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Following the announcement by Finance Minister Nirmala Sitharaman of significant tax reductions for middle-income earners within the new tax framework, many individuals are questioning whether the government intends to eliminate the previous tax system. The Finance Minister did not address the existing tax structure, nor does the Budget document provide any elaboration on it. However, it does clarify that the updated tax brackets pertain only to those who choose the new regime. The previous tax structure was designed for those who take advantage of exemptions and deductions for items such as House Rent Allowance (HRA), life insurance premiums, contributions to the Public Provident Fund, and medical insurance policies. Individuals selecting the old regime have their taxable income calculated after applying the relevant exemptions. This income is then subjected to tax based on specified brackets: there is no tax for incomes up to Rs 2.5 lakh, a 5 percent rate for incomes between Rs 2.5 lakh and Rs 3 lakh, another 5 percent for those earning between Rs 3 lakh and Rs 5 lakh, 20 percent for income ranging from Rs 5 lakh to Rs 10 lakh, and a 30 percent rate for income exceeding Rs 10 lakh.
The Modi administration launched the new tax framework during the fiscal year 2020-21. Finance Minister Sitharaman indicated plans to eventually phase out all tax exemptions. In the years following the introduction of the new system, most taxpayers continued to utilize the old structure and claimed deductions. The government has now established the new tax structure as the standard, requiring taxpayers to actively select the old regime if they prefer to be taxed under it. With the recent Budget omitting any mention of the previous system while detailing advantages of the new regime, there is growing speculation about whether the forthcoming Income Tax law will abolish the old regime completely. Last August, the government reported that approximately 72 percent of income tax returns submitted for the fiscal year 2023-24 opted for the new regime, with the remainder adhering to the old system. Following the introduction of the new rebates, it is anticipated that more individuals will transition to this new framework.
To evaluate the tax owed under the two differing systems, let's use an example of an annual income of Rs 16 lakh. In the new system, no tax is applied on the first Rs 4 lakh of income. Following that, for the portion of income between Rs 4 lakh and Rs 8 lakh, a tax rate of 5 percent will be imposed, resulting in Rs 20,000. For the income range of Rs 8 lakh to Rs 12 lakh, the tax rate rises to 10 percent, equating to Rs 40,000. Lastly, on the income from Rs 12 lakh to Rs 16 lakh, the tax rate is 15 percent, which amounts to Rs 60,000. Consequently, the total tax obligation sums up to Rs 1,20,000. Thanks to the introduced rebates and revised tax brackets in the current Budget, this is Rs 50,000 lower than the current tax burden.
On the other hand, if you choose to utilize the old tax regime with exemptions totaling Rs 4 lakh and an annual income of Rs 16 lakh, your taxable income would drop to Rs 12 lakh. Based on the old tax brackets, your total income tax would reach Rs 1,72,500, which is Rs 52,000 higher than the tax under the new regime.
When deciding whether to go with the old or new tax structure, it is important to consider what kinds of deductions or exemptions a taxpayer should pursue to gain advantages similar to those in the new regime. The assessment will vary according to individual circumstances, and based on this, one can identify which tax regime offers greater benefits. The expansion of tax brackets in the new regime means that taxpayers may need to claim larger amounts in deductions or exemptions to match the tax liabilities of the new structure. Adopting the new regime allows taxpayers to avoid the pressure of investing in tax-saving instruments such as public provident funds (PPF) and assured return insurance policies. This results in more disposable income, enhancing their freedom to select investments. From the government's viewpoint, increased disposable income among citizens can stimulate spending and foster economic development. Additionally, it alleviates the government’s responsibility to manage interest payments on schemes like the PPF.
However, there is a downside to this shift. Transitioning to the new tax system may discourage investment in social security provisions, such as health insurance and savings plans with a lock-in period, like PPF. Although this change provides taxpayers with greater financial flexibility and increased disposable income, it could pose significant challenges if they do not develop savings strategies for unexpected future needs and reinforce their social safety nets.
