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Why Demonetization Is A Good News for Income Taxpayer

Income Taxpayer in India is a typical salaried class individual who does not have any choice but to pay income tax :). Only 5 Crore people in India are Income Taxpayer rather who file Income Tax Return. Max concentration is in the Income bracket of 5L to 9L per annum. This also explains the reason for the high-income tax rate in India. It is important to bring more and more people under tax net to reduce the income tax rate. I discussed it in detail in my post, Income Tax – A myopic view.

Besides high-income tax rate, the income tax refund is another major issue/pain area for income taxpayer. Though the government is trying its best to simplify the process of a tax refund. For example, Income tax refund of up to Rs 5000 and refunds, if outstanding arrears are up to Rs 5000 are processed within 1 month without adjustment. The refunds of up to Rs 50,000 are also processed within 1 month as shared by the readers of this blog. If you face any issue in claiming income tax refund or don’t know how to claim the refund, you can check out the post, How to claim income tax refund?

In my opinion, demonetization is good news for an Income Taxpayer. Now you must be wondering how? If we link all the steps taken by the government and the thought process, you can easily conclude what is coming your way. Let me share with you

Why Demonetization Is A Good News for Income Taxpayer

1. Lower Income Tax Rate:

In my opinion, one of the hidden or indirect objectives of a demonetization is better compliance on the tax front. For sure, income tax rates will drop drastically because of demonetization. Demonetization will ensure better tax compliance and more & more people will start paying income tax. The increase in no of income taxpayer means lower income tax rate.

Now this is not my conclusion but if you recall some of the interviews of our Finance Minister, he clearly stated that he is open to lower income tax rate if more people come under tax net :). The math’s is very simple. Hypothetically, if the average tax rate is 20% and there are 2 Crore people paying this tax. In case this figure increase from 2 Crore to 8 Crore then the tax rate will reduce in the same proportion for equivalent tax collection. Therefore, average income tax rate will be 5%.

If demonetization achieves its desired results then income taxpayer can expect flat single digit income tax rate in a couple of years. I am anticipating that govt may scrap all types of direct taxes and introduce flat 1% or 2% transaction tax i.e. everyone will be income taxpayer in India. In such a scenario, a transaction tax will be levied either at the source or at the time of the transaction. I will be taxed 2% every time if I will spend money or on my income. For example, if I will buy grocery worth Rs 2000 then Rs 40 will be deducted towards transaction tax. Alternatively, if Rs 2000 is credited to my account as an income then Rs 40 should be deducted as tax and balance Rs 1960 should be credited. It will be applicable for everyone.

2. No harassment of Income Taxpayer:

The tax compliance is indirectly proportional to the income tax rate. Lower the income tax rate higher the tax compliance. Similarly, the so-called tax harassment is indirectly proportional to tax compliance. High tax compliance virtually means NO harassment. Therefore, if the income tax rate is high then the income taxpayer has a tendency to evade tax. Tax evasion means low tax compliance. Low tax compliance provides an opportunity to income department to find more tax evasion cases. More tax evasion cases create a perception of tax harassment among income taxpayer. On the contrary, even a simple income tax notice seeking clarification from income taxpayer is also considered as tax harassment.

To summarize, with lower income tax rate the incentive to evade tax will fade away. Here by incentive, I mean cost-benefit analysis. For example, one of my friends recently told that he is willing to pay a penalty of Rs 25,000 if the income tax department differs with his understanding to save income tax of Rs 50,000. In this case, Assuming tax benefit is reduced to Rs 12,500 and penalty remain the same i.e. Rs 25,000 with the same assumption that income tax rate will reduce to 5% from 20%. In this case, I can bet everyone will prefer to pay Rs 12,500 income tax rather taking a risk of penalty of Rs 25,000.

3. Simplified Rules and Regulations:

The rules and regulations related to income tax are a bit complicated for income taxpayer to understand. In 2009, the then finance minister introduced Direct Taxes Code to replace Income Tax Act, 1961. The original draft proposed to do away with the perquisites and allowances. It was a bold attempt and gradually died its natural death. In my opinion, the income tax rules and regulations can be simplified by increasing tax compliance. Therefore, demonetization is a 1st and a foremost indirect step towards simplified rules and regulations.

Like I said that if the transaction tax becomes reality then income taxpayer cannot demand more simplified tax structure then this. For income/transaction I will pay 2% tax. For transaction tax to become reality it is important that India becomes cashless economy. The reason being, the government will not be able to collect transaction tax on cash dealings. Therefore, in my opinion, govt will keep reducing cash limits on certain transactions. There is also the possibility that government may limit the cash holding per person.

Words of Wisdom:

Demonetization will have a deep impact on Indian economy. It is just the beginning to clean up Indian Economy. India is in an urgent need of tax reforms. After GST, there is a widespread expectation that Indian Government will bring direct tax reforms. I hope that direct tax reforms will also address the double taxation issues.

Before any direct tax reforms, it is important to flush out black money from the system Secondly, India should become cashless economy. It is quite interesting to note that the highest denomination currency in America is $100. Therefore, it is critical to discouraging the use of high denomination currency.

Lower income tax rate will mean more money in the hands of income taxpayer thus more spending. It will boost the economic growth. Last but not least, the tax burden should be borne equally by all the citizens of the country. One section of the society should not feel that they are carrying the tax burden of more than 95% population. The transaction tax if become reality will mean equal tax burden. The more you earn, the more you will be taxed. The question of tax evasion will not arise in such a scenario.

Copyright © Nitin Bhatia. All Rights Reserved.

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Nitin Bhatia
Nitin Bhatia
7 years ago

In my opinion, all the tax benefits on tax saving schemes will cease to exist. As i mentioned, it was also proposed in original DTC i.e. Direct Tax Code.

Harshit Vyas
Harshit Vyas
7 years ago
Reply to  Nitin Bhatia

yes i also thought same may be if that happen i should have to paid up my lic policy and concentrate paying home loan faster let me know your opinion for the same just for reference i am paying premium since last 6 years

and also i like to say thanks to you as your blog has helped me a lot as initially i was about to take HL from hfc (IIFL) due to builder’s suggestion and just .1% higher interest rate comparing to axis bank at that time but after reading your blog i had taken it from Axis bank and now my interest rate is 9.2 and i guess it will also reduced further due to demonetization and sbi’s FD interest rate cut


Nitin Bhatia
Nitin Bhatia
7 years ago
Reply to  Harshit Vyas

It is difficult to predict how things will shape up. I suggest you continue with existing plan and may decide in future.

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