Old vs. new tax regime: How to make a choice?

Tax payers can choose to continue with the old tax slabs and retain the benefit of 100 exemptions or shift to the new tax regime with lower rates but just 30 exemptions. The million dollar question is; how should tax payers make this choice?

Feb 04, 2020 03:02 IST India Infoline News Service

Income Tax
One of the key changes in personal taxes in the Union Budget 2020 was the shift to a dual tax regime. This is largely on the lines of the model offered to corporates in September 2019. Corporates were given two choices, either opt for 30% tax with all exemptions or choose 22% tax with no exemptions. A similar option has been given to individual tax payers too in Budget 2020. Tax payers can choose to continue with the old tax slabs and retain the benefit of 100 exemptions or shift to the new tax regime with lower rates but just 30 exemptions. The million dollar question is, how should tax payers make this choice?
 
How the tax rates compare: Old vs. new regime?
Income Level Old Tax Rate New Tax Rate
Up to Rs2.50 lakhs Nil Nil
Rs2.50 lakhs to Rs5 lakhs 5% 5%
Rs5.00 lakhs to Rs7.50 lakhs 20% 10%
Rs7.50 lakhs to Rs10 lakhs 20% 15%
Rs10 lakhs to Rs12.5 lakhs 30% 20%
Rs12.5 lakhs to Rs15 lakhs 30% 25%
Above Rs15 lakhs 30% 30%
Source: Budget Documents
 
The old regime has just 3 applicable tax rates of 5%, 20% and 30%, whereas the new tax regime has 6 granular rates of tax. Above an income level of Rs15 lakhs, the rates will remain the same under both the regimes.  But, the difference is a lot more nuanced. The new regime of tax requires that you forgo most of the exemptions including standard deduction, Section 80C benefits, Section 80D benefits, Section 24 for interest on home loans, HRA exemptions etc. If you are currently availing these exemptions, will it make sense to shift to the new tax regime?
 
What to do if you are already availing exemptions?
Let us understand this better with the example of two persons (A and B) with annual income of Rs7.25 lakhs and Rs10 lakhs respectively. Assume that currently they are availing the following benefits; (a) Professional Tax – Rs2,500 (b) Standard Deduction – Rs50,000 and (c) Section 80C – Rs150,000. Total deductions would thus work out to Rs202,500. How would their post tax income look like in the told tax regime versus the new tax regime? 
Total Income Rs7.25 Lakhs (A) DETAILS Total Income Rs10 lakhs (B)
Old Tax Regime New Tax Regime Old Tax Regime New Tax Regime
7,25,000 7,25,000 Total Income 10,00,000 10,00,000
2,02,500 Nil Less: deductions 2,02,500 Nil
5,22,500 7,25,000 Net Taxable Income 7,97,500 10,00,000
17,000 35.000 Tax Payable 72,000 75,000
680 1,400 Cess 2,880 3,000
17,680 36,400 Total Tax Payable 74,880 78,000
 
In the case of A and B, the final tax liability is higher under the new regime despite A paying 10% lower tax rate and B paying 5% lower tax rate. That is largely because, the exemptions are making the old regime more profitable in both the cases.
 
Does the new tax regime add value at all?
For both the levels of income above, the old regime looks better. Where does the new regime really fit in? The trick lies in how much of exemptions you utilize. In the above case where the income level is Rs10 lakh, let us assume that B saves only Rs50,000 under Section 80C instead of the full limit of Rs150,000. Of course, the exemption of Rs50,000 on standard deduction and Rs2,500 on professional tax will continue.
DETAILS Total Income Rs.10 lakhs (B)
Old Tax Regime New Tax Regime
Total Income 10,00,000 10,00,000
Less: deductions 1,02,500 Nil
Net Taxable Income 8,97,500 10,00,000
Tax Payable 92,000 75,000
Cess 6,680 3,000
Total Tax Payable 95,680 78,000
 
Clearly,  the new tax regime is beginning to add value if you consider lower levels of exemptions. This is also more pragmatic because a person earning Rs10 lakh would find it hard to really utilize the full Rs1.50 lakh limit under Section 80C.
 
How to take a view: Old regime vs. new regime?

What factors to consider while making the choice? Here are four things to consider.
  1. Most people have committed outlays under Section 80C. These include CPF, Life Insurance, Tuition Fees, Home loan principal, etc. In such cases, the old regime is better.
  2. In case you have a home loan (especially low cost home), the old regime makes double sense as your exemption is now Rs3.50 lakhs and not Rs2 lakhs.
  3. If your annual income is under Rs10 lakh, you can apply the affordability test and see if you really need to take on too many investment commitments. In that case, the new regime would work better.
  4. Finally, if you are starting off on  your career, the new regime is better and you can always to opt for the old regime at a later stage.

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