De-Tax. Softening the blow for high income earners

The recent Budget has dealt a blow to the super-rich with a sharp increase in the tax surcharge. For individuals whose taxable income is more than ₹2 crore and up to ₹5 crore, the surcharge on tax has been increased from 15 per cent to 25 per cent. And for those whose taxable income is more than ₹5 crore, the surcharge has been increased from 15 per cent to 37 per cent.

With this, the maximum marginal tax rate will go up to 39 per cent for those in the ₹2 crore-5 crore taxable income bracket, and to 42.74 per cent for those with taxable income over ₹5 crore. That’s a jump of about 3 percentage points and 7 percentage points respectively from the earlier maximum marginal tax rate of 35.88 per cent.

With these new surcharge levels, there are now five categories of taxpayers – those with taxable income of a.) up to ₹50 lakh (no surcharge), b.) more than ₹50 lakh and up to than ₹1 crore (10 per cent surcharge), c.) more than ₹1 crore and up to ₹2 crore (15 per cent surcharge), d.) more than ₹2 crore and up to ₹5 crore (25 per cent surcharge), e.) more than ₹5 crore (37 per cent surcharge).

The hit from the surcharge spike can be substantial. For instance, an individual with taxable income of ₹2.1 crore will now pay ₹79.4 lakh as tax compared with about ₹73 lakh earlier — an increase of about ₹6.35 lakh. And someone with taxable income of ₹7.1 crore will now pay about ₹3 crore as tax compared with ₹2.52 crore earlier — a jump of about ₹48 lakh.

But there is a silver lining too for high-income earners who have to pay surcharge on tax. This is in form of marginal relief.

Small benefit

Thanks to this benefit, the increase in income tax due to surcharge will not be higher than the actual increase in income above the thresholds (₹50 lakh, ₹1 crore, ₹2 crore and ₹5 crore). In such cases, the surcharge will be restricted to the income above the threshold. This helps those with taxable income that is marginally higher than the thresholds.

Here’s an example. Say, an individual has taxable income of ₹50,10,000 (₹50 lakh and ten thousand). Given that his income is more than ₹50 lakh, he is subject to surcharge of 10 per cent on tax. So, his total tax liability (without marginal relief) will be ₹15,04,932, comprising ₹13,15,500 tax, ₹1,31,550 surcharge (10 per cent on tax) and ₹57,882 cess (4 per cent on tax plus surcharge).

Had the individual’s taxable income been ₹50,00,000 (₹50 lakh), he would not be subject to surcharge and his total tax liability would have been ₹13,65,000, comprising ₹13,12,500 tax, no surcharge and ₹52,500 cess (4 per cent on tax plus surcharge).

Now, see the illogic here. For an increase in taxable income of just ₹10,000 (₹50,10,000 less ₹50,00,000), the individual ends up paying ₹1,39,932 more in total tax (₹15,04,932 less ₹13,65,000). To avoid this anomaly, the taxman offers the benefit of marginal relief. It effectively restricts the increase in tax to the increase in income in such cases — about ₹10,000 or so in the above example.

Formula

This, it does through a formula. For incomes above ₹50 lakh up to ₹1 crore, Marginal relief = Calculated surcharge minus 70 per cent of (taxable income minus threshold income). In the above example, marginal relief = ₹1,31,550 minus 70 per cent of (₹50,10,000 minus ₹50 lakh). So, marginal relief equals ₹1,24,550. This marginal relief is reduced from the calculated surcharge to arrive at the actual surcharge. So, the actual surcharge is ₹7,000 (₹1,31,550 less ₹1,25,550). Now, based on this actual surcharge, the total tax liability on ₹50,10,000 works out to ₹13,75,400, comprising ₹13,15,500 tax, ₹7,000 surcharge and ₹52,900 cess (4 per cent on tax plus surcharge). In effect, thanks to marginal relief, the total tax liability has come down by nearly ₹1.3 lakh.

Note that the marginal relief benefit is available only on surcharge, and not on cess. So, in the above example, though the increase in taxable income above the threshold limit of ₹50 lakh is ₹10,000, the increase in total tax is ₹10,400. As the taxable income keeps increasing, to say ₹52,00,000, the marginal relief amount keeps reducing and eventually becomes zero. That’s when the relief stops.

Tweaks for higher thresholds

What happens when the taxable income crosses the ₹1-crore threshold and 15 per cent surcharge becomes applicable? For incomes above ₹1 crore, while calculating marginal relief, we also need to take into account the fact that if the taxable income was ₹1 crore (the threshold), the surcharge at 10 per cent would have been ₹281,250.

To that extent, the marginal relief will also reduce. So, the formula needs to be tweaked. Hence, for taxable incomes above ₹1 crore up to ₹2 crore, marginal relief = calculated surcharge minus 70 per cent of (taxable income minus threshold income) minus ₹2,81,250. Similar tweaks to the formula need to be done when the taxable income exceeds the thresholds of ₹2 crore and ₹5 crore.

To sum, marginal relief is based on the fair principle that increase in income tax should not exceed the increase in income. Says, Rakesh Nangia, Managing Partner, Nangia Advisors (Andersen Global), “Through marginal relief, even the affluent do not have to bear an unfair tax burden, on account of their income being marginally higher than the threshold. The law imposes the burden of nation building on the wealthy, but at the same time protects them from being unjustly taxed.”

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