Taxpayers are facing a unique dilemma, i.e., whether to select the traditional old tax regime of claiming tax deductions or to give away the tax deductions and claim lower tax rates provided under the new optional tax regime introduced in Finance Act 2020.

This year, while making their income tax declarations to employers for the purpose of tax deduction at source(TDS), taxpayers are facing a unique dilemma, i.e., whether to select the traditional old tax regime of claiming tax deductions or to give away the tax deductions and claim lower tax rates provided under the new optional tax regime introduced in Finance Act 2020.

The old tax regime provides a 3-tier tax rate slabs: 5%, 20% and 30% for income above Rs 2.5 lakh up to Rs 5 lakh, above Rs 5 lakh up to Rs 10 lakh and income over Rs 10 lakh, respectively. While calculating taxable income under old scheme, individuals can claim tax free allowances like Leave Travel Concession (LTC), House Rent Allowance (HRA), and certain other allowances. Additionally, standard deduction of Rs 50,000, deduction for interest paid on home loan, deductions for tax saving investments specified under chapter VI A, etc., allow taxpayers to lower their tax outgo by investing in specific schemes. These tax breaks significantly reduce the taxable income.

New tax regime
The alternative tax regime offers six slabs with low tax rates, if taxpayers forego a set of 70 exemptions and deductions available under income tax laws (including LTC, HRA, standard deduction, deduction under chapter VI A, etc.). The new tax rates are: 5%, 10%, 15%, 20%, 25% and 30% for income slabs of above Rs 2.5 lakh up to Rs 5 lakh, above Rs 5 lakh up to Rs 7.5 lakh, above Rs 7.5 lakh up to Rs 10 lakh, above Rs 10 lakh to Rs 12.5 lakh, above Rs 12.5 up to Rs 15 lakh and income over Rs 15 lakh, respectively.
Income up to Rs 5 lakh is exempt under both the tax regimes.

The choice
On the face of it, the lower tax rates in the new regime should result in lower taxes. However, the benefit offered in the form of reduced rates proves to be inconsequential and sometimes negative, since the same is counterpoised by removal of exemptions and deductions. Those who have made investments in order to claim tax reliefs will not find the new regime attractive.

Taxpayers with no home loan, staying in rent-free accommodation and preferring to make small or no investments may find the new scheme beneficial. The reduced rates will also leave more disposable income in the hands of people who cannot lock their funds in prescribed investments for some reason.

Based on a very broad calculation, any taxpayer claiming total deductions/ exemptions more than Rs 2.5 lakh is likely to remain beneficial under the old scheme. However, taxpayers will have to do a comparative analysis of their tax liability under old as well as the new regime. If significant amount of tax breaks were being availed by the taxpayers, then it would be better to continue paying tax under the old regime.

Individuals not having business income shall be given choice to select between old or new scheme each year, and thus, may exercise the more beneficial option after careful evaluation each year. However, for individuals having business income, option once exercised shall be final. Salaried individuals are granted an option to choose between old and new scheme at the time of making their tax declaration to employer for the purpose of TDS. Having said that, even if any individual chooses one option at the time of making declaration to employer for TDS, he is free to change the option and select another one, at the time of filing the ITR.