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Effective Tax Rate

Updated on July 18, 2023

The Effective Tax Rate (ETR) in India is a measure of the actual tax burden on an individual or business after accounting for various deductions, exemptions, and tax credits. It represents the rate at which their taxable income is effectively taxed, taking into consideration the progressive nature of the tax system.

To calculate the ETR, one needs to determine the total tax liability by considering applicable tax rates, including any surcharges and cess. Then, the total tax liability is divided by the taxpayer’s total taxable income to obtain the ETR.

Why is effective tax rate important?

Unlike the nominal tax rate, which is based on the tax brackets and tax rates specified in the income tax slabs, the ETR provides a more accurate reflection of the taxpayer’s overall tax burden. This is because the ETR considers the impact of different tax slabs, deductions, exemptions, additional taxes like cess and surcharge applicable after certain taxable income, and other provisions that may alter the effective tax liability.

The ETR helps individuals and businesses understand the proportion of their income or profits that goes towards paying taxes. It allows for a more meaningful comparison of tax burdens across different income levels or entities.

For example, if a taxpayer’s total taxable income is Rs. 10,00,000 and the total tax liability, including cess and surcharge, is Rs. 2 lakh, the ETR would be 20%. This means that, on average, the taxpayer is paying taxes at a rate of 20% on their taxable income, taking into account all applicable provisions.

Understanding the ETR is important for tax planning and evaluating the impact of tax deductions, exemptions, cess, and credits on one’s overall tax liability. By analyzing the ETR, individuals, and businesses can make informed decisions to optimize their tax obligations and manage their finances effectively.