Section 87A Rebate & Health and Education Cess: A Hidden New Tax Regime Distortion
Under a fair tax system, an assessee with a higher income should never end up with a lower post-tax income than another person earning less. However, the way Section 87A rebate, marginal relief and the 4% Health & Education Cess operate together under the new tax regime can, in specific cases, break this basic equity principle.
This distortion is not widely appreciated, because most discussions stop at marginal relief on income-tax and ignore how cess is computed. When cess is added, an odd outcome appears: an assessee crossing the rebate threshold by a small amount can suffer a drop in net take-home income compared to someone earning less.
The root problem lies in the cliff-type structure of Section 87A rebate, the limited scope of marginal relief, and the independent levy of cess on the final income-tax.
The Policy Intention Behind Section 87A
Section 87A was introduced to grant relief to small and middle-income assessees by allowing a rebate of income-tax up to a specified income level. Under the new tax regime, this provision is structured so that once an assessee’s taxable income is within the rebate limit, the income-tax up to a prescribed amount is effectively reduced to zero.
In principle:
- Assessees below the rebate limit should pay no income-tax (subject to the ceiling in
Section 87A), - Assessees marginally above it should not be disproportionately worse off merely because they exceeded the limit by a small amount,
- Marginal relief is supposed to ensure that additional tax does not exceed additional income over the threshold.
While this looks sound on paper, the interaction with cess subtly changes the outcome.
How the Anomaly Appears in Practice (Salaried Case)
Consider two salaried employees under the new tax regime, both eligible for the standard deduction of ₹75,000. The computation below demonstrates how the anomaly surfaces when we compare their net take-home income:
Illustration – Two Employees Under New Tax Regime
Assumptions:
- Both opt for the new tax regime,
- Both avail standard deduction of ₹75,000,
- Cess is levied at 4% as Health & Education Cess on income-tax.
Particulars – Salary Comparison
| Particulars | Employee X | Employee Y |
|---|---|---|
| Gross Salary | 12,90,000 | 13,50,000 |
| Less: Standard Deduction | (₹75,000) | (₹75,000) |
| Taxable Income | 12,15,000 | 12,75,000 |
| Income-tax before rebate | 60,000 | 69,000 |
| Less: Rebate u/s 87A / Marginal Relief | 60,000 | 9,000 |
| Income-tax payable | Nil | 60,000 |
| Health & Education Cess @ 4% | Nil | 2,400 |
| Total Tax Liability | Nil | 62,400 |
| Net Take-home Income | 12,90,000 | 12,87,600 |
Key contrast:
- Difference in Gross Salary: ₹60,000
- Difference in Net Take-home: Employee Y, despite earning ₹60,000 more, takes home ₹2,400 less than Employee X.