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While there are merits and demerits of both the old and new regimes, it becomes cumbersome for taxpayers to pick the best-suited tax regime. Here is a simplified assessment of both the regimes to answer a few pertinent questions
The Government of India introduced a new optional tax rate regime starting from April 1, 2020 (FY 2020-21), for the hindu undivided family (HUF). Consequently, Section 115BAC has been added to the Income Tax Act, 1961 (the Act) that prescribes reduced tax rates for individual taxpayers and HUFs on forgoing specified tax deductions or exemptions.
For an individual taxpayer, FY 2020-21 is the first instance where they get to choose between the old tax regime and the new tax regime while filing their income tax returns. In the wake of the Covid-19 outbreak, the due date to file the tax return which was on July 31, 2021 has been extended to December 31, 2021.
The extension is beneficial to those who are yet to file their returns as it also allows time to analyse both the regimes and opt for the most suited one. In case of those who have already filed their returns with this evaluation, a revised tax return can be filed till December 31, 2021.
The new tax regime has widened the scope of taxation with seven tax slab rates ranging from 0% to 30% with the highest tax rate applicable on income above INR 15 lakh. Contrary to the new regime, there were four tax slabs in the old regime from 0% to 30% with the maximum rate applicable on income above INR 10 lakh.
Here’s how applicable tax rates under both the regimes work:
| Income level (INR) | Old tax rate regime* | New tax rate regime |
|---|---|---|
| Up to 2,50,000 | 0% | 0% |
| 2,50,001 to 5,00,000 | 5% | 5% |
| 5,00,001 to 7,50,000 | 20% | 10% |
| 7,50,001 to 10,00,000 | 20% | 15% |
| 10,00,001 to 12,50,000 | 30% | 20% |
| 12,50,001 to 15,00,000 | 30% | 25% |
| Above 15,00,000 | 30% | 30% |
In the case of the old tax regime, tax rates are as applicable to individuals below the age of 60 years, including non-resident individuals.
The government has taken cognisance of the fact that the Act has various exemptions and deductions which make compliance by the taxpayer and administration of the tax laws by the tax authorities a burdensome process.
To give relief to taxpayers the simplified tax rate regime requires specified tax deductions and exemptions to be forgone. Therefore, it is important to evaluate the impact of deductions/exemptions being claimed vis-à-vis the benefit of lower tax rates. Some of the popular tax exemptions/deductions which are not allowed under new tax regime include:
An individual or HUF taxpayer may opt for the new tax regime based on their specific situation and sources of income. Switching to the new tax regime can be done either on a year-on-year basis or only once. However, the frequency mostly depends on the source of income during the year.
Where income includes business or professional income:
In the case where an individual or HUF has income from a business or profession, once the option to avail new tax rates for a financial year has been exercised, the new rates shall apply for subsequent years. However, the law provides such taxpayers’ one single option of switching back to the old tax regime should their circumstances change. This switch-back option is available only once in a lifetime unless the taxpayer ceases to have any income from a business or profession.
Where income does not include business or professional income:
If an individual or HUF does not possess income from a business or profession, the selection can be made on a year-on-year basis. For individuals with salaries, the employer is required to withhold tax before the payment of the salaries. The employee is, however, required to inform the employer regarding their preferred tax rates.
An employee may choose between old and new tax regimes at the beginning of the year and intimate the employer, or at the time of joining new employment during the year. However, at the time of filling the personal tax return, the employee can change the tax regime.
For example, at the beginning of the year, an employee opts for the new tax regime and the employer deducts tax based on slab rates under the new tax regime. However, during the year they make certain tax-deductible investments like contribution to provident fund, payment of medical insurance premium, etc., and at the time of filing the income tax returns (ITR), they realise the old tax regime is more beneficial to them. In such a situation, they have the choice to opt for the old tax regime while filing the tax return though the employer had withheld taxes based on the new tax regime.
Since the eligible deductions, sources and quantum of income differs for every individual, one rule cannot be applied to all. Taxpayers will need to evaluate and compare the tax liability under both regimes and then decide on which to opt for.
In case a taxpayer has investments in tax saving instruments, pays premiums on life or a medical insurance policy, children’s school fee, home loan principal repayment, etc., and avails the benefit of the deduction for HRA, LTA, etc. it may be more beneficial to opt for old tax regime since the benefit of deduction/exemption can be availed in the old tax regime.
Below is an illustration of how two taxpayers have the same gross income but are eligible for different tax deductions/exemptions.
Taxpayer 1 and Taxpayer 2 are salaried taxpayers with no other sources of income
| Details for FY 2021-22 | Taxpayer 1 (in INR) | Taxpayer 2 (in INR) |
|---|---|---|
| Income from Salary | 20,00,000 | 20,00,000 |
| Exemption for HRA | 1,20,000 | Nil |
| Exemption for LTA | 50,000 | Nil |
| Standard Deduction | 50,000 | Nil |
| Deduction u/s 80C for EPF, PPF | 150,000 | 150,000 |
Let us understand which tax regime is more beneficial for both the taxpayers
Taxpayer 1
| Old Tax Regime (in INR) | New Tax Regime (in INR) | |
|---|---|---|
| Income from Salary | 20,00,000 | 20,00,000 |
| Less: Exemption for HRA | 1,20,000 | Not applicable |
| Less: Exemption for LTA | 50,000 | Not applicable |
| Less: Standard Deduction | 50,000 | Not applicable |
| Less: Deduction under Section 80C for PF | 150,000 | Not applicable |
| Net taxable Income | 16,30,000 | 20,00,000 |
| Tax on the above | 3,13,560 | 3,51,000 |
We can see in the above example that the old tax regime is beneficialto Taxpayer 1 as taxes are less by INR 37,440.
Taxpayer 2: Does not have eligible exemptions for HRA, LTA
| Old Tax Regime (in INR) | New Tax Regime (in INR) | |
|---|---|---|
| Income from Salary | 20,00,000 | 20,00,000 |
| Less: Standard Deduction | 50,000 | NA |
| Less: Deduction under Section 80C for EPF | 150,000 | |
| Net Income chargeable under the head salary | 18,00,000 | 20,00,000 |
| Tax On the above | 366,600 | 351,000 |
In case of taxpayer 2, where deductions for HRA and LTA are not applicable, the new tax regime is more beneficial by INR 15,600.
Taxpayers having income under head profit or gains from a business or profession and would like to opt for the new tax regime are mandatorily required to file the Form 10IE before filing the tax return. Similarly, Form 10IE is required to be filed by taxpayers who wish to switch back to the old tax regime
Form 10IE can be filed electronically, similar to efiling of the tax return by logging into the e-filing portal (https://www.incometax.gov.in/). Also, the form will be filed using either the digital signature or through an electronic verification code (i.e., EVC) as in the case of the tax returns.
The form requires the taxpayer to submit personal details such as name, PAN, address, date of birth, nature of business/profession, if applicable, and furnish details of any previous Form 10IE filed.
Taxpayers who do not have a business income are not required to file Form 10-IE and they can exercise the option under 115BAC while filing return of income in ITR 1 or ITR 2.
Over the last few years, the government has taken various steps to move towards a simpler tax regime. Considering the peak rate of 30% and the peak surcharge on tax at 37% on income exceeding INR 5 crore, India still has one of the highest tax rates applicable to individual taxpayers. Therefore, there is room to make the new tax regime more attractive for a larger segment of individual taxpayers once the government considers further broadening the tax slabs aimed at balancing the impact of forgoing various deductions or exemptions.
To ensure you’re making the right decision, thorough learning about both the tax regimes is as paramount as staying updated about new amendments proposed by the government.
This article was originally published in Forbes.