The impact of increase in the rebate u/s 87A on your Income Tax


In the recent announcement in the Interim Budget on 1st February, the Honorable Finance Minister had announced an increase in the tax rebate to Rs. 5,00,000.

Since, the announcement there has been a lot of confusion with regards to the type of tax concession it is. Whether it is an increase in the income tax slab or is it the rebate u/s 87A?

And for those who are not aware of the section 87A, they are even more confused as how is this change going to affect their income tax liability without a change in income tax slab rate.

Let's simplify all of it, step by step.

Let's begin with how the tax was calculated initially.

Case I: Calculation of Income Tax without Rebate u/s 87A

Taking an example, say a person earned Rs. 5 lakhs p.a. Out of this income his investments are Rs. 1.5 lakh which are tax deductible.


Income before investment

5,00,000

Tax deductible investment

1,50,000

Balance - Taxable Income

3,50,000


Now, this Balance taxable income is taxed according to the income tax slab, which is,


Income Tax Slab

Rate

0-2,50,000

0

2,50,000 - 5,00,000

5%

5,00,000- 10,00,000

20%

Above 10,00,000

30%


Please note that this income tax slab rate can change. We are taking the slab rate which are applicable for current year i.e. FY 2019-20 as it is remains unchanged.

Now this taxable income of Rs. 3,50,000, will be taxed keeping the above slab in mind,


Income Tax Slab

Rate

Taxable Income (Rs. 3,50,000)

0-2,50,000

0

2,50,000

2,50,000 - 5,00,000

5%

1,00,000

5,00,000- 10,00,000

20%

-

Above 10,00,000

30%

-


So whatever is your balance income after deducting the investments, you divide it according to the slabs. Referring the above table if your taxable income was say Rs. 6,00,000 then you will divide the first 2,50,000 in the first slab then the next 2,50,000 in the second slab the balance 1,00,000 in the third slab.

Now, multiply the corresponding rate to the income to get your tax liability,


Taxable Income (Rs. 3,50,000)

Rate

Tax Liability

2,50,000

0

-

1,00,000

5%

5000

-

20%

-

30%


Here, the tax liability comes out to be Rs. 5000.

This is how the tax is normally calculated. I am not adding the Health and Education Cess @ 4% for easier calculation. It will help to keep the data simple.

Case 2: Calculation of tax liability with Rebate u/s 87A (Old limits)

Now, let's talk about the much awaited Rebate u/s 87A,

The Rebate u/s 87A previously said that if your taxable income,(please note it is taxable income and not just income, which is arrived at after deductions, if any), is up to 3.5 lakhs, then under this section, whatever your tax liability is, you will get a flat rebate of Rs. 2500.

Let's refer back to our example,

Here our tax liability was Rs. 5000. And our taxable income was also Rs. 3.5 lakhs, not more than that.

Thus, we are eligible for the rebate u/s 87A, which makes our net tax liability to 5000 - 2500 = 2500.

Thus, reducing the tax liability to Rs. 2500.

Now, the point to note here is that, you will only get this rebate if your taxable income was up to Rs. 3.5 lakh. Even if it Rs. 3.6 lakhs, you will not be eligible for the rebate. And you will have to pay the tax just according to the slabs.

I hope by now the concept of rebate us 87A is clear.

Now, let's discuss the change in rebate u/s 87A and its impact on your income tax liability.

Case 3: Calculation of tax liability with revised limit of Rebate u/s 87A

The rebate u/s 87A has been increased from the Rs. 3.5 lakhs to Rs. 5 lakhs. And the deduction has been increased to Rs. 12,500.

To understand the impact of this change, let's take a fresh example with new figures,

Say now you earn Rs. 6.5 lakhs before investment. And you make a tax deductible investment of Rs. 1.5 lakhs


Income before investment

6,50,000

Tax deductible investment

1,50,000

Balance- Taxable Income

5,00,000


Now, this Balance taxable income is taxed according to the income tax slab, which is,


Income tax slab

Rates

0-2,50,000

0

2,50,000 - 5,00,000

5%

5,00,000- 10,00,000

20%

Above 10,00,000

30%


Now this taxable income of Rs. 500,000, will be taxed keeping the above slab in mind,


Income Tax Slab

Rate

Taxable Income (Rs. 5,00,000)

0-2,50,000

0

2,50,000

2,50,000 - 5,00,000

5%

2,50,000

5,00,000- 10,00,000

20%

-

Above 10,00,000

30%

-


Now, multiply the corresponding rate to the income to get your tax liability,


Taxable Income (Rs. 5,00,000)

Rate

Tax Liability

2,50,000

0

-

2,50,000

5%

12,500

-

20%

-

30%


Here, the tax liability comes out to be Rs. 12,500.

This is how the tax is normally calculated. I am not adding the Health and Education Cess @4% for easier calculation. It will help to keep the data simple.

Now, let's talk about the impact of change in Rebate u/s 87A,

As discussed earlier, the rebate u/s 87A has been increased from the Rs. 3.5 lakhs to Rs. 5 lakhs. And the deduction has been increased to Rs. 12,500.

Here, our taxable income is Rs. 5,00,000, which is in the revised limit of rebate u/s section 87A. But had it been the earlier limit of Rs. 3.5 lakhs we would not be eligible for the rebate.

Now, that we are eligible let's see how much rebate the revised limit of section 87A is allowing. It says that the deduction has been raised from Rs. 2,500 to Rs. 12,500.

Therefore, we can use this rebate to decrease our tax liability.

So, the revised tax liability after deduction become, Rs 12,500- 12,500 = 0.

As you can see, after the increase in the rebate limit now if you earn up to Rs. 500,000 of taxable income then you do not have to pay any tax.

So even if you are earning more than 5 lakhs, which is your gross income, with tax planning and making the right use of the deductions you can bring your taxable income to Rs. 5,00,000 you won't have to pay tax and you will save the Rs. 12,500.

But please keep in mind, if your taxable income increases even by Rs. 10,000 i.e. your taxable income become Rs. 5,10,000 then you will not be eligible for the rebate.

If there was an increase in the slab rate then it would benefit everyone. Even the ones who are in the higher tax brackets. But with change in the rebate u/s 87A, it is a targeted benefit only for the people who fall under the mid bracket earning Rs. 500,000 or less.

I hope this article helps to clear your confusion regarding the income tax slab and rebate u/s 87A. Please feel free to ask any questions in the comments below.

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Prerna Saraogi 
on 05 February 2019
Published in Union Budget
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