Tax System in India: Old vs New Regime

In this blog, I have explained the Indian Tax System in simple terms. The concepts I have covered are so basic that every person should know them. You'll feel relieved that you finally understand these simple things. Let’s begin by learning how the government collects tax.

Types of Taxes: Direct and Indirect

1. Direct Tax (like Income Tax)
2. Indirect Tax (like GST)

Understanding the difference is simple:

• Direct tax is based on income, which makes it more progressive and fair.
• Indirect tax (like GST) is the same for everyone, regardless of income. For example, whether you buy a chocolate for ₹5 or ₹500,000, the GST percentage is the same for both the rich and the poor. This makes it less fair since everyone pays the same rate.

What is Direct Tax?

Direct Tax is more fair and progressive, meaning the more you earn, the more tax you pay. For example, if you earn less than ₹2.5 lakh annually, you pay no tax, but if you earn ₹5 lakh or more, the tax rates increase in a marginal system (different rates for different income brackets).

Most salaried individuals pay taxes upfront via TDS (Tax Deducted at Source). Businesses, on the other hand, can deduct their expenses before paying tax on their net income. This allows businesses to function smoothly and continue contributing to society by creating jobs.

What is Indirect Tax (GST)?

Indirect tax is levied on consumption. When you buy something, like a chocolate bar, the business collects GST and pays it to the government.

Now, the GST varies based on the type of product:

• Essential items like food, eggs, or newspapers often have no GST or a lower rate.
• For goods like ice cream or luxury items, GST can go up to 18% or even 28%.

For example, staying at a hotel with a room rent below ₹7,500 will attract 12% GST, but staying at a luxury hotel may cost you 28% GST. Similarly, luxury items like large cars or cigars are taxed more heavily, sometimes with a cess, which is an additional tax used for specific government purposes.

Who Should Register for GST?

If your business income exceeds a certain threshold, GST registration is compulsory. Even if your income is below the threshold, you can voluntarily register, but that increases compliance costs (e.g., for accounting). Once registered, you must collect GST from your customers and pay it to the government, even if they delay payment.

Input Tax Credit (ITC)

Input Tax Credit is a benefit businesses receive. For example, if McDonald’s buys equipment and pays GST, it can claim that GST back since it is selling a final product (burgers) that also attracts GST. This ensures businesses aren’t taxed on both inputs and outputs.

As a content creator, if someone buy a camera for ₹1,00,000 and pay GST, he/she can claim that input tax credit against the GST he/she charges to their clients.

Old vs. New Tax Regime

The old regime has bigger tax slabs and allows for deductions (like under section 80C for investments in ELSS or PPF). The new regime has lower tax rates but no deductions.

Which regime should you choose?

It depends on how much you earn and what deductions you’re eligible for. If you have significant deductions, the old regime may be better. However, the new regime is now the default, and unless you inform your employer, your tax will be deducted under the new regime. For salaried employees, you can switch regimes at the time of filing your tax return. However, business owners can only switch once, and once they choose the new regime, they can’t go back.

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