Ongoing issues of Tax Rebate Section 87A on Special income wef 5th July 2024

Introduction

As per Section 87A of the Income Tax Act, 1961 which provides a rebate upto rupees 25,000 in case the income of an individual taxpayer is less than rupees 7 lakh under the new taxation regime, which result in no taxation on individual till the income of rupees 7 lakh.

In this article I am going to discusses this issue which is relating to the section 87A and change in utility, which came up after the department released a new utility on 5^th of July 2024 which focussed mainly on short-term capital gains on shares.

What is the Issue coming with the industry?

After COVID 2019, which gave a hype in trading and stock market, we all know that many taxpayers have both income short-term as well long-term capital gains from shares. The Income tax law clearly states that the rebate under Section 87A does not apply to long-term capital gains on shares (Section 112A). However, there is no such restriction in case of short-term capital gains which is arising as per section 111A of Income tax act.

Consequently, the rebate as per the section 87A of INR 25,000 was being allowed and given in case of short-term capital gains, and this practice was followed till July 5, 2024, hence making the taxpayers to smoothly claim this deduction for the short-term capital gains on shares, and it was even supported by the Income Tax utility on the e-filing site.

Now the question is those who filed their return and claimed the same before 5^th of July 2024 will get “defective return notice”? I don’t have any answer to this question!

What does this mean?

Until July 5, 2024, both taxpayers and the Income Tax portal utility had accepted that the rebate as per the Section 87A was applied to short-term capital gains. However, on July 5, 2024, the Income Tax utility was surprisingly changed to disallow the above rebate of INR 25000 on short-term capital gains from shares. This sudden change has caused confusion, especially since many taxpayers had already filed their returns considering the rebate.

What is defective return?

A return may be treated as defective on account of incomplete or inconsistent information in the return or in the schedules or for any other reason, for which we need to form a proper and satisfactory reply for the department.

What is a Legal point of view?

The Income tax law states that in case a taxpayer’s total income as per the the new tax regime is up to INR 7 lakh, they are eligible for a rebate of INR 25,000 or the amount of tax payable, whichever is less. This was the accepted interpretation until the unexpected change on July 5, 2024.

Dose that means it is as per the law which states a notwithstanding provision in case of new tax regime? Which means “Notwithstanding any provision” is a phrase that’s often used in legal documents to indicate that a statement or provision takes precedence over other conflicting clauses. It can also be used to express an exception to a rule, such as when a special situation allows a specific rule to be ignored

It is hereby written in starting of the law relating to new tax regime so is it taken into consideration with this new tax regime? You may comment below your views

What is the current situation and response?

If I am wrong in my analysis above, then this significant change in the utility may contradict the original intention of the law and has created unnecessary confusion. The Institute of Chartered Accountants of India as well as the Bombay Chartered Accountants Society have requested the Ministry of Finance to revert to the pre-July 5, 2024, situation.

What are the special rates and the applicability of Rebate?

When a taxpayer opts for the new tax regime, their entire income is considered under this regime. Even if a special rate of 15% applies to short-term capital gains, the taxpayer remains under the new tax regime, which is the basic requirement for the rebate under the Section 87A. The Section 111A which is dealing with short-term capital gains, does not explicitly disallow the rebate under Section 87A.

Let us Examine the Proviso

The proviso restricting the rebate under Section 87A states:

Provided that where the total income of the assessee is chargeable to tax under sub-section 115BAC, and the total income does not exceed seven hundred thousand rupees, the assessee shall be entitled to a deduction from the amount of income tax on his total income, on an amount equal to one hundred percent of such income tax or an amount equal to twenty-five thousand rupees, whichever is less

This proviso hereby has two parts the total income is chargeable to tax under subsection 115BAC and second one is the total income does not exceed ₹7 lakhs, hence as this proviso is already amended hence will this amendment supersede this Notwithstanding clause? Lets wait and watch what happens

The definition of total income is given in Section 2(45), which includes short-term capital gain from shares as part of total income.

Why Blocking Rebate 87A is Justified in the case of Long-Term Capital Gains on Shares?

Section 112A restricts the rebate under Section 87A for long-term capital gains on shares. However, Section 111A, which deals with short-term capital gains, does not have such a restriction, meaning the rebate should be available for short-term capital gains.

Rebate under Section 87A – Intent of Law

As per the Finance Bill 2023 and the budget speech of the Finance Minister that indicated that the rebate under Section 87A is meant for individuals with a total income up to ₹7 lakhs under the new tax regime. There was no mention of restricting the rebate for short-term capital gains on shares or any other income chargeable to special rates.

What Happened on July 5, 2024?

No change in law was made on July 5, 2024, justifying the restriction of the rebate of Section 87A on short-term capital gains. The restriction appears to be based on a misinterpretation of the law. The utility should be corrected, and taxpayers should be given more time to file their returns.

Let us discuss this with example

What was happening before 5 July 2024?

Suppose Shraddha have total income of Rs. 5,75,000 out of which Short Term Capital Gain u/s 111A is Rs 25,000, hence the tax liability of Shraddha is calculated as follows:

Tax on total Income:

Up to Rs 3,00,000: NIL
Rs 3,00,001 to 5,50,000: Rs 12,500 (2,50,000 * 5%)
Tax on STCG u/s 111A: Rs 3,750 (30,000 * 15%)
Total Tax: Rs 17,000
Rebate u/s 87A: Rs 17,000 (as total income is less than Rs 7 lakh)
Total Tax Payable: Rs 0 
 
Now what is happening after 5th July 2024?

In this case Shraddha would no longer receive the rebate on the STCG portion of her income as the rebate is only applied to the normal rate income as per the new utility, hence Tax Liability is calculated as follows:

Tax on total Income:

Up to Rs 3,00,000: NIL
Rs 3,00,001 to Rs 5,50,000: Rs 12,500 (2,50,000 * 5%)
Tax on STCG u/s 111A: Rs 3,750 (25,000 * 15%)
Total Tax: Rs 17,000
Rebate u/s 87A: Rs 12,500 (only on normal rate income)
Total Tax Payable: Rs 3,750 plus cess @4% i.e. Rs 3,900

Hence it is imposing burden on Shraddha who is earning short term capital gain and making her pay Rs. 3,900 as taxes

Conclusion

The sudden shift in the Income Tax utility on July 5, 2024, has an impact on the rebate under Section 87A for short-term capital gains. This change, which now disallows the rebate, has led to confusion and hassle. The law doesn’t limit this rebate for short-term capital gains. To align with the law’s original intent, the utility needs fixing.

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