As discussions intensify ahead of the Union Budget 2026, a long-standing tax anomaly affecting small taxpayers has once again come under scrutiny. The Bombay Chamber of Commerce and Industry (BCCI) has urged the Finance Ministry to amend the Income Tax Act to ensure that individuals do not lose the benefit of the Section 87A tax rebate merely because they earn capital gains alongside modest regular income.
In its Pre-Budget Memorandum for FY 2026-27, the chamber has highlighted how taxpayers with relatively low incomes are being disproportionately burdened when their total income includes short-term or long-term capital gains, even if such gains arise from occasional transactions.
Why Small Taxpayers Lose the Section 87A Rebate
Section 87A of the Income Tax Act provides a rebate to resident individuals whose taxable income falls below a prescribed threshold, effectively reducing or eliminating their tax liability. However, the rebate does not apply to income taxed at special rates, such as short-term capital gains (STCG) under Section 111A and long-term capital gains (LTCG) under Section 112.
While Section 112A(6) offers limited relief by allowing the Section 87A rebate to be claimed on tax payable on "other income" after excluding LTCG on listed equity shares and equity-oriented mutual funds, similar relief is not available under Sections 111A and 112. This mismatch, BCCI argues, results in unfair denial of the rebate to taxpayers earning capital gains from other assets or short-term equity transactions.
Sections 111A and 112 Create an Uneven Tax Outcome
Section 111A governs short-term capital gains from listed equity shares, equity-oriented mutual funds and units of business trusts, provided securities transaction tax (STT) is paid. Such gains are currently taxed at a flat 20% for transfers made on or after July 23, 2024. Section 112, on the other hand, applies to long-term capital gains from most other capital assets such as land, buildings, gold and unlisted shares.
Because these sections lack a provision similar to Section 112A(6), taxpayers with total income between Rs 2.5 lakh and Rs 7 lakh lose their eligibility for the Section 87A rebate on normal income if they earn even a small amount of capital gains under these provisions. This results in a higher effective tax burden, despite their overall income remaining within the rebate threshold.
Capital Gains Tax Hikes Have Worsened the Impact
The issue has been further exacerbated by recent increases in capital gains tax rates. Short-term capital gains under Section 111A have risen from 15% to 20%, while tax on certain long-term capital gains under Section 112 has increased from 10% to 12.5%.
BCCI has pointed out that many of these capital gains are often one-time or incidental in nature, yet they push small taxpayers out of rebate eligibility, leading to a tax outcome that appears inconsistent with the government's stated objective of providing relief to lower and middle-income groups.
Key Recommendations Made to the Finance Ministry
To address this issue, BCCI has proposed that Sections 111A and 112 be amended to align with Section 112A(6). This would allow small taxpayers to continue claiming the Section 87A rebate on their slab-rate income, even if they earn capital gains taxed at special rates.
In addition, the chamber has recommended:
- Increasing the Section 87A rebate income threshold under the New Tax Regime from Rs 7 lakh to Rs 12 lakh
- Raising the maximum rebate amount from Rs 25,000 to Rs 60,000
- Ensuring that the rebate does not exceed the tax payable under Section 115BAC
- Retaining the exclusion of capital gains taxed at special rates from the rebate itself
What the Law Currently Provides
Under the New Tax Regime, for FY 2025-26, resident individuals with taxable income up to Rs 12 lakh are eligible for a rebate of up to Rs 60,000 under Section 87A. However, this rebate is restricted to income taxed at slab rates and does not apply to capital gains taxed at special rates, including STCG under Section 111A and LTCG under Section 112.
This position was explicitly clarified in Budget 2025. While salaried taxpayers earning up to Rs 12.75 lakh can still have zero tax liability due to the enhanced standard deduction of Rs 75,000, any capital gains earned during the year continue to attract tax irrespective of overall income levels.
Budget 2026 Could Offer a Course Correction
Tax experts believe that Budget 2026 presents an opportunity to rationalise the rebate framework and remove unintended hardships faced by small taxpayers. By extending limited rebate relief to cases involving capital gains, the government could restore parity across income categories while preserving the integrity of special tax rates.
As pre-Budget consultations gather pace, all eyes will be on whether the Finance Ministry addresses this long-pending issue and aligns the rebate structure with the broader goal of taxpayer-friendly reform.
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