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Surcharge and Marginal Relief in Income tax

surcharge-and-marginal-relief-income-tax

Government levies income tax on income earned by a person during a year. In certain cases, where the level of income goes beyond the certain limit, the government wants that they should contribute more to tax-kitty of the government than those earning a lower income. So the government imposes additional taxes on rich persons in addition to income tax already imposed and this additional tax is called ‘Surcharge’. The surcharge is a tax on tax. Since surcharge is levied on a person earning a high level of income, it is also called ‘super-rich tax’.
    Under Income Tax Law, presently for Assessment Year 2019-20 (Financial Year 2018-19), in case of an individual, a surcharge of 10% applies if income is more than Rs. 50 lakh but does not exceed Rs. 1 crore in a financial year. A surcharge is levied at 15% if income exceeds Rs 1 crore in a financial year. Thus, there is no surcharge if the income does not exceed Rs. 50 lakh.

    Similarly, a firm has to pay a surcharge of 12% if total income exceeds Rs. 1 crore.

    Surcharge applies over and above regular income tax. So if the tax rate is 30% and the surcharge is 10%, then, the total tax rate (including surcharge) comes to 33%, and not 40%. This is because the surcharge is a tax on tax. 

    Some numeric examples to show the effect of surcharge. 

    When Surcharge applies, the question of Marginal relief arises and comes into the picture. To understand the concept of marginal relief, we need to look back at the surcharge. As discussed, Surcharge applies if income exceeds a specified limit and that too on tax amount or tax rate. So, if the tax rate is 30%, the tax rate after surcharge of 10%, is 33% and not 30%+10%=40%.

    The concept of surcharge in income-tax is illustrated below-

    Income 
    100 
    100 
    Tax @ 30% 
    30 
    30 
    Surcharge @ 10% 
      3 
    10 
    Total 
    33 
    40 
    Result 
    Correct 
    Wrong 

    Due to the applicability of surcharge, one will find that a marginal increase in income over the specified limit beyond which surcharge applies, the total tax outgo is higher than the incremental income over the specified limit.

    This is illustrated below with the help of a numerical example.

    Computation of surcharge in case of a firm:

    In case of a firm, tax is levied at a flat rate of 30% on total income and a surcharge of 12% is applicable if the total income exceeds Rs. 1 crore and is computed with and without surcharge case in the following manner-

     Particulars              
     Case 1
    No Surcharge case   
     Case 2  
    Surcharge case  
     Total Income     70,00,000 1,10,00,000
     Tax @ 30%  21,00,000 33,00,000
     Add: Surcharge @ 12%     NA 3,96,000
     Total Tax 21,00,000 36,96,000
    Note: Health and Education Cess of 4% is ignored

    In the case of individuals where tax is computed on a slab basis, the surcharge is computed in the manner given below-

    Particulars

    Case 1

    No Surcharge case   

    Case 2  

    Surcharge case  

    Total Income    

    40,00,000

    60,00,000

    Tax 

    10,12,500

    16,12,500

    Add: Surcharge @ 10%    

    NA

    1,61,250

    Total Tax

    10,12,500

    17,73,750

    Note: Health and Education Cess of 4% is ignored

      Income Slab

    Tax rate

    Tax amount

    Upto Rs. 2.50 Lakh

    Nil

    Nil

    Rs. 2.5L to Rs. 5L (Rs. 2,50,000)

    5%

    12,500

    Rs. 5L - Rs. 10L (Rs. 5,00,000)

    20%

    1,00,000

    Above Rs. 10 Lakh

    For Rs. 40L = 40-10 = Rs. 30L


    30%

    9,00,000

    For Rs. 60L = 60-10 = Rs. 50L

    15,00,000

    Total Tax for Rs. 40 Lakh income


    10,12,500

    Total Tax for Rs. 50 Lakh income


    16,12,500


    The above table exhibits how to compute the tax and surcharge on tax.

    Now consider the following cases of a firm-

    Particulars

    Case 1

    No Surcharge case   

    Case 2  

    Surcharge case  

    Effect of marginal increase

    Total Income    

    1,00,00,000

    1,01,00,000

    1,00,000

    Tax @ 30%

    30,00,000

    30,30,000

    30,000

    Add: Surcharge @ 12%    

    NA

    3,63,600

    3,63,600

    Total Tax

    30,00,000

    33,93,600

    3,93,600

    Income after tax

    70,00,000

    67,06,400

    (-)2,93,600


    With the above table, it is clear that for an increase in income by Rs. 1,00,000 over Rs. 1 crore, total tax outgo increased by Rs. 3,93,600 which has resulted in after-tax income by Rs. 2,93,600. The net income after-tax actually decreased even after higher pre-tax income. This anomaly in after-tax income is due to the applicability of surcharge only.

    From the equity point of view, one should not have lower after-tax income due to surcharge. It is totally unjustified if a person is earning a higher pre-tax income should have a lower after-tax income. No doubt a person earning a higher income should pay higher tax but at the same time, it should not be a case where a person earning a higher pre-tax income should pay so much of higher tax that his after-tax income goes below the level of income of the person who has lower pre-tax income. At best, both should have the same after-tax income i.e. Rs. 70,00,000 in the given case.

    From the above table, it is seen that after-tax income in case 2 is reduced by Rs. 2,93,600 from the level of Rs. 70,00,000. To bring the after-tax income to the level of Rs. 70,00,000, the surcharge needs to be reduced by that amount since after-tax income is reduced only due to surcharge. It must be remembered that tax of Rs. 30,000 on the additional increase of income of Rs. 1,00,000 has to be paid under all the circumstances. Hence, the reduction in post-tax income of Rs. 2,93,600 is required to be reduced from the computed surcharge of Rs. 3,63,600. After the reduction of the surcharge, the new surcharge comes to Rs. 70,000 (Rs. 3,63,600 - Rs. 2,93,600).

    If surcharge of Rs. 70,000 is levied on total income of Rs. 1,01,00,000, the after-tax income will be Rs. 70,00,000 which is similar to case 1. Further, the total tax payment is more in case 2 than case 1 since case 2 is earning a higher pre-tax income, as shown below-

    Particulars

    Case 1

    No Surcharge case   

    Case 2  

    Surcharge case  

    Effect of marginal increase

    Total Income    

    1,00,00,000

    1,01,00,000

    1,00,000

    Tax @ 30%

    30,00,000

    30,30,000

    30,000

    Add: Surcharge @ 12%    

    NA

    3,63,600

    70,000

    70,000

    (3,63,600-2,93,600)

    Total Tax

    30,00,000

    31,00,000

    1,00,000

    Income after tax

    70,00,000

    70,00,000

    0


    In this context, it should be noted that the reduction in after-tax income which in turn reduces the computed surcharge is called as 'Marginal Relief'.

    To overcome the anomaly in after-tax income due to higher incidence of the surcharge and to provide relief for the marginal increase in income over the specified limit beyond which Surcharge applies, the concept of Marginal Relief is introduced and enshrined in law.

    One will find the legal provisions proving marginal relief in the Finance Act of every year itself. Part-I of First Schedule read with section 2 of the Finance Act incorporates the provision of Marginal relief or MR.

    For example, Section 2(3) and Part-I of First Schedule of Finance Act, 2018 provides as follows-

    First proviso to Section 2(3) of Finance Act, 2018-

    Provided that the amount of income-tax computed in accordance with the provisions of section 111A or section 112 of the Income-tax Act shall be increased by a surcharge, for the purposes of the Union, as provided in Paragraph A, B, C, D or E, as the case may be, of Part I of the First Schedule: 

    Part-I of First Schedule – specifies rates of surcharge for different persons and different specified limit beyond which surcharge shall apply for those persons. For example, in case of a Firm, the surcharge is levied as per the expression as given below- 

    Surcharge on income-tax 

    The amount of income-tax computed in accordance with the preceding provisions of this Paragraph, or the provisions of section 111A or section 112 of the Income-tax Act, shall, in the case of every firm, having a total income exceeding one crore rupees, be increased by a surcharge for the purposes of the Union calculated at the rate of twelve per cent. of such income-tax:

    And, the Marginal Relief is enshrined in law with the following words- 

    Provided that in the case of every firm mentioned above having total income exceeding one crore rupees, the total amount payable as income-tax and surcharge on such income shall not exceed the total amount payable as income-tax on a total income of one crore rupees by more than the amount of income that exceeds one crore rupees. 

    In other words, total income tax payable as income tax and surcharge shall not exceed the additional income over Rs. 1 crore limit or other specified limit for surchrge, as the case may be


    The law nowhere used the term 'Marginal Relief’ but is used in the 'Explanatory Notes' to state that Marginal relief has also been provided in all cases where surcharge is proposed to be levied.

    In this article, only the case of a Firm is taken for the purpose of explaining the legal expression that is used to levy surcharge and provides marginal relief. One may refer to the Finance Act, 2018 or of any year to read the provisions related to a surcharge and marginal relief for other persons.

    How to compute Marginal Relief and 'Surcharge' after Marginal Relief? 

    In the computation of tax liability, one needs to calculate the 'surcharge' and not the marginal relief. However, one can calculate the marginal relief too separately for knowledge purpose.

    Computation of Marginal Relief

    Arithematically, one can calculate the marginal relief in the following manner.

    Step 1: Calculate the surcharge on the tax amount. 
    Step 2: Calculate the excess income over Rs. 1 crore (the specified limit over which surcharge applies)
    Step 3: Multiply the amount determined in step 2 with 0.70 (which is the after-tax rate, where the tax rate is 30%)
    Step 4: Marginal Relief is the difference between the amount determined in step 1 and step 3.

    In excel formula, marginal relief can be computed as below

    MR = Calculated Surcharge on tax on Total Income - 0.7 * (Total Income - 10000000)

    In excel terms, the formula will be

    =B2-(0.7*(B1-10000000))


    Where cell B1 contains the total income amount and cell B2 contains the tax amount.

    Excel formula to compute the Surcharge on Total Income with marginal relief:

    =MIN(0.7*(B1-10000000),0.12*(B2))


    Where cell B1 contains the total income amount and cell B2 contains the tax amount. This formula will take care of the marginal relief and compute the final surcharge amount as applicable for the given total income.

    Particulars

    Case 1

    No Surcharge case   

    Case 2  

    Surcharge case with marginal relief  

    Case 3  

    Surcharge case with no marginal relief  

    Total Income    

    1,00,00,000

    1,01,00,000

    1,08,00,000

    Tax @ 30%

    30,00,000

    30,30,000

    32,40,000

    Add: Surcharge @ 12%    

    NA

    70,000

    3,88,800

    Total Tax

    30,00,000

    31,00,000

    36,28,800

    Income after tax

    70,00,000

    70,00,000

    71,71,200

    Marginal Relief

    NA

    2,93,600

    0


    Cess is nullifying the relief – How cess increases the tax liability and nullifies the relief given by the Marginal Relief? 

    Please note that Marginal Relief is given for Surcharge only and not for Cess. Note that even though marginal relief provides relief for a marginal increase in income beyond the specified limit over which surcharge applies but no such relief is given for cess. Thus total tax outgo increases after cess are applied. The total tax outgo may take out part of income after cess is applied. 

    Where MR applies in case of surcharge, the net tax payable actually rises because of the higher base amount of total income on which tax is calculated and subsequent relief is given. It results in lower after-tax income. However, where the surcharge applies in full without MR, no such anomaly occurs.

    Particulars

    Case 1

    No Surcharge case   

    Case 2  

    Surcharge case with marginal relief  

    Case 3  

    Surcharge case with no marginal relief  

    Total Income    

    1,00,00,000

    1,01,00,000

    1,08,00,000

    Tax @ 30%

    30,00,000

    30,30,000

    32,40,000

    Add: Surcharge @ 12%    

    NA

    70,000

    3,88,800

    Total Tax

    30,00,000

    31,00,000

    36,28,800

    Health & Edu. Cess @ 4%

    1,20,000

    1,24,000

    1,45,152

    Total Tax liability

    31,20,000

    32,24,000

    37,73,952

    Income after tax

    68,80,000

    68,76,000

    70,26,048

    Marginal Relief

    NA

    2,93,600

    0

     
    From the above table, it is clear that even though due to marginal relief the post-tax income is the same but if the cess is considered the after-tax income gets reduced by Rs. 4,000. A person earning Rs. 1 crore is earning an after-tax income of Rs. 68.80 Lakh whereas the after-tax income is Rs. 68.76 Lakh for a person earning Rs. 1.01 crore before paying tax.

    When it is opined that Marginal Relief on surcharge is given to relief for an increase in tax which is disproportionate to increase in income but such logic does not apply in case of cess. This anomaly is still continuing. It is a point to ponder why the law left cess out of the purview of marginal relief? 

    Another such anomaly and increase in tax which is disproportionate to income are found in case of rebate that is allowed u/s 87A of the Income Tax Act, 1961. 

    Rebate u/s 87A in tax amount is allowed up to Rs. 12,500 if the total income does not exceed Rs. 5,00,000 (from FY 2019-20 or AY 2020-21). Thus, if the Total Income is Rs. 5,00,000 in a previous year, the tax liability is Rs. 12,500. After claiming rebate u/s 87A of Rs. 12,500, the final or net liability will be reduced to 0 (zero). 

    However, if the total income is Rs. 5,00,001 then no rebate u/s 87A will be allowed and total tax liability comes to Rs. 12,500. Therefore, by earning Re 1 more, the person has to shed Rs. 12,500 towards income-tax because there is no concept of marginal relief for a rebate that is allowed u/s 87A of the Income Tax Act, 1961 and results in higher tax liability which is disproportionate to increase in income.

    Excel sheet to calculate Surcharge and Marginal Relief





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