Summary: The article highlights an unintended anomaly in the interaction between the rebate under Section 87A, marginal relief, and the 4% Health & Education Cess under the new tax regime. It demonstrates that a taxpayer earning slightly above the rebate threshold may end up with lower post-tax income than someone earning less, despite marginal relief limiting the income-tax liability. The anomaly arises because marginal relief applies only to income tax, while the Health & Education Cess continues to be levied on the reduced tax amount, resulting in an additional burden that can exceed the incremental income earned. The issue affects not only salaried individuals but also taxpayers with interest, rental, business, or other income taxable at normal slab rates. The article argues that this outcome violates the principle of tax equity and suggests a legislative amendment to extend the rebate or marginal relief to the total tax liability, including cess, ensuring that taxpayers earning more are never left with lower take-home income.
When Earning More Results in Taking Home Less: An Anomaly in Section 87A Rebate and Health & Education Cess
One of the cardinal principles of taxation is that a person earning a higher income should never be left with a lower post-tax income than a person earning less. Surprisingly, under the present design of the rebate under section 87A, read with the levy of the 4% Health & Education Cess, this principle does not always hold good.
Until recently, I too was under the impression that if one taxpayer earned ₹60,000 more than another, the worst possible outcome could only be that both would have the same net take-home income after tax because of the operation of marginal relief. To my surprise, I discovered that this assumption is incorrect.
Illustration – Salaried Taxpayers
Assume both individuals opt for the new tax regime and are entitled to the standard deduction of ₹75,000.
| Particulars | Employee A | Employee B |
| Gross Salary | 12,75,000 | 13,35,000 |
| Less: Standard Deduction | (₹75,000) | (₹75,000) |
| Taxable Income | 12,00,000 | 12,60,000 |
| Income-tax before rebate | 60,000 | 69,000 |
| Less: Rebate u/s 87A / Marginal Relief | 60,000 | 9,000 |
| Income-tax payable | Nil | 60,000 |
| Health & Education Cess@ 4% | Nil | 2,400 |
| Total Tax Liability | Nil | 62,400 |
| Net Take-home Income | 12,75,000 | 12,72,600 |
Difference in Gross Salary: ₹60,000
Difference in Net Take-home: Employee B receives ₹2,400 less than Employee A despite earning ₹60,000 more.
*Marginal relief effectively restricts the income-tax to ₹60,000, but the cess continues to be levied on that tax.
The Anomaly Is Not Restricted to Salary. The same issue equally affects taxpayers earning interest income, rental income, business income or any other income taxable at normal slab rates.
Consider the following example:
| Particulars | Taxpayer A | Taxpayer B |
| Taxable Income | 12,00,000 | 12,60,000 |
| Income-tax before rebate | 60,000 | 69,000 |
| Less: Rebate u/s 87A / Marginal Relief | 60,000 | 9,000 |
| Income-tax payable | Nil | 60,000 |
| Health & Education Cess @ 4% | Nil | 2,400 |
| Total Tax Liability | Nil | 62,400 |
| Net Income after Tax | 12,00,000 | 11,97,600 |
Here again, the taxpayer earning ₹60,000 more is left with ₹2,400 less after tax.
What Causes This Anomaly?
At first sight, it appears that the 4% Health & Education Cess is responsible. However, that is only partly true.
The real cause is the design of the rebate under section 87A, which creates a sharp cliff at the rebate threshold. Marginal relief attempts to soften this cliff by restricting the income-tax payable. However, the cess is still computed on the reduced tax, thereby increasing the liability beyond the additional income earned.
Thus:
- Section 87A creates the discontinuity.
- Marginal relief attempts to smooth it.
- The 4% cess amplifies the anomaly.
A Simple Legislative Solution
The anomaly can be eliminated by ensuring that the rebate or marginal relief applies to the aggregate tax liability, including the Health & Education Cess, rather than only to the income-tax component.
If the legislative intention is that a taxpayer earning marginally more should never be worse off than another earning less, then the total tax payable-including cess-should never exceed the additional income earned over the rebate threshold.
Conclusion
The present anomaly appears to be an unintended consequence of legislative drafting. While the objective of section 87A is to provide relief to middle-income taxpayers, its interaction with the Health & Education Cess produces a result that offends a basic principle of tax equity.
A small legislative amendment extending the benefit of marginal relief to the entire tax liability (including cess) would remove this anomaly and ensure that earning more never results in taking home less.
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