Many taxpayers in India are confused after receiving income tax notices despite claiming the Section 87A rebate. If you have capital gains, this could be the reason. Find out why capital gains affect tax rebate eligibility and how to ensure compliance with the latest tax laws.

Understanding Section 87A Rebate and the Confusion Among Taxpayers

With the new tax regime in FY 2025-26, many taxpayers are unsure whether they qualify for the Section 87A rebate. This rebate provides relief to individuals with lower taxable income, reducing their tax liability to zero. However, those with capital gains are increasingly receiving tax notices. So, what’s causing this confusion? Let’s break it down.

What Is Section 87A Rebate?

Section 87A of the Income Tax Act, of 1961, allows eligible taxpayers to claim a tax rebate if their net taxable income falls within a specified limit. The rebate is available under both the old tax regime and the new tax regime but with different conditions.

Eligibility Criteria for Section 87A (As per FY 2025-26 Rules):

1. Applicable only to resident individuals – HUFs, firms, and companies cannot claim this rebate.
2. Income should not exceed ₹7,00,000 (for the new tax regime) and ₹5,00,000 (for the old tax regime).
3. Maximum rebate allowed – Up to ₹25,000 under the new regime and ₹12,500 under the old regime.

New Tax Regime vs. Old Tax Regime – How the Rebate Works

If your taxable income is within these limits, your tax liability becomes zero after claiming the rebate.

Does the Rebate Apply to Capital Gains?

No, capital gains are not considered for Section 87A rebate eligibility. The rebate applies only to tax on normal income (such as salary, pension, or business income) but not to special tax rates applicable to capital gains.

• Long-term capital gains (LTCG) over ₹1,00,000 are taxed at 10% and do not qualify for the rebate.
• Short-term capital gains (STCG) under Section 111A are taxed at 15% and are also excluded from rebate benefits.

This is one of the primary reasons why taxpayers with capital gains receive tax notices when they incorrectly apply the rebate on capital gains tax.

When Is the Rebate Allowed or Denied?

When the Rebate Is Allowed:

• The taxpayer is a resident individual (not HUF, firm, or company).
• Total taxable income (excluding LTCG and STCG) is ₹7,00,000 or less under the new tax regime.
• The taxpayer has only regular income sources, such as salary, pension, or business income.
• The tax liability before the rebate does not exceed ₹25,000 under the new regime or ₹12,500 under the old regime.

When the Rebate Is Denied:

• The total taxable income exceeds ₹7,00,000 (new regime) or ₹5,00,000 (old regime).
• The taxpayer has capital gains that are taxable separately (LTCG above ₹1,00,000 or STCG under Section 111A).
• The taxpayer is an HUF, partnership firm, LLP, or company, which are not eligible for the rebate.
• The taxpayer is filing under the old tax regime but has taxable income exceeding ₹5,00,000.

Why Are Taxpayers with Capital Gains Receiving Notices?

Despite meeting the income limit, many taxpayers are still receiving tax notices. Here’s why:

1.  Capital Gains Are Not Considered for Rebate Eligibility

Capital gains tax is calculated separately, and Section 87A does not apply to long-term or short-term capital gains taxed at special rates. Taxpayers who mistakenly claim the rebate on capital gains may receive a notice.

2.  Tax Filing Errors and Incorrect Computation

Common mistakes include:

• Not reporting capital gains separately in the correct section of the ITR.
• Claiming the rebate incorrectly even when taxable income (excluding capital gains) exceeds the limit.
• Choosing the wrong tax regime while filing an ITR, leads to errors in rebate calculation.

3.  Mismatch Between Tax Slab and Capital Gains Tax

Even under the new tax regime, capital gains tax rates remain separate from the regular tax slab system.

4.  Misinterpretation of the Rebate Provision

Many taxpayers assume that if their total taxable income (including capital gains) is within ₹7,00,000, they qualify for the rebate. However, the rebate does not apply to capital gains, leading to incorrect claims.

5.  Automated IT Department Alerts for High-Value Transactions

The income tax department tracks high-value transactions related to property sales, mutual fund redemptions, and stock trading. If these gains are not correctly disclosed, the system flags the inconsistency, resulting in tax notices.

6.  Underreporting of Capital Gains Due to Lack of Awareness

Some taxpayers fail to report capital gains accurately, leading to scrutiny, penalties, and tax notices.

What Should Taxpayers Do If They Receive a Notice?

If you receive an income tax notice related to an incorrect Section 87A rebate claim, follow these steps:

1. Read the Notice Carefully: Understand the reason for the notice and the discrepancies pointed out by the tax department.
2. Log into the Income Tax Portal: Go to the e-filing portal to check the details and response options.
3. Verify Your Tax Computation: Recalculate your taxable income, ensuring that capital gains have been reported correctly.
4. File a Revised Return (if necessary): If you made an error in your original return, file a revised ITR before the deadline.
5. Respond to the Notice: Use the online response system on the income tax portal to provide explanations or pay any additional tax if required.
6. Seek Professional Help: If you are unsure how to respond, consult a tax professional to avoid penalties or further scrutiny.

Final Thoughts

The Section 87A rebate offers valuable tax savings, but taxpayers with capital gains need to be cautious while claiming it. Capital gains tax is not eligible for rebate, which often leads to tax notices. By understanding the rules, filing the correct ITR form, and ensuring accurate tax computation, you can avoid unnecessary tax notices and penalties.

For expert guidance on understanding the confusion surrounding the Section 87A Rebate and why taxpayers with capital gains are receiving notices, or to clarify any doubts regarding the rebate, feel free to consult CA Pratik S. Kothari for professional assistance and accurate tax advice.