The Union Budget 2025 introduced significant changes to India's taxation system, aiming to simplify tax structures and provide relief to taxpayers. One notable feature is the introduction of marginal tax relief in the new tax regime, designed to prevent taxpayers from facing disproportionately high taxes when their income slightly exceeds a certain threshold. This article explores the concept of marginal tax relief, the features of the new tax regime effective from FY 2025-26, and the implications for both individual and corporate taxpayers.
Understanding Marginal Tax Relief
Marginal tax relief is a mechanism that ensures taxpayers do not experience a substantial increase in tax liability when their income marginally surpasses a specific threshold. In progressive tax systems, where tax rates escalate with higher income brackets, a slight increase in income can sometimes lead to a disproportionately higher tax burden. Marginal tax relief addresses this issue by providing a gradual increase in taxation, thereby avoiding a "tax cliff."
How Marginal Tax Relief Works
Scenario Without Relief:
If a taxpayer's income exceeds a particular threshold by a small amount, they might be pushed into a higher tax bracket, resulting in a significantly higher tax liability on the entire income.
Scenario With Relief:
Marginal tax relief ensures that the additional tax payable does not exceed the actual income that surpasses the threshold. This means the taxpayer only pays tax on the excess amount, preventing an undue increase in overall tax liability.
For instance, if the tax-free income threshold is ₹700,000 and a taxpayer earns ₹710,000, without marginal tax relief, they might face a higher tax rate on the entire income. With marginal tax relief, the higher rate would apply only to the ₹10,000 exceeding the threshold, ensuring fairness in taxation.
Features of the New Tax Regime from FY 2025-26
The new tax regime, effective from the financial year 2025-26, introduces several key features aimed at simplifying the tax structure and providing benefits to taxpayers:
Revised Income Tax Slabs
The new income tax slabs have been restructured to reduce the tax burden on individual taxpayers. The tax exemption threshold has been raised to ₹1.28 million (approximately $14,800) from the previous ₹700,000, with reduced rates for higher income brackets. This restructuring aims to enhance household consumption, savings, and investment.
Introduction of Marginal Tax Relief
To prevent taxpayers from facing a sudden spike in tax liability when their income slightly exceeds a threshold, the new regime incorporates marginal tax relief. This ensures a smoother transition between tax brackets and maintains fairness in the taxation process.
Simplification of Tax Structure
The new regime aims to simplify the tax filing process by reducing the number of exemptions and deductions. This move is intended to make tax compliance easier and more straightforward for taxpayers, encouraging voluntary compliance and reducing the scope for tax disputes.
Optional Transition
Taxpayers have the option to choose between the old vs new tax regime based on their financial situation and preferences. This flexibility allows individuals to select the regime that offers the most benefits, considering factors like available deductions and overall tax liability.
Corporation Tax Marginal Relief
In addition to individual taxpayers, the concept of corporation tax marginal relief has been introduced to support small and medium-sized enterprises (SMEs):
Objective:
To prevent SMEs from experiencing a sharp increase in tax liability when their profits marginally exceed a certain limit, thereby encouraging business growth and investment.
Mechanism:
Similar to individual marginal relief, corporations whose profits slightly exceed the threshold for higher tax rates receive relief to ensure that the additional tax payable does not outweigh the excess profit.
Impact:
This relief promotes a more equitable tax environment for businesses, fostering economic development and job creation.
Implications for Taxpayers
The changes in the new tax regime have several implications for taxpayers:
Increased Disposable Income
With higher exemption limits and restructured tax slabs, taxpayers are likely to have more disposable income, potentially boosting consumer spending and economic growth.
Simplified Tax Compliance
The reduction in exemptions and deductions simplifies the process of e-filing of income tax, making it more accessible and less time-consuming for taxpayers.
Reevaluation of Tax Saving Strategies
Taxpayers may need to reassess their tax-saving investment options, such as life insurance and other instruments, to align with the new regime and maximise benefits.
Decision Between Old and New Regime
Individuals must compare the old vs new tax regime to determine which is more advantageous, considering factors like eligibility for deductions and overall tax liability.
Utilising Tools for Tax Planning
To navigate the changes effectively, taxpayers can leverage various tools and resources:
Income Tax Calculator:
An income tax calculator can help individuals estimate their tax liability under both the old and new regimes, facilitating informed decision-making.
Professional Consultation:
Seeking advice from tax professionals can provide personalised insights into optimising tax planning strategies under the new regime.
The introduction of marginal tax relief in the new tax regime from FY 2025-26 marks a significant step towards a more equitable and simplified taxation system in India. By restructuring the new income tax slabs and incorporating mechanisms like marginal tax relief for both individuals and corporations, the government aims to reduce tax burdens and stimulate economic growth.
** Tax exemptions are as per applicable tax laws from time to time.
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