Direct Taxes in India

• Extensive amendment. The Income-tax Act 1961 had been amended nearly 65 times with more than 4,000 amendments over six decades, through annual Finance Acts and 19 separate Taxation Laws Amendment Bills.
• Numerous exemptions and deductions, added over the years for socio economic objectives such as encouraging saving, boosting exports and promoting balanced growth.
• A reduced tax base and increased litigation, because those exemptions narrowed the base and multiplied disputes.
• Traditional legal language, with long sentences, numerous provisos and extensive explanations.
• A fragmented structure with outdated provisions no longer in use.

How it was made. In July 2024 the Finance Minister announced the intention to overhaul the 1961 Act. A departmental committee of the Central Board of Direct Taxes conducted the review. The Income-tax Bill 2025 was introduced and referred to a Select Committee of Parliament; the Government then withdrew it and introduced a revised Income-Tax (No. 2) Bill 2025 incorporating most of the Committee's recommendations, which was passed by both Houses in the monsoon session.

What it does, and what it deliberately does not.

The single most examinable feature: the tax year. The Act replaces the two terms previous year and assessment year with one concept, the tax year, defined as the twelve month period of the financial year commencing on 1 April. A student who explains that the old law taxed the income of a previous year in the following assessment year, and that the 2025 Act uses one period instead, has understood the reform's character: it changes the taxpayer's experience of the law rather than the law's substance.

The date to remember: the Act came into force on 1 April 2026.

Progression, and why direct taxes carry the equity argument

A progressive tax takes a larger proportion of a larger income. Proportional takes the same proportion at every level. Regressive takes a smaller proportion as income rises.

Income tax is progressive, being charged in slabs at rising rates, and it is the only major Indian tax that is. That is why the equity of the whole structure depends so heavily on it, and why the abolition of wealth and estate duties matters: the burden of redistributive taxation now rests almost entirely on income.

Indirect taxes tend to be regressive in effect, because a poor household spends a larger share of its income on taxed goods, which is the argument taken up in [Indirect Taxes and the Goods and Services Tax].

The theoretical support for progression is the law of diminishing marginal utility from [What Economics Is]: a rupee taken from a rich person costs less in satisfaction than a rupee taken from a poor one, so equal sacrifice requires unequal rates. That is the ability to pay principle stated precisely.

What the direct taxes yield

From the Union Budget 2026-27, in crore rupees.

Note the ordering, which surprises people. Taxes on income exceed corporation tax, and the gap has widened. In 2024-25 income taxes were 12.35 lakh crore against corporation tax of 9.87 lakh crore; the Budget Estimates for 2026-27 are 14.66 lakh crore against 12.31 lakh crore. The personal income tax is now the single largest source of Union tax revenue.

Merits and demerits of direct taxes

Merits.

1. Equitable, because they can be graduated to ability to pay and are the only practicable means of progression.
2. Certain. The taxpayer knows what is due and the Government can estimate the yield, which satisfies Smith's canon of certainty.
3. Elastic. Yield rises with income automatically, and rates can be varied.
4. Economical to collect, particularly with deduction at source and electronic filing.
5. They create civic awareness. A person who pays visibly takes an interest in how the money is spent.
6. Anti inflationary. They reduce disposable income and therefore demand, so they work as an automatic stabiliser.

Demerits.

1. Evasion. They are easy to evade where income is not documented, which is a serious problem in an economy where 55.8 per cent of employment is self employment.
2. Inconvenience. They require returns, records and computation.
3. Arbitrariness in the rates. There is no scientific basis for choosing one slab rather than another.
4. They may discourage saving, work and enterprise at high rates.
5. They cover only a part of the population, so the burden concentrates on the documented.
6. Litigation. The 1961 Act's history, nearly 65 amendments and more than 4,000 changes, is itself the illustration, and reducing dispute was the stated object of the 2025 Act.

A worked example: the same rupee, taxed two ways

Facts. Priya earns a salary. Konark Ltd earns profit and pays her that salary.

The corporation tax is charged on Konark's profit. Konark is legally liable and pays it. Whether Konark bears it is another question: it may reduce dividends, hold down wages, or raise its prices. The impact is certain; the incidence is contested.

The income tax is charged on Priya's total income. She is liable and she bears it: she cannot recover it from her employer, from a customer or from anybody else. Impact and incidence coincide, which is what makes it direct.

Under the 2025 Act. Priya's income for the twelve months from 1 April is her income for that tax year, and she files for that tax year. Under the 1961 Act the same income was the income of the previous year, assessed in the following assessment year, and the two terms had to be kept apart. The tax payable is the same; what has changed is that there is now one period instead of two.

Tax deducted at source. Konark deducts tax from Priya's salary and pays it to the Government. That is a method of collection, not a separate tax, and it satisfies Smith's canon of convenience by collecting when the income arises. Under the 2025 Act, the provisions on deduction at source, previously scattered across many sections, are consolidated in section 393.

What beginners get wrong

"Direct tax is paid directly to the government." The test is who bears the burden, not who hands over the money. Tax deducted at source is paid to the Government by the employer and is still a direct tax on the employee.

"The Income-tax Act 1961 governs income tax in India." It was repealed. The Income-tax Act 2025 has been in force since 1 April 2026.

"The new Act changed the tax rates." It expressly did not. The stated framework was no major policy change and no modification of rates; the reform is of language, structure and administration.

"Corporation tax is India's largest tax." Taxes on income exceed it, and the gap is widening: 14.66 lakh crore against 12.31 lakh crore on the Budget Estimates for 2026-27.

"India taxes wealth." It does not. Wealth tax was abolished from the assessment year 2016-17, estate duty in 1985 and gift tax as a separate levy in 1998.

Limits and criticism

The base is narrow. A tax on documented income reaches the salaried and the corporate sector far more completely than the self employed, and [The Salient Features of the Indian Economy] shows how large the latter is.

The classification is imperfect. Corporation tax is called direct although its final incidence is uncertain.

Simplification is not liberalisation. The 2025 Act reduces complexity of expression; it does not reduce the number of decisions a taxpayer must make about exemptions and deductions, which was the deeper source of dispute.

No wealth or inheritance tax means that the accumulation of wealth is untaxed except when it produces income, which is a standing criticism from the equity side and is defended on the grounds of collection cost and capital flight.

Quick revision

1. Direct tax: impact and incidence on the same person; the burden cannot be shifted. Indirect tax: the two are on different persons.
2. Principal Indian direct taxes: tax on income of non corporate persons, corporation tax, and the securities and commodities transaction taxes. Abolished: estate duty 1985, gift tax as a separate levy 1998, wealth tax from assessment year 2016-17.
3. The Income-tax Act 2025 came into force on 1 April 2026 and replaced the Income-tax Act 1961.
4. Why the 1961 Act was replaced: nearly 65 amendments and over 4,000 changes in six decades, numerous exemptions narrowing the base and multiplying litigation, traditional legal language, and a fragmented structure with obsolete provisions.
5. How the 2025 Act was made: announced July 2024; a CBDT departmental committee; the Income-tax Bill 2025 referred to a Select Committee; withdrawn and replaced by the Income-Tax (No. 2) Bill 2025, passed in the monsoon session.
6. Key features: the tax year, replacing previous year and assessment year, defined as the twelve months of the financial year from 1 April; definition of virtual digital assets; consolidation, for example all deduction at source into section 393; and section 532, power to frame schemes eliminating the interface with the assessee so far as technologically feasible. No change of rates or of policy.
7. Yield, Budget Estimates 2026-27: corporation tax 12,31,000 crore, taxes on income 14,66,000 crore, together 26,97,000 crore of gross tax revenue of 44,04,086 crore, about 61 per cent. Income taxes now exceed corporation tax.
8. Merits: equity and progression, certainty, elasticity, economy, civic awareness, anti inflationary effect. Demerits: evasion, inconvenience, arbitrary rates, possible disincentive, a narrow base, and litigation.
9. Progression rests on diminishing marginal utility, so that equal sacrifice requires unequal rates.

Test yourself

1. Distinguish a direct tax from an indirect tax, and say why the distinction is imperfect. A direct tax is one in which the impact and the incidence fall on the same person, so that the person legally liable to pay it also bears the burden and cannot shift it to anybody else, as with the income tax paid by an individual. An indirect tax is one in which the two are separated: the seller is liable and pays the tax to the Government, but recovers it from the buyer in the price, so that the impact is on the seller and the incidence on the buyer. The distinction is imperfect because the final incidence of a tax is an economic question rather than a legal one. Corporation tax is classified as direct because the company is liable, yet the burden may fall on shareholders through reduced dividends, on employees through lower wages or on customers through higher prices, and economists cannot settle the proportions. Similarly, how much of an indirect tax the seller can actually pass on depends on the elasticities of demand and supply.

2. Which statute governs income tax in India today, and why was it enacted? The Income-tax Act 2025, which came into force on 1 April 2026 and replaced the Income-tax Act 1961. It was enacted because the 1961 Act had become unworkably complex: it had been amended nearly 65 times with more than 4,000 amendments over six decades, through annual Finance Acts and nineteen separate Taxation Laws Amendment Bills; successive exemptions and deductions introduced for socio economic purposes had narrowed the tax base and multiplied litigation; the Act was written in traditional legal language with long sentences, numerous provisos and extensive explanations; and the accumulation of amendments had left a fragmented structure containing obsolete provisions. The Finance Minister announced the intention to overhaul it in July 2024, a departmental committee of the Central Board of Direct Taxes conducted the review, the Income-tax Bill 2025 was referred to a Select Committee, and the Government then withdrew it and introduced the Income-Tax (No. 2) Bill 2025 incorporating most of the Committee's recommendations, which Parliament passed in the monsoon session.

3. What are the principal features of the Income-tax Act 2025? It simplifies language, removes obsolete provisions and consolidates and restructures the law into fewer sections and chapters, with schedules, tables and formulae for clarity. It introduces the concept of the tax year, a single twelve month period being the financial year commencing on 1 April, which replaces the two earlier terms previous year and assessment year. It defines virtual digital assets, including cryptocurrencies and tokenised assets. It groups provisions previously scattered across the statute, so that all the rules on tax deduction at source are now in a single section, section 393. And section 532 empowers the Central Government to frame schemes to improve efficiency, transparency and accountability by eliminating the interface with the assessee so far as technologically feasible and by optimising resources through economies of scale and functional specialisation. Importantly, the Act was framed on the express basis of no major change in tax policy and no modification of rates.

4. State the merits and demerits of direct taxes. Merits: they are equitable, since they can be graduated to ability to pay and are the only practicable means of progression; they are certain, so that the taxpayer knows the liability and the Government can estimate the yield; they are elastic, since the yield rises automatically with income and rates can be varied; they are economical to collect, particularly through deduction at source and electronic filing; they create civic awareness, because a person who pays visibly takes an interest in public expenditure; and they act as automatic stabilisers, reducing disposable income and therefore demand when incomes rise. Demerits: they are easy to evade where income is undocumented, which matters greatly in an economy where 55.8 per cent of employment is self employment; they are inconvenient, requiring returns, records and computation; the rates are inevitably arbitrary, since no principle fixes one slab rather than another; at high rates they may discourage work, saving and enterprise; they reach only the documented part of the population, so the burden concentrates; and they generate litigation, as the history of the 1961 Act shows.

5. Why does the equity of India's tax structure depend so heavily on the income tax? Because the income tax is the only major Indian tax that is genuinely progressive, being charged in slabs at rates that rise with income, and because the other instruments of redistributive taxation have been abolished: estate duty in 1985, gift tax as a separate levy in 1998 and wealth tax from the assessment year 2016-17. Indirect taxes, which account for about 38 per cent of the Union's gross tax revenue, tend to be regressive in effect, since a poorer household spends a larger proportion of its income on taxed goods. The consequence is that the entire redistributive burden of the tax system rests on the tax on income, and that accumulated wealth escapes taxation altogether unless and until it produces income.

6. Which yields more in India, corporation tax or taxes on income? Taxes on income, and the margin has widened. On the Union Budget documents, corporation tax was 9,86,767 crore rupees in the actuals for 2024-25 against taxes on income of 12,35,171 crore, and the Budget Estimates for 2026-27 are 12,31,000 crore for corporation tax against 14,66,000 crore for taxes on income. Together they amount to 26,97,000 crore out of a gross tax revenue of 44,04,086 crore, or about 61 per cent. The personal income tax is therefore now the single largest source of Union tax revenue, which reverses the position commonly stated in older textbooks and reflects both the widening of the salaried base and the reduction of corporate rates.