The New Direct Tax Regime (2020): Relief or Burden?

Written by Dr. Seshadri Kumar, 02 February, 2020

Copyright © 2020 Dr. Seshadri Kumar. All Rights Reserved.

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Abstract

This article analyzes the effect of the “massive tax cuts” of the 2020 Indian Union Budget direct tax rates. It is seen that the new direct tax rate scheme benefits very few people, and most people would be better off choosing the old scheme in their tax computation for the next year. The new direct tax regime is simpler than the old scheme, but it costs taxpayers more.

Several analyses comparing the old and new schemes have come out in social media. But most of them have ignored a key proviso in the new tax scheme, which is that no exemption or deduction is allowed. Most analyses have only looked at the effect of section 80C, but overlooked the more important Housing Rent Allowance (HRA) exemption and the Housing Loan exemption, both of which are substantially more than the 80C deduction and the standard deduction. There are many more deductions available, such as section 80D, section 80CCC, section 80CCD, section 80TTA, section 80GG, section 80E, section 80EE, section 80CCG, section 80DD, section 80DDB, section 80U, section 80G, section 80GGB, section 80GGC, section 80RRB, section 80TTB … all of which will not be available under the new direct tax scheme.

This work considers four of the main deductions/exemptions: HRA, Section 80C, Section 80D (mediclaim), and the Standard Deduction, in comparing the old and new direct tax schemes.

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Summary of Old and New Direct Tax Schemes

The direct tax scheme of 2019-2020 was as follows:

1. The taxable income was calculated by subtracting several exemptions and deductions from the gross income, some of which are listed below:
   1. Section 80C, which is a deduction allowed for investment in LIC, PPF, or mutual funds, up to 1.5 lakhs.
   2. The standard deduction, which is Rs. 50,000, and is meant to subsume many other deductions, such as the deduction for medical expenses, which used to be allowed in previous years.
   3. Section 80D, which is for mediclaim, allowable up to a maximum of Rs. 25,000.
   4. The housing exemption, which applied to a House Rent Allowance (HRA) or a Housing Loan (HL) payment.
2. On this taxable income, tax was assessed as follows:
   1. Taxable income of Rs. 0-5 lakhs: zero tax if the total taxable income was less than or equal to Rs. 5 lakhs.
   2. If the taxable income is over Rs. 5 lakhs, then the following tax slabs are operational:
      1. Rs. 0 – Rs. 2.5 lakhs: no tax.
      2. Rs. 2.5 – Rs. 5 lakhs: 5% of income above Rs. 2.5 lakhs.
      3. Rs. 5 – Rs. 10 lakhs: 20% of income above Rs. 5 lakhs.
      4. Above Rs. 10 lakhs: 30% of income above Rs. 10 lakhs.
      5. The above slabs are cumulative – hence, if someone makes Rs. 9 lakhs, they would have to pay 5% of Rs. 2.5 lakhs + 20% of Rs. (9-5) lakhs.

The new direct tax scheme of 2020-21 is as follows:

1. No exemptions or deductions are allowed. The idea behind this is to make the tax code simpler. To make up for this, the tax rates have been marginally reduced at the lower end, as discussed below. Hence, the gross income ends up being the total taxable income.
2. On this taxable income, the tax payable is again calculated according to the following slabs:
   1. Taxable income of Rs. 0-5 lakhs: zero tax if the total taxable income is less than or equal to Rs. 5 lakhs (as before).
   2. If the taxable income is over Rs. 5 lakhs, then the following tax slabs are operational:
      1. Rs. 0 – Rs. 2.5 lakhs: no tax (as before).
      2. Rs. 2.5 – Rs. 5 lakhs: 5% of income above Rs. 2.5 lakhs.
      3. Rs. 5 – Rs. 7.5 lakhs: 10% of income above Rs. 5 lakhs.
      4. Rs. 7.5 lakhs – Rs. 10 lakhs: 15% of income above Rs. 7.5 lakhs.
      5. Rs. 10 lakhs – Rs. 12.5 lakhs: 20% of income above Rs. 10 lakhs.
      6. Above Rs. 15 lakhs: 30% of income above Rs. 15 lakhs.
      7. As before, the above slabs are cumulative – hence, if someone makes Rs. 9 lakhs, they would have to pay 5% of Rs. 2.5 lakhs (5-2.5) + 10% of Rs. 2.5 lakhs (7.5-5) + 15% of Rs. 1.5 lakhs (9-7.5).

Which Scheme Is Better For You?

From an examination of the rules above, it is clear that the old scheme allowed many exemptions and deductions, but had higher slab rates, whereas the new scheme does not allow any exemptions or deductions, but has lower slab rates.

The elimination of deductions and exemptions simplifies the tax code and makes the reporting requirements easier. For example, if one wishes to avail of the HRA deduction, one must show rent receipts for the entire year to their employer. If one wishes to claim a PPF deduction, one must show the passbook of the PPF account to prove that one had actually invested the declared amount of money in PPF.

However, people will not mind more paperwork if it means saving some money. The elimination of extra paperwork should not result in the payment of more taxes. Indians are very cost-conscious, and place more value on money than time.

Case 1: IT Employee in Bangalore with a Salary of Rs. 9 Lakhs/Year

Assume that the HRA exemption that this employee can avail of is Rs. 12,000 per month. The current rules state that the allowable HRA exemption is the minimum of:

1. The actual HRA paid by the company.
2. Rent in excess of 10% of basic salary
3. 40% of basic salary (50% if you live in Mumbai, Delhi, Chennai, or Kolkata)

Let us make some reasonable assumptions. Let us say that the rent paid by the employee is Rs. 15000 per month, and that his basic salary is 40% of his total salary. Thus his basic salary is 0.4 x Rs. 9,00,000 = Rs. 3,60,000, or Rs. 30,000 per month. Then the three numbers are:

1. Actual HRA paid = Rs. 12,000
2. Rent in excess of 10% of basic salary = Rs. 15,000 – 0.1 x Rs. 30,000 = Rs. 15,000 – Rs. 3000 = Rs. 12,000
3. 40% of basic salary = 0.4 x Rs. 30,000 = Rs. 12,000

In this case, the three numbers end up being the same thing, and so the HRA exemption is Rs. 12,000 per month, or Rs. 1,44,000 for the whole year.

Let us also assume that the employee invests the maximum allowable of Rs. 1.5 lakhs in Section 80C – related investments for the year and Rs. 25,000 for medical insurance under section 80D.

There is also the standard deduction of Rs. 50,000 that he can avail of. Thus, under the old scheme with deductions and exemptions, the total taxable income is: Rs. 9,00,000 – Rs. 1,44,000 – Rs. 1,50,000 – Rs. 50,000 – Rs. 25,000 = Rs. 5,31,000. Under the new scheme, there are no deductions or exemptions, so the total taxable income is the full Rs. 9,00,000.

Tax under old scheme:

• Total taxable income: Rs. 5,31,000.
• The first 2.5 lakhs are tax-free.
• Since this is above Rs. 5 lakhs, tax payable for 2.5-5 lakhs = 5% of 2.5 lakhs = Rs. 12,500.
• Tax for Rs. 5 lakhs to Rs. 5.31 lakhs: 20% of Rs. 0.31 lakhs = Rs. 6,200.

Total tax to be paid under old scheme: Rs. 12,500 + Rs. 6,200 = Rs. 18,700

Tax under new scheme:

• Taxable income: Rs. 9 lakhs
• 0-2.5 lakhs: 0
• 2.5-5 lakhs: 5% of 2.5 lakhs = Rs. 12,500
• 5-7.5 lakhs: 10% of 2.5 lakhs = Rs. 25,000
• 7.5-9 lakhs: 15% of 1.5 lakhs = Rs. 22,500

Total tax to be paid under new scheme: Rs. 12,500 + Rs. 25,000 + Rs. 22,500 = Rs. 60,000

The tax under the new scheme is more than triple what the employee needed to pay under the old scheme.

Case 2: Employee with a Salary of Rs. 15 Lakhs/Year

Assume that the HRA exemption or housing loan exemption the employee is eligible for is Rs. 25,000/month (a reasonable number – detailed calculations not shown).

Assume also that the employee has availed fully of the Rs. 1.5 lakh deduction under section 80C, the Rs. 25,000 deduction under section 80D, and the Rs. 50,000 standard deduction.

So, the total deductions and exemptions available under the old scheme are:

1. Section 80C: Rs. 1.5 lakhs
2. HRA: Rs. 25,000 x 12 = Rs. 3 lakhs
3. Standard deduction: Rs. 50,000
4. Section 80D: Rs. 25,000

Taxable income under old scheme: Rs. 15 lakhs – Rs. 1.5 lakhs – Rs. 3 lakhs – Rs. 50,000 – Rs. 25,000 = Rs. 9.75 lakhs

Tax payable under old scheme:

• 0-2.5 lakhs: 0
• 2.5-5 lakhs: 5% of 2.5 lakhs = Rs. 12,500
• 5-9.75 lakhs: 20% of 4.75 lakhs = Rs. 95,000

Total tax payable under old scheme: Rs. 12,500 + Rs. 95,000 = Rs. 107,500

Taxable income under new scheme: Rs. 15 lakhs (no exemptions or deductions)

Tax payable under new scheme:

• 0-2.5 lakhs: 0
• 2.5-5 lakhs: 5% of 2.5 lakhs = Rs. 12,500
• 5-7.5 lakhs: 10% of 2.5 lakhs = Rs. 25,000
• 7.5-10 lakhs: 15% of 2.5 lakhs = Rs. 37,500
• 10-12.5 lakhs: 20% of 2.5 lakhs = Rs. 50,000
• 12.5-15 lakhs: 25% of 2.5 lakhs = Rs. 62,500

Total tax payable under new scheme: Rs. 12,500 + Rs. 25,000 + Rs. 37,500 + Rs. 50,000 + Rs. 62,500 = Rs. 1,87,500

Again, the tax payable under the new scheme is substantially (74%) higher.

Effect of Deductions and Exemptions

It can be seen from the previous examples that even though the tax rates for incomes below 15 lakhs have been reduced, with more tax slabs, the tax payable has actually increased. Of the deductions and exemptions considered here, three have a fixed maximum: section 80C (1.5 lakhs), standard deduction (Rs. 50,000) and section 80D (Rs. 25,000). The total from these three comes to Rs. 2.15 lakhs. The bigger contribution to reducing the taxable income is the HRA in case of rent or the Housing Allowance in case of home ownership for which one has to pay off a loan. In our first example, this was Rs. 1.44 lakhs, and in the second example, it was Rs. 3 lakhs. When this is deducted from the tax payable, the tax payable reduces dramatically.

This can be seen in Figures 1-3, which show the tax payable at different gross incomes for different total deduction/exemption amounts. It can be seen (Figure 1) that when the total deduction/exemptions are less than Rs. 2.5 lakhs, the tax payable is lower for the older scheme at low incomes but higher for the older scheme at higher incomes. For a total deduction/exemption amount of Rs. 2 lakhs, the point at which the new scheme tax becomes lower than the old scheme tax is about Rs. 12.25 lakhs/year.

Figure 1. Tax Calculation at Total Exemptions/Deductions of Rs. 2 Lakhs/Year

At a total deduction/exemption amount of Rs. 2.5 lakhs, the tax from the new scheme is higher than the tax from the old scheme until the gross income reaches Rs. 15 lakhs/year, as can be seen in Figure 2. After this, the tax payable from both schemes is the same as the income rises.

Figure 2. Tax Calculation at Total Exemptions/Deductions of Rs. 2.5 Lakhs/Year

For a total deduction/exemption amount greater than Rs. 2.5 lakhs, the tax from the new scheme is always greater than the tax from the old scheme. This can be seen in Figure 3.

Figure 3. Tax Calculation at Total Exemptions/Deductions of Rs. 3 Lakhs/Year

Conclusions

The new direct tax scheme is disadvantageous to anyone who has a total of deductions and exemptions higher than Rs. 2.5 lakhs. For a lower amount in deductions and exemptions, there is a threshold income above which the new scheme is more advantageous and below which the old scheme is more advantageous. This can be the case for those who live in their own (fully paid-up) home and so do not have any rent to pay or have any housing loan payments. For everyone else, it seems to be more advantageous.

For this year, this is not a serious problem for the people, since the choice of which tax scheme to adopt is left to the taxpayer. But it is a cause for worry for the future, because the government has indicated its preference for the new scheme and so there is a strong possibility that next year, the taxpayer will not have a choice but to use the new tax scheme and therefore pay higher taxes.

This budget is a lost opportunity for the government, and indicates that the government has still not understood the cause of the economic slowdown – that the slowdown is demand-driven, not supply-driven. Yet, all of the government’s measures have been aimed at the supply side. The government has been heaping sop upon sop for industry – decreasing corporate tax, removing the dividend tax, lowering interest rates, and so on. This would be a good prescription if demand were high and if what was stopping companies was the cost of doing business and of getting finance. But the situation in India today is one in which common people are cutting down on buying Rs. 5 Parle biscuit packs and underwear. No sane company will take out loans to build new plants when demand is so low and when asset utilization capacity is as low as it is today in India.

So the correct prescription for this budget would have been to drastically cut taxes at the low end. Perhaps by making incomes of up to Rs. 10 lakhs/year tax-free. That would have been a bold move. The income foregone by the government would have been more than made up for by revenues due to increased consumption, which would have given the Indian economy a boost and the chance to recover.

But such a tax cut would only have benefited the organized sector. A similar boost was also needed for the unorganized sector. In yet another sign that the government simply does not understand the economic crisis, the government has reduced the allocation for MNREGS from Rs. 71,000 crores in the previous year to Rs. 61,500 crores in the 2020-21 budget. With a devastated rural sector, the only thing saving them from utter destitution has been the MNREGS. The move to reduce funding to the MNREGS will only worsen an already bad situation on the rural front.

But, as we have seen time and again, the one thing most dramatically lacking in this government is common sense. And hence this insipid and worthless budget, which does not show any sense of urgency or any acknowledgment of the massive economic crisis that the country is in. One can only reluctantly conclude that the free fall the Indian economy has been in for the last year will continue unabated for the next year, thanks to the incompetent leadership of the country. And it does not look like we will hit rock bottom anytime soon.

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Disclaimer: All the opinions expressed in this article are the opinions of Dr. Seshadri Kumar alone and should not be construed to mean the opinions of any other person or organization, unless explicitly stated otherwise in the article.

Disclaimer: The author is not a tax professional. These are purely his personal opinions and calculations based on assumptions that are clearly stated in this article. The author makes no claims as to the accuracy of his conclusions. Readers can judge the accuracy of his conclusions based on their own study. Readers are advised to do their own calculations and checks and not base any decisions exclusively on the author’s recommendations. The author recommends that anyone who is seriously considering the conclusions/recommendations presented in this article double-check them with a tax professional before adopting them. The author is not liable for any losses any reader may incur as a result of adopting any recommendations given in this article.