Pre-budget outlook: How to make new tax regime attractive, simplify compliance

A press release issued on 2 August 2024 showed that 72% of taxpayers who filed their returns by 31 July 2024 chose the new tax regime, up from 67 percent in FY23. While it’s heartening to see the majority of taxpayers moving to the new regime, there’s been a marginal increase of 5 percentage points in FY24 from the year before.

While the simplified filing process and lower tax rates are appealing, 28 percent of taxpayers still preferred the old tax regime due to its beneficial deductions and exemptions such as investments in the Public Provident Fund and the National Pension System, house rent allowance, leave travel allowance, and housing loan interest allowance.

This contrast highlights the differing benefits of the two regimes. The new tax regime appeals to those with straightforward finances, while the old tax regime suits individuals leveraging deductions and exemptions for optimised tax payouts.

The new tax regime faces challenges that have hindered its widespread adoption. One of the primary issues is the lack of incentives for savings, a cornerstone of the old tax regime, which encourages long-term financial planning through deductions for investments in instruments such as PPF, NPS, and equity-linked savings schemes.

In contrast, the new tax regime does not provide similar encouragement, making it less appealing to those accustomed to leveraging tax benefits for wealth accumulation.

Enhancements to consider

With the Union Budget approaching, the focus shifts to how the government might overhaul the new tax regime to attract more taxpayers. To make the new tax regime more enticing, the government could consider several enhancements.

Firstly, increasing the standard deduction would provide taxpayers with a higher flat deduction, offsetting the benefits of exemptions available in the old tax regime. For instance, resetting the current standard deduction to ₹2 lakh, considering inflation, could significantly boost disposable income. A slab-based standard deduction could also be formulated, offering higher standard deductions for high-income earners.

Secondly, another potential measure is revising the tax slabs such as raising the threshold for the 5% tax rate to ₹5 lakh or extending the 10% slab to ₹15 lakh, thereby easing the burden on middle-income earners. Additionally, adjusting slab rates such as reducing the 20% rate to 15% or lowering the 30% rate for higher-income groups could incentivise taxpayers to switch regimes.

These changes would address the concerns of those favoring the old tax regime, striking a balance between simplicity and financial benefits, ultimately making the new tax regime more competitive and taxpayer friendly.

Taxpayers who earn income from business or profession should be allowed greater flexibility in choosing their tax regime. Currently, once a taxpayer with business income opts into the new tax regime, they are locked into it and can only switch back to the old regime once in their lifetime.

flexibility

After switching back, they lose the option to re-enter the new regime again in the future. This restriction should be lifted, allowing taxpayers with business income to opt into and out of the new tax regime with more flexibility.

This adaptability could ensure that business owners can choose a tax regime based on changes in their income patterns, deductions, and overall tax planning strategies from year to year.

Additionally, to draw taxpayers to the new tax regime, the compliance burden could be reduced for individual and Hindu Undivided Family taxpayers with income above ₹50 lakh by relaxing asset disclosure requirements by raising reporting thresholds, allowing category-wise aggregation, and exempting low-value personal assets. This could ease compliance while ensuring transparency and efficiency.

The new tax regime represents a pivotal step toward simplifying tax compliance and fostering a transparent fiscal framework. However, there’s still a need for strategic recalibration to address taxpayer concerns.

In the upcoming budget, the government has a unique opportunity to refine the regime and offer better incentives to align with the financial aspirations of taxpayers while promoting equitable and efficient taxation. With bold reforms, this budget could mark a turning point, fostering greater acceptance and shaping a fairer and more efficient income-tax landscape for individuals in India.

Sandeep Jhunjhunwala is partner and Sanjay Kumar is director, Nangia Andersen LLP