Revise salary structure to make the best of tax gains

Effective from the current financial year 2025-26, individuals opting for the new regime would be entitled to a full tax rebate of up to Rs. 60,000 under Section 87A of the Income-tax Act if their net taxable income does not exceed Rs. 12,00,000. This will result in zero tax liability for taxpayers opting for new tax regime.

This structural change offers a unique opportunity for employers to redesign pay packages to further lower taxes under the new tax regime. This can be done by eliminating the deductible allowances, such as House Rent Allowance (HRA), Leave Travel Allowance (LTA) under the old regime, and adding reimbursement components to reduce the documentation requirements for both the employer and employee.

Growing Preference for the New Tax Regime

Income tax return ( ITR) filing statistics from the previous year indicate that:

• Around 16.5% of individual ITR filers (approximately 1.24 crore out of 7.54 crore) reported total taxable income exceeding Rs 10 lakh
• The remaining 83.5% (approximately 6.30 crore ITR filers) have income up to Rs 10 lakh.

These statistics emphasise that most of the Indian taxpayers fall within income brackets that are more favourably taxed under the new tax regime.

Comparison of income tax slabs under old and new tax regime for FY 2025-26
Here is a comparison of income tax slab rates under old and new tax regime:


**Subject to available rebate

Tax Savings Comparison: Old vs. New Tax Regime
The table below provides a comparison of income tax liabilities under the old and new tax regimes for various income levels and the tax savings under the new regime and the deductions required under the old regime to achieve parity.


Optimising the Pay Structure under the New Tax Regime
It becomes imperative for employers to review and possibly realign the Cost to Company (CTC) structures for employees. This restructuring involves consolidating fragmented allowances and proof-based reimbursements (like HRA, LTA, and medical) into a fixed, straightforward salary structure, reducing the dependency on documentation and verification.

Employees enjoy higher liquidity and zero tax liability, while employers benefit from ease of compliance, as there would be no requirement for collecting and verifying investment proofs, rent receipts, or other similar documentation.

A simplified salary structure with fixed allowances and minimal conditional components reduces administrative workload, mitigates the risk of TDS defaults, and streamlines payroll operations.

Illustration 1 - Assuming a Cost to Company (CTC) of Rs. 12,75,000
For instance, the illustrative restructuring of the compensation structure is as under:


Illustration 2 - Assuming a Cost to Company (CTC) of Rs. 20,00,000


Illustration 3 - Assuming a Cost to Company (CTC) of Rs. 39,00,000


Note: The above are only illustrative instances of the salary structure under alternative regimes and are not intended for tax planning purposes.

If the difference in income tax liability between both tax regimes is not significant then going for new tax regime may be more convenient for the taxpayers. They can get similar results with new tax regime without the corresponding paperwork required in the old tax regime. Overall, in case if the compensation structure is reviewed and recalibrating (refer illustration above), there could be significant reduction in the overall documentation requirements for both employer (to collect and retain documents) and to the employee (to submit eligible investment proofs).

It is pertinent to note that the rebate u/s 87A is available only on income taxed at normal slab rates under the new regime. Income subject to special tax rates such as short-term capital gains under Section 111A, long-term capital gains under Section 112A, or income from lotteries and betting, etc is not eligible for the rebate. Further, it is advisable to keep some cushion as the rebate is based on taxable income which includes not only salary income but other incomes such as dividend income, interest income, rental income, etc.

Conclusion

The liberalised tax framework introduced through the recalibrated New Tax Regime in Finance Act, 2025 presents a unique opportunity for both employers and employees to simplify salary structuring and enhance disposable income. With the increased rebate limit under Section 87A making net taxable income up to Rs. 12 lakhs completely tax-free, a well-aligned compensation strategy can eliminate the need for TDS deduction, reduce compliance overhead, and improve employee liquidity.

(The article is written by Dr Suresh Surana, a practising chartered accountant.


(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com)