Income Tax Alert: Section 87A Rebate Not Allowed on Special Rate Income, Notices Sent to Taxpayers

Siddhi Jain | September 24, 2025 11:15 AM CST

The Income Tax Department has clarified that taxpayers cannot claim Section 87A rebate on income taxed at special rates, such as short-term capital gains (STCG). Several individuals who claimed this rebate while filing returns for the financial year 2023–24 are now receiving notices, with the department demanding payment of the pending tax amount.

Why Section 87A Rebate Is in Focus

Under the new tax regime in FY 2023–24, individuals with an annual income of up to ₹7 lakh were eligible for a tax rebate under Section 87A, effectively reducing their tax liability to zero. In the old regime, this rebate was applicable only up to ₹5 lakh.

However, the Central Board of Direct Taxes (CBDT) has once again emphasized that rebates are not applicable on income taxed at special rates, such as STCG under Section 111A. Despite this, many taxpayers claimed rebates on such income last year, leading to confusion and disputes.

Department Issues Notices, Sets Deadline

The Income Tax Department has made it clear that taxpayers who wrongly availed this rebate must pay the outstanding tax by December 31, 2025. A circular issued on September 19, 2025, highlighted that in some cases, returns were processed with rebates allowed even on special-rate income. These claims are now being corrected, and demand notices are being sent to taxpayers.

The department has further clarified that if the tax is not paid within the deadline, interest under Section 220(2) will also be charged on the pending amount. However, if payment is made before December 31, 2025, the interest component will be waived.

Past Court Intervention

The issue first gained prominence in July 2024, when the tax utility was updated to automatically restrict rebates in cases where income included STCG. This led to several taxpayers being denied the benefit, even though their total income was under ₹7 lakh.

The matter eventually reached the Bombay High Court, which in December 2024 directed the Income Tax Department to allow affected taxpayers to file revised returns between January 1 and January 15, 2025. Many taxpayers revised their filings in the hope of receiving rebate on STCG as well.

Despite these efforts, the department later issued intimations in February 2025, rejecting such claims and raising tax demands. The Union Budget 2025 also settled the matter, explicitly clarifying that from FY 2025–26 onwards, no rebate will be available under Section 87A if the income includes special rate components such as STCG.

Expert Opinions and Taxpayer Options

According to tax experts, taxpayers now have two choices: either settle the pending demand or pursue a legal battle.

Chartered Accountant Mayank Mohanka, founder of TaxAaram.com, explained:

“If the disputed amount is small, it is more practical to pay the outstanding tax rather than go for litigation. The Income Tax Department has categorically stated that rebate under Section 87A is not allowed on special rate income.”

Key Takeaways for Taxpayers

Section 87A rebate applies only to regular income, not on income taxed under special provisions like STCG (Section 111A).
Taxpayers who wrongly claimed rebates are receiving demand notices.
The deadline to clear dues is December 31, 2025; interest will be waived if paid before this date.
The matter has already been tested in court, but the government has clarified its stand in Budget 2025.
Going forward, NRIs and resident taxpayers alike must be cautious while filing returns and avoid claiming rebates on ineligible income sources.

Final Word

The latest circular from the Income Tax Department sends a clear message: rebates under Section 87A will not cover special rate income like short-term capital gains. With notices already reaching taxpayers and a strict deadline in place, individuals are advised to review their returns carefully and comply with the department’s demand to avoid further penalties.