The latter are likely to benefit from a refund mechanism introduced by the 2019 Interim Budget. A refund is a deduction from the IT payable and Section 87A of the Information Technology Act allows for a full refund of tax for a person with income up to Rs. 5 lakh subject to an upper limit of Rs. 12,500. So while the basic exemption limit is Rs. 2.5 lakh , with the discount, a person with an income of up to Rs. 5 lakh bears no tax burden.
In fact, if the taxpayer takes full advantage of Rs. 1.50 lakh available as a deduction for various investments made during the year (such as government provident fund, home loan repayment, LIC premium, tax-saving mutual funds), gross income of up to Rs. 6.50 lakh may not attract IT at all. Further, if such taxpayer is salaried, the standard deduction of Rs. 50,000 would ensure that a gross income of up to Rs. 7 lakh may not attract tax. (See Case 1).
However, the same taxpayer may suffer a severe shock if he has realized long-term capital gains, for which a “concessional” tax rate of 20% is prescribed under section 112. For example , long-term capital gains resulting from the sale/transfer of debt mutual funds, unlisted shares, real estate are taxed under this section at 20%, with the benefit of indexing.
Need for Amendment: “Although the preferential tax rate under Section 112 may be an advantage for an individual in the higher tax bracket, it is very disadvantageous for an individual who receives his or her taxable income, including long-term capital gains, less than Rs. 5 lakh,” says Ketan Vajani, Chartered Accountant and Chairman of the House of Tax Advisors (CTC).In fact, this professional association has included this issue in its memorandum pre-budget presented to officials of the Ministry of Finance.
Vajani goes on to illustrate: A retired person sold his dwelling house and realized long term capital gains of Rs. 4,000,000. His other income, in that particular financial year, is only Rs. 75,000, bringing his total income to Rs. 4.75 lakh. According to the logic of section 87A, his tax liability should be nil.
Unfortunately, he will end up paying a tax of Rs. 32,500. Here is how (see case 2).
“Even after getting a refund, a refund of Rs. 12,500, this individual will end up paying Rs. 32,500 as the basic tax, plus a tax of Rs. 1,300, bringing his total tax to Rs. 33,800 In short, he pays taxes even though his total income is less than Rs. 5 lakh,” says Vajani.
The Chamber of Tax Advisors has indicated that given the inequity created, Article 112 should be amended. The long-term capital gains tax should be charged at 5% (instead of 20%), in cases where the total income, including this long-term capital gain, exceeds the limit of basic exemption of Rs. 2.5 lakh but less than Rs. 5,000,000.