Budget 2023: Choosing the right tax regime

But that does not mean that the taxpayer cannot opt for the old regime. In fact, individual taxpayers, except those with income from business, can switch between the two tax regimes every year. This flexibility will also be available to new taxpayers.

New Income Tax regime, Budget 2023: What changes?

Introduced in 2020-21, the new tax regime has found few takers so far. While the government wanted to push individuals towards the new tax regime, which did not allow any deduction or exemption, the benefits on tax savings in the old regime far outweighed benefits of migrating.

But Sitharaman changed all that by offering a significantly more attractive version of the new tax regime in the latest Budget.

The scope of full rebate on income tax has been expanded to those earning up to Rs 7 lakh per annum from Rs 5 lakh under the new regime. This essentially means that anyone with an annual income of up to Rs 7 lakh will not have to pay any income tax, that too without claiming any deduction. Government officials estimate that nearly one crore income tax return filers stand to benefit from this.

As the enhanced rebate in the new scheme is set to leave more in the hands of individuals, disposable incomes at the lower end of the income curve could rise, which in turn could push up consumption.

Benefits under new tax regime

Additionally, the Finance Minister extended the benefit of standard deduction under the new tax regime, and raised the exemption limit from Rs 2.5 lakh to Rs 3 lakh. She also tweaked the tax slabs, effectively lowering the tax rates under the new regime for those earnings up to Rs 15 lakh per annum, leading to a cumulative benefit of Rs 37,500 for an individual earning up to that amount. If the benefit of standard deduction is added, it leads to an overall benefit of Rs 47,500 for such an individual.

On the other end of the spectrum, the super-rich – those with annual income of over Rs 5 crore – will benefit from reduction in income tax surcharge to 25 per cent from 37 per cent. This would reduce the effective rate of income tax for this group to 39 per cent from 42.7 per cent.

Should you shift to the new regime?

There is no simple and universal answer to this. Each individual should compute her tax liability as per both the regimes, and then opt for the more beneficial system. As per our analysis, unless an individual claims heavy tax deductions, she stands to benefit by migrating to the new regime.

A comparison of tax computations for an individual earning Rs 15 lakh per annum under both tax regimes suggests that her annual tax liability will be Rs 1,45,600 under the new regime, against Rs 1,24,800 in the old regime. However, it is worth noting that to save the additional Rs 19,800 in tax, the individual will have to claim deductions worth Rs 1.50 lakh under Section 80C, Rs 25,000 on health insurance premia for self and family, Rs 50,000 as health insurance premium for senior citizen parents, and Rs 2,00,000 towards home loan interest.

For anyone with an annual income of more than Rs 15 lakh, the tax liability under the old regime would be lower by around Rs 30,000 a year, or Rs 2,500 a month, and that too if most deductions are claimed up to their maximum permissible limits. But the pool of taxpayers claiming hefty deductions is extremely small.

As for those falling under lower income slabs, the tax liability differential would be higher in favour of the old tax regime if she, somehow, manages to claim all of the four deductions. If an individual earning Rs 10 lakh manages to claim all these deductions, her tax liability under the old regime would be Rs 18,200 instead of Rs 54,600 in the new regime.

However, it is highly improbable that an individual at that income level will be able to claim heavy deductions.

Will this impact savings?

There is an argument that by nudging taxpayers towards the new regime, the government will end up weakening the savings culture in the Indian market, as the old regime ensured people invested in small saving instruments, life insurance products, NPS, equity-linked savings schemes of mutual funds, among others, to reduce tax liability.

However, the counterview is that forced savings just to save tax led people to pick suboptimal investment products. The fundamental idea behind this argument is that savings and investments should be driven by financial goals and right instruments, not by tax considerations.

While most of the new tax payers entering the job market invest and save only to avail tax benefits under the old regime, financially savvy investors know which product is best to achieve their financial goals and invest accordingly.

“What is important for taxpayers to keep in mind is that even if they shift to the new tax regime, they should keep aside Rs 1 lakh to Rs 2 lakh (which they would have invested under OTR for 80C benefits and NPS) and invest in the best financial products available in the markets to achieve their long term goals. This way, they would have the best of both worlds,” said Vishal Dhawan, founder, Plan Ahead Wealth Advisor.