Reforming individual income tax

Replace the six-slab tax structure with a new three-slab structure with no deductions and exemptions, except towards insurance premium and donations

Senior citizens will be unable to claim the deduction up to Rs 50,000 for interest income from banks and post-office deposits.
Senior citizens will be unable to claim the deduction up to Rs 50,000 for interest income from banks and post-office deposits.

By TV Mohandas Pai & S Krishnan

Income tax law in India has become complicated, thanks to the government providing some or the other tax benefit or concession. It is now time for simplification of individual taxation, as was done in the FY06, when the then FM doubled the basic exemption limit from Rs 50,000 to Rs 1 lakh, and tax at base rate of 10% was chargeable on income between Rs 1 lakh and Rs 1.5 lakh, with only three slabs and a maximum tax rate of 30%. This led to an upsurge in compliance and tax collection in the subsequent years.

No significant rate reduction has been effected in India for the past few years, except for the 5% reduction on the first tax slab in FY18. The maximum individual base tax rate in India is now 30% and the effective tax rate is 42.74% for individuals earning more than Rs 5 crore per annum after considering a surcharge of 37% and health and education cess of 4%. In comparison, the global and Asian average in 2021 are 31.27% and 28.38%, respectively.

The Finance Act 2020 introduced a new optional tax regime for individuals, and HUF taxpayers are to pay income tax at lower rates from FY21. The new regime with six slabs (from 5% to 30%) has widened the range of taxation, and the highest tax rate of 30% is applied on income above `15 lakh. The prevailing tax regime had three tax slabs, and the highest rate of 30% was applied on income above Rs 10 lakh. However, if individuals and HUF taxpayers choose to file their tax return under the new regime, they will be unable to claim about 70 deductions and tax exemptions such as HRA, LTA, payment of life insurance premia, repayment of the principal amount of a housing loan, payment of interest on a housing loan for a self-occupied property, deduction for health or medical insurance premium, donations under Section 80G, etc. Senior citizens will be unable to claim the deduction up to Rs 50,000 for interest income from banks and post-office deposits.

In the tax filing season for FY21, it appears that not many taxpayers have opted for the new regime. According to Revenue Budget FY22, more than 50% of the individual taxpayers derive their income primarily from salaries. The salaried class would have opted for the old tax regime since they could claim deductions under Section 80C up to a maximum amount of Rs 1.5 lakh per annum towards their contribution to PF and repayment of principal amount of housing loan, if any. In addition, they could claim deduction on interest on housing loans and a standard deduction of Rs 50,000 or the amount of salary, whichever is less. The new tax regime was not attractive for taxpayers claiming deduction of more than Rs 2.5 lakh. While the salaried class claim deductions under Chapter VI-A, profit-linked deductions (i.e., deduction on certain business incomes) are not claimed by them. On the other hand, the group of non-salaried individuals claim both types of deductions. Consequently, the tax impact on salaried individuals is higher than that on non-salaried individuals. The data analysis of the tax returns filed by individuals over 2014-18 (latest such data on CBDT website) corroborates this. The average per capita salary income was Rs 7.94 lakh in FY18 whereas the average per capita income from business or profession of individuals was `5.14 lakh. It is hard to believe that individuals undertaking business have lesser income. The salaried class is subject to tax deduction at source on their entire income even before their salary is paid to them resulting in reporting of appropriate income and tax.

The middle-class and the salaried class have suffered significantly in the past two years due to loss of jobs, uncertainty in employment, lower income and high expenditure. It is time to provide relief to them through an easy-compliance tax structure that leaves more cash with them. Considering the six-slab tax regime is not attractive to a large number of taxpayers, it may be appropriate for the government to replace the six-slab tax structure with a new three-slab tax structure with no tax deductions and exemptions, except towards insurance premium and donations.

This will simplify the tax structure, make filing easier, provide more cash to taxpayers, help citizens above the age of 55 who may not have the need to claim tax deductions based on investments and incentivise people in business or profession to declare higher income. This will ensure that taxpayers will take economic decisions based on merit and not on any unnecessary investment to claim deductions etc. The probable loss of revenue under this new tax scheme will be made up by removing all of the deductions for this class of taxpayers.

According to Budget FY22, the revenue impact of providing major tax incentives for individuals/HUF taxpayers is Rs 1.06 lakh crore. If we remove the cumulative impact of deductions under sections 80D and 80G (Rs 5,391 crore), the net savings for not providing the major tax incentives would be ~Rs 1.01 lakh crore. The government can make good any loss from the proposed tax scheme from this net savings.

Taxpayers eligible to claim a deduction of more than Rs 3.75 lakh under the old scheme, as compared to the new scheme, may opt to file under the old scheme. The tax impact under the old scheme with all deductions and under the new scheme with deductions only for sections 80D and 80G can be evaluated by the following example. Assuming a taxpayer having an income of Rs 20 lakh has contributed Rs 1.5 lakh towards 80C deductions, paid Rs 3 lakh towards interest on housing loan, Rs 75,000 towards health insurance for self, family and senior citizen parents, Rs 1,25,000 towards Leave Travel Concession and Rs 10,000 towards 80G donation, the tax impact under both the schemes would be summarised in the accompanying graphic.

Assuming the taxpayer has no housing loan, the total deductions under the old scheme would be Rs 4.05 lakh and the taxable income would be Rs 15,95,000. The tax liability would be Rs 3,02,640 under the old scheme, higher than the tax liability of Rs 2.87 lakh under the proposed scheme. The additional deduction under the old scheme is Rs 3.25 lakh (Rs 4.05 lakh less Rs 80,000 under the new scheme) resulting in higher tax liability.

Under the proposed tax scheme, more taxpayers will be left with more cash in hand due to lower tax liability, increasing consumer spending too, a big boon.

Respectively, chairman, Aarin Capital Partners, and tax consultant 

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