Budget 2020 introduced a new personal income tax regime for individual tax payers with lower tax rates but more tax slabs. Also, it removed all available deductions and exemptions. The Finance Minister gave tax payers an option to choose between the new regime and the old one, which in fact made the whole process seem complex. Understanding income tax can often be overwhelming for tax payers, and a lot of factors can even make it confusing. For instance, several people tend to end up calculating wrong deductions by deducting the allowable deductions from total tax liability instead of their Gross Total Income. This article intends to explain the older tax system and compare it with the new regime in the most layman manner possible.

Advantages of the old tax system:

India's gross savings rate was approximately 30% in March 2019 and domestic savings was a significant contributor to the overall rate. This was because, the old income tax regime helped promote savings for any future eventuality like marriage, education, purchase of house property, medical exigency, etc. by enforcing investments in specified tax-saving instruments like ULIPs, which over a period inculcated the savings culture in individuals. So, if more individuals will opt for the new regime, the savings rate would decrease. Nevertheless, the consumption cycle and demand would be revived.

Advantages of the new tax system:

The new regime offers reduced tax rates and compliances. Also, as most of the exemptions and deductions are not available, tax filing becomes simpler as there is lesser documentation required. Moreover, the reduced tax rate provides more disposable income to people who could not invest in specified instruments due to certain financial or personal reasons. Therefore, offering increased liquidity in the hands of the taxpayers and allowing the flexibility of customizing the investment choice.

Investor may not prefer to lock-in funds in the prescribed instruments for the specified period: Under the new regime, all taxpayers would be treated at par because the benefit of deduction/allowance does affect tax liability. This can be especially helpful for taxpayers who may not subscribe to the specified modes of investments, as most of these investments have a lock-in period. They can instead invest in open-ended instruments, which provide them good returns as well as the flexibility of quicker withdrawal.

Which tax system is better?

For income segments up to Rs 15 lakh, the New Tax Regime has proposed lower income-tax rates but only at the cost of you giving up exemptions and deductions available under various provisions of the Income Tax Act. This means you will have let go of some exemptions including Leave Travel Allowance (LTA), House Rent Allowance (HRA), and deductions available including Insurance Premium payout and Savings Account Interest under chapter VI A of the IT Act Section 80 such as 80C, 80CCC, 80CCD, 80D, 80DD, 80E, 80EE, 80G, 80GG, 80GGA, 80GGC, etc.

Even the standard deduction of Rs 50,000 under Section 16 available to salaried individuals and the deduction on home loan interest, under Section 24(b) will not be allowed. However, the deduction under Section 80CCD (2), which is employer’s contribution on account of an employee in a notified pension scheme and Section 80JJAA for new employment can be claimed.

Therefore, it is very clear that the changes introduced don’t make things easier for tax payers. One shall deeply understand both the sides before choosing the regime which is most beneficial for them. The older regime will work in the interest of your financial wellbeing if you are looking to fulfill your financial goals like wealth creation through investments in tax-saving instruments, paying premiums to meet health and life insurance needs, paying children’s school fees, buying a house with a home loan, etc. On the inverse, the new regime will do well to someone who is not intending to invest major amounts in tax saving plans.