refund of input tax |
| Exempt supply | No tax, but no credit for input tax |
| Reverse charge | The recipient, instead of the supplier, pays GST, such as for services of a goods transport agency or legal services to businesses |
| Inverted duty structure | When the tax on inputs is higher than the tax on the final product, leading to accumulation of credit |
| Composition scheme | A simple scheme for small taxpayers (turnover up to ₹1.5 crore for goods) to pay tax at a low flat rate without ITC |
| GSTN | Goods and Services Tax Network, the IT backbone of GST, now a government-owned company |
| E-way bill | An electronic document required for moving goods worth more than ₹50,000 |
| E-invoicing | Invoices registered on a government portal, mandatory for businesses with a turnover above ₹5 crore |
| GSTAT | Goods and Services Tax Appellate Tribunal for appeals against orders of GST officers |
Other tax terms
| Term | Meaning |
|---|---|
| Pigovian tax | A tax on activities with negative externalities, such as pollution or tobacco, named after A. C. Pigou |
| Tobin tax | A small tax on currency transactions, proposed by James Tobin to curb speculation |
| Angel tax | Tax on share premium received by unlisted companies above fair value; abolished from 2024-25 |
| Round tripping | Money sent abroad and brought back as foreign investment, often to avoid tax or launder money |
| Tax haven | A country with very low or no taxes and secrecy, used to avoid taxes |
| Tax expenditure | Revenue foregone because of exemptions and deductions |
| Sin tax | A high tax on goods considered harmful, such as tobacco and alcohol |
| Windfall tax | A one-time tax on unusually large profits, as India levied on domestic crude oil producers from 2022 to 2024 |
| Faceless assessment | Assessment without physical contact between taxpayer and officer, introduced in 2020 |
| Vivad se Vishwas | Schemes to settle tax disputes, run in 2020 and 2024 |
Trends in India's tax system
- Direct taxes now account for more than half of the centre's gross tax revenue, compared with less than a third in the early 1990s.
- The number of income tax returns has grown sharply, helped by TDS, TCS and data analytics.
- GST collections have grown steadily, with monthly gross collections well above ₹1.5 lakh crore.
- The general government tax-to-GDP ratio is around 18%, lower than the average for advanced economies.
- Tax policy has moved towards lower rates, fewer exemptions and better compliance through technology.
Challenges
- A narrow income tax base: only a small share of people pay income tax.
- A large informal economy and the use of cash.
- Disputes and litigation, with large amounts locked up in appeals.
- Taxing the digital economy and multinational firms.
- Balancing revenue needs with the demand for lower taxes.
Way forward
- Widen the tax base by bringing more income into the formal system.
- Keep tax rates stable and simple, with fewer exemptions.
- Bring petroleum products and electricity into GST in phases.
- Use data and technology for compliance, with taxpayer-friendly service.
- Reduce litigation through faster appeals and settlement schemes.
- Cooperate internationally on BEPS and the global minimum tax.
Possible exam and interview questions
- Explain the structure of GST in India and the role of the GST Council. What changes did GST 2.0 bring? (620 words)
- Distinguish between direct and indirect taxes. Why is a higher share of direct taxes considered desirable? (420 words)
- Distinguish between tax buoyancy and tax elasticity, with an example.
- Explain composite supply, mixed supply and the reverse charge mechanism under GST.
- Interview: Should petrol and diesel be brought under GST?
Related reading: Union Budget concepts, fiscal policy, and inflation.
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