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Why FM must fix the optional income tax scheme of no exemptions and flat tax rates

Amitabh Tiwari
·3-min read
Finance Minister Nirmala Sitharaman: Photo: Getty Images
Finance Minister Nirmala Sitharaman: Photo: Getty Images

Finance Minister Nirmala Sitharaman in Budget 2020 announced a concessional tax regime for individuals with new slabs and tax rates for those willing to forego all existing exemptions.

In the new system, there are 7 tax slabs versus 4 in the existing system. A person opting for the new system will not get any benefit of exemptions and deductions like 80C for investments, 80D for medical insurance premium, interest on home loan under Section 24, contribution to pension scheme, house rent allowance, standard deduction, etc. There are altogether 70 exemptions available for an individual taxpayer.

However, to compensate for not being able to claim deductions / exemptions, the tax rates under the new system are liberal. For example, while the 30% tax rate kicks in at above Rs 10 lakh income in the existing system, it kicks in at Rs 15 lakh and above in the new system.

The new system was aimed at simplifying the tax filing process for individuals. If a person has lesser or even the same tax liability in the new system, he / she would choose it.

However, the new system has not gained acceptance as tax slabs are narrow and tax liability is higher for most people.

In India the standard saving rate is about 30%. Suppose a person earns a salary of Rs 20 lakh. He can thus save Rs 6 lakh which can be used to pay interest on home loan (Rs 2 lakh), principal on home loan (Rs 1.5 lakh) and contribute to pension scheme (Rs 0.5 lakh).

All of this together with standard deduction of Rs 50,000, aggregating to Rs 4.5 lakh is allowed as a deduction from income. His net taxable income is Rs 15.5 lakh in the existing scheme.

He will get the deduction of Rs 50,000 under NPS in the new scheme as well. However, his taxable income will be much higher at Rs 19.5 lakh in the new scheme.

His tax liability in the existing system of deductions / exemptions is Rs 2.65 lakh while it is higher at Rs 3.1 lakh in the new scheme.

The finance minister needs to make this concessional scheme more attractive for taxpayers so that more and more people use it. It would lead to a much simpler process, and save a lot of time for the individual, human resources in corporations and tax authorities.

If the finance minister reduces the tax slabs to six, the highest incidence of tax will occur at income above Rs 25 lakh and not Rs 15 lakh.


Note: Tax rebate of Rs 12,500 is available in both systems effectively making income up to Rs 5 lakh exempt from income tax.

This will bring in some sort of parity with other countries. In China, the 30% tax rate is applicable on income above Rs 42 lakh. In Russia, all income is taxed at 13% (less than half our peak rate). In the US, income above Rs 10 lakh and up to Rs 27.5 lakh is taxed at just 12%.

In Singapore, the first Rs 10 lakh income is exempt from tax while the highest slab attracts a tax rate of 22%. In South Africa, 31% tax rate is applicable on income of about Rs 15 lakh and above.

Under the proposed system, his tax liability in the above example will reduce to Rs 2.15 lakh, Rs 50,000 lower and will hence become attractive.

A change in the concessional tax regime will increase the take home salary of salaried individuals and leave more money in the hands of professionals. This will provide the much needed relief to individuals in the pandemic era. Hope the Finance Minister is listening...