Explainer : India considers income tax cuts, all you need to know

A Reuters report quoting government sources showed the Indian government is considering cutting personal income tax for the middle class to boost consumption.

However, the sources said the discussions are ongoing and no concrete decisions have been taken yet.

The announcement will come in the budget on February 1.

Even if the government does decide to go ahead with tax cuts, it would be under the new regime introduced in 2020.

According to the discussions, individuals with earnings up to ₹1.5 million will not pay any tax.

Currently, for income between ₹300,000 and ₹1.5 million the tax rate is 5 to 20  per cent, while higher income is taxed at 30  per cent.

Under the new regime, though, there are no exemptions allowed, compared to the older regime, which allows exemptions on housing rentals, home loan interest and principal repayment, and insurance.

However, filing tax returns under the 2020 regime is less complicated.

Default and options

The new regime was the default tax structure, with Indians given a choice to opt for the old regime.

While some murmurs are floating the government will mandate the new regime, reports suggest India will continue with both regime options similar to the current fiscal year's choices.

Individuals have the option of choosing the old regime, although, they cannot alter their choice once the new regime is opted for.

New vs old regime

Individuals need to look at the tax burden based on both regime's based on their investment choices for the year and make choice.

Take a look at the tax rates under both regimes for comparison and making the choice.

Government's plan to stimulate growth

Sources reveal that this move aims to provide relief to the middle class and stimulate consumption in response to the country’s slowing economy.

The tax cuts would primarily impact city dwellers, who are facing high living costs, and could encourage more taxpaye₹to opt for the newer 2020 tax system.

The potential tax reductions could make the simplified 2020 system more attractive to taxpayers, as it removes many exemptions but offe₹lower rates.

India’s central government sources quoted by Reute₹indicate that such tax reforms could encourage wider adoption of this system,

Especially in the face of rising food inflation and weaker consumer demand.

The government has not yet specified the exact revenue loss from any cuts, but the goal is to stimulate economic activity amid sluggish growth.

India’s economy has faced a significant slowdown, with growth dropping to its slowest pace in seven quarters between July and September unexpectedly.

Despite this, the government is optimistic that rural demand will continue to show resilience, and urban demand is expected to pick up.

The country’s growth forecast for the fiscal year 2024/25 stands at 6.5 percent, at the lower end of its projected range.

With challenges such as high inflation and global uncertainties, including a stronger US dollar, India’s tax reforms could play a critical role in boosting domestic consumption and supporting the middle class, which remains politically vocal about high tax burdens.

Changes to tax structure this year

Modifications to the income tax system occurred midway through the year 2024.

The reason behind this is that the government announced the Union Budget 2024 in July, following the general elections that took place between April and June of that year.

The income tax law amendments that were revealed in July 2024 may have slipped the minds of many taxpayers due to the budget's mid-year presentation.

Beginning with the fiscal year 2024–25, the majority of the income tax adjustments that were announced in July 2024 go into effect.

When you file your income tax return (ITR) in July 2025, you'll be able to claim different tax deductions and exemptions because of these changes.

The government adjusted the income tax brackets under the new tax system.

Major relief for Indian middle class? Govt mulls tax cuts amid economic challenges: Reports

For the current fiscal year 2024–25, taxpayers will benefit from increased savings due to the reduced income tax brackets of the new tax system.

The government raised the standard deduction limit and modified the income tax brackets under the new tax system.

Standard deduction changes

The standard deduction for people filing under the new tax regime for FY 2024-25 is ₹75,000, an increase from ₹50,000 in the prior regime.

The revised tax structure raises the standard deduction for family pensioners from ₹15,000 to ₹25,000.

For the fiscal year 2024–25 (modified for 2025–26), the standard deduction limit stays constant for individuals opting to utilise the prior tax framework.

India considers income tax cuts to boost consumption

The old tax system provided a standard deduction of ₹50,000 for salaried and pensioner individuals, and ₹15,000 for family pensioners.

Salary earners and retirees can reduce their tax liability via the new regime's increased standard deduction, which they can use to their advantage.

Salary, pension, or family pension recipients are eligible to take a standard deduction from their gross income before determining their tax liability.

Funds paid out by insurance firms cannot be claimed as a standard deduction.

National Pension Scheme changes

An individual can get a bigger break on their employer's National Pension System (NPS) contribution if they choose the new tax system in FY 2024-25.

Under the new system, worke₹can deduct their employers' NPS contributions up to 14 per cent of their base income.

Up to 10 per cent of a worker's base income can be deducted in the past.

To determine taxable income, this deduction is taken from gross income in accordance with Section 80CCD (2) of the Income Tax Act, 1961. 

This deduction is the sole one available under the new tax system, aside from the standard deduction.

The previous tax system allowed for an additional deduction of ₹50,000 for NPS investments made under Section 80CCD (1b) and a Section 80C deduction of ₹1.5 lakh.

Under the older tax system, the maximum amount that an employer may deduct from their NPS contributions for tax reasons remained unchanged.

People who want to pay less tax under the new system will be able to do so thanks to a larger deduction offered under the new system compared to the previous one.

Keep in mind that you would be responsible for paying taxes on employer contributions to EPF, NPS, and Superannuation funds if their combined value exceeds ₹7.5 lakh in a given fiscal year.

Additionally, taxes will be withheld on both the interest and return that is generated on the excess contribution.

Tax on capital gains changes

In the fiscal year 2024–25, the government will enforce new laws on capital gains taxes. The objective of the amendments was to optimise the framework for taxing capital gains.

A 20 per cent tax will be imposed on all short-term capital gains derived from shares and equity-oriented mutual funds. This has been increased from 15 per cent to 20 per cent.

Income tax brackets applicable to earnings will be imposed on short-term capital gains derived from diverse assets, such as real estate, gold, and other non-financial holdings.

The taxation rate for long-term capital gains is 12.5 per cent, irrespective of the asset type. The long-term capital gains tax rates will now be standardised across all asset classes.

Long-term capital gains (LTCG) on investments in stocks and equity-oriented mutual funds are now exempt from taxes up to ₹1.25 lakh every fiscal year, an increase from the previous threshold of ₹1 lakh.

The income tax on long-term capital gains (LTCG) on the sale of residential property is no longer entirely indexable.

If an individual acquires a residence on or before July 22, 2024, and then divests it, they will incur taxation on long-term capital gains (LTCG) in two manners, as stipulated by the new regulations.

Two methodologies exist:

(a) LTCG tax with indexation, calculated at 20 per cent, and

(b) LTCG tax without indexation, calculated at 12.5 per cent. In the absence of indexation benefits, long-term capital gains (LTCG) on the sale of a house acquired on or after July 23, 2024, will be subject to a tax rate of 12.5 per cent.

Only residents and Hindu Undivided Families (HUFs) may elect the LTCG taxation option for homes acquired before July 23, 2024.

Other taxable entities, including non-residents, will be obligated to remit 12.5 per cent without indexation.

The revised capital gains tax framework simplifies the method by which individuals ascertain their taxable income from capital gains.

In the past, various capital assets were subject to separate regulations for determining capital gains tax.

Capital gains holding period changes

The government has modified the time period for capital assets to further categorise capital gains as long-term or short-term.

The new criteria stipulate two holding periods for capital assets to determine whether earnings are classified as short-term or long-term.

Profits from the sale of any listed investment held for twelve months are classified as long-term capital gains.

Conversely, for capital gains on non-listed assets to qualify as long-term, the holding period for these securities must be 24 months.

Adjusting the holding period will facilitate taxpayers in monitoring the duration for which they must retain specific assets prior to sale, ensuring that their capital gains qualify as long-term capital gains.