Stay with old tax regime or switch to new one?

Union Budget presented on February 01, 2020 is said to be the longest Budget in the history, spanning around 2 hours 40 minutes. In this Budget, Finance Minister Nirmala Sitharaman did propose a lot of things that might prove to be good in the long-run. However, they missed out the expectations made in the pre-budget phase. As a result of this, Sensex fell by almost 1,000 points on Saturday.  

It was expected that in order to stimulate consumption, Finance Minister would bring in some relief in the form of personal income tax as well as capital gains tax on equity. Although, nothing happened with respect to capital gains tax, but a new personal income tax regime was introduced.

With this, now the tax payer has an option of either availing the new regime with no exemption and deductions or staying with the old one availing all the deductions and exemptions. Finance Minister in her speech added that this new tax regime will simplify the work of tax payers. On the contrary, it has confused tax payers as now they need to check which regime suits them more. But not to worry! In this article, we would try to find out which tax regime is better and does it make sense at all to switch to the new regime?

The study

To understand which tax regime is better, we carried out a study by assuming certain income scenarios and compare both the tax regimes to understand which one is more appropriate.

Scenario I

In this scenario, we have assumed an annual income to Rs 7 lakh and annual expenses to be Rs 2.4 lakh. We have also assumed a home loan of Rs 30 lakh with 8.5 per cent rate of interest and 20 years as the loan tenure. EMI calculates to Rs 26,000 per month and Rs 3.12 lakh per annum.

With this, you can avail the home loan interest deduction of Rs 2 lakh in the initial loan years. This coupled with a standard deduction of Rs 50,000 itself is enough to make your income tax free. However, if you are not availing any home loan then, your tax liability becomes Rs 30,000. Hence, in such a situation, you would need to avail the tax deduction under section 80C of Rs 1.5 lakh along with the standard deduction to make your income tax free.

Thus, if you switch to the new regime then, you will have to pay income tax of Rs 20,000. However, in this calculation, we have not assumed any Employee Provident Fund (EPF) deduction, which is allowed in the new regime. Considering EPF, your tax liability drops to Rs 11,600. But remember, here we have assumed your basic plus Dearness Allowance (DA) to be 50 per cent of the income. This might differ from one case to the other.

Scenario II

In this scenario, we are assuming income to be Rs 10 lakh and expenses to be Rs 3.48 lakh and EMI is assumed to be Rs 35,000 per month or Rs 4.2 lakh per annum. We also applied deductions like interest in home loan to be Rs 2 lakh, deduction under section 80C of Rs 1.5 lakh, deduction under section 80CCD of Rs 50,000, a standard deduction of Rs 50,000 and deduction under section 80D of Rs 25,000.

With all the deductions, you need to pay tax of Rs 5,000. However, if you do not have any home loan interest outgo, then you would be paying tax of Rs 45,000. In the new regime, as there are no deductions available apart from few, your tax liability comes to Rs 44,500. Here, we have assumed EPF deduction. So, as you can see, if we ignore the home loan interest deduction then, in both the regimes, you are paying the same amount of tax.

Scenario III

In the final scenario, we have assumed income of Rs 15 lakh and expenses to be Rs 5.1 lakh and EMI is assumed to be Rs 52,000 per month or Rs 6.24 lakh per annum. We applied all the deductions that we did in the second scenario.

So, with all the deductions, you are required to pay tax of Rs 1.07 lakh. However, if you are not availing any home loan, your tax liability stands at Rs 1.67 lakh whereas, in case of the new tax regime, you need to pay tax of Rs 1.3 lakh. Here, we have assumed EPF deduction under the new tax regime. So, if we ignore the home loan interest deduction, then in the new regime benefits, you get more than the old one.

Conclusion

With all the above workings, we can say that both are on par with their own pluses and minuses. So, which tax regime to go with? If your income is Rs 7 lakh or below, then you should stay with the old tax regime. Also, irrespective of your income, stay in the old tax regime, only till you are able to avail the tax deduction on your home loan interest. However, if you are not availing any home loan and your income is above Rs 7 lakh then, it makes sense to switch to the new tax regime.

Also, if you are a retired individual, the new tax regime would be beneficial, as you have certain deductions like death-cum-retirement benefit, commutations of pensions, leave encashment on retirement, amount received under Voluntary Retirement Scheme (VRS) up to Rs 5 lakh, EPF, etc. Even if we do not consider these deductions then also, it makes more sense for retired individuals to shift to the new tax regime.

From a personal finance standpoint, it is better to clear off all your debt before your retirement. So, with this, you won’t be able to avail deduction on home loan interest. Also, it is advised that you do not have any life insurance in your retirement. Even if you plan to buy health insurance in retirement, it would be costly. Hence again, you would automatically lose on some of the deductions post retirement.

Though during retirement, you can still avail tax deduction of Rs 1.5 lakh by investing in ELSS and standard deduction of Rs 50,000. But if your income is more than Rs 7 lakh in retirement, then even with ELSS deduction, you would be paying more tax than in the new tax regime.

Hence, you need to evaluate where you fall and accordingly, choose wisely between the two regimes. Although, it would be prudent to note that in any of the calculations, in case of old regime, we have not considered the fees that you might pay to a Chartered Accountant (CA) for consultation and filling tax returns. On an average, they charge Rs 3,000 to Rs 4,000. And in the new tax regime, you do not need CA at all.