By Ishita Sengupta
Budget 2025 income tax expectations: As we all gear up for the Union Budget later this week, the big question for individual taxpayers is whether the Hon’ble Finance Minister will completely scrap the old tax regime? Well, time will only give the answer but the moot question is – would it be prudent to do so?
Let’s step back for a bit of analysis! The new income tax regime was introduced in 2020 as an optional regime for individual taxpayers. The primary objective was to introduce a more simplified tax structure by removing the plethora of deductions and exemptions. The Government also provided significant relief to taxpayers by reducing income-tax rates, thus nudging them to adopt the new income tax regime. It was quite apparent that the Government intended to phase out the old income tax regime in due course. As per media reports, there were very few takers of the new income tax regime in the initial years.
To give a further push, vide Finance Act, 2023, the Government made the new income tax regime as the default regime and brought more attractive changes related to the new income tax regime, by reducing the income-tax rates further, capping the maximum marginal rate (MMR) at 39%, introducing the standard deduction of ₹50,000 for salaried individuals, increasing the income level for 100% tax rebate etc. The trend even continued for the subsequent year wherein vide Finance (No. 2) Act, 2024, the slab rates were further tweaked for better, standard deduction for salaried individuals was hiked, deduction for employer’s NPS contribution increased by 4% etc. This seems to have worked its magic. As per Press Release issued by the Ministry of Finance on August 2, 2024, 72% taxpayers opted for the new income tax regime in FY 2023-24 ITRs filed until July 31, 2024.
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While this appears to be a large percentage, one cannot disregard the fact that the 28% taxpayers opting for the old income tax regime in FY 2023-24 is still a considerable number. Furthermore, while we do not have the necessary data to understand clearly which section of taxpayers are still in favour of the old income tax regime, it is not difficult to guess. From salaried taxpayers’ perspective, the ones benefiting from popular tax exemptions and deductions such as, HRA, LTA, home loan interest, 80C deductions, insurance premia, charitable donations etc. would be still opting for old income tax regime.
Given this, is it worth evaluating if the lower tax rates under the new income tax regime really offset the tax deductions/ exemptions which taxpayers have to forego?
We have categorised individual taxpayers in four general baskets as per their annual gross income – (A) individuals having income up to ₹15 lakh, (B) individuals having income between ₹15 lakh – ₹1 Cr, (C) HNIs having income between ₹1 – ₹5 Cr and (D) ultra-HNIs having income beyond ₹5 Cr.
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Category A represents the largest filing population, possibly young salaried taxpayers, many of them millennials, who may not have invested in long term assets like house properties and other savings schemes. Hence, they would typically prefer hassle-free filing and less burden of documentation proof, etc. At the other end of the spectrum are the ultra-HNIs who would prefer the MMR currently capped at 39% in the new income tax regime due to surcharge cap vis-à-vis 42.74% in the old income tax regime. For both these categories, new income tax regime seems to be the clear winner.
It is the people in between who seem to make up the largest group as the old income tax regime filers. These individuals generally spend a significant part of their earnings and savings on rising house rent and home loan EMIs, children’s education, medical expenditure especially for their aged dependents and towards their own retirement savings. They also tend to donate to help a social cause. HNIs would comparatively spend, invest and donate more.
The available standard deduction against salary income is definitely not commensurate with the rising YoY expenses. The continuity of existing tax benefits under the old income tax regime hence becomes a critical part of their financial planning to meet their cash budgets. As more consequential tax savings would be available to individuals in Categories B and C and their MMR in both the regimes is the same, they would generally find the old income tax regime more attractive. It is also important to remember that many of these tax deductions, e.g., for home loan interest, insurance premia, savings schemes, etc. were originally introduced to give a boost to the related industry, by incentivising taxpayers to spend on them.
If discontinued, this could also have an adverse impact on such payee organisations and investee entities in meeting their objectives, fund requirements etc. In view of these, the Government should not rush to scrap the old income tax regime entirely, either in the existing income-tax law or the probable new Direct Tax Code, at least for a few more years till the average taxpayer develops the habit of prudent financial planning.
In the interim, the Government could consider announcing its roadmap of phasing out the old income tax regime coupled with an additional carrot of lower tax rates to encourage this middle-income group to voluntarily adopt the new income tax regime.
(Authored by Ishita Sengupta, Partner and India Leader, Vialto Partners. Shaishav Shah, Director, Vialto Partners contributed to the article. Views are personal)