Income tax reforms: As the Union Budget 2025-26 approaches, direct tax reforms remain a key expectation, especially for salaried taxpayers eager for relief. News reports say finance minister Nirmala Sitharaman is considering significant changes to income tax slabs under the new tax regime. Among the proposals being evaluated is making annual income up to Rs 10 lakh entirely tax-free, or introducing a 25% tax slab for income between Rs 15 lakh and Rs 20 lakh.
Currently, income above Rs 15 lakh is taxed at the highest rate of 30%. If the proposals are implemented, it could offer substantial relief to taxpayers earning up to Rs 20 lakh annually. Government may absorb a revenue loss of Rs 50,000 crore to Rs 1 lakh crore to provide this relief.
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The proposed overhaul could significantly boost urban consumption at a time when GDP growth has slowed, as evidenced by the seven-quarter low of 5.4% in Q2FY25. Taxpayer relief would increase disposable incomes, spurring spending in urban areas, where consumption has been muted. This aligns with past efforts by Sitharaman, such as the 2023 increase in the Section 87A rebate under the new tax regime, which exempted individuals earning up to Rs 7 lakh annually, provided they opted out of most deductions.
Income tax reforms: Simplified tax structures
India’s tax system has often been criticised for its complexity and insufficient alignment with inflation. Raising the income tax exemption limit to Rs 5.7 lakh would ensure that tax levels remain consistent with inflationary trends, reducing the compliance burden for lower-income groups. While several countries employ automatic inflation indexing for tax slabs, India has yet to adopt this globally accepted practice. Such indexing would protect taxpayers’ purchasing power and enhance the system’s equity.
The new tax regime, which currently offers a standard deduction of Rs 75,000, has scope for improvement. Introducing progressive standard deductions based on income levels could enhance fairness across salary brackets. Allowing exemptions for health insurance, housing loans, and life insurance would make the new tax regime more competitive, encouraging more taxpayers to adopt it.
Streamlining the TDS framework
The complexity of the Tax Deducted at Source (TDS) system has often posed challenges for taxpayers and businesses. With varying rates and thresholds, compliance becomes cumbersome. Simplifying the TDS framework by eliminating less significant categories would ease the administrative burden without compromising revenue collection, especially in light of digitalised tax processes and interconnected databases.
Reclassifying Futures and Options (F&O) trading as speculative activity is another proposed reform. Retail investors, 90% of whom incur losses in F&O trading, often misuse current provisions that classify such trading as non-speculative, allowing them to offset losses against other income. Aligning taxation with the speculative nature of F&O trading would discourage excessive risk-taking and bring fairness to the system.
Capital gains tax and savings
India’s capital gains tax regime is also under review. Proposed changes include increasing the tax on equity gains and raising the securities transaction tax for F&O trades. These reforms aim to target high-income earners and corporations, aligning with the government’s intent to generate revenue from wealthier segments.
At the same time, declining bank deposits due to a shift in household savings toward equities is a growing concern. Equitable tax treatment for fixed deposits could incentivise traditional savings, bolstering financial stability. The Reserve Bank of India (RBI) has urged banks to adopt innovative deposit strategies, and supportive tax policies could complement these efforts.
Dispute resolution and modernisation
Tax disputes remain a significant issue, with pending cases amounting to Rs 10.5 lakh crore as of March 2023. Schemes like Vivad Se Vishwas have provided avenues for dispute resolution, but additional measures, such as reducing reassessment periods and raising monetary thresholds for reassessments, could further alleviate this burden. The government’s intention to comprehensively review the Income Tax Act is an opportunity to address contentious provisions, simplify compliance, and enhance predictability.
Structural changes are also being considered to modernise the tax administration. These include replacing terms like “assessment year” and “financial year” with a unified “tax year” for clarity, reducing the number of additional forms required for tax filing, and making these forms readily accessible online. Tabular depictions for identical taxpayers could further simplify the filing process, improving taxpayer experience and compliance.
The Union Budget 2025-26 offers a critical opportunity to implement a tax policy that is fair, efficient, and aligned with India’s economic aspirations. Proposals such as making income up to Rs 10 lakh tax-free or introducing a new 25% tax slab for higher earners could provide relief to millions of taxpayers, boost consumption, and stimulate economic growth. Complementing these measures with inflation-indexed exemptions, streamlined compliance processes, and equitable tax treatment for savings would create a robust and inclusive tax system. By adopting these reforms, the government can not only address current economic challenges but also lay the groundwork for a prosperous and equitable India.