Rupees 40,000 Standard Deduction to Add to Income Tax Burden

Standard Deduction
Standard Deduction

At first glance, a Standard Deduction of Rupees 40,000 on income tax looks like an attractive proposition for the common taxpayer. And in a way, it does provide relief for every category of individual or organization who become liable to income tax in a financial year.

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What is Standard Deduction ?

The Standard deduction is an amount deductible from your gross income before calculating taxable income for the purposes of government levy. In India, it is applied as a fixed subtraction from the gross value of income. In the USA, for example, different tax return filers are assigned different deductions based on income brackets. The important thing to note here is that no document will be asked as evidence for claiming the standard deduction.

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This device has been a part of the Income Tax statute in India, before. It was stopped in the Financial year 2005-06. In the same year, the previous provision of SD amounting to Rupees 30,000 and 40% of income in the alternative, whichever was less, was terminated.

Does a Standard Deduction of Rupees 40,000 on income  tax exemption is effectively Rupees 2,90,000?

In India, if you earn Rupees 2,50,000 or less in a year and no other income from any other source, your tax liability becomes NIL and the only reason for you to file income tax returns is that you want to consolidate your financial or credit status to apply for a loan.

So, the short answer is Yes.

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However, what you lose in lieu of standard deduction is medical reimbursements of up to Rupees 15,0000 in a year and travel or conveyance allowance of up to Rupees 19,200 in a year. Both these components used to be non-taxable till AY 2016-17.

This makes the net benefit of tax reduction to the tune of Rupees 5,800.

Increase in Cess from 3% to 4%

Pertinent to this discussion is the fact that cesses on income tax have been increased from the earlier 3% to 4%.

Note that the advantage of income tax you pay with standard subtraction applied could dwindle or vanish depending on which tax bracket you fall in precisely because of this 1% increase in cess.

This is demonstrated by the examples below:

  • Ramesh is a UI Developer working on his first job in a start-up. He earns Rupees 25,000 every month, which turns out to be exactly Rupees 300,000 a year. Subtracting the tax exemption of 2,50,000 and then SD of 40,000, his taxable income becomes Rupees 10,000 in a year.
    Because Ramesh falls in the under 500,000 slab, his income tax rate is 5% of 10,000. This means Ramesh’s tax is Rupees 500.
    From this figure, we apply a rebate under Section 87A of the Income Tax Act, of Rupees 2,500 or Rupees 500 (100% of tax) because Ramesh earns less than Rupees 3,50,000 in a year. Ramesh will, therefore, owe the government zero tax.
  • Sunanda is a corporate lawyer and earns Rupees 15,60,000 in a year. Less tax exemption of 2,50,000 and SD of 40,000 leaves 12,80,000.
    Now Sunanda’s income up to Rupees 500,000 less (2,50,000 + 40,000 =) 2,90,000will be taxed at the rate of 5%. That is, Rupees 2,10,000 will be taxed at 5%. This gives a tax of Rupees 1,050.
    Income between 500,000 and 10,00,000, ie, 500,000 would be taxed at the rate of 20% to yield a tax of Rupees 100,000.
    Income between 10,00,000 and the gross salary, ie, 15,60,000, is Rupees 5,60,000. This is subject to a tax rate of 30% to yield an amount of tax payable as Rupees 1,68,000.
    Now, we add these taxes: 1,050 + 100,000 + 1,68,000 = 2,69,050.
    Add 4% of this amount as cess: 2,69,050 + 4% of 2,69,050 = 2,79,812.Had the cess been 3%, the tax would have been Rupees 2,77,121.5.Note that rebate under Section 87A does not apply to Sunanda because her income exceeds Rupees 3.5 lakh in a year.
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