Indians have a choice between two tax systems, and the option they choose will depend on their annual income, ability to take advantage of eligible exemptions, and nature of investments.
A quick background: Government of India implemented a new tax framework in 2020, which features more slabs and lower tax rates. However, it also continued with the old tax regime. While the new tax regime offered lower tax rates compared to the old tax regime, the taxpayer will have to forgo most of the tax deductions and exemptions (except for certain permissible items) that are available under the existing regime.
As the new tax regime introduced in 2020 did not find many takers, the government felt the need to revise the new tax system to make it more attractive. In budget 2023, major tweaks were announced to the existing new tax regime, keeping the old tax regime in its same form. It generally appears as an effort from the government to revise the new tax regime ‘meaningfully’, making it attractive for taxpayers in certain slabs and encourage them to evaluate and decide.
As per government sources it is understood that around 66% of taxpayers have opted for New Tax Regime (CBDT Chairman).
In the Budget 2024, Finance Minister further brought in changes to the new tax regime (we call it New Tax Regime 3.0), to make it more appealing to the taxpayers with an expectation of further increasing the adoption rate.
Old Tax Regime (Old TR) and Revised New Tax Regime (New Tax Regime 3.0): The slabs and tax rates under both the regime, are as follows:
New tax regime 3.0 – Major changes and pointers:
• New Tax regime 3.0 continue to have five slabs
• Standard Deduction increased to Rs.75,000
• Rebate for income up to Rs.7 lakh
• Essentially this means, for someone with annual income of Rs. 7,75,000, adjusting for standard deduction, the effective tax outgo would be nil.
• New tax regime to be the default one. Taxpayer should opt for old tax regime if they wish to.
The break-even or the indifference points (of exemptions) for Old Tax Regime and Revised New Tax Regime:
Following table illustrates the tax outgo as per ‘Old TR without eligible deductions’ and ‘New Tax Regime 3.0’ across different annual income ranges and the level of exemptions where the tax outgo under Old TR matches New TR. Beyond this point, Old TR becomes attractive than New TR.
Which regime should you choose?
Deciding between Old Tax Regime and Revised New Tax Regime for FY25 onwards:
Both regimes have merits and drawbacks. The choice is based on the taxpayer’s investment and expense patterns, as well as the liability circumstances. With a few examples, we help you understand what suits better between the two.
Scenario 1 – Nil or lower eligible deductions and Income below Rs.7.75 Lakhs: The chart above shows that choosing the New Tax Regime is advantageous if one’s annual income is less than or up to Rs. 7,75,000 (approximately Rs. 64,580 per month), given the fact that there is nil tax outgo. It still remains attractive even for someone who has lower amount of deductions, less than Rs.2.25 lakhs.
At what level does the Old TR matches New TR: If the eligible deductions are at Rs.2,25,000 and above, then Old Tax Regime equals New Tax Regime 2.0 with nil tax.
Scenario 2 – Income above Rs.7.75 Lakhs and with eligible deductions: However, once a person’s yearly income exceeds Rs. 7,75 000, an evaluation is required, taking into consideration the total eligible deductions. The table shows that choosing New TR is the best option with a tax outlay of Rs. 33800, if someone’s yearly revenue is Rs. 900000 and their deductions are less than Rs. 250000 (excluding the standard deduction).
At what level does Old TR becomes attractive: If the deductions exceed the indifference point, say if it is Rs.260000 then the tax outgo as per Old TR is Rs.31720, which is better than the New TR, by Rs 2,080.
Scenario 3 – Higher Income level, along with higher deductions: From the table illustration, one could notice, as the income level goes up, the deduction level also increases, where Old TR equals or gets attractive than New TR.
Let’s take the example of Rs.15 Lakhs annual income. Here the tax outgo as per the New TR is Rs.1,30,000. It remains attractive for those with eligible deductions less than Rs.4,58,333 (including standard deduction). If the combined deductions exceed this level, say if the amount is Rs.4,60,000, then Old TR gets attractive, with tax outgo is Rs.1,29,480, that is Rs.520 lesser than New TR. Here, one should carefully consider the investment and other existing deduction(s), in order to take advantage of the best of options available.
Similar calculation shows that if the total of deductions exceeds Rs.483334, Old TR becomes attractive across income levels above Rs.16 lakhs, with same tax outgo differential between Old TR and New TR. Higher the deductions, more the tax differential advantage in Old TR.
To further illustrate the point, let us assume that one with income of Rs.17.5 Lakhs, has a combined deductions of Rs.5 Lakhs (incl Std Ded), then the tax outgo under the Old TR is Rs. 1,95,000, which is Rs. 5200 less than Rs.2,00,200 under New TR.
Goal Planning – the pioneering factor:
Changes in tax regime also raise questions about the financial planning aspect. Most often we find our thoughts oscillating between financial planning and tax planning, wondering which one should take precedence. We believe that while planning for the future one should think from a financial planning perspective as well as any potential tax efficiency angle. In many of the currently popular tax-saving sections, the products are either goal-oriented or have to do with life objectives.
Some prominent tax saving sections and the limits per annum:
• Section 80C: Covers investments made in instruments such as ELSS, PPF, expenses like tuition fees paid for up to 2 children, repayment of home loan principal, payment of life insurance premium, etc. Limit: Rs.1,50,000.
• Section 80D: Health Insurance Premium. Limits: Rs.25,000 + Rs.25,000 (self and parents are <60 years age); Rs.50,000 + Rs.50,000 (self and parents are >60 years age).
• Section 80CCD(1B): New Pension Scheme. Limit: Rs.50,000.
• Section 24: Interest payment on home loan. Limit: Up to Rs.2,00,000 (also there are affordable housing loans with separate limits subject to conditions).
In addition to the above, there are few other exemptions / allowances which are available for claiming as deduction in the old tax regime.
