A Deeper Dive Into The New Income Tax Regime: Mostly Pros And A Few Cons

The new income tax regime, which will become the default one for most individual taxpayers, needs a deep dive since more than half of them are expected to shift to this dispensation which has almost no exemptions.

The changes to tax rates and basic exemptions relate to assessment year 2024-25 (that is the financial year starting 1 April 2023), with the changes being notified under sub-section (1A) of section 115BAC of the Income Tax Act.

The new rates are zero for incomes upto Rs 3 lakh, 5 per cent for incomes in the range of Rs 3-6 lakh, 10 per cent for the Rs 6-9 lakh slab, 15 per cent for Rs 9-12 lakh, 20 per cent for the Rs 12-15 lakh slab, and 30 per cent for those reporting incomes above Rs 15 lakh. 

The obvious change is the removal of the old 25 per cent rate applied to the Rs 12.5-15 lakh slab. 

The second key change relates to the introduction of a Rs 50,000 standard deduction, making it similar to the old tax regime, which remains an option for taxpayers.

The third change is about offering a rebate to taxpayers earning upto Rs 7 lakh, which means the new effective tax-free income is Rs 7.5 lakh including standard deduction.

But things get interesting as we dive deeper into the implications of the new tax regime.

One, since all deductions under 80C, 80D and 80 TTA are gone, it now implies that your deductions for contributions to provident fund and the National Pension Scheme, earlier given limits of Rs 1.5 lakh and Rs 50,000 separately, are gone.

The new tax regime effectively has shifted all taxpayers to a TEE regime, which implies a tax-exempt-exempt status on retirement corpuses.

A TEE regime means that you can invest only post-tax amounts on your contributions to PF and NPS, but the earnings on the accumulating investments and final payouts are tax-free.

But, luckily, you still pay no tax as long as these investments are together lower than Rs 2 lakh, since the new tax-free threshold is Rs 7 lakh, plus standard deduction. You also get no deductions for investments in insurance policies or health cover payments.

Two, the big gain in the new tax regime is not really any major saving in taxes, but cash flows.

For example, you no longer have to invest in mutual funds or insurance just for tax deductions. You now have the option to opt for much cheaper term insurance as against the higher-premium money back policies that are essentially part insurance, part mutual fund, combined into one product.

Three, the big gain will really be in the simplicity of tax filings, since you no longer have to submit details of investments made to your company accountant towards the end of the year.

Since there is no deduction available on house rent allowance, your company need not break your salary up into multiple components just to save on tax, and you can opt for a cheaper rented dwelling to save on costs.

To file taxes, all you now need to do is to enter your gross salary figure, add your returns from interest and dividends and other incomes, check your TDS (tax deducted at source) credits under AS26 statements, and pay the advance or balance tax (by June 15, September 15, December 15, March 15, and self-assessment tax after that, in each financial year).

Even if you end up paying marginally higher taxes in income ranges above Rs 15 lakh, the hassle you save may be worth the additional payment.

The Economic Times, which made some computations on actual taxes paid on incomes of Rs 25 lakh and Rs 60 lakh, showed that the increase in taxes in the new regime is Rs 23,000 in each case (ie, less than Rs 2,000 a month), but the real saving is in cash flows, since you save on tax-deductible investments of Rs 4.5 lakh and Rs 8.5 lakh.

You get more discretionary money under the new regime even when you pay more taxes.

For those without carried forward losses to set off against gains, the new regime is as good as the old.

But we also need to record some misses in the new tax regime. The much anticipated reforms in the complicated capital gains regime did not materialise, but could easily have been attempted in the new regime while retaining the old one for those who benefit from it.

This would have allowed the government to do a pilot before plunging into wholesale changes to the capital gains regime.

For example, if all capital gains, short term and long term,  were to be taxed at 15 per cent in the new regime, with long-term gains getting the benefit of indexation, it would have nudged more people to opt for a simpler regime and a moderate rate hike long-term capital gains tax.

This can still be done before the budget is passed in March.

The 25 per cent tax rate could have been retained for the Rs 15-18 lakh slab, thus encouraging more people to opt for the new regime.

Instead, we now have a big leap from 20 per cent to 30 per cent after the Rs 15 lakh income limit. One wonders if the revenue losses would have been greater, but a tapered slab rate would have been better.

But all in all, the new regime is a game changer, both for compliance and as a cure against individual addiction to specific tax deductions.