Tax Demand Notices and Section 87A Rebate Issues: What Taxpayers Need to Know

Many taxpayers are currently facing income tax demand notices due to the denial of the Section 87A tax rebate on special rate income, such as Short Term Capital Gains (STCG), for the Income Tax Returns (ITRs) of FY 2023-24 (AY 2024-25). This issue, which was believed to be settled after the Bombay High Court judgment on January 24, 2025, has once again resurfaced, creating anxiety among small taxpayers.

Understanding Section 87A Tax Rebate

Section 87A provides a tax rebate to taxpayers with a total income of up to Rs 5 lakh under the old tax regime (resulting in a rebate of up to Rs 12,500) or up to Rs 7 lakh under the new tax regime (resulting in a rebate of up to Rs 25,000) for FY 2023-24 (AY 2024-25). This tax rebate can effectively reduce the net tax liability to nil for eligible income levels. Taxpayers are now faced with the dilemma of either complying with the tax notice or preparing to legally contest it. Although there is an option for filing a grievance or reprocessing request, experts are uncertain whether the tax department will acknowledge such requests due to the lack of official clarification regarding the rebate’s denial on special rate income like STCG.

The Origin of the Notices

The issue began on July 5, 2024, when the Income Tax Department modified its ITR utility software, prohibiting taxpayers from claiming the Section 87A tax rebate on special rate income, including STCG. Taxpayers who filed their ITR before this date could still claim the rebate, which has led to tax demand notices being issued since February 24, 2025, for those who did so.

As the due date to file original ITRs for FY 2023-24 (AY 2024-25) was July 31, 2025, with an extended deadline for belated or revised ITRs until January 15, 2025, many revised filings that claimed the Section 87A tax rebate on STCG were submitted around this time. Consequently, these ITRs are still in processing status and have been flagged with tax demands.

The Bombay High Court Ruling

On January 24, 2025, the Bombay High Court addressed the issue by questioning the rationale behind the removal of the Section 87A claim option from the ITR utility. The court emphasized that eliminating a claim option, which was previously available, cannot be justified merely on administrative discretion without legal grounding. The judgment urged the Income Tax Department to permit taxpayers to claim the Section 87A tax rebate on special rate income, but it also stated that the final decision would depend on judicial examination.

Current Taxpayer Recommendations

The recent Budget 2025 has introduced amendments that specify the Section 87A rebate will not apply to special rate incomes, effective from April 1, 2025. However, this amendment does not hold retrospective applicability, raising questions regarding the legitimacy of current tax demand notices for FY 2023-24 (AY 2024-25).

Taxpayers are advised as follows:

  • DA Prakash Hegde suggests small taxpayers may wish to refrain from contesting minor tax demand amounts related to the Section 87A rebate denial. He encourages professional bodies and law firms to take these issues to court collectively.
  • Rahul Jain, Director at Khaitan & Co, notes that while the Bombay High Court allowed taxpayer claims, it did not affirm the validity of those claims. Taxpayers should evaluate their next steps depending on the tax amounts involved, which may include filing appeals if challenged by the tax department.
  • CA Ashish Karundia highlights that those who have submitted rectification requests have often found no change in their tax demand status. Taxpayers are left with options: appeal to the CIT (Appeals) or pay the demanded amount. Similar cases have seen successful appeals, but this may vary.
  • CA Bimal Jain recommends taxpayers first file a rectification request and then register a grievance with the tax department. The CBDT should update its processing framework to accommodate the claims validly made.
  • CA Hardik Kakdiya criticizes the demand notices for being counter to the resolutions provided in the court and stresses the department’s duty to adhere to legal standards despite the ongoing bureaucratic processes.
  • CA Mihir Tanna remarks that conflicting provisions in the law may lead to continued litigation, with taxpayers advised to consider paying the disputed tax to avoid penalties.

Government Response and Future Actions

Taxpayers who receive tax demand notices should consider:

  1. Filing a Rectification Request: Assert that the tax demand is erroneous based on recent court decisions.
  2. Challenging the Notice Legally: If the rectification is denied, use the Bombay High Court’s ruling as legal support.
  3. Paying the Tax Demand: If ongoing disputes are not financially feasible, settling the tax may prevent further complications.

In conclusion, the situation surrounding the Section 87A tax rebate and associated tax demand notices remains complicated. Taxpayers should seek expert guidance tailored to their specific circumstances and remain vigilant about their rights in light of ongoing legal developments. The Income Tax Department must issue clear guidelines to resolve these issues promptly to alleviate taxpayer burdens.