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Indirect Tax

Updated on April 4, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Indirect Tax Meaning

An indirect tax can be transferred to another entity; it is imposed on the manufacturer, who then passes it on to the customers. The tax amount is added to the product’s selling price in the form of Excise duty, Service tax, VAT, etc.

It is also known as consumption tax; consumers pay for the taxes indirectly—by paying more for the product. It is not obvious to most customers. The US charges Indirect taxes at a subnational level. The states also impose certain taxes. In addition, local jurisdictions have the authority to impose a sales tax.

Key Takeaways

  • An indirect tax is a form of imposition by the local, state, or central government. The charges are imposed on one entity, but its financial liability falls on another.
  • These charges are imposed on goods and services manufactured or sold by businesses.
  • Indirect taxes are further classified into excise duty, customs duty, sales tax, service tax, entertainment tax, stamp duty, securities transaction tax, goods, and service tax, and value-added tax.

Indirect Tax Explained

Indirect Tax

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An indirect tax is imposed by the government on organizations that can recover the amount from customers. It is a tax that is charged on manufacturers—who pass it on to customers. Hence, the consumers are the final TaxpayersTaxpayersA taxpayer is a person or a corporation who has to pay tax to the government based on their income, and in the technical sense, they are liable for, or subject to or obligated to pay tax to the government based on the country’s tax laws.read more.

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The US charges indirect taxes at a subnational level. State and local jurisdictions also have the authority to impose indirect charges.

The following features distinguish indirect tax from direct taxes:

Types of Indirect Taxes

Indirect taxes are classified into the following types:

Indirect Taxes Types

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  1. VAT (Value Added Tax): The government charges VATVATValue-added tax (VAT) refers to the charges imposed whenever there is an accretion to a product's usefulness or value throughout its supply chain, i.e., from its manufacturing to its final selling point. It is an indirect tax levied on the product consumption.read more on goods that improve across the supply chain. The charges are imposed on price appreciation at every stage of the supply chain. Ultimately, it is the customer who bears the burden at the final consumption stage.
  2. Service Tax: It is levied on individuals or businesses that render services—consultancy, legal, hospitality, etc.
  3. Excise Duty: Excise duty is levied on manufacturing goods; the manufacturer collects the amount from the customer. It is also called an excise tax.
  4. Customs Duty: The government charges a percentage on the import and export of goods.
  5. Securities Transaction Tax (STT): It is levied on stock exchangeStock ExchangeStock exchange refers to a market that facilitates the buying and selling of listed securities such as public company stocks, exchange-traded funds, debt instruments, options, etc., as per the standard regulations and guidelines—for instance, NYSE and NASDAQ.read more transactions—the purchase and sale of securities. The term securities refer to stocks, bondsBondsBonds refer to the debt instruments issued by governments or corporations to acquire investors’ funds for a certain period.read more, mutual fundsMutual FundsA mutual fund is a professionally managed investment product in which a pool of money from a group of investors is invested across assets such as equities, bonds, etcread more, etc.
  6. Stamp Duty: It is imposed on the purchase and sale of immovable properties or assets. It is collected by the particular state government—depending on where the respective property is physically located. It is even imposed on legal documents, agreements, and registries.
  7. Entertainment Tax: This type of tax is imposed on every transaction, product, or service involving any sort of entertainment—movies, sports, stage shows, and exhibitions.
  8. Goods and Service Tax (GST): The GST is one tax that includes and replaces multiple indirect taxes such as VAT, excise duty, service tax, etc.

Examples

Let us look at some examples to understand the practical application.

Example #1

XYZ Ltd. sells toilet fittings in Washington. Keeping with the state laws, a 9.22% sales taxesSales TaxesThe government levies sales tax on the consumption of various goods and services as the percentage added to the product and services from which the government earns revenue and does the company's welfare. In the United States, 38 different states have different taxes, from Alaska (1.76%) to Tennessee (9.45%).read more is charged on the sale of this product. If the base price per tap is $6.25, determine the marginal selling price (inclusive of sales tax).

Solution:

Marginal Sales Price = Base Price + [Base Price × (Sales Tax Rate/100)]

Marginal Sales Price = $6.25 + [$6.25 × (9.22/100)] = $6.83

Therefore, the customer will pay $6.83 for buying a tap (inclusive of sales tax).

Example #2

Let us assume that the US government charges a 10% service tax on spa services. If the base price of the service is $100, what will be the billing amount?

Solution:

Total Bill = Base Price + Service Tax

Total Bill = = $100 + [$100 × (10/100)] = $110

Thus, the client will pay $110 for the spa (including service tax).

Advantages and Disadvantages

Indirect charges benefit businesses as it is not charged from their pockets. Let us discuss other benefits:

The demerits are as follows:

Frequently Asked Questions (FAQs)

What is the difference between indirect and direct tax?

An indirect tax is imposed on one person by the government, but its liability can be transferred to another person. In contrast, direct taxes are imposed on the person (or entity) who pays them.

What is an example of an indirect tax?

If a customer watches a movie in a multiplex, the ticket price includes entertainment tax—paid to the government. This is an indirect method of collecting revenue from the citizens.

Who pays the indirect tax?

End customers are the actual taxpayers. These charges are not very obvious; they are added to the selling price of commodities.

This article has been a guide to What is Indirect Tax and its Meaning. We discuss indirect tax features, definition, economics, VAT & examples from the US, UK & India. You can learn more about accounting from the following articles –

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