Ahead of Budget 2025, the government should focus on reduction in tax on gains on bank deposits, adjusting income tax exemption limits and raising fixed deductions to keep in pace with inflation, according to former Central Board of Direct Taxes Chairman JB Mohapatra.
Mohapatra, in a report for Global Trade Research Initiative, gave four key reforms for a more efficient tax structure, including simplifying the TDS system and classifying Futures and Options as speculative activity. Here is a look at the reforms he proposed.
#1: Adjust Income Tax Exemptions And Deductions For Inflation
The threshold for an individual’s income tax liability has remained unchanged at Rs 2.5 lakh since 2014. Adjusted for an annual inflation rate of 5.7%, Rs 2.5 lakh in 2014 is equivalent to just Rs 1.4 lakh today. To maintain the same real value, the threshold under the old regime of individual’s taxation should reasonably have been Rs 5.7 lakh. Further, the current fixed deductions and exemptions should also be adjusted:
◆ The Rs 10,000 deduction for savings deposit interest, set in 2013, is worth only Rs 5,000 today. It should be raised to Rs 19,450 by 2025 to account for inflation.
◆ The Rs 1.5 lakh deduction for life insurance premiums, provident fund contributions, or superannuation fund payments, last revised in 2015, is now equivalent to Rs 83,000. By 2025, it should be adjusted to Rs 2.6 lakh.
◆ The Rs 25,000 deduction for medical insurance payments, last updated in 2016, has dropped to Rs 14,750 in today’s terms. The inflation-adjusted limit for 2025 should be Rs 41,000.
“Many countries already provide automatic inflation indexing for tax slabs, threshold taxability, and deductions, serving as a global benchmark for India to emulate,” Mohapatra said.
#2: Simplify Tax Deducted At Source System
TDS was introduced in 1961 with four categories: salaries, interest on securities, dividends, and payments to contractors. Over time, it has expanded to 40 categories of TDS and 13 versions of TCS.
Despite this expansion, most TDS revenue comes from a limited number of sources, such as salaries, dividends, contracts, professional services, rent, and payments to non-residents.
The current TDS framework complicates compliance due to varying rates and thresholds. The government could consider removing TDS for less significant categories.
#3: Reclassify Futures And Options As Speculative Activity
The Income Tax Act currently classifies F&O trading as non-speculative, despite SEBI’s report stating that 90% of retail investors face losses in F&O trading, which is inherently speculative.
This allows losses to be set off against some categories of income. Reclassifying F&O gains and losses as speculative would prevent such set-offs, aligning taxation with the speculative nature of F&O trading and discouraging excessive risk-taking.
India is now the world’s largest F&O market, with NSE and BSE contributing over 80% of global turnover as of April 2024. Revising this classification would bring tax treatment in line with the activity’s true nature.
#4: Reduce Tax On FD, Deposit Gains
Long-term capital gains from equities held for one year are taxed at 12.5%, while interest from fixed deposits is taxed at individual slab rates, reaching up to 30%. This tax disparity encourages households to favour equity investments over FDs.
To address this imbalance, the tax on FD interest earned from deposits held for over 365 days should be capped at 12.5% for individual taxpayers, with reasonable conditions attached to the legislative move.
The move will also help reduce concerns raised by RBI in 2024 over declining bank deposits, as household savings shifted to equities due to a rising stock market.
