The conundrum of Income Taxation in India

The Income Tax (IT) Act was first enacted in 1922 and since then it has witnessed changes that have altered the course of direct taxation in India. A new act was introduced in 1961 and each amendment since then has accounted for various socioeconomic changes. To put this into context, the 21^st century has witnessed the following changes in personal income tax slabs:

2005-06

For the first time in ten years, P. Chidambaram announced significant changes to the budget in his proposal. The tax slabs were changed to:

Income (Rs)	Tax
0-1 lakh	Tax Free
1 lakh – 1.5 lakh	10%
1.5 lakh – 2.5 lakh	20%
2.5 lakh +	30%

2010-11

This budget witnessed Pranab Mukherjee make much needed changes to the tax slabs five years after changes made by P. Chidambaram.

Income (Rs)	Tax
0-1.6 lakh	Tax Free
1.6 lakh – 5 lakh	10%
5 lakh – 8 lakh	20%
8 lakh +	30%

2012-13

Pranab Mukherjee introduced further changes to the tax slabs 2 years after:

Income (Rs)	Tax
0-2 lakh	Tax Free
2 lakh – 5 lakh	10%
5 lakh -10 lakh	20%
10 lakh +	30%

2017-18

Arun Jaitley was the next proponent of changes in income tax slabs, which were:

Income (Rs)	Tax
0-2.5 lakh	Tax Free
2.5 lakh – 5 lakh	5%
5 lakh -10 lakh	20%
10 lakh +	30%

The budgets have proposed various other changes for taxation of income of senior and super senior citizens. They also came with measures in which wealth tax was abolished and in its place, surcharge was introduced on the income of the super-rich, accompanied with changes in the structure of rebates and reductions for the lower income strata.  

The existing tax slabs are as follows:

Income (Rs)	Tax
0-2.5 lakh	Tax Free
2.5 lakh – 5 lakh	5%
5 lakh -10 lakh	20%
10 lakh +	30%

Along with applicable cess and surcharge

The way forward

In the build up to the Union Budget 2020-21, there were mixed expectations regarding changes to the income tax slabs. However, with the government’s stance towards corporate taxation, the general outlook was positive – one that expected slash in personal income tax rates.

However, under the proposed tax regime, Indian taxpayers have been given an option to choose between the new regime- with lower tax rates, and the old one. But the new regime comes with a catch as taxpayers have to forego various deductions and exemptions to avail its supposed benefit. These deductions include Standard deduction, HRA, and investments made under 80C, among others, for salaried and non-salaried individuals. In the new regime, Employer’s contribution to Employee Provident Fund (EPF) is tax free, but there could be an upper limit proposed as deduction and the balance would become taxable.

The proposed tax regime is as follows:

Income (Rs)	Tax
0-2.5 lakh	Tax Free
2.5 lakh – 5 lakh	5%
5 lakh -7.5 lakh	10%
7.5 lakh – 10 lakh	15%
10 lakh – 12.5 lakh	20%
12.5 lakh – 15 lakh	25%
15 lakh +	30%

No changes have been made to the cess and surcharge rates, and a rebate of Rs 12500 is available for individuals with income below Rs 5 lakh under Section 87A, making the tax liability zero. FM Sitharaman claimed that for an individual earning Rs 15 lakh a year, he/she would save Rs 78000, subject to the fact that the taxpayer would avail no deductions. The FM also estimated that this regime would result in Rs 40000 crore of tax revenue forgone by the government for the benefit of taxpayers. However, these estimates are flawed. For a salaried individual, the new regime results in a higher taxable income.

Consider an individual that earns Rs 25 lakh as salary. The taxpayer’s tax liability under both regimes would be as follows:

Particulars	Old Regime	New Regime
Income	₹  25,00,000.00	₹  25,00,000.00
less: deductions
80(C)	₹    1,50,000.00	₹                      –
80(CCD) – NPS	₹       50,000.00	₹                      –
80(D) – Health Insurance premium	₹       25,000.00	₹                      –
HRA	₹    3,00,000.00	₹                      –
Taxable Income	₹ 19,75,000.00	₹ 25,00,000.00
Tax Liability	₹    4,05,000.00	₹    4,87,500.00

The Tax Liability of an individual increases with the new regime. For an individual living on rent, an HRA deduction of Rs 3 lakh is estimated. However, for a homeowner, this deduction is not applicable, but another one pertaining to interest on home loan is applicable up to an amount of Rs 2 lakh. In any case, an individual will be subject to a higher tax liability under the new regime.

The objective of such a change was stated as tax relief for taxpayers and simplification of the filing process to reduce involvement of professionals. However, these changes would successfully achieve neither goal as the new regime results in an increased tax burden and doubles the calculation involved.

Among other changes, the budget proposed to abolish Dividend Distribution Tax (DDT) and make dividend taxable in the hands of the investor. The only deduction allowed under this regime is interest expense, and is limited to 20% of income earned as dividend. Under the current regime, companies pay DDT of 20%, and individuals that receive dividend income above Rs 10 lakh are liable to pay 10% dividend tax. Individuals falling above the 20% tax bracket are at a disadvantage as their tax liability on dividend income is now higher than the original DDT.

With respect to NRIs, the budget proposed to reduce the residency threshold for individuals in India from 182 days to 120 days, which is against the international norm of 182 days. The budget also proposed that any Indian citizen that fails to qualify as a resident of any other country will be deemed as a resident of India. This implies that such an individual’s income would be taxed in India. This proposal has a significant impact on the shipping industry as mariners travel on international waters and could be deemed citizens of India based on the new visitation requirements, witnessing their foreign earned income taxed in India.

From the perspective of the government, this comes down to the principles of tax elasticity and tax buoyancy. Tax Elasticity refers to the relationship between change in tax revenue and change in tax rates. Whereas, tax buoyancy refers to the sensitivity of growth in tax revenue relative to GDP growth. This is relevant as a higher GDP growth rate results in a higher growth in tax revenue. The government’s estimate of 10% nominal growth in GDP for next year with retail inflation currently at 7.35% is worrisome as it indicates a real growth rate of 2.5%, lagging at the tax buoyancy front. With this statistic and the option of new tax slabs, it is necessary to estimate and observe the interaction effect of these variables. Will the government be able to meet its fiscal deficit target  with a negative effect of tax buoyancy and elasticity?