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Is The New Personal Tax Regime A Boon Or A Bane?

As an individual taxpayer, which tax regime you should stick to – the new or the old?

A vendor walks along a flooded road in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)
A vendor walks along a flooded road in Mumbai. (Photographer: Dhiraj Singh/Bloomberg)

The union budget was tabled by Finance Minister Nirmala Sitharaman on Feb. 1, 2020, with the objectives of stimulating growth, simplifying the current tax structure, bringing in ease of compliance and reducing litigation.

As one of the measures, an alternative simplified tax regime has been introduced for individuals and Hindu Undivided Families or HUFs. The new personal tax regime contains reduced tax rates spread over six income slabs. However, the underlying condition is that the taxpayer availing the new regime will have to forego several specified deductions/exemptions and set-off of losses. The existing higher education cess and surcharge rates continue to apply at the same rates under the new regime.

The shift is optional for taxpayers, i.e. the taxpayer can choose to either continue paying tax on the existing rates while claiming the benefit of deductions and exemptions or pay tax under the new regime but without claiming the specified deductions and exemptions. The choice will be available every year for taxpayers having no business income. The choice can be made at the time of filing the tax return before the applicable due date.

However, for taxpayers having a business income, the switch to the proposed system once made will be irreversible for all subsequent years except for another switch only once in the subsequent years.

The big question is whether the new regime indeed gives more cash to the taxpayers.

The table below compares existing tax rates and rates in the new regime.

Is The New Personal Tax Regime A Boon Or A Bane?

Under the new regime, a taxpayer will have to forego all deductions under Chapter-VIA, i.e. related to employee’s contribution to provident fund and the National Pension Scheme, medical and life insurance premia, repayment of housing loan principal, etc. The only exception is a deduction available for the employer’s contribution to the Notified Pension Scheme. Also, for salaried taxpayers, standard deduction, the deduction for professional tax, exemptions for leave travel concession, house rent allowance, etc. will also be unavailable under the new regime.

Furthermore, loss from house property cannot be set-off against other incomes. 

Given that most taxpayers are currently availing some, if not all, the above, and a lot of investment decisions have been made on this basis, it remains to be seen how many are willing to make the switch.

Knowing Where You Stand

With the introduction of lower slab rates under the new regime, a question arises as to which regime would be more beneficial for the taxpayer. The answer clearly depends on the income and investment structure of individual taxpayers.

A rough simulation shows that individuals earning an income of over Rs 12.25 lakh claiming deductions or exemptions of up to Rs 2 lakh will benefit from the new regime. For example, a total income of Rs 15 lakh with deductions and exemptions up to Rs 2 lakh, currently subject to a tax of Rs 2.1 lakh will have a reduced tax liability of Rs 1.95 lakh under the new regime, a saving of Rs 15,600.

However, for taxpayers currently claiming substantial deductions and exemptions, the old regime may continue to be more advantageous. For example, an individual earning income of Rs 20 lakh with eligible deductions and exemptions of Rs 4 lakh will still pay less tax of almost Rs 46,800 under the old regime. Hence, the taxpayer will need to compare the tax liability under the old and new regimes to determine whether a switch is worthwhile from a tax-saving perspective.

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Follow-On Impact

There are a few other perhaps unintended implications that may arise due to the new regime, and it remains to be seen how Indian taxpayers will react eventually. For the past few years, the government has been trying to encourage people to increase savings and bring in a culture of investing in insurance and pension products. NPS was introduced with this very thought – that people should realise the importance of saving for the twilight years, more so as most Indians have limited social security coverage. It is also well known that most people who have invested in these products have done so largely to claim tax benefits.

With its removal of deductions and exemptions, the new regime may well reverse the current trend as taxpayers will be discouraged from making investments and payments if they are no longer eligible for such deductions/exemptions.

Secondly, under the new regime, individuals are required to exercise the option ‘in the prescribed manner’, that is at the time of filing their original income tax return within the prescribed due date. It suggests that there is no room for a taxpayer to file a revised return under the new regime if the choice was not made while filing the original tax return. Nor will this option be available if the original return is not filed within the due date.

Furthermore, for salaried taxpayers who are subject to tax deducted at source by their employers, it is unclear whether the employer can carry out the withholding compliances considering the new tax rates if employees opt for the new regime.

In the current version of the Finance Bill, no corresponding amendment has been proposed in the withholding tax sections. If such facility is not introduced, the larger purpose of giving more cash in the hands of taxpayers may fail as it could lead to a situation where TDS will be at a higher rate and the taxpayer may have to claim a refund on the tax return for the excess TDS, thus locking up funds.

The Finance Minister mentioned in her budget speech that the purpose of introducing the new regime is to make compliance easy. Considering the added conditions of removal of specific deductions and exemptions, taxpayers will now have to consciously determine which regime is more beneficial. Coupled with this option being available every year only to those without business income, and a reverse switch is available only once to those with business income, this adds a degree of complexity to the whole filing process. It would have been a more generous and effective move if the investment-linked deductions/exemptions were continued and the option could be made at the beginning of the year rather than while filing the tax return.

Considering that the government can still make necessary changes in the draft provisions, one hopes that the Finance Minister takes these aspects into cognisance so that the real objectives of simplicity and more cash to the taxpayers are achieved.

Ishita Sengupta is Partner - Personal Tax, and Hitesh Sharma is Director - Personal Tax, at PwC India. Deepti Wadhwa, Manager at PwC India also contributed to the article. Views expressed are personal.

The views expressed here are those of the authors and do not necessarily represent the views of BloombergQuint or its editorial team.