Income tax was first introduced in the country during the pre-Independence period in 1860 by Sir James Wilson, a civil servant in British India. “The tax was introduced as a temporary measure to meet the expenses of the British government during the sepoy mutiny of 1857 (also known as the first war of Indian independence). It was initially levied on a small percentage of the population," said Tapati Ghose, partner at Deloitte.
Eventually, income tax became permanent and its scope expanded to include a larger portion of the population as the government looked for newer sources of income.
The year 1961 is said to have shaped the current tax system. Significant amendments in the rules gave birth to the Income Tax Act of 1961, which empowered authorities to levy, administrate, collect and recover income tax. In terms of tax rates, during 1973-74, India witnessed the highest marginal tax rate (including surcharge) of 97.75%. It was gradually brought down to 50% in 1991-92 and further slashed to 30% in the following years. Currently, it stands at 42.7%.
India, like many other countries, follows a progressive tax structure to levy tax. That is, the tax rate increases as the taxable amount increases. At present, we have four tax slabs under the old tax regime: There is no tax on income up to ₹2.5 lakh. Income of ₹2.5–5 lakh is taxed at 5% (with tax rebate), ₹5– 10 lakh at 20% and that above ₹10 lakh at 30%.
The above slab limits were mostly left unchanged in the last one decade, despite the rise in inflation in the country (see graphic). The government reduced the burden on those in the bottom of the pyramid, to an extent, by introducing tax rebate and standard deduction ( ₹50,000 for salaried).
However, those in the middle and higher income groups have more expectations from Budget 2023. They want a rejig of the maximum slab limits to match the current environment of rising income levels.
With inputs from Tapati Ghose, partner from Deloitte, we lay down the key events in the history of income tax with respect to changes in tax slabs and tax rates for individuals starting 1991 (see graphic), the beginning of a decade of economic reforms in the country. Note that we haven’t considered ‘deductions’ that are allowed from the taxable income for the purpose of this story.
Key events
Former finance minister P. Chidambaram, in his ‘dream budget’ in 1997, made several changes by replacing the then tax rates—15%, 30% and 40%— with new rates of 10%, 20% and 30%, respectively.
Introducing the new tax rates and brackets, Chidambaram said “I believe that a good tax policy should aim at moderate rates, a wider tax base, simpler procedural rules and securing greater compliance."
It was again Chidambaram who, in 2005, altered the tax brackets in a significant way. In that budget, he introduced a separate exemption limit for women at ₹1.25 lakh ( ₹1 lakh for the ordinary taxpayer) which is not there anymore. Further, in 2008, he raised the minimum and maximum limits to ₹1.5 lakh and ₹5 lakh respectively. Thereafter, a major change in the personal income tax in India was witnessed only in 2017-2018, when the then finance minister, Arun Jaitley, slashed the minimum tax rate to 5% from 10% for those in the tax bracket of ₹2.5 lakh to ₹5 lakh.
In Budget 2020, current finance minister Nirmala Sitharaman introduced the new tax regime (7 slabs), which offers low tax rates but without the benefit of most deductions and exemptions.
Currently, individuals earning up to ₹2.5 lakh per annum do not have to pay any taxes. Further, taxable income up to ₹5 lakh is tax-free due to the rebate provided by Section 87A. The maximum tax bracket with limit of ₹10 lakh (taxed at 30%) has been left unchanged since 2012. The increase in the middle-class population in India in the last few years makes a strong case for the revision of this limit, according to experts.
Surcharge: on and off
In the past, a surcharge (tax on tax) on direct taxes was generally levied to meet the revenue needs arising from natural calamities. In the 1990s, it was levied only when there was a special revenue requirement for the centre.
In 2000, then finance minister Yashwant Sinha decided to rise the surcharge tax from 10% to 15% to meet the “heavy and unexpected expenditure burden" for defence requirements on the back of the Kargil war. “I trust that the relatively better-off sections of society would bear this additional burden cheerfully," he added in his Budget speech.
In 2001, he removed the surcharge except 2% on all tax payers (earning more than ₹60,000) for the Gujarat Earthquake relief.
Following that, surcharge was removed and reintroduced with different thresholds in various budgets. Since 2013—when Chidambaram introduced 10% surcharge on income exceeding ₹1 crore—the levy has become permanent in India.
At present, the surcharge rate is 10% of the tax amount for income of ₹50 lakh and above but not exceeding ₹1 crore. For income above ₹1 crore but not exceeding ₹2 crore, it is levied at 15%. The tax goes up to 25% if the income exceeds ₹2 crore but not ₹5 crore. For income exceeding ₹5 crore, surcharge is as high as 37% of the tax amount. This pushes the highest marginal tax rate (including surcharge) to 42.74%, which is the highest in the last three decades.
The surcharge is in addition to the levy of education cess, which was introduced in India in 2004 at 2%. It is now called ‘health and education cess’ charged at 4% on the amount of tax plus surcharge.
Technology push
The history of income tax in India would be incomplete without the mention of the department’s move towards technology-based processing of returns in the last two decades.
From Saral forms in the early 2000s for filing I-T returns electronically, the income tax department in India now has a system of end-to-end online preparation and e-filing of income tax returns, e-payment of taxes and refunds directly in taxpayers’ bank accounts throughout the country.
To further ease the tax filing process, the department has come out with pre-filled tax returns which has details including salary income, capital gains from securities, bank interests, dividends and tax deductions.
In terms of assessments, we now have e-assessment of tax returns and a faceless appeal system. The government laid the groundwork for the National Faceless Income Tax Appellate Tribunal Centre, a quasi-judicial authority to file appeals against the orders of the authorities in the appeals department.
The income tax system has certainly come a long way in India but needs to go further in terms of having tax brackets that account for inflation and a steady tax regime in the long-run.
