Standard Deduction is a flat amount that was cut from the salary/income of an individual until it was abolished in FY2006. Before we get into the nuances of the new standard deduction norms introduced in the Union Budget 2018, it would be prudent to understand how the original standard deduction worked.
How was the old standard deduction calculated?
The old model of standard deduction as a flat deduction from the total income had the following features:
Why was standard deduction abolished in Budget 2005?
In the Union Budget 2005, then Finance Minister P Chidambaram had announced the summary abolition of the standard deduction benefit to salaried employees. His argument was that since the standard deduction was in the nature of an allowance, it was naturally taxable and hence, there was no merit in continuing the scheme. With this, the standard deduction stood abolished from 2005 onwards.
Highlights of the 2018 announcement on standard deduction
In the Union Budget 2018, Arun Jaitley reintroduced the standard deduction at a flat rate of Rs. 40,000 pa.
The following are the key highlights of the new standard deduction announcement:
Actual benefit of standard deduction to salaried employees and pensioners
The illustration below captures the impact that this shift will have on the net taxable salary income of the individual assessee on a salary income.
Details | AY2018-19 | AY2019-20 |
---|---|---|
Gross Salary | Rs. 650,000 | Rs. 650,000 |
Transport Allowance (Rs. 1,200/month is exempt) | Rs. 19,200 | Not Applicable |
Medical Allowance | Rs. 15,000 | Not Applicable |
Standard Deduction | Not Applicable | Rs. 40,000 |
Net Salary post deductions | Rs. 615,800 | Rs. 610,000 |
Impact of shift to Standard Deduction | -- | Net salary reduces by Rs. 5,800 due to standard deduction |
The benefit in the above case may not appear to be too attractive when the net impact is considered after adjusting for the forsaken benefits of transport allowance and medical allowance. However, the benefit could be more pronounced in case of pensioners. Check out the illustration below:
Details | AY2018-19 | AY2019-20 |
---|---|---|
Gross Pension Income | Rs. 520,000 | Rs. 520,000 |
Transport Allowance (Rs. 1,200/month is exempt) | Not Applicable | Not Applicable |
Medical Allowance | Not Applicable | Not Applicable |
Standard Deduction | Not Applicable | Rs. 40,000 |
Net Income post deductions | Rs. 520,000 | Rs. 480,000 |
Impact of shift to Standard Deduction | -- | Net income reduces by Rs. 40,000 as a result of standard deduction |
Thus, it can be observed from the above illustrations that the benefit of standard deduction is much higher in case of pensioners than it is for salaried employees. Nonetheless, the new system is more convenient as claiming standard deduction does not require an employee to produce bills and, consequently, is administratively simpler.
Understanding the impact of standard deduction shift on actual tax payable
One should keep in mind that the introduction of standard deduction has been accompanied with some other changes to the calculation of tax on salary. For example, medical allowance and transport allowance have been scrapped in lieu of standard deduction. On the other hand, the Education Cess has been increased from 3% to 4% in the Union Budget 2018.
What would be the overall impact of all these changes? Let us compare the actual tax calculations between AY2018-19 and AY2019-20.
Tax Calculation on Salary | AY2018-19 | AY2019-20 |
---|---|---|
Gross Income | Rs. 2,825,000 | Rs. 2,825,000 |
Transport Allowance (Rs. 1,200/month is exempt) | Rs. 19,200 | Not Applicable |
Medical Allowance | Rs. 15,000 | Not Applicable |
Standard Deduction | Not Applicable | Rs. 40,000 |
Net Income post deductions | Rs. 27,90,800 | Rs. 27,85,000 |
Income Tax Calculations | ||
Income Tax | Rs. 6,49,740 | Rs. 6,48,000 |
Surcharge | 0 | 0 |
Education Cess (@2% of tax payable) | Rs. 12.995 | Not Applicable |
Secondary and Higher Education Cess (@ 1% of tax payable) | Rs. 6,497 | Not Applicable |
Education and Health Cess (Combined rate of 4% of tax payable) | Not Applicable | Rs. 25,920 |
Total Tax Liability | Rs. 6,69,232 | Rs. 6,73,920 |
Additional tax paid under the New Standard Deduction formula | Rs. 4,688 |
In a nutshell, there are two key things that we need to understand about the new standard deduction in the overall picture of your tax calculation.
In the above illustration, the tax liability of the individual goes up despite the standard deduction as he has to pay a higher surcharge in AY2019-20. This explains the increase in tax liability for that year.