Marginal Tax Rate Definition & Importance

According to the Income Tax Act of India, whenever you’re earning an income, you need to pay income tax on it. Persons earning an income above a certain amount must pay the applicable income tax. The income tax system is progressive in nature, so as the income increases for an individual, so does the amount of income tax liability.These levels of income are divided into brackets, with each bracket attracting a particular amount of income tax. The income tax rate applicable on each progressive bracket of income is termed as marginal tax rate. In India, the term usually used for the marginal tax rate is the slab rate.Let us understand, in detail, what the marginal tax rate is and its importance.

The marginal tax rate is the income tax rate applicable on each income bracket or slab. According to the income tax slabs set by the government, as the income increases, so does the tax liability . Persons earning more than Rs. 2.5 lakh in a year are liable for income tax and as their income increases, a higher slab of tax will be applicable.Thus, the marginal tax rate increases as the individual’s income bracket increases. The aim of the marginal tax rate is to tax individuals based on what they earn, so that those that are earning more are taxed higher and those that are earning less are taxed lesser.As an individual falling under the higher Income Tax bracket, you are liable to pay an additional surcharge. This surcharge on your income is levied as an extra tax issued by the Government of India. However, the 2023 Budget updates provide relief to taxpayers effective from 1st April 2023.The Finance Ministry reduces the highest surcharge rate on income above ₹ 5 Crores from 37% to 25%, eventually bringing down the Maximum Marginal Tax Rate from 42.74% to 39%In the new tax regime, a tax rebate is implemented for incomes up to ₹7 Lakhs, meaning you would not be liable to pay taxes if your income falls below ₹7 Lakhs. Also read: New Tax Regime Under Section 115BAA for Domestic Companies

The marginal tax rate in India for individuals is as follows:

The corporate marginal tax rate in India for the year 2021 is 25.17% with cess and surcharges for domestic companies.As per the Income Tax Act, 1961 , from 1st April 2023, surcharge Rates for individual /HUF /AOP /BOI / Artificial Judicial Persons are as follows:

Note:

• The surcharge rate for Association of Persons (AOPs) consisting exclusively of companies as members has been set at 15%. It applies to AOPs with total income exceeding ₹ 2 Crores during the financial year
• The surcharge on long-term capital gains (LTCG) from listed equity shares, units, etc., has been limited to 15%

Also read: Income Tax Surcharge Rate & Marginal Relief - All You Need To Know

The marginal tax rate gives an idea of how much the tax liability will be for an individual. And this can help them plan their finances better. For example, if a certain individual falls under a higher tax bracket due to their income, they can take measures to lower their taxable income by investing in tax saving instruments. When they do that, they’ll be considered at a lower marginal tax rate and their tax liability will be reduced.

As per Section 2(29C) of the Income Tax Act, 1961, the term “maximum marginal rate” is defined as the rate of income-tax (including surcharge on income tax, if any) applicable to the highest slab of income in the case of an individual, association of persons or body of individuals as specified in the Finance Act of the relevant year.It is basically the highest income tax slab as defined by the government. In some cases, like for a Trust of an Association of Person (AOP), the income is taxed directly at the highest marginal tax rate, rather than at the lower slab rates.

The assessment of tax of individual members of BOI and AOP is dependent on whether they are eligible to be charged tax at the maximum marginal rate or not.If a member of an AOP or BOI is liable to be taxed at the maximum marginal rate or any higher rate, the share of profit of that member is exempt from tax and it cannot be included in the total income of the member as per Section 86(a).The maximum marginal tax rate is 30.9% in such a case and if this rate is applied then the share of profit of the member is exempt from tax.

The Marginal Tax Rate is, therefore, the tax applicable on every progressive income slab as decided by the government. The marginal tax rates according to the old regime are 5%, 10%, 15%, 20%, 25%, and 30%, as the income increases from Rs. 2.5 lakh per annum to more than Rs. 15 lakh per annum.Thus, the marginal tax rate tells the individual how much their tax is as per their income, and how much it can be if their income was to be increased, either via promotion or bonuses. In this way, they can plan their finances and use tax saving methods wherever applicable. Also read: 5 Penalties Every Taxpayer Must Know for Income Tax Defaults