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Budget 2023: Budget 2023 income tax: Why there is a case for increased standard deduction on salary

Akhil Chandna
Akhil Chandna
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Union Budget 2023: An increase in the standard deduction may serve multiple purposes and provide much-needed relief to salaried taxpayers!

The Income-tax Act, 1961 not only provides for levy of tax on income, but it also provides various methods for claiming deductions and rebates. Generally, deductions are allowed based on how taxpayers spend their money. The standard deduction is one such deduction available to salaried individuals.

The standard deduction aims to achieve parity between taxpayers who receive salary income and those who receive income from their business or profession. People who make a living through their profession or business are entitled to claim a deduction for a variety of expenses incurred to earn such income from business or profession. However, salaried taxpayers are not eligible to claim such a deduction for expenses.

The 'standard deduction' is a flat deduction available for salaried individuals without requiring proof of any expense actually incurred. Historically, the 'standard deduction' had been available for salaried individuals for many years. The same was however removed in the year 2005 and then re-introduced in the 2018 Union Budget.

Budget 2018 reinstated the standard deduction for an amount of Rs 40,000 (applicable for financial year 2018-19) by withdrawing tax benefits available for transport allowance (of Rs 19,200) and reimbursement of medical expenses (of Rs 15,000) which broadly resulted in net increase in deduction of Rs 5,800. The goal of reintroducing the standard deduction was to reduce paperwork and compliance burdens for employers while also providing tax relief to salaried individuals. In the following financial year, the standard deducted limit was raised to Rs 50,000.

Let us understand this with a small example:

Table with 4 columns and 8 rows. Currently displaying rows 1 to 8.
Financial Year 2017-18 2018-19 2019-20
Situation No standard deduction Standard deduction of Rs 40,000 Standard deduction of Rs 50,000
Gross salary 1000000 1000000 1000000
Less: Standard deduction NIL 40000 50000
Less: Transport allowance 19200 NIL NIL
Less: Reimbursement of medical expenses 15000 NIL NIL
Taxable salary 965800 960000 950000
Final Tax liability (at current rates) 109886 108680 106600
Effective Tax Rate 11.27% 11.32% 11.22%

The above table shows a comparison of the taxable salary for different financial years on an assumed annual salary of Rs 10,00,000. After considering the applicable limits of standard deduction, exemption for transport allowance and reimbursement of medical expenses, the reduction in taxable income between financial year 2017-18 and financial year 2019-20 is only Rs 15,800 (Rs 9,65,800 minus Rs 9,50,000). The resulting tax savings are insignificant, failing to even keep pace with inflation over time. In addition, there has been no change in the standard deduction limit in the last four financial years.

Standard Deduction Issues:

It is the need of the hour to increase the standard deduction limit available to salaried individuals, due to the following reasons:

  • Significant rise in inflation rate: Given the high inflation and the increased living expenses of salaried individuals over the past few years, the standard deduction of Rs 50,000 is very low. As a result, periodic revisions to the standard deduction are essential to account for the rising cost of living expenses incurred by the salaried class.
  • Increased cost of working from home due to the Covid-19 pandemic: Due to the Covid-19 pandemic, a significant portion of the salaried class has switched to the Work from Home (WFH) system. This has led to increasing costs for such salaried personnel, including higher food and infrastructural costs as well as higher utility rates (furniture, internet, printer, scanner etc.). Although some expenses such as travelling and formal attire have decreased, the overall cost has gone up. Many nations around the world, including the UK, Germany, etc., have offered tax reliefs or deductions for specific WFH expenses.
  • There is an essential need to offer some kind of tax benefit to make up for the increased costs incurred by salaried employees as a result of these expenses. Raising the standard deduction would be an administratively simpler way to compensate the salaried class. This will also bring parity with individuals earning income from business or profession, who are eligible to claim actual expenses or also have the option to elect a presumptive basis of taxation where certain percentage of gross income is deemed as an expense.
  • Increase in medical costs after Covid-19 pandemic: Health issues have risen significantly since the pandemic. This is accompanied by a rise in insurance costs as a result of premium increases by insurance service providers. It is important for salaried employees to receive some relief in the form of an increased standard deduction to off-set such expenses.

Standard Deduction Recommendations:

As the above reasons have contributed to an increase in overall expenses and cost of living for salaried employees, there is a need to increase the standard deduction to provide relief to salaried employees. An increase in the standard deduction to Rs 1,00,000 or Rs 1,50,000 would provide welcome relief to the salaried class from ever-rising inflation rates. A table showing the tax benefits at the current level of standard deduction and at the recommended increase in the standard deduction is given below:

Tax Benefits If Standard Deduction Is Increased

Table with 4 columns and 5 rows. Currently displaying rows 1 to 5.
Situation Standard deduction of Rs 50,000 If Standard deduction is increased to Rs 1 lakh If Standard deduction is increased to Rs 1.5 lakh
Gross salary 1000000 1000000 1000000
Less: Standard deduction 50,000 100,000 150,000
Taxable salary 950,000 900,000 850,000
Final Tax liability (at current rates) 106,600 96,200 85,800
Effective Tax Rate 11.22% 10.69% 10.09%

Given the aforementioned factors and the government's intention to simplify the tax system, an increase in the standard deduction may serve multiple purposes and provide much-needed relief to salaried taxpayers!