Two years ago, Finance Minister Nirmala Sitharaman gave income tax payers the option to pay tax at lower rates, provided they exclude tax exemptions available to them such as interest earned from savings bank accounts and deduction from income to repay home loans. Have given , The choice created a dual tax system, even though most taxpayers remained with the old regime of higher tax rates, three income brackets, and multiple deductions. Only a few have migrated to the new concessional tax regime of six slabs, no deduction and lower rates. It’s needlessly messy.
According to an exclusive report by Mint, the finance ministry is working to dismantle the tax system. It is welcome. According to the report, the ministry may sweeten the no-deduction-lower-rates option by further reducing the tax rates. How can it be made to work successfully this time?
There is a need for a simple and efficient tax system in which compliance is easy for the taxpayers and evasion is difficult. Also, given the lack of an adequate and proper social security system in the country and a large segment of the working age population, the tax treatment of savings should be changed to encourage people to save smartly.
Let us first understand the new system introduced in FY 2021. In this option, income between Rs. 5 lakh and Rs. 7.5 lakh is taxed at 10%, while income between Rs. from 7.5 lakhs 10 lakh is taxed at 15%. Whereas in the old regime the entire income up to Rs. 10 lakh tax is levied on 20% flat.
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before The slab above 10 lakhs that attracts 30% tax has been divided into three parts – with rates of 20% for Rs. 10-12.5 lakhs, 25% Rs. 12.5 lakh-15 lakh and then 30% Rs. 15 lakh and above.
While introducing the new option, the government showed with examples how, for the same income, the new regime has lower tax expenditure. Yet, only a few taxpayers have opted to forego the tax exemptions and deductions. Most have chosen to stick with the old scheme.
This is because skipping tax breaks – such as on savings deposited with public provident funds or premiums paid on life insurance – necessitates a fundamental change in long-term financial and retirement planning.
These considerations are likely to dominate taxpayers’ choices. Therefore, there is no guarantee that further reduction in tax rates will lead to many more buyers, sweetening the exemption-free tax regime.
The income tax system should be reformed in a more fundamental way. One, the government should abolish the dual tax system, and there should be only one system. Two, the tax slab should be limited to two or three. This is called ‘bracket creep’, where inflation prompts a person to pay taxes at a higher rate even if his income has not increased in real terms. A liberal tax rate structure should go hand in hand with the removal of deductions. Third, reforms in tax treatment on savings should not be delayed.
The government may consider doing away with tax breaks for savings schemes for investments in PPF and post office savings, and instead raise the limit for paying income tax. Savers should not be influenced by the tax breaks on offer in their financial planning decisions. Also, the tax system should not treat investment gains or income differently from income from other sources of income.
What is called an exemption-free tax treatment method in tax jargon should be applied. In this, any savings are not taxed, but only income from property is taxed. Meaning, the profit from the sale of the house is not taxable if the investment is made in shares and vice versa.
Broadly speaking, this principle is now followed in the sale of housing properties. If the proceeds from the sale of a house are invested in a new home, capital gains on the sale are exempt from tax. To encourage brainstorming properties idea to extend it to all financial assets. This will allow people to defer their tax liability till the point when the amount is withdrawn, leaving more financial savings.
The result would be that India would end up taxing retirement savings. For a country that does not have a proper social security system seeking relief or compensation. However, this will be taken care of with the lower tax rates and wider slabs offered in the sweetener.
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