The Union Budget 2020 announced a new simplified tax regime for the taxpayers. This regime offers a lower rate of income tax to those who are ready to forfeit tax deductions and exemptions, thereby allowing the entire income to tax.
Giving an example of tax savings under the new tax regime, finance minister Nirmala Sitharaman in her speech had said that a person earning ₹15 lakh in a year and not availing any deductions would have to pay ₹1,95,000 as tax compared with ₹2,73,000 in the old regime. This translates into a benefit of ₹78,000 under the new regime, and this has become extremely relevant now given the spate of job cuts and pay cuts that most people are facing right now.
“A person fearing job loss or substantial salary cuts may consider opting for the benefit of lower tax rate under the new tax regime wherein he is not required to make the investment to avail specified deductions (such as 80C, 80D, etc) and thus can also have some liquidity in his hands," said Suresh Surana, founder, RSM India, a tax consulting firm.
But does opting for the new tax regime a one-size-fits-all answer? Not really. Your income level, whether you are salaried or non-salaried will determine if the new tax regime will hand you any benefit. Some of you might have already made the choice between the tax regime but you can connect with your HR as some of the companies allow the employees to change the tax regime at the beginning of every month.
Making the case for the new tax regime
For a salaried person with an income of up to ₹5 lakh, it doesn’t make sense to go for new regime as there is no tax as per the old regime. The government enhanced the rebate to ₹12,500 last year, and those having net taxable income of up to ₹5 lakh don’t have to pay tax. Even for those who have income above ₹5 lakh, it will depend on the deduction and exemption one is claiming.
“Whether the new tax regime will bring in more liquidity due to lower tax liability, the answer is not straightforward. It depends on the quantum of deductions or exemptions being claimed by the taxpayer under the old tax regime," said Sonu Iyer, Tax Partner and People Advisory Services Leader, EY India.
There are certain deductions such as house rent allowance (HRA), interest on a home loan, deduction against provident fund (PF) contribution under Section 80(C), which are most commonly availed by salaried individuals. They don’t have to pay anything to avail HRA and PF deduction as they are part of salary income against which they can claim deductions. So, not availing them doesn't impact their liquidity.
However, under a few scenarios where you may not be availing of these deductions, you may benefit from opting for the new tax regime due to the lower tax rates.
Not availing HRA and home loan interest deduction
If you are staying with your parents or staying in your own house and not paying rent, you can’t claim HRA deduction. In case you don’t have a home loan, you won’t be claiming deduction of ₹2 lakh on interest paid. These are some of the major deductions, which if you are not claiming, then you may opt for the new tax regime.
So, now let’s understand it with an example. Assuming a person earns a salary of ₹15 lakh. Under the old tax regime, he is eligible for a standard deduction of ₹50,000 and deduction of ₹1.5 lakh under Section 80(C). Assuming he or she is not claiming other deductions, the taxable income would be ₹13 lakh after standard deduction and Section 80(C) deductions. The total tax liability will be ₹2,10,600 under the old regime. Under the new tax regime, without any deductions, the total tax liability will be ₹1.95 lakh.
“There is a tax savings of ₹15,600, which will increase the net take-home of the individual and bring in more liquidity in the hands of the individual under the new tax regime," said Iyer.
₹50,000 HRA deduction claimed
Again, in the above example, if the HRA of the person is ₹50,000 and the person is availing ₹1.5 lakh deduction under Section 80(C) then his tax liability under the old regime will be ₹1.95 lakh and even under the new regime, the tax liability will be ₹1.95 lakh.
Here as the tax liability is the same under both regimes. The person may opt for the new tax regime as here he or she will not be required to make additional investment under Section 80(C) if that is not being exhausted by the mandatory provident fund contribution. If the person is required to invest more to the exhaust Section80(C) limit, it might put a strain on his finances if he is facing liquidity crisis. Thus adopting new tax regime would be better.
Therefore, how much liquidity a person will gain will depend on a case to case basis and the number of deductions and exemption one is claiming. One needs to separately calculate the tax liability under both the old and the new tax regime to understand which one to choose.
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