Understanding Section 87A Rebate and Capital Gains Tax: Recent Controversies and Legal Interpretations
Facts and Issues of the Case
In the Indian tax landscape, Section 87A of the Income Tax Act, 1961, provides a rebate to resident individuals whose total income does not exceed a specified threshold. This provision aims to offer tax relief to individuals with lower income brackets. However, a significant controversy emerged regarding the applicability of this rebate to incomes taxed at special rates, particularly short-term capital gains (STCG) under Section 111A.
The crux of the issue lies in the interpretation of whether the rebate under Section 87A applies to STCG, which is taxed at a special rate of 15% under Section 111A. While Section 112A explicitly restricts the rebate for long-term capital gains (LTCG), Section 111A does not contain such a restriction. Despite this, the Income Tax Department, through updates to its tax filing utility software, began disallowing the rebate for STCG, leading to confusion and disputes among taxpayers. Taxpayers who had claimed the rebate on STCG found themselves receiving tax demand notices, as the Centralized Processing Centre (CPC) adjusted or denied the rebate claims. This administrative action, taken without a corresponding legislative amendment, raised questions about its validity and the rights of taxpayers to claim rebates on special rate incomes.
Observations by the Court and Tribunal
The controversy reached the judiciary when the Chamber of Tax Consultants filed a Public Interest Litigation (PIL) before the Bombay High Court. The court observed that the Income Tax Department’s action of modifying the utility software to prevent taxpayers from claiming the rebate on STCG was arbitrary and lacked legislative backing. The court emphasized that administrative tools should not override substantive rights granted by law. In its interim order, the Bombay High Court stated that procedural changes, such as software modifications, cannot curtail the statutory rights of taxpayers. The court highlighted that any ambiguity in the law should not be unilaterally interpreted by the revenue authorities to the detriment of taxpayers. It stressed the importance of adhering to the rule of law and ensuring that taxpayers are not denied benefits due to administrative decisions lacking legal authority.
Furthermore, the court noted that while the issue of rebate applicability to STCG is debatable, the revenue cannot assume its interpretation is conclusive and prevent taxpayers from making bona fide claims. Such actions, the court observed, violate constitutional principles and the rights of taxpayers to have their claims adjudicated through proper legal channels.
Applicable Law
Section 87A of the Income Tax Act provides a rebate to resident individuals whose total income does not exceed a specified limit. The rebate amount and eligibility criteria have evolved over time, with the Finance Act, 2025, proposing to increase the income threshold for the rebate under the new tax regime to ₹12 lakh and the maximum rebate amount to ₹60,000. Section 111A deals with the taxation of STCG arising from the sale of equity shares and mutual funds where Securities Transaction Tax (STT) has been paid. Such gains are taxed at a special rate of 15%. Notably, Section 111A does not explicitly restrict the applicability of the Section 87A rebate. In contrast, Section 112A, which pertains to LTCG, explicitly states that the rebate under Section 87A is not available for such gains. The absence of a specific restriction in Section 111A has led to differing interpretations. Tax experts argue that, in the absence of an explicit prohibition, the rebate should be available for STCG. The Income Tax Department’s administrative action to disallow the rebate through software changes, without a legislative amendment, has been a central point of contention.
Conclusion by the Tribunal or Court
The Bombay High Court’s observations underscore the principle that administrative actions cannot override statutory provisions. The court’s interim order serves as a reminder that taxpayers’ rights must be protected and that any changes affecting these rights should be enacted through proper legislative processes. While the Finance Act, 2025, has proposed amendments to clarify the inapplicability of the Section 87A rebate to special rate incomes, including STCG, these changes are prospective and do not affect previous assessment years. Therefore, for the assessment year 2024-25, taxpayers who claimed the rebate on STCG may have valid grounds to contest any demand notices issued by the tax authorities. Taxpayers facing such issues are advised to consult with tax professionals and consider filing appeals or representations to assert their rights. The situation highlights the importance of clear legislative drafting and the need for administrative actions to align with the law. As the legal interpretations evolve, taxpayers must stay informed and proactive in safeguarding their entitlements under the tax laws.
