Midway through Financial Year 2019-2020, Finance Minister Nirmala Sitharaman announced major tax cuts for corporations in the hope that this would help revive India’s slowing economy. The cuts weren’t straightforward, though: they would only apply if the companies were willing to give up other exemptions for they might have been eligible under the tax code. As a consequence, each firm had to decide if they wanted a simple tax rate or a complex one with the benefit of various deductions.
On Saturday, Sitharaman extended the same offer to those who pay income tax in India.
In the latter half of her Budget Speech for 2020 – reportedly the longest-ever, with the finance minister visibly unwell and unable to finish the address – Sitharaman announced a whole new set of tax rates. These too were only for those who are willing to give up exemptions in the tax code.
“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,” Sitharaman said.
She added: “It is almost impossible for a taxpayer to comply with the Income-tax law without taking help from professionals. 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.”
Each of these levels is lower than what it was in the previous regime, except for those with income more than Rs 15 lakh, for whom the taxation rate – 30% – remains the same. The chart below explains:
What does this mean for ordinary taxpayers?
The answer is complex. In terms of headlines, the government has indeed offered a much simpler tax code with lower rates than before. This should offer considerable relief.
But by keeping two tax regimes, individuals will now have to make a choice about which one is better for them.
Should someone earning Rs 7.5 lakh to Rs 10 lakh move from a taxation rate of 20% to 15%? The answer sounds like it should be a yes, but remember, at the rate of 20%, they could also get Rs 1.5 lakh in deductions under 80C of the code, as well as various other exemptions for everything from house rent to home loans.
The question everyone will be asking is, will I be paying less tax under the old tax regime or the new one?
Chartered Accountants will undoubtedly have their calculators ready over the next few weeks, to help make this decision.
What makes it even more complicated is that Sitharaman announced that the government is doing away with a number of the exemptions under the old regime. According to her speech, around 70 of more than 100 that were in the tax code have been removed, leaving only around 30 exemptions for those who stick to the higher tax regime.
This seems like a useful, incentive-based system for people to move over to a simpler code. It also liberates the cash of some people from tied-down investments – such as the Public Provident Fund, Equity-linked Saving Schemes or other tax-saving instruments – letting them invest or save as they see fit.
But the proof will only come if people actually do make the switch, if the changes have been designed smartly enough.
The Economic Survey, a research document presented the day before the Budget, pointed out that the corporate tax cuts announced last year are likely to end up benefiting less than 1% of firms. This is because most are already being taxed at a lower rate, thanks to various exemptions that they would have had to give up.
The difficulty for the government would come if most people remain on the older higher-tax regime, while continuing to avail of various exemptions.
This would mean the government now has eight different tax slabs, resulting in a code that is actually more complex. This also brings up questions of revenue: only once we get a sense of how many individuals switch or stay, will the government actually have an accurate idea of how much income tax revenue it is going to be able to collect.