Issue with Rebate under Section 87A for Capital Gain Tax: A Detailed Look

Summary: The Income Tax Department has begun processing tax returns with unexpected demands, particularly for those with capital gains income, due to the disallowance of the Section 87A rebate. This rebate, available under both the old and new tax regimes, offers a reduction in tax liability for incomes below specific thresholds. However, the department’s recent update to the ITR utility (on July 5, 2024) has caused confusion by incorrectly disallowing this rebate for various special rate incomes, such as short-term capital gains (STCG), even when they should still qualify. Long-term capital gains (LTCG) from equity shares or mutual funds are excluded from this rebate, but other special rate incomes, like speculative income and virtual digital assets (VDAs), still qualify. The discrepancy between the law and the ITR utility has raised concerns, leading to demands for corrective action from the Finance Ministry. Until these corrections are made, taxpayers are advised to wait before paying any demands based on this error, as the department is expected to reprocess affected returns.

Introduction:

The Income Tax Department has started processing several returns with demand, especially for taxpayers whose source of income is from capital gains. This main reason for the demand is the department is disallowing the rebate under Section 87A for capital gains under the new tax regime. In many cases, taxpayers are also not given the benefit of the unexhausted threshold limit, and only the basic rebate of Rs. 25,000 under Section 87A is being considered. This is leading to situations where even a simple return, with just Rs. 3,00,000 of capital gain income, results in a demand after processing.

Before diving into the issue, it is essential to understand the provisions of Section 87A.

Rebate Under Section 87A

A rebate is a reduction in the tax liability. Under Section 87A, the maximum rebate limit is Rs. 12,500 under the old tax regime and Rs. 25,000 under the new tax regime. This rebate can only be claimed if the taxpayer’s taxable income does not exceed the prescribed limit for that financial year. Under the new tax regime, resident individuals with taxable income up to Rs. 7,00,000 are eligible for the rebate. Under the old tax regime, the maximum annual income eligible for the rebate was Rs. 5,00,000, with a maximum rebate of Rs. 12,500.

How this Rebate Works under the New Regime and When It’s Not Applicable?

In the old regime, the maximum rebate was Rs. 12,500. Under the new regime, taxpayers with income less than Rs. 7 lakh are eligible for a rebate of up to Rs. 25,000 under Section 87A. In case the income exceeds Rs. 7 lakh, Rebate under marginal scheme will be available.

However, in certain cases, the rebate is not applicable, such as:

• For non-residents.
• On long-term capital gains from the sale of equity shares or equity-oriented mutual funds taxable under Section 112A.

Even if the total income is less than Rs. 7 lakh, the rebate is not available in above cases. However, other special rate incomes like STCG, speculative income, virtual digital assets (VDAs) etc. would still qualify for the rebate under Section 87A, as there is no specific provision disallowing it for these incomes.

The Problem: Mismatch Between the Act and ITR Utility

Up until July 5, 2024, there was no confusion regarding the rebate under Section 87A, and the e-filing portal was functioning properly. However, after updation of the new ITR utility on July 5, 2024, the department began incorrectly disallowing the rebate for various special rate incomes, including short-term capital gains (STCG) taxable at 15% under Section 111A. This change was made without any amendments to Section 87A or the respective special income sections of the Income Tax Act.

As a result, taxpayers with total incomes of up to Rs. 5 lakh (under the old regime) or Rs. 7 lakh (under the new regime) are being forced to pay tax on special rate incomes like STCG, which is against the provisions of the law.

Author’s Commentary on the Issue

According to Section 112A(6), the rebate under Section 87A is not available on long-term capital gains (LTCG) from the sale of listed equity shares or equity-oriented mutual funds. However, this restriction applies only to LTCG, not STCG. Therefore, taxpayers with STCG should still be eligible for the rebate under Section 87A.

While LTCG on listed shares and equity mutual funds is excluded from the rebate, LTCG on other assets like real estate or unlisted shares can still benefit from the rebate. Even other special rate incomes like speculative income and virtual digital assets (VDAs) still qualify for the rebate under Section 87A

Key Questions Raised by This Issue

• How can there be a discrepancy between the provisions of the Income Tax Act and the functioning of the ITR utility?
• Why was the tax computation in the utility changed mid-way through the filing period?
• If the department intended to disallow the rebate on capital gains, why did the portal allow filing with the rebate until July 5, 2024?

What Should Taxpayers Do Now?

If you have claimed the rebate under Section 87A on eligible income and your return has been processed with a demand, there is no need to rush to pay the demand immediately. Many representations have been made to the Finance Minister, including by BCAS, to correct the utility and processing system. Once these corrections are made, the department is expected to reprocess the returns automatically, nullifying any demands.

In summary, while the rebate under Section 87A remains a vital benefit for taxpayers with incomes below Rs. 7 lakh, the current ITR utility has created confusion. Until the issue is resolved, it’s advisable to wait for a correction rather than paying any unjustified tax demands.

Conclusion:

Generally, the Laws are declared well before the beginning of financial year so that assessee can plan his taxation. Why there is a sudden modification post 5th July for restricting 87A rebate after the end of FY that too after Lacs of ITRs have been filed availing such benefit. This is cruel/unethical move by the department impacting Lacs of assessee.

To avoid such discrepancies in the future, it is essential that the Income Tax Department ensures that any updates to the ITR utility are consistent with the provisions of the Income Tax Act. Before making any changes to the e-filing portal or return filing utilities, thorough testing and validation should be carried out to ensure alignment with the law. Additionally, timely communication regarding any amendments or changes to the filing process should be provided to taxpayers, reducing confusion and preventing unintended demands. By enhancing coordination between the legislative framework and the technology platforms, the department can prevent such errors and safeguard taxpayers from unnecessary financial stress. Clear and precise guidelines for both taxpayers and officers will ensure smooth compliance and foster confidence in the system.

I hope this article helps you understand the issue and provides guidance on how to address it effectively. In case of any query, you can reach out to me on [email protected].