A newly graduated student-turned-entrepreneur, Sonal had a great year. She started her own home decor business and just celebrated her first business anniversary. Although the year saw a lot of ups and downs, she made good revenue. With her father’s help, she met an accountant who was helping her with the year-end finance tallying. He gave her excerpts on all things tax. While she had a fairly good idea about the taxes, some points were still unclear. If you are in a similar position like her or want to better understand the tax regime in India, this blog is for you.

Old vs. New Tax Regime: A brief overview

The new tax regime was introduced in the 2020 budget. Although it has been two years, there is still a lot of debate over which is suitable and why both regimes exist.

To begin with, there were four tax slabs in the old regime, with a maximum rate of 30% applicable on income above Rs. 10 lakhs. On the other hand, the new tax regime offers six tax slabs with prevailing rates reduced on income up to Rs. 15 lakhs.

However, the option for this concessional tax regime comes with a cost, as certain deductions, including the standard deduction of Rs. 50,000, deduction under section 80C of Rs. 1.50 lakhs, and interest on the self-occupied property of Rs 2 lakhs, will no longer be available to those in the new tax regime. Simply put, all taxpayers would be treated at par under the new regime, and the benefit of deduction/allowances would not be criteria for availing of the tax exemption.

How is the New Tax regime different from the existing tax regime?

The new tax regime is different in many ways.

  • Firstly, it offers more slabs with lower tax rates. For instance, within the Rs. 5 lakhs to Rs. 10 lakhs bracket, the new regime offers two tax rates — 10% for those between Rs. 5 lakhs and Rs. 7.5 lakhs and 15% for those between Rs. 7.5 lakhs and Rs.10 lakhs.
  • Secondly, the new regime does not have provisions for major exemptions and deductions such as leave travel allowance, children education allowance, house rent allowance, standard deductions on salary, interest on housing loan, specific investments, or expenses under chapter VI-A, and deduction for professional tax.
  • Thirdly, there is the freedom to invest based on preference as the new tax regime does not have an obligatory requirement to invest in specific instruments such as PPF or insurance. This allows the taxpayer to align their investments based on their financial goals.
  • Lastly, there is an option to switch between two regimes based on their income source. If an individual or HUF has income from business or another profession, there is only once in a lifetime to switch back to the old regime if they choose the new one in the current financial year. However, salaried individuals can make the selection year-on-year.

Income tax slab for FY 2022-23

Here is a quick summary of the two tax regimes based on income level.

Total income New tax regime Old tax regime
Upto Rs. 2.5 lakhs Nil Nil
Rs. 2.5 lakhs to Rs. 5 lakhs 5% 5%
Rs. 5,00,001 to Rs. 7.5 lakhs 10%
Rs. 7,50,001 to Rs. 10 lakhs 15% 20%
Rs. 10,00,001 to Rs. 12.5 lakhs 20%
Rs. 12,50,001 to Rs. 15 lakhs 25% 30%
Rs. 15,00,001 and above 30%

Exemptions and Deductions in the new tax slabs

Exemptions allowed Exemptions removed
Interest received on Post Office Savings Account under Section 10(15) (i) the maximum amount of Rs. 3,500. Standard deduction of Rs. 50,000 for salaried individual
Gratuity received from the employer up to a maximum amount of Rs. 20 lakhs Leave travel allowance
Amount received from Life Insurance Policy on maturity under Section 10(10D). House rent allowance
Employer contribution in NPS or EPF up to 12% of salary and interest on EPF up to 9.5% p.a. Professional tax paid by a maximum of Rs. 2,500/-

Decoding the two tax regimes

To understand the two tax slabs, let’s calculate Sonal and her father’s income tax under both the new and old regime.

Sonal’s slab under both the new and old regime remained the same as her income was Rs. 4.9 lakhs. Her father had an annual income of Rs. 7,50,000. He had made an investment in PPF of Rs. 1,50,000 under Section 80c, Rs. 50,000 in NPS as per Section 80CCD, medical insurance of Rs. 50,000 under Section 80D, and HRA of Rs. 10,000.

Since he was in the 2nd slab per old regime, he saw a difference in his tax rate. As per the new tax rate, he was taxed at 10% in comparison to 20% as per the old tax regime. At first glance, the new tax regime seemed advantageous. But upon considering the exemptions and deductions, there is a clear difference in the overall amount that Sonal’s father will end up paying. Once the exemptions were calculated, he was entitled to receive a rebate with no extra payment. However, the new tax regime will make him liable to the extent of Rs. 39,000.

Old or New Tax Regime: Which regime to choose?

Although there is no one-size-fits-all, the new tax regime is a welcome change among those in the lower-income group or have difficulty investing in certain financial instruments that have a specific lock period. To determine which tax regime to follow, an individual taxpayer should calculate their income tax liability at the applicable tax rates under both regimes and compare which offers better benefits and lower tax.

Sonal’s current situation remained the same as per tax calculation in either regime as a young businesswoman. However, she realized a decision must be made when her business grows in the next financial year. But until then, Sonal decided to celebrate her little success with family and friends.