New Tax Regime Sets Maximum Income Tax Rate at 39% for 2026-2027

Individuals and certain entities will face a maximum 39% income tax rate under the new tax regime for Tax Year 2026-2027. This Maximum Marginal Rate applies to specific income categories to prevent tax avoidance. The new regime streamlines surcharges, capping them at 25%. However, exceptions exist, potentially leading to higher rates in specific AOP or BOI scenarios.

Under the Income-tax Act, certain categories of income are taxed at the Maximum Marginal Rate (MMR) rather than the normal slab rates or other rates otherwise applicable to the assessee. The concept was introduced as an anti-avoidance measure to prevent high-income taxpayers from reducing their tax liability by splitting income among multiple entities, such as private trusts, Associations of Persons (AOPs), or Bodies of Individuals (BOIs), that could otherwise benefit from lower tax rates.

By taxing such income at the MMR, the Act seeks to maintain tax neutrality and curb tax avoidance, particularly where the beneficiaries' or members' shares are indeterminate or where the legislature considers taxation at the highest rate appropriate.

These provisions apply to specific entities and situations, including certain trusts, AOPs/BOIs, business trusts, Alternative Investment Funds, and registered NPOs. The following table summarises the key provisions under which income is chargeable to tax at MMR.

Section

Description

223 of the ITA 2025 (115UA of the ITA 1961)

Income of a business trust [except capital gain covered under Section 196, 197 and 198 of the ITA 2025 (corresponding to Section 111A, 112 and 112A of the ITA 1961)] is taxable at MMR.

224 of the ITA 2025 (115UB of the ITA 1961)

Business income of Category-I or Category-II Alternative Investment Fund (AIF), not registered as a Company or Firm, is taxable at MMR.

307 of the ITA 2025 (164 of the ITA 1961)

Income of a Private Discretionary Trust is taxed at MMR if the shares of the beneficiary are indeterminate.

308 of the ITA 2025 (164A of the ITA 1961)

Income of an oral trust is taxed at MMR.

309 of the ITA 2025 (167B of the ITA 1961)

Income of AOP or BOI if shares of members are indeterminate or unknown.

Income of AOP or BOI if shares of members are determined, and the total income of any member (excluding his share from AOP or BOI) exceeds the basic exemption limit.

352 of the ITA 2025 (115TD of the ITA 1961)

Accreted income of an NPO registered under Chapter XVII-B of the ITA 2025 (corresponding to Section 12AA or 12AB of the ITA 1961) shall be taxable at MMR if such NPO converts into, merges with or transfers any of its assets upon dissolution to a non-charitable organisation.

Note: Under the ITA 1961, Section 161 provides that profits and gains from a business of a private trust are taxable at MMR, except where the trust is declared by will exclusively for the benefit of any relative dependent on him for support and maintenance, and is the only such trust so declared by him. This provision is no longer available under the ITA 2025.

Definition of MMR

Section 2(70) of the ITA 2025 (corresponding to Section 2(29C) of the ITA 1961) defines the term MMR as the income tax rate (including surcharge on income tax) applicable to the highest slab of income for an individual, AOP, or BOI, as specified in the Finance Act for the relevant year.

Computation of MMR

The new tax regime was introduced under Section 115BAC of the Income-tax Act, 1961 (ITA 1961), and continues under Section 202 of the ITA 2025, with substantially similar provisions and conditions. This new tax regime became the default tax framework for individuals, HUFs, AOPs, BOIs, and AJPs from AY 2024-25. Thus, a question about the MMR has repeatedly arisen during return filing, and the question is whether it should be 39% or 42.744%, which is calculated as follows:

Particulars

New Tax Regime

Old Tax Regime

Highest slab rate of income tax [A]

30%

30%

Highest rate of surcharge [B]

25%

37%

Tax plus surcharge [C = A × (1 + B)]

37.5%

41.1%

Health & Education cess @ 4% [D = C × 4%]

1.5%

1.644%

Maximum Marginal Rate [C + D]

39%

42.744%

Note: The surcharge rate differs significantly between the old and new tax regimes. Under the old regime, the surcharge is levied at four rates, with the maximum rate of 37% applying when total income exceeds Rs. 5 crore. In contrast, under the new tax regime, the surcharge has been streamlined and capped at 25%.

Note: The surcharge rate is capped at 15% for an AOP comprising only companies as its members, resulting in an MMR of 35.88% (30% + 15% surcharge + 4% cess). Consequently, such AOP may be subject to a lower MMR than the generally applicable rate of 39%.

Applicable MMR

From what we have talked about, it looks like the applicable MMR depends on the tax regime applicable to the entity. When the new tax regime is the default regime, the MMR should be 39%. A higher rate applies only in exceptional cases where the law specifically prescribes it.

For example, Section 311 of the ITA 2025 (corresponding to Section 167B of the ITA 1961) provides an exception to the general MMR rule for AOPs and BOIs. It provides that if any member is chargeable to tax at a rate higher than the AOP's or BOI's MMR, the relevant income of the AOP or BOI is taxed at that higher rate. Thus, if a member is taxed at 42.744% under the old tax regime, the AOP's relevant income will also be taxed at 42.744%, rather than 39%.

Conclusion

The MMR is 39% under the default tax regime and increases to 42.744% only when the old tax regime applies. For an AOP or BOI, if a member is chargeable to tax at 42.744% under the old tax regime, the relevant income of the AOP may also be taxed at that higher rate, even if the AOP or BOI is taxable under the default tax regime. Therefore, taxpayers should first identify the applicable tax regime and surcharge threshold before concluding whether the effective rate is 39% or 42.744%.