Goodbye old tax regime; new regime now more attractive

It is a no-brainer that those earning up to  ₹12 lakh should opt for the new tax regime.
It is a no-brainer that those earning up to 12 lakh should opt for the new tax regime.

Summary

  • Zero tax up to 12 lakh as well as the attractive new tax slabs are only applicable to the new tax regime, but at the same time, the old tax regime does remain relevant in some cases.

The budget’s biggest, shiniest takeaway: no tax on income up to 12 lakh. Union finance minister Nirmala Sitharaman’s announcement was met with much cheer and enthusiastic number-crunching across the country.

Before you pop the champagne, though, there are two points to consider. First, zero tax up to 12 lakh as well as the attractive new tax slabs are only applicable to the new tax regime. At the same time, the old tax regime does remain relevant in some cases.

Second, if your taxable income is 12 lakh, your tax liability is not zero; it is 60,000 (per the new tax slabs). However, it will become zero once the rebate of 60,000 kicks in (it was earlier 25,000).

And if you are salaried (as opposed to self-employed), you get an additional standard deduction of 75,000. This means that income up to 12.75 lakh is practically tax free for the salaried class. To be sure, the income limit for claiming this rebate has been increased to 12 lakh from 7 lakh earlier.

If you earn even 10,000 above the 12 lakh or 12.75 lakh threshold, you will not be eligible for this tax rebate and your tax liability will come in at 61,500. But you don't have to pay it thanks to marginal relief. Tax actually payable after marginal relief will come in at 10,000. Marginal relief ensures that those slightly above an income tax slab threshold are not unfairly taxed compared to those below the threshold.

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However, marginal relief is not limitless. For instance, if you have an annual taxable income of 12.75 lakh (or 13.5 lakh for salaried), your tax liability will stand at 71,250. Marginal tax relief will not kick in at this income level. You will still have to pay a tax of 71,250.

Another caveat: this rebate will not apply to special grade incomes such as capital gains. It means if you have earned capital gains from the stock market or by selling a property, it will be taxed separately. It will not get included in your normal income of up to 12 lakh, which is eligible for the tax rebate. So, having a 10 lakh salary income and 2 lakh income from the share market does not mean that you can club them together. You will have to pay capital gains tax on the 2 lakh income from the market.

(Graphics: Mint)
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(Graphics: Mint)

To be sure, some earlier benefits can also be leveraged. For instance, even if your income is above the 12 lakh or 12.75 lakh rebate limit, you still have the ongoing provision of claiming deduction on home loan interest of a rented-out property under the new tax regime, which has no upper cap.

Another deduction that is still allowed in the new tax regime is employer contribution to your NPS (national pension system). An individual can claim a deduction of up to 14% of the basic salary if her employer makes a contribution to NPS.

Old vs new tax regime

Considering the new regime’s altered framework, does it still make sense to opt for the old tax regime?

It is a no-brainer that those earning up to 12 lakh should opt for the new tax regime. In case of a gross income of 14 lakh, a Mint analysis with the help of some tax experts shows that you need to claim more than 5.18 lakh deduction and exemption to be better placed in the old tax regime. If you cannot make this much deduction/exemption, you should simply opt for the new tax regime.

Similarly, those having a gross income of 20 lakh need to claim more than 7.08 lakh deduction/exemption in the old tax regime for lower tax liability compared to the new tax regime.

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This break-even point is 7.87 lakh for 24 lakh income and 8 lakh for income between 25 lakh and 5 crore. The new tax regime is better for those having an income above 5 crore thanks to a lower surcharge rate of 25% applicable in new tax regime against 37% in the old tax regime.

Who should opt for the old regime?

With the revised rates announced under the new regime, the old regime has been rendered useless for most taxpayers. As per the break-even amount analysed at different income levels, taxpayers under the old regime will not be able to break even even by availing most of the popular tax deductions and exemptions available.

These include 1.5 lakh deduction under 80C, 25,000 on medical insurance premiums, 50,000 NPS contributions and 2 lakh deduction on home loan interest. Home loan interest is capped at 2 lakh for a self-occupied house, whereas full interest paid in a year is deductible for rented house, but this benefit is also allowed under the new tax scheme.

The only tax exemption that can move the needle in favour of the old regime is house rent allowance (HRA).

However, HRA benefits only high-income taxpayers paying high rents of 60,000 or more.

Let's understand with an example. Assume Mr. A has an income of 48 lakh. He pays 65,000 rent per month ( 7.8 lakh annually). If we assume Mr A's basic salary at 20 lakh and HRA allowance 10 lakh, he will qualify for 5.8 lakh HRA exemption. He also gets 50,000 standard deduction. Other deductions in his case are 1.5 lakh under section 80C, which will be easily exhausted with just EPF (employee provident fund) contributions, 50,000 contribution to NPS under Section 80CCD, and 20,000 medical insurance premium under Section 80D.

So, the total tax exemption he gets is 8.5 lakh. The breakeven point for those earning above 24 lakh is 8 lakh. Since Mr. A can claim a deduction/exemption of more than the breakeven threshold, he will be better placed in the old tax regime.

As can be seen in the above example, HRA makes up the largest chunk of the total exemption. This means if the taxpayer pays low rent, even claiming HRA may not make the old tax regime favourable for her.

Benefits of new regime

With the income slabs widened and the highest slab raised to 24 lakh after which the top marginal rate of 30% is applicable, taxpayers stand to save substantially more tax under the new regime. Rebate has been given on incomes up to 12 lakh, raised from 7 lakh. That is straightway a saving of 80,000 for all taxpayers earning from 7 lakh to 12 lakh.

Highlighting the savings that taxpayers will get with the new rates, finance minister Sitharaman cited certain examples. “A person having income of 18 lakh will get a benefit of 70,000 in tax (30% of tax payable as per existing rates). A person with an income of 25 lakh gets a benefit of 1.1 lakh (25% of his tax payable as per existing rates)," she said.

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It should be noted that Sitharaman's tax saving figures don’t consider 75,000 standard deduction available to salaried individuals. Salaried will arrive at a slightly lower tax saving amount after deducting 75,000 from their gross incomes.

With the old tax regime left unchanged and a spate of new changes announced in the new tax regime, one can safely assume that the old tax regime will soon be history. Data from CBDT (central board of direct taxes) shows that more than 72% of taxpayers have already adopted the new tax regime.

 

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