Direct Tax vs Indirect Tax: Where the Difference Lies

Direct Tax vs Indirect Tax: Where the Difference Lies

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.

A Comparison of These Two Tax Systems

  • Incidence of collection: Direct taxes are usually collected directly by the government through a variety of levies such as personal income tax and corporate tax, whereas indirect taxes are collected by an intermediary, such as a retailer, a service provider, an e-commerce operator etc. and are then passed on to the government.
  • Source or destination based: Direct taxes are usually source/origin based, i.e. tax is levied in the country where the income is earned, assets are located, or the subject is resident. However, indirect taxes, such as value-added tax (VAT) or goods and services tax (GST), are typically imposed in the country where the goods or services are supplied or ultimately consumed, regardless of their place of origin/production or location of the supplier.
  • Regressive tax: Direct taxes tend to be progressive, i.e. those with higher incomes or assets typically pay a higher tax. Indirect taxes are often regressive, i.e. those with lower incomes end up paying higher taxes proportionally because indirect taxes such as GST, VAT and sales tax are typically applied at a fixed rate, regardless of the taxpayer’s income level.
  • Transactional nature: Direct taxes are income-driven and are only imposed on individuals or entities that meet certain income thresholds or specified criteria, whereas indirect taxes are more transactional in nature, meaning they are imposed at every stage of the supply chain, from the production to the final sale of goods or services.

Summary of the Major Differences Between Direct and Indirect Tax Systems

Tax System
Rate Structure

👉Learn more about indirect taxes in this blog post on Indirect taxes.

Recently, indirect taxation has gained increasing importance as a source of global government revenue. This can be attributed to factors such as rapid globalization and evolving consumption patterns. As a result, many countries are implementing new indirect tax policies that aim to modernize taxation, thereby improving tax compliance, reducing tax evasion, and enhancing their overall economy. OECD has published valuable insights into consumption tax trends and related policy recommendations.

Digitization of Indirect Taxes

Many countries have recently shifted towards digitization of tax compliance. One of the most significant trends includes the introduction of the e-commerce VAT package and the One-Stop-Shop (OSS) by the European Union. This package came into effect in July 2021. It introduced new rules for the VAT treatment of cross-border e-commerce transactions that aimed at ensuring a level playing field for businesses and improving the collection of VAT on online sales. The OSS allows companies to declare and pay VAT on their cross-border sales of goods and services within the EU in a single Member State, simplifying the VAT compliance obligations for businesses.

This digitalization trend is expected to continue, with many more countries jumping on the bandwagon.

👉Learn more about EU countries’ VAT regulations from Fonoa’s Global VAT Guide.


Electronic invoicing or e-invoicing is becoming increasingly popular across the world. Many countries have mandated using e-invoicing systems to simplify and streamline the invoicing process. With e-invoicing, invoices are generated, transmitted, and received electronically, eliminating the need for paper-based invoices. E-invoicing can be integrated with other business systems, i.e. ERPs, to streamline financial processes further.

👉Learn more about multiple countries' e-invoicing regulations from Fonoa’s Global VAT Guide.

Real-time Reporting

With real-time reporting, businesses report their tax transactions to the tax authorities in real-time. This helps increase transparency and reduce the chances of non-compliance. Real-time reporting is becoming more popular as tax authorities seek to improve tax compliance and reduce the tax gap. With real-time reporting, tax authorities can identify and address tax issues more quickly, reducing the time and effort required to resolve tax disputes.

Increased Use of Automation

Both tax authorities and businesses increasingly use automated tools for tax compliance and reporting. Read our article for insights on tax automation considerations for global businesses.

How can Fonoa help?

Fonoa is a one-stop shop for automating taxes for the Internet economy.

Fonoa offers the following product suite to automate indirect tax compliance:

  • Fonoa Lookup is a single solution to validate tax IDs globally.
  • The Fonoa Tax engine automatically determines the correct VAT/ GST treatment for sales transactions in over 140 countries. With minimal necessary transaction data input, Fonoa’s tax engine instantly determines if the transaction is taxable and the applicable VAT/GST rate. Easy to integrate with and built for high performance.
  • Fonoa Invoicing is a solution to issue locally compliant tax invoices in any language so they don’t have to build and maintain an expensive invoicing solution in-house.
  • Fonoa Reporting reports transactional data to tax authorities from one platform. Stay updated on regulatory changes and comply with E-invoicing rules with Fonoa Reporting.

👉To learn more, get in touch with Fonoa - Contact Sales!

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