New Income Tax Regime – Structural Shift in Taxation under Income Tax Act

New Income Tax Regime – Structural Shift in Taxation under Income Tax Act 1961

Introduction  

Budget 2020 was considered to be unique in many ways. It was the first budget of the decade 2020. Moreover it was the most anticipated budget in recent times as Indian economy was grappling from a slowdown in the growth rate for a couple of quarters. People were expecting significant rate cuts in personal income tax rates after a historic rate cut  in Corporate Taxes on 20th September 2019 to boost consumption in the economy. However the Government did cut the tax rate but it did in an unprecedented manner. The New Tax slabs and the caveats attached with them will impact Indian Society in the long run as the government wants to shift the economy from saving oriented economy to consumption oriented economy. 

Honourable Finance Minister(FM) Nirmala Sitaraman in her budget has introduced a new taxation regime under personal taxation.  Instead of giving relief to all the Individual & HUF by increasing the tax slabs directly, Budget 2020 have proposed to introduce new section 115BAC in the Income Tax Act 1961 in which Individuals or HUF have been given an option to give up various exemptions and get advantage of lower tax rates. Following is the comparison of the existing tax rates and the new tax slabs. 

However new taxation regime comes with few caveats which are as under: 

1. Assessee shall have to forgo plethora of deductions and exemptions granted under Income Tax Act 1961.

Salaried Assessees shall not be entitled to the following exemptions/ deductions as under:  

• Leave travel concession as contained in clause (5) of section 10;

• House rent allowance as contained in clause (13A) of section 10;

• Some of the allowance as contained in clause (14) of section 10;

• Allowances to MPs/MLAs as contained in clause (17) of section 10;

• Standard deduction, deduction for entertainment allowance and employment/professional tax as contained in section 16;

• free food and beverage through vouchers provided to the employee as notified in section 10(14).

However, few exemptions have been allowed under new tax regime under section 10(14) as under: 

• Transport Allowance granted to a divyang employee to meet expenditure for the purpose of commuting between place of residence and place of duty

• Conveyance Allowance granted to meet the expenditure on conveyance in performance of duties of an office;

• Any Allowance granted to meet the cost of travel on tour or on transfer;

• Daily Allowance to meet the ordinary daily charges incurred by an employee on account of absence from his normal place of duty.

Assessee who have income under the head Profits & Gains from Business & Profession shall
not be entitled take followings deductions/exemptions:

• Additional depreciation under clause (iia) of sub-section (1) of section 32;

•  Deductions under section 32AD, 33AB, 33ABA;

• Various deduction for donation for or expenditure on scientific research contained in sub-clause (ii) or sub-clause (iia) or sub-clause (iii) of sub-section (1) or sub-section (2AA) of section 35;

• Deduction under section 35AD or section 35CCC;

• Exemption for SEZ unit contained in section 10AA;

Provisions relating to AMT u/s 115JC and provisions relating to carry forward and set off of AMT credit, if any, u/s 115JD shall not apply to such individuals or HUF having business or profession income.

General Deductions & Exemptions which any assessee shall have to forego is as Follows:

• Allowance for income of minor as contained in clause (32) of section 10;

• Interest under section 24 in respect of self-occupied or vacant property referred to in sub-section (2) of section 23. (Loss under the head income from house property for rented house shall not be allowed to be set off under any other head and would be allowed to be carried forward as per extant law);

• Deduction from family pension under clause (iia) of section 57;

• Any deduction under chapter VIA (like section 80C, 80CCC, 80CCD, 80D, 80DD, 80DDB, 80E, 80EE, 80EEA, 80EEB, 80G, 80GG, 80GGA, 80GGC, 80IA, 80-IAB, 80-IAC, 80-IB, 80-IBA, etc). However, deduction under sub-section (2) of section 80CCD (employer contribution on account of employee in notified pension scheme) and section 80JJAA (for new employment) can be claimed.

1. Individuals or HUF who do not have Business or Profession Income shall have the option to choose a new income tax regime for every previous year. For the other assessee, the option to choose a new income tax regime only once and it shall have to be continued for all the previous subsequent years. They will be given an option to opt out from the new Tax  Regime. Once once the individual or HUF shall never be eligible to exercise option under this section, except where such individual or HUF ceases to have any business or profession income.

Analysis

Nirmal Sitaraman in her budget speech quoted regarding the new tax regime as under: 

“Currently the Income Tax Act is riddled with various exemptions and deductions which make compliance by the taxpayer and administration of the Income Tax Act by the tax authorities a burdensome process. It is almost impossible for a taxpayer to comply with the Income-tax law without taking help from professionals. In order to provide significant relief to the individual taxpayers and to simplify the Income-tax law, I propose to bring a new and simplified personal income tax regime wherein income tax rates will be significantly reduced for the individual taxpayers who forgo certain deductions and exemptions. 

In the new tax regime, substantial tax benefit will accrue to a taxpayer depending upon exemptions and deductions claimed by him. For example, a person earning  Rs 15 lakhs in a year and not availing any deductions etc. will pay only Rs 1,95,000 as compared to Rs 2,73,000 in the old regime. Thus his tax burden shall be reduced by 78,000 in the new regime. He would still be the gainer  in the new regime even if he was taking deduction of Rs 1.5 Lakh under various sections of Chapter- VI-A of the Income Tax Act under the old regime.

Based on the speech of the the Honourable Finance Minister intention of the government for introduction of new tax regime is clear  

1. Reduction in compliance cost and ease of complexity for the Assessee

2. Reduction in tax liability of the Assessee

But on analysing the provision of the new section 115BAC, i.e. new tax regime, none of the above points seems to get fulfilled.

Under the new taxation regime, Assesee shall have to decide every year whether to continue with the old tax system or choose the newer tax system. He shall have to calculate how much benefit he will get under the existing tax system with all deductions & exemptions against the reduction in tax liability under the new tax system by forgoing various deductions & exemptions. It’s too much to expect from a normal assessee to make such complex calculations himself and make a decision.  New tax regime have increased the complexity instead of simplifying it.

The example given by the honourable FM of a person earning Rs 15 lakhs per annum and highlighting a major tax saving of Rs 78,000 by comparing  the tax liability under both existing tax system and newer tax regime with assumption that the assessee do not avail any deductions and exemption. However the assumption has itself a big flaw. Out of all the 4.86 crore returns filed by the Individuals & Huf for the FY 19-20 till January 2020, there will be an extremely miniscule number of Assessees who might not have claimed any deduction or exemptions in any form in their income tax returns. Many deductions are mandated by the statute e.g Contribution to Provident Funds by the employee. Many of the deductions/exemptions are claimed by the assessee for the expenses they will have to incur for their livelihood eg. paying rent and claiming HRA (in case of salary) or claiming deduction u/s section 80GGA in case of other assessee. Almost all the assessee shall have at least one account in Saving Bank in which assessee will earn an interest and claim deduction u/s 80TTA. Hence some of the deductions /exemptions claimed by the assessee are actually for the expenses which are either mandated by some other statute or they have to be incurred for the livelihood. We can say that some deductions/exemptions are not optional but necessary. 

Let us understand the new tax regime with an illustration and also compare it with the existing tax system.

Mr X is employed with ABC Limited. The salary structure for the FY 2020-21 is as under : 

Mr X also invested Rs 60,000 in Tax Saving Mutual Funds and pay insurance premium of Rs 14,000, medical insurance premium of Rs 19,000. He pays rent of Rs 25,000 pm

He also earns interest of Rs 5,500 on balance in saving bank account. 

Mr X has also availed Housing Loan of Rs 50,00,000 on which he paid Rs 1,25,000 as interest and Rs 65,500 as principal amount. 

Calculation of Tax under both Tax Regimes: 

Based on the above example, we can clearly see that the new tax regime is not beneficial to the assessee as he has to pay Rs 1,18,560 as tax while if he decides to remain under the existing tax regime, he would not have to pay any tax at all. 

Pros of New Income Tax Regime:

1. There are chances that people will stop buying insurance policies at the end of the financial year just for the purpose of saving tax. 

2. Millennials will be the most beneficiary of the new tax regime as they dont have a tendency to save and invest. With lower tax on their income, they will have higher disposable income and they will increase the consumption in the economy.

Cons of the New Tax Regime:

1. India is a country where the government does not sponsor social security to its citizens. There are few schemes by the government  where free healthcare benefits, subsidized housing benefits and pension benefits are available to the residents of our country but there is a lack of fully developed social security mechanism in India unlike developed countries in the world. Hence people have to save and invest on their own for their retirement. Various deductions under section 80C and section 80D motivates and incentives people to invest by giving tax benefits. However under the new tax regime, with no incentive to save and invest for retirement, there are chances that people, especially the younger generation, shall not save for retirement and start spending recklessly and will not be able to build sufficient retirement corpus and will end up zero savings in future.

2. The Government of India has a very ambitious dream of Housing for all till 2022. To accomplish this dream, the government is giving subsidy to first time homebuyers. However the government has taken a contrary stand under by not allowing deduction of Interest on Housing Loan u/s 24(b) and principal portion of housing loan under section 80C, or stamp duty payment under section 80C. Such provisions will be a roadblock for the government’s ambitious dream.

3. In order to incentivise the purchase of the electric vehicle by an individual, the government in its Budget 2019, introduced section 80EEB in which individuals can claim deduction of Interest Payment upto Rs 1,50,000 on loan taken for buying electric vehicles. But in the new tax regime, assessee will not be able to claim this deduction. This will be a roadblock for the government’s efforts to push clean energy and incentivise electric vehicles.

4. Government has also disincentivized the manufacturing activities undertaken by the individuals /Huf specially MSME units by not allowing additional  depreciation under section 32(1)(iia) & deductions under section 35AD under the new tax regime. This will disincentivize new investments and expansions plans of the MSME sectors and indirectly affect job creation. We all know that msme is the key job creator in our country. 

5. The new tax regime will be a big headache for the employers as their employees will have the option to choose one of the tax system. The calculation of TDS will be more tedious as there is no clarity from the government regarding how and when the declaration shall be taken from employees who want to opt for a new tax regime.

6. Individual and  HUF with business & profession income have not been given the option to choose the new tax regime for every previous year unlike other Assessee. There was no such need to differentiate between assessees for the new tax regime.

Who will opt for New Tax Regime:

1. Millennials who generally don’t save and invest will be the biggest beneficiary of the new tax regime. 

2. Young Assessees who have started earning recently and  whose insurance policies and other tax saving investments are done by their parents

3. Assessees whose are in high tax bracket but do not have investments  options and other tax saving liabilities eg existing Home Loans, HRA etc 

4. Employees who are earning higher salaries and their employers are not liable for registration under EPF Act.

5. Assessee who is not into manufacturing business where he does not have an option to claim additional depreciation u/s 32(iia). 

Suggestion to the government for making changes in the new tax regime to make it more practical and attractive.

1. The Government has tried to implement the tax regime as suggested in the DTC code report submitted to the government in August 2019 which suggested substantial changes in tax slabs and lower tax rates and non  New Tax slabs suggested as under.

Source : ET wealth

However implemented the suggestion half heartedly and gave an option to choose to choose a new tax regime with revised tax slabs and reduced tax liability but no deductions and exemptions.  However the new tax slabs will increase the tax liability instead of reducing the same. Government should have adjusted the tax slabs under the new tax regime in a manner it should have been tax neutral for the assessee. This could have actually made the tax system for the taxpayers simple in true sense. With no deductions and exemptions to be claimed and paying tax on the actual income would have satisfied the government’s objective to simply the income tax for a normal taxpayer and it can file the Income return by itself without the help of the professional. 

1. Government must retain some of the deductions and exemptions which are mandatory for an assessee eg professional tax deducted from salary , employee contribution to provident fund etc. These deductions are mandated on the employees and in most of the cases are not optional. Such deductions have to be given to the assessee.

2. Government must not force the assessee to forgo all the deductions under 80C. Government could have promoted term pure insurance plans  retaining the deduction for the premium paid for the term insurance plans and not allowing premiums for other forms of life insurance policies. This step will discourage the mis -selling of insurance policies by the agents who sell the endowment policies which are embedded with the ultra low returns and assesses buy the same only for the tax benefit purposes. Assessee will be inclined to separate its insurance requirements  needs from the investment goals and will look for better investment avenues. 

3. Government should allow deductions for interest on housing loans under  section 24(b) and principal amount under section 80Cfor the affordable housing schemes.This will not derail the Housing for All vision of the government.

4. Government should also give assessee with business income an option to choose the new tax regime every year just like other eligible assessee and the restriction of allowing to choose only once should be removed. 

5. Government should continue to allow deductions under section 80C by investing in tax saving mutual funds in order to deepen the capital market of India. Government may increase the lock in period from 3 years to 5 years or 10 years in order to make assessee stay invested and reap the benefit of the investment in the capital market for a longer horizon.

6. Government should also allow deduction under section 80D as healthcare cost in India is rising rapidly and it is now a necessity to have medical insurance in every family to safeguard against medical emergencies. 

Ending Remarks:

Honourable FM in her budget speech have quoted as under: 

“I have reviewed all the exemptions and deductions which got incorporated in the income tax legislation over the past several decades. It was surprising to know that currently more than one hundred exemptions and deductions of different nature are provided in the Income-tax Act. I have removed around 70 of them in the new simplified regime. We will review and rationalise the remaining exemptions and deductions in the coming years with a view to further simplifying the tax system and lowering the tax rate.”

Based on the above speech,  we can easily foresee the intention of the government that  the new tax regime is going to stay and in the coming years, the government may gradually shift to a new tax regime with lower taxes with lesser deductions and exemptions by making the scrapping existing tax system. The government has already introduced similar tax structures for the companies by introducing section 115BAA which gives option to the companies  of paying corporate tax at lower rates but will have to forgo various deductions and exemptions. Similar provisions are introduced for Co-operative Societies in this budget by introducing section 115BAD. Assessees shall have to gradually reconsider their investments and tax saving options in order to take maximum benefit of the new tax regime.