The union budget 2020 introduced a new personal tax regime for individual taxpayers. From lower tax rates to reforms in tax assessment, the union budget 2020 has proposals that could offer relief to individual taxpayers. However, the option for such concessional tax regime requires the taxpayer to forego certain specified deductions. These include standard deduction of Rs. 50,000, deduction under section 80C of Rs 1.50 lakh and interest on self-occupied property of Rs. 2 lakh which are availed by most taxpayers. As a result, the concessional tax regime may not always be beneficial.
Union budget 2020 offers individuals the choice of paying tax under the new regime of lower income tax rates by forgoing the tax exemptions/deductions or continue to pay tax under the existing income tax laws by claiming the applicable exemptions and deductions.
So, let’s understand this in more detail.
The budget has proposed a new tax regime in addition to the existing, i.e. old tax regime. However, the new tax regime is optional. To put it simply, the assessee can choose between the new tax regime and the old tax regime depending on what is best suitable from a tax planning point of view.
Let’s understand tax calculation using example.
Based on the above illustrative table, it is evident that the maximum benefit that can be availed under the new regime (in case no investments are made) is Rs. 75,000 in terms of tax savings.
What are the Pros of New Tax Regime?
Reduced tax rates and compliances: The new regime provides for concessional tax rates compared to rates in the existing or old regime. Furthermore, as most of the exemptions and deductions are not available, the documentation required is lesser and the tax filing is easier.
Flexibility of customizing the investment choices: In the existing tax regime a taxpayer can avail the benefits of deductions only if he makes investments in certain instruments and in the manner as prescribed in the act. This restricts the investment choices for the taxpayer as he has to make the investments only in the instruments specified. However, the new regime provides taxpayer with a flexibility of customizing their investment choices.
Increased liquidity in the hands of the taxpayer: The reduced tax rate would provide more disposable income to the taxpayer, who could not invest in specified instruments due to certain financial or other personal reasons.
Investor may not like to lock-in funds in the prescribed instruments for a specified period: Most of the investments have a lock in period of, before which it cannot be withdrawn. But under the new regime, all taxpayers would be treated at par and benefit of deduction/allowances would not be criteria for availing the tax exemption. This may be helpful for those categories of taxpayers who may not subscribe to the specified modes of investments. They can now invest in open-ended mutual funds/instruments/deposits, which provide those good returns as well as flexibility of withdrawal as well. For instance, certain eligible instruments have a longer lock-in period such as fixed deposits with banks and post offices have a lock-in period of five years, equity-linked savings schemes (ELSS) is for a period of three years, National Savings Certificates (NSC) for five years, etc.
What are the cons of the new tax regime?
Non availability of certain specified deductions: Under the new tax regime you will have to forgo some exemptions [to name a few, such as Leave Travel Allowance (LTA), House Rent Allowance (HRA), etc.] and deductions available under chapter VI A of the act that grant deductions under section 80 [such as 80C, 80CCC, 80CCD, 80D, 80DD, 80E, 80EE, 80G, 80GG, 80GGA, 80GGC, etc.] Even the standard deduction under section 16 [which is currently Rs. 50,000] available to salaried individuals and the deduction on Home Loan Interest, under section 24(b) will be disallowed. Around 70 exemptions and deductions have been removed in the new tax regime. Only the deduction under section 80CCD(2) [i.e., Employer’s Contribution on account of an employee in a Notified Pension Scheme] and Section 80JJAA [i.e. for new employment] can be claimed.
What are the pros of the old tax regime?
The older regime by enforcing investments in specified tax-saving instruments, over the period inculcated the savings culture in individual and led to savings for any future eventuality like marriage, education, purchase of house property, medical, etc.
India’s gross savings rate was approximately 30 per cent in March 2019 and the domestic savings by individuals is a significant contributor to the overall savings rate. If more individuals will opt for the new regime, the savings rate would decrease; nevertheless the consumption cycle and demand would be revived.
What are the cons of the old tax regime?
The investor cannot opt for any other star-rated funds, which may be performing better than the specified instruments, which are mostly risk-averse in nature and may not provide significant returns over the period of investments.
The tax benefits under the old regime are available on Investments in Specified Instruments and also there is a specific lock-in prescribed for most of the instruments from three-five years. This may not be not a suitable tax-saving option for millennial’s, who prefer to spend than save, and senior citizens, as they would prefer having liquidity in their hands and investing in instruments which have a flexible and open-ended tenure.
In case of assessment proceedings before the tax authorities, documentation and proof of investments is required to be retained in the old regime, which may not be required in the new regime.
Which regime is better- new or old?
The new tax regime has proposed lower income-tax rates, for income segments up to Rs. 15 lakh. But you need to remember that the proposed lower tax rates will be applicable only if you are willing to give up exemptions and deductions available under various provisions of the income-tax act, 1961.
Any taxpayer, who is looking for flexibility in the investment choices and does not want to invest in the specified eligible instruments, may consider opting for the new tax regime. However, it is advisable to do a comparative evaluation under both the regimes, before opting to continue with the old regime or opting for the new regime.
A taxpayer can exercise the choice every year and adopt any regime which is beneficial (except for those who have income from business or profession). Individuals who have income from business or profession cannot switch between the new and old tax regimes every year. If they opt for the new taxation regime, such individuals get only one chance in their lifetime to go back to the old regime. Further, once switched back to existing tax regime, they will not be able opt for new tax regime unless their business income ceases to exist.
Let’s understand tax calculation under both the scenarios-
As per the illustration above, if the gross income is Rs. 10 lakh or above and you are utilizing deductions under section 80C, 80D, and 24(b) of the income tax act, 1961, then you are better off under the older regime, it works in your favor from a tax planning standpoint. While for individuals in the middle-income group, earning a gross income of up to Rs 5 lakh; the new regime may prove advantageous.
The Rs 2 lakh threshold will be very easily crossed if you live on rent and claim HRA exemption or have taken a home loan and claim deduction for the interest. Taxpayers who claim the full deduction under Section 80C would be better off sticking to the older tax regime.
How to Opt for New Tax Regime?
If you wish to opt for the new tax regime, you will have to inform your employer through the declaration form. The employer will start deducting tax at source (TDS) accordingly for each month. You cannot switch to the other during the rest of the financial year as far as TDS from salary is concerned. However, the employee will have the right to choose whether to go for the new tax system or stick with the old one at the time of filing the tax return. However, certain exemptions can only be claimed through the employer and these may not be available at the time of filing return.
The new tax regime has multiple tax slabs with lower tax rates than the current regime but most deductions are not available. Each individual will have to evaluate which regime is favorable to him depending on the deductions and exemptions he plans to claim. The more exemptions an individual claims, the less likely he/she is to benefit from the New Optional Tax Regime; however which regime is beneficial will vary on a case to case basis.