Guide to Standard Deduction

Understanding Standard Deduction for Salaried Employees

Budget 2018: Standard Deduction makes a comeback after 13 years

With effect from 1st April 2018, standard deduction of Rs 40,000 (or the amount of the salary, whichever is less), would be allowed from salary income. However, at the same time Transport Allowance of Rs 19,200 and Medical Reimbursement of Rs 15,000 has been scrapped. So on a net basis, an additional deduction of Rs 5,800 is applicable for a person having “Income from Salary”.

What is Standard Deduction?

Standard deduction is basically a flat amount subtracted from the salary income before calculation of taxable income. No proof is required for claiming standard deduction. Conceptually, standard deduction is supposed to take care of expenses which are not allowed as deduction under income tax rules.

Advantage of Standard Deduction

Simplicity is the biggest advantage of standard deduction. It is allowed as straight deduction from Salary income. No bills or proof is required to be submitted to claim standard deduction.

Standard deduction available on Pension income

Standard deduction of Rs 40,000 is also available for person having pension income from former employer. In such cases pension income is taxed under the head “Income from Salaries” and accordingly the standard deduction of Rs 40,000 is available.

However pension income in the nature of annuity income from insurance companies or under National Pension Scheme (NPS) would not be eligible for standard deduction since such income is not in the nature of Salary. Such annuity would be taxed under the head “Income from Other Sources”.

History of Standard Deduction in India

Standard deduction was introduced for the salaried taxpayers in 1974. However it was discontinued from the assessment year 2006-07. Reason cited by the then Finance Minister Mr. Chidambaram for discontinuation of standard deduction was that general exemption limits were being raised, and the income slabs were being broadened. However these argument was fallacious, given that benefit of higher general exemption and income tax slabs is available to all assesses, regardless of nature of Income. The benefits cited were not exclusively for salaried person but available to person having income from business or other sources as well.

Before it was discontinued, i.e. in AY 2005-06 standard deduction was Rs 30,000 or 40% of salary (if salary did not exceed Rs 5 Lakhs); or a deduction of Rs 20,000 (if salary exceeded Rs 5 Lakhs).

Gross vs Net Income debate

Income tax by definition is levied on net income. A businessmen would deduct all business related expenses and pay tax only on Net Profit (and not on Gross Profit). Similarly when you sell any capital asset, tax is not paid on Gross receipts but is paid after deduction of cost of acquisition of asset and selling expenses from the Gross receipts. Taking forward the same logic, income from house property is taxed not on gross rental income, but after deducting municipal taxes and standard deduction of 30% of net annual value.

There is an exception to the rule. And an unfair one!

In a limited way, Income from Salary is taxed on gross basis. Not all legitimate expenses incurred by a person to earn Salary income are allowed as deduction. Only specific portion of Salary, i.e. some allowances like House Rent Allowance, Travel Allowance, etc are treated as tax free. There are limits applicable to the amount of these allowances regarded as tax free and any amount received in excess of this limit is taxable. It is to be noted that the employee might actually be incurring expense on House Rent or Travel in excess of the amount treated as tax free, but still the Salary income is not reduced by the entire expenditure amount, but only to the extent of applicable limit for these allowances.

Deductions from Salary is not allowed in terms of expense directly attributable to earning of that income. For example, expenditure incurred on travel and conveyance is directly attributable to earning Salary income and should thus be allowed as deduction without any limitation (Transport allowance was allowed earlier but amount of Rs 1600 per month is not commensurate with the expenditure incurred in most of the cases). Similarly any expense incurred in acquiring new knowledge or skill, which results in either enabling the person to maintain or enhance Salary income should be allowed as deduction. Expense incurred on subscription of journals or for buying books which enhances knowledge of an employee and enables him to earn this income should be allowed as deduction.

Standard deduction is supposed to take care of such expenses which are not allowed under the Income tax rules. Thus re-introduction of standard deduction moves the taxability under the head Salary from Gross basis to Net basis in a limited way. Amount of standard deduction ideally should be set as percentage of Salary income rather than having same amount for all. Amount of expenses incurred by a person will be directly proportional to salary levels. Hence fixing the standard deduction amount to a fixed amount regardless of the salary level is not sufficient, but is anyway a good start.

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