Context: The Government in the Union Budget 2025-26 has announced no personal income tax on income up to 12 lakhs per annum. Apart from it several other key tax reforms are announced expected to have a big impact on individuals across all income categories.
Relevance of the Topic: Prelims: Basic idea of New Tax Regime; tax dynamics of India.
Major Highlights:
1. Basic Exemption Limit Raised to Rs 4 Lakh:
- The government has proposed increasing the basic exemption limit under the new tax regime from Rs 3 lakh to Rs 4 lakh.
- As a result, individuals with an annual taxable income of up to Rs 4 lakh will have zero tax liability.
- Taxpayers opting for the new tax regime will not be required to file an income tax return, if they do not meet other mandatory filing criteria.
2. Full Tax Rebate for Income up to Rs 12 Lakh:
- The income threshold for availing a full tax rebate has been raised from Rs 7 lakh to Rs 12 lakh under the new tax regime.
- This means that taxpayers earning up to Rs 12 lakh annually will pay no income tax.
- A standard deduction of 75000 rupees for salaried employees is announced, making a cumulative tax benefit of 12.75 lakh rupees.
- However, incomes subject to special tax rates, such as capital gains, are excluded from this rebate calculation.
3. Revised Income Tax Slabs:
- The new tax regime will feature an additional 25% tax bracket, expanding the total number of slabs to seven. The updated structure is as follows:
4. Updated Return Filing Window Extended:
- Taxpayers will now have five years, instead of the current three, to file updated tax returns.
- However, additional tax penalties will apply—60% for returns filed in the fourth year and 70% in the fifth year.
5. Higher Limit for Foreign Remittance under LRS:
- The threshold for a 20% Tax Collected at Source (TCS) on foreign remittances under the Liberalised Remittance Scheme (LRS) has been raised from Rs 7 lakh to Rs 10 lakh per annum.
- Additionally, TCS will no longer be levied on remittances for educational purposes funded through loans from specified institutions.
Rationale behind Tax Benefits
- Slumping demand: There has been a slump in demand for goods in the market, especially the automobile and real estate sector, due to low disposable income with the salaried employees.
- Stagnant salaries: Economic Survey 2024-25 has observed that the employees in the companies are working on low salaries, leading to net reduction in the salaries (i.e., inflation rate is more than the salary increment).
- Inflation: The tax burden combined with rising inflation and stagnant salaries leaves less scope for the individual to participate in the economic growth of the nation.
Potential Impact of Benefits
The slabs and rates have been changed to benefit all taxpayers to reduce the tax burden of the middle class and leave more money in their hands, boosting household consumption, savings, and investment.
- Reducing triple burden: It will help in reducing the triple burden of tax-inflation and low salaries on the middle class.
- Rise in Demand: The tax benefits will increase the disposable income and will increase consumption expenditure. This, in turn, will fuel the sluggish GDP growth rate.
- Increase in the savings: Indian savings has reduced in the past 10 years by 5%, reduction in the tax will help the middle class to invest the money in the saving instruments.
Major Constraints in Indian Direct Tax
- Narrow tax-base: India have a low tax base where only 2% people pay income tax due to;
- Large number of deductions in the income tax.
- Vast presence of informal labour force lead to reduction in tax paying citizens
- Exemption on agricultural income leads to tax evasion.
- High Litigation and Dispute Resolution Issues: A large number of tax cases are pending in courts, leading to delays and inefficiencies in tax collection.
- Lack of Awareness and Compliance: Many individuals and businesses lack knowledge of tax laws, leading to unintentional non-compliance.
- Tax Administration Inefficiencies: Limited manpower, outdated technology, and bureaucratic hurdles hinder effective tax collection.
- Political and Social Factors: Pressure from interest groups, political interference, and populist measures such as tax exemptions reduce overall tax collection.
- Black Money and Corruption: The presence of black money in the economy and corruption within tax administration weaken efforts to collect direct taxes effectively.
- Low Penalties and Weak Enforcement: Weak enforcement mechanisms and relatively low penalties for tax evasion do not act as strong deterrents.
However, in recent times the net direct tax collection has increased. E.g., Net direct tax collections in India from April 1, 2024, to January 12, 2025, reached Rs 16.90 lakh crore, reflecting a 16% growth year-on-year.
Probable reasons for rise in Net Direct Tax Collections:
- Ease of Compliance:
- Simplified tax filing mechanism (like pre-filed Income Tax Returns, user-friendly online tax portal)
- Integration of PAN with Aadhar has streamlined the verification process.
- Use ofTechnology:
- Digital payment systems to file tax with simplified transactions.
- e-verification and e-assesment processes.
- Faceless Assessment Scheme for greater transparency and efficiency in income tax assessments.
- Rise in Incomes has also facilitated higher tax payments by individuals.
- Simplification of Tax Rules:
- Rationalisation of tax slabs, incentives for filing returns have led to voluntary compliance. E.g. ‘Honoring the Honest’ campaign.
- Decrease in cost of collection is attributed to:
- Adoption of centralised processing centres (E.g., CPC Bengaluru)
- Automation of processes like return filing, scrutiny and refund issuance.
- Increase in the efficiency of tax administration.
- Formalisation of the economy.
To improve direct tax collection in India further, reforms should focus on simplifying tax laws, expanding tax base, enhancing digital compliance, strengthening enforcement, and curbing tax evasion.