Section 87A Rebate and Capital Gains
Section 87A of the Income Tax Act provides a tax rebate to resident individuals with total income up to Rs 7 lakh under the new tax regime (Rs 5 lakh under the old), effectively making their entire tax liability zero — however, a significant controversy arose from FY2023-24 onwards regarding whether this rebate can be applied against special-rate capital gains taxes, with ITAT rulings and CBDT clarifications creating conflicting guidance.
Section 87A was originally introduced in the Finance Act 2013 and has been progressively enhanced. Under the new tax regime, a rebate of up to Rs 25,000 is available for individuals with total income (inclusive of all income types) not exceeding Rs 7 lakh — effectively making the effective tax rate zero for taxpayers below this threshold. The provision appears straightforward but a technical controversy emerged around its interaction with special-rate capital gains.
The controversy centres on whether the Section 87A rebate can offset tax on short-term capital gains (STCG) from equity instruments taxed at 20% (post-Finance Act 2024, formerly 15%) under Section 111A or long-term capital gains (LTCG) taxed at 12.5% under Section 112A, for taxpayers whose total income including capital gains remains below Rs 7 lakh. The plain language of Section 87A states the rebate applies against the income tax payable — which would include taxes computed at special rates on capital gains. However, the ITD's software infrastructure (the ITR filing utility) initially refused to allow the rebate against special-rate capital gains, effectively treating the rebate as available only against tax on normal income.
Several taxpayers and tax professionals challenged this computational restriction. Multiple ITAT (Income Tax Appellate Tribunal) benches examined the issue. The Surat bench of ITAT, in a case decided in 2024, held that the rebate under Section 87A is a deduction from income tax payable computed under Chapter XII — and since STCG under Section 111A is computed as income tax (albeit at a special rate), the rebate should be available. This ruling aligned with the textual interpretation of the statute. However, CBDT subsequently issued a clarification through the ITR utility restricting the rebate against special-rate capital gains for FY2023-24 onwards, creating a direct conflict between the ITAT ruling and the administrative position.
The practical implication: a taxpayer with salary income of Rs 4 lakh and STCG of Rs 2.5 lakh (total income Rs 6.5 lakh, below the Rs 7 lakh threshold) would logically expect zero tax under Section 87A. The CBDT's utility-level restriction requires them to pay tax on the STCG component at 20%, resulting in Rs 50,000 of tax. If the ITAT interpretation prevails and is upheld by a High Court, this taxpayer is entitled to a refund. The matter remained unresolved and contested as of the most recent legislative session, making it one of the most practically significant pending tax controversies for retail equity investors.
Taxpayers navigating this issue for their FY2023-24 and FY2024-25 returns must decide whether to follow the CBDT utility position (pay tax, avoid scrutiny) or file claims based on the ITAT ruling (claim rebate, potentially face notices). The safer administrative path — particularly for taxpayers without the resources for ITAT litigation — is to follow the CBDT position and monitor Supreme Court or High Court developments on the issue.