No zero tax on Rs 7 lakh if stocks yield capital gains, warns expert after ITR rule change

A widely circulated claim suggesting that income up to Rs 7 lakh is completely tax-free under the new tax regime is now misleading after a crucial change to the Income Tax Return (ITR) utility released last year. Chartered Accountant Himank Singla has highlighted a significant shift in tax regulations that could impact retail investors with capital gains under Rs 7 lakh. An update to the Income Tax Return (ITR) utility, effective from 23 July 2024, affects the rebate under Section 87A, previously believed to offer complete tax relief for incomes up to Rs 7 lakh. Singla warns that "the idea that everyone earning up to ₹7 lakh pays zero tax is now factually incorrect in several cases."

The new update stipulates that any income taxed at special rates, such as short-term capital gains under Section 111A or long-term gains under Section 112A, disqualifies individuals from the Section 87A rebate. This means investors with even minimal capital gains may face unexpected tax liabilities. Singla explains, "After the 23.07.2024 update, if your income includes even ₹1 that is taxed at special rates—like short-term or long-term capital gains, or lottery winnings—you lose eligibility for the Section 87A rebate under the new regime."

Retail investors, particularly those in the stock market, may feel the brunt of these changes. According to Singla, "This means if you earn Rs 6.9 lakh in total, but Rs 10,000 of that is from capital gains, you will be taxed on the entire amount—no rebate," illustrating how even small gains could lead to higher tax obligations. "It’s a major blow to salaried individuals who dabble in the stock market or invest in mutual funds," Singla added.

He further notes that the rebate limitations under the new tax regime could dissuade individuals from investing in stocks and mutual funds. "This disincentivises retail investors, especially those who assumed small capital gains would not affect their tax liability," Singla observed. Previously, the old tax regime allowed rebates to offset some of these incomes, a benefit no longer available.

Understanding rebate under Section 87A

The rebate under Section 87A, intended to reduce tax liability for resident individuals, is now applicable only within strict parameters. For the financial year 2024–25, the rebate is limited to Rs 25,000 if total income is up to Rs 7 lakh. "The rebate can’t be used to offset long-term capital gains under Section 112A. That’s a critical detail many taxpayers overlook, especially those investing in equities or mutual funds," cautioned Singla.

The introduction of a marginal relief provision seeks to mitigate disproportionate tax burdens for those slightly exceeding the Rs 7 lakh threshold. However, Singla advises caution, stating, "Filing based on half-baked assumptions can lead to unnecessary tax outgo or notices. Know what qualifies, and file accordingly." 

Section 87A Rebate Eligibility (FY 2024–25)

In light of these complexities, Singla recommends that taxpayers carefully review their income sources before filing returns. Understanding the specific components of taxable income is crucial to avoid unexpected tax liabilities. This update underscores the need for taxpayers to be fully informed about their eligibility for rebates under the revised tax rules.

The recent changes reflect a broader effort to streamline tax benefits while ensuring compliance with the new regime. As taxpayers navigate these adjustments, awareness of how special rate incomes affect rebate eligibility is critical to optimising tax outcomes.