Corporation tax obligations are mostly composed of fractions of corporation income. Corporate income-tax rate structures are typically progressive, which means that average tax rates climb with income and reach a maximum rate quickly enough that practically all of large firms’ income is taxed at the highest rate.

In the United States in 1999, corporations with net incomes of up to $50,000 paid 15% tax; this rate jumped to 34% on revenues over $100,000 and 35% on incomes over $10 million. Other countries tax corporate revenue at comparable rates, which can vary depending on the size, location, and industry of the corporate taxpayer.

Thus, desires to rectify geographic income disparities led Germany, Italy, and other countries to offer tax concessions for investment in depressed regions, while mineral-rich countries such as South Africa and Papua New Guinea subject mineral extraction to taxation at supranormal rates.

Much popular and public policy attention is devoted to the tax planning activities and corporate tax obligations of big businesses—and with good reason since corporate income tends to be concentrated in a relatively small number of large companies. For example, in 1997, there were 4.7 million active corporations in the United States, of which approximately 9,000 had assets exceeding $250 million. These 9,000 large corporations accounted for 86 percent of total US corporate assets, 80 percent of net corporate income, and 78 percent of total corporate tax payments.

The American federal corporate income tax was introduced in 1894 but was found to be unconstitutional the following year; it reappeared as a gross receipts tax in 1909 and was modified to become a genuine income tax following ratification of the 16th Amendment to the US Constitution in 1913. The US corporate tax rate in 1913 was 1 percent.

The corporate tax rate rose over time, though it remained below 15 percent until World War II, at which point it rose sharply. Corporate tax was a major revenue source for the US federal government between World War II and the late 1960s when corporate tax collections consistently represented more than 20 percent of federal government revenue. 

Corporate tax collections have fallen as a fraction of total government revenue since then, though they exceeded $188 billion in 1998, representing approximately 11 percent of US federal government revenues, or 2.2 percent of US gross domestic product (GDP). This pattern is repeated in other high-income countries, many of whose corporate income tax rates and tax provisions are remarkably uniform.

In a typical recent year (1994), top marginal corporate tax rates among the 12 member countries of the European Union ranged from a low of 33 percent to a high of 45 percent, with just a single country (Germany) taxing corporate income at a rate in excess of 40 percent.

Direct or Indirect

Corporate tax obligations consist of both direct and indirect taxes. Direct taxes are typically expressed as fractions of corporate income, whereas indirect taxes include sales taxes, value-added taxes, excise taxes, property taxes, payroll taxes, and import and export duties. Corporate indirect tax payments exclusive of payroll taxes commonly exceed their direct tax payments in overall magnitude (Desai et al., 2004a).

Much of the interest in corporate taxation nevertheless turns on the direct tax component, since indirect taxes such as value-added taxes are imposed on all business activities, whether or not undertaken by corporations.

The corporate income tax rate structure is usually progressive, meaning that average tax rates rise with income, typically reaching a maximum rate rapidly enough that almost all of the income of large corporations is subject to tax at the highest rate. In the United States in 2014, corporations earning net income up to $50,000 paid a 15% tax; this tax rate rose to 25% on income above $50,000, 34% on income above $75,000, and 35% on income above $10 million. Other countries tax corporate income at similar rates that can vary according to the size, location, and industry of the corporate taxpayer.

Much popular and public policy attention is devoted to the tax planning activities and corporate tax obligations of big businesses – and with good reason since corporate income tends to be concentrated in a relatively small number of large companies. For example, in 2011 there were 5.8 million active corporations in the United States, of which 2831 had assets exceeding $2.5 billion. These 2831 large corporations accounted for 81% of total US corporate assets, 68% of net corporate income, and 68% of total corporate tax payments.

The American federal corporate income tax was introduced in 1894 but was found unconstitutional the following year; it reappeared as a gross receipts tax in 1909, and was modified to become a genuine income tax following ratification of the 16th amendment to the US constitution in 1913. The US corporate tax rate in 1913 was 1%. The corporate tax rate rose over time, though it remained below 15% until World War II, at which point it rose sharply.

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The corporate tax was a major revenue source for the US federal government between World War II and the late 1960s, when corporate tax collections consistently represented more than 20% of federal government revenue. Corporate tax collections have since fallen as a fraction of total government revenue, though federal corporate tax collections exceeded $220 billion for tax year 2011, when total corporate tax collections by all levels of US government were 9.4% of total government revenues, or 2.3% of US gross domestic product (GDP).

In the same year, the 34 OECD countries collected corporate tax revenue that averaged 8.7% of total government revenues, or 3.0% of GDP. The US (federal plus average state) statutory corporate tax rate in 2013 was 39.1%, making it the highest of all the OECD countries, which averaged 25%, and which included five countries (Ireland, Slovenia, Poland, Hungary, and the Czech Republic) with statutory corporate tax rates below 20%.

Direct Tax

A direct tax is one that a person or organization pays directly to the authority that levied it. Individual taxpayers pay the government directly for income tax, real property tax, personal property tax, and asset taxes.

Direct taxes in the United States are mostly based on the ability-to-pay premise. According to this economic theory, individuals with more resources or a higher income should pay more taxes. Some critics perceive this as a disincentive for people to work hard and achieve more money because the more they earn, the more taxes they must pay.

Direct taxes cannot be passed on to a different person or entity. The individual or organization upon which the tax is levied is responsible for paying it.

A direct tax is the opposite of an indirect tax, wherein the tax is levied on one entity, such as a seller, and paid by another—such as a sales tax paid by the buyer in a retail setting. Both kinds of taxes are important revenue sources for governments.

The modern distinction between direct taxes and indirect taxes came about with the ratification of the 16th Amendment to the U.S. Constitution in 1913. Before the 16th Amendment, tax law in the United States was written so that direct taxes had to be directly apportioned to a state’s population. A state with a population that was 75% of the size of another state’s, for example, would only be required to pay direct taxes equal to 75% of the larger state’s tax bill.

This antiquated verbiage created a situation in which the federal government could not impose many direct taxes, such as a personal income tax, due to apportionment requirements. However, the advent of the 16th Amendment changed the tax code and allowed for the levying of numerous direct and indirect taxes.

Examples of Direct Taxes

Corporate taxes are a good example of direct taxes. If, for example, a manufacturing company reports $1 million in revenue, $500,000 in the cost of goods sold (COGS), and $100,000 in operating costs, its earnings before interest, taxes, depreciation, and amortization (EBITDA) would be $400,000. If the company has no debt, depreciation, or amortization, and has a corporate tax rate of 21%, its direct tax would be $84,000 ($400,000 x 0.21 = $84,000).

An individual’s federal income tax is another example of a direct tax. If a person makes $100,000 in a year, for example, and owes the government $20,000 in taxes, that $20,000 would be a direct tax.

There are a number of other direct taxes that are common in the United States, such as the property taxes that homeowners are required to pay. Those are typically collected by local governments and based on the assessed value of the property.

Other types of direct taxes in the U.S. and elsewhere include use taxes (such as vehicle licensing and registration fees), estate taxes, gift taxes, and so-called sin taxes on liquor and cigarettes, for example.

Indirect Taxes

Indirect taxes are basically taxes that can be passed on to another entity or individual. They are usually imposed on a manufacturer or supplier who then passes on the tax to the consumer. The most common example of an indirect tax is the excise tax on cigarettes and alcohol. Value Added Taxes (VAT) are also an example of an indirect tax.

Types of Indirect Taxes

What many people are not aware of is that practically everyone pays taxes, especially indirect taxes. This is because taxes are imposed on almost all the products that we consume. Here are some of the types of indirect taxes.

• 1. Sales tax

Whenever people go to the malls or department stores to shop, they are already about to pay indirect taxes. Goods such as household items, clothing, and other basic commodities are subject to such types of taxes. Upon payment at the counter, the final sale price is padded with a sales tax that the store collects and pays to the government.

• 2. Excise tax

Excise tax is also very common. When a manufacturer buys the raw materials for the company’s products, for example, tobacco for cigarette companies, they already need to pay indirect taxes on the items. Through a part of the normal course of business, the manufacturer can pass on the burden to the consumers by selling the cigarettes at a higher price.

• 3. Customs tax

Ever wonder why imported products are expensive? It is because of customs tax. When a container filled with bananas from another country enters the US, the importer pays a tax (customs tax), which is then passed on to consumers.

• 4. Gas tax

Yes, buying gasoline for vehicles contains an indirect tax.

Example of Indirect Taxes

Let us use the example of VAT to illustrate how an indirect tax is imposed. Say, for example, John goes to the outlet store to buy a refrigerator that’s priced at $500. When he asks the sales representative, he or she will declare the sale price, which is $500, and that is the right answer.

The refrigerator’s real value is actually less than that, but because a VAT has been added (usually 10% to 20%), the sale price is now $500. If John looks at his receipt, he will see the actual price of the refrigerator before the tax was added. It is the manufacturer of the unit or item who collects the tax from the sale price and pays it to the government.

Advantages

Taxes may sound like an added burden for consumers, but indirect taxes are not always just a negative thing. Here are some of their advantages:

• 1. The poor can do their share

Unlike direct taxes that usually exempt the poor, indirect taxes allow them to actually contribute their part in collecting funds for a country or state.

• 2. They aren’t very obvious

Indirect taxes, as they are incorporated in the sale price of an item, are not very obvious. People don’t feel they are being taxed simply because the tax comes in small values. Plus, add the fact that they are not indicated in the price tag, but can only be seen on the purchase receipt. Also, they can be avoided by not buying the goods.

• 3. Collection is easy

Unlike direct taxes where documents need to be accomplished and filing is required, indirect taxes are paid the moment a consumer buys a product. The tax is collected by the supplier and paid to the government.

• 4. Discourages consumption of harmful products

Alcohol and cigarettes are heavily taxed. By taxing such products, people are discouraged by their price, thereby saving them from consuming harmful items.

Indirect taxes and direct taxes differ in many ways, but the most common is how they are paid.

• From the name itself, direct tax is paid directly to the government while the indirect tax is paid indirectly. It means that though it is imposed on a particular company or supplier it can pass the tax on to consumers, ultimately transferring the burden to the latter.
• Direct taxes, on the one hand, are taken from an individual’s earnings, while indirect taxes are imposed on goods that consumers buy. Furthermore, direct taxes are calculated based on the paying capacity of the individual. Indirect taxes, on the other hand, do not look at the consumer’s ability to pay but are the same for everyone who buys the goods or services.
• Examples of indirect taxes are excise tax, VAT, and service tax. Examples of direct taxes are income tax, personal property tax, real property tax, and corporate tax.

Their Importance for Companies

• Direct tax is paid directly by the taxpayer to the government and cannot be shifted, while indirect tax can be passed on to others.
• Direct taxes are levied on people and entities and are proportionate to the taxpayer’s income or assets.
• Examples of direct taxes include income tax, corporate tax, and property tax.
• Indirect taxes are levied on goods and services and are based on the value of the good or service.
• Examples of indirect taxes include VAT, GST, customs duties, and tariffs.
• Direct tax is progressive in nature, meaning the tax burden increases with income.
• Direct tax can be complex, so using direct tax software can be beneficial.
• Direct tax can be broken down into five different categories: individual income tax, corporate income tax, capital gains tax, estate tax, and property tax.

Conclusion

Direct taxes are levied on individuals or entities directly by the government. In contrast, Indirect taxes are those collected by an intermediary (e.g. marketplaces, manufacturers, platform owners, vendors) from the end consumer. In other words, the direct tax burden falls directly on the taxpayer, whereas indirect taxes are paid by consumers indirectly through the goods and services they purchase.

Some of the most common examples of direct taxes include income tax, corporate tax, capital gains tax and property tax. These taxes are based on income or assets. On the other hand, the most common examples of indirect taxes include goods and services tax (GST), value-added tax (VAT), sales tax, excise tax and customs duty. These taxes are based on the consumption or expenditure of goods and services.

In today’s era of globalization, businesses need to understand various tax systems that could impact their operations. In this article, we explain how indirect taxes differ from direct taxes, why indirect taxes are increasingly more important for businesses in current times, and some recent trends in this area.