Why is tax-free income Rs. 12.5 L in new tax regime?

For the current financial year 2025-26, the widely quoted figure for tax-free income under the new tax regime is Rs. 12.75 lakh - a number cited in government press releases, Parliamentary discussions, and newspaper reports. It was presented as the threshold under which a salaried taxpayer would pay no tax to the government under the new tax regime. However, a closer look at the Finance Act, 2025 reveals an unexpected discrepancy - the actual tax-free income limit for small taxpayers is Rs. 12,50,000 under the new tax regime.

This discovery raises an important question: Why does this variance exist? Let's break it down step by step.

The tax-free income structure under the new tax regime
At first glance, the tax-free income of Rs. 12.75 lakh under the new tax regime seems straightforward. However, this relief is not available to all taxpayers but applies specifically to small taxpayers who meet certain conditions.
Here's the breakdown of how the tax-free income was originally understood:
1. The taxpayer earns a total taxable income, including salary, of Rs. 12.75 lakh.
2. He opts for the new tax regime under section 115BAC.
3. A standard deduction of Rs. 75,000 is claimed (as per the new tax regime, which allows a higher deduction than the old tax regime).
4. After the deduction, the taxable income stands at Rs. 12 lakh.
5. Tax payable on Rs. 12 lakh is Rs. 60,000, per the income tax slab rates under the new tax regime announced in the Budget 2025.
6. The taxpayer claims the section 87A tax rebate of Rs. 60,000, reducing the net tax liability to nil.

Looking at the structure, it appears perfect. However, when applying the Finance Act, 2025, provisions precisely as written, it turns out this scenario does not hold true for the current financial year 2025-26. The issue stems from the interaction between three key provisions- Section 16 (Deductions from salary income), Section 87A (Tax rebate), and Section 115BAC (New tax regime)-which fail to work together seamlessly.

The mismatch in the Finance Act, 2025
Three provisions dictate how the tax-free income threshold is determined under the new tax regime:
1. Section 115BAC-The new tax regime
The Finance Act, 2023, introduced section 115BAC(1A), which provides revised income tax slab rates for taxpayers who opt for the new tax regime. It classifies rates under three clauses:

• Clause (i): Applicable for financial year 2023-24
• Clause (ii): Applicable for financial tear 2024-25
• Clause (iii): Applicable from financial year 2025-26(inserted via the Finance Act, 2025)

These income tax slab rates define the taxation framework for a particular financial year under which a taxpayer's income is computed.

2. Tax Rebate under section 87A
To ease the tax burden, the Finance Act, 2025 increased the section 87A tax rebate, raising the threshold for tax-free income from Rs. 7 lakh to Rs. 12 lakh. Consequently, tax liability for incomes up to Rs. 12 lakh is effectively reduced to zero.

3. Standard deduction under section 16
A critical component of the tax-free income computation is the standard deduction. Initially, the deduction for salaried employees was Rs. 50,000, but the Finance (No. 2) Act 2024 introduced an enhanced deduction of Rs. 75,000 under a new proviso to section 16(ia) under the new tax regime.

However, the proviso Section 16(ia) specifically references clause (ii) of section 115BAC(1A), which applies to the previous financial year 2024-25-but does not mention clause (iii), which governs the current financial year 2025-26. Due to this omission, the enhanced standard deduction of Rs. 75,000 under the new tax regime fails to be available for the current financial year 2025-26. This would effectively mean that for the current financial year 2025-26, a standard deduction of Rs 50,000 is available under the new and old tax regimes.

The consequence: Tax-free income shrinks
Since the higher standard deduction of Rs. 75,000 does not apply in the financial year 2025-26, the effective tax-free income reduces from Rs. 12.75 lakh to Rs. 12.50 lakh. This oversight contradicts the statements made by the Finance Minister and the Income Tax Department, who consistently cited Rs. 12.75 lakh as the tax-free threshold under the new tax regime.
What can the government do now?
This appears to be a drafting error in the Finance Act, 2025, rather than an intentional policy change. A similar omission exists in section 57(iia), which governs deductions from family pensions. If left unaddressed, it could create confusion among taxpayers.

To fix the issue, the Government has three possible courses of action:
1. Issuing a corrigendum - A simple non-legislative correction to amend the wording. This is the quickest solution, but only works for minor errors.
2. Promulgating an ordinance - If Parliament is not in session, the President can issue an ordinance to resolve the issue temporarily.
3. Passing an Amendment Act - During the next parliamentary session, a formal legislative amendment can correct the provisions permanently.

Conclusion
This discrepancy between policy statements and the Finance Act, 2025 text calls for immediate clarification. If left unrectified, taxpayers might face unexpected tax liabilities, contradicting the intended relief promised by the government.

A correction-whether through a formal amendment or a simple clarification-would ensure that taxpayers receive the full benefit of the revised tax-free limit and that legislative provisions accurately reflect government policy.

(The article is written by Dr. Vinod K. Singhania, Leader - Research and Advisory, Taxmann and CA Naveen Wadhwa, Vice-President of Research and Advisory at Taxmann.)

(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com)