Finance Minister Nirmala Sitharaman announced on Saturday that Indians with incomes up to ₹12 lakh will effectively pay no income tax. They still need to pay the tax, but will receive a rebate of ₹60,000 under Section 87A of the Income Tax Act. However, certain types of income, including capital gains from selling stocks and property, are not eligible for tax rebates.
Let’s say Mr A has annual income of ₹12 lakh. On the surface, it looks like a happy situation since there’s no tax on income up to ₹12 lakh under the new regime. But if only ₹10 lakh of this is salary income and ₹2 lakh is from selling equities or property, he will still need to pay capital gains tax on the ₹2 lakh gains. “Rebates cannot be applied to capital gains taxed at special rates,” confirmed Anurag Jain, co-founder & partner at ByTheBook Consulting LLP.
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Luckily, debt mutual funds bought after April 2023 fall under Section 50AA and are eligible for such rebates, though units bought before April 2023 don’t qualify. “The thumb rule to follow is that whatever is taxed at slab rates is eligible for a tax rebate under Section 87A and those incomes that are taxed at special rates, like capital gains from stocks, equity MFs, and properties will not be eligible for Section 87A rebate,” said Siddharth Deb, director, people advisory services tax, Ernst & Young.
How will this benefit investors?
To keep things simple, let’s say someone just retired and redeemed a part of her debt mutual fund portfolio that was acquired after April 2023. She has no other active income. Now let’s compare what would happen if she sold it before and after April 2025, when the changes announced in the Budget will take effect.
Let’s say she booked a ₹12 lakh capital gain before April 2025. This is treated like any other income and taxed at the slab rate. Under the new tax regime, once this income exceeds ₹3 lakh, it becomes taxable at slab rates. As per Ernst & Young, she would have paid ₹83,200 tax on this, including education cess if she sold before April 2025.
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If she sold the same debt mutual fund after April, it would attract zero tax thanks to an increase in tax rebate under Section 87A. Recall that there is effectively no tax up to ₹12 lakh of income per year. That’s a direct tax saving of Rs.83,200. You might be wondering how this is possible as we mentioned that there’s a maximum rebate of Rs.60,000 under Section 87A.
That’s because Budget 2025 announced that the basic exemption limit would be increased from ₹3 lakh to ₹4 lakh. It also made various tweaks to the tax rate in various income slabs under the new tax regime, further sweetening the deal for middle-class Indians even without the Section 87A rebates.
What about debt funds bought before April 2023?
Debt mutual funds bought before April 2023 fall under Section 122 and do not qualify for rebates. That’s because they are taxed differently than normal income. If they are held for more than 24 months (long-term capital gains), they are taxed at 12.5%.
That said, they also benefit from the recent Budget. Two scenarios could arise – when sold before and after April 2025.
Say a person who booked ₹12 lakh in capital gains had invested before April 2023. If she sold before April 2025, she would have to start paying taxes on income exceeding ₹3 lakh because that was the previous exemption limit. So she would have to pay 12.5% tax on ₹9 lakh of capital gains, or ₹1,12,500. After adding ₹4,500 education cess, it would be Rs.1.17 lakh, according to EY.
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But if she sold after April 2025, there would be no tax on up to ₹4 lakh of income, meaning the 12.5% tax would kick in after ₹4 lakh. Her total tax liability would drop to Rs.1.04 lakh (12.5% of ₹8 lakh).
“Under the new tax regime, the basic exemption limit was increased from ₹3 lakh to ₹4 lakh in the recent Budget. Since this example assumes the person has no other income, the 12.5% LTCG will be calculated on gains above ₹4 lakh as compared to ₹3 lakh before,” said Deb of Ernst & Young.
So, what should you do?
Jain of ByTheBook Consulting said investors should first check whether they acquired their debt mutual funds before or after April 2023 since this would significantly alter their tax bill. Secondly, the recent changes announced in the Budget will take effect from April, so unless there is an urgent need, you can save tax by selling those debt MFs on or after 1 April.
“It is advisable to take the help of a professional as this can get complicated,” said Jain. “It’s important to know which income is eligible for Section 87A rebates and which will be taxed at special rates with no rebate.”
