Two of India’s most prominent regulatory bodies — the Central Board of Direct Taxes (CBDT) and the Drugs Consultative Committee (DCC) — issue prosecution-related guidelines that appear structurally similar. Both are administrative instructions directing enforcement officers on prosecution thresholds and procedures. Yet Indian courts treat them in diametrically opposite ways.

CBDT prosecution guidelines are binding on the Income Tax Department: courts routinely quash prosecutions launched in violation of them and have even imposed costs on the Department. In contrast, DCC prosecution guidelines are not binding on Drug Inspectors: courts consistently hold that executive instructions issued through CDSCO cannot override statutory provisions, which is where the law draws a clear distinction between CBDT circulars being binding in nature and DCC guidelines not carrying the same force.

This article identifies the foundational reason for this divergence: Section 119 of the Income Tax Act, 1961 is an express statutory conferral of binding power, whereas the Drugs and Cosmetics Act, 1940 contains no equivalent provision. The article develops a “statutory transmission belt” doctrine to explain when administrative instructions acquire legal force, traces the Supreme Court’s jurisprudence, and proposes legislative reform to close the enforcement gap.

I. INTRODUCTION

In a legal system governed by the rule of law, the binding force of any norm must ultimately trace back to a statute or the Constitution. Administrative instructions—however consistent or well-intentioned—are not self-validating. Their authority depends on whether the parent statute confers power on the issuing body to create binding norms.

This principle, though conceptually straightforward, produces sharply divergent outcomes across India’s regulatory landscape.

Consider:

• CBDT (Tax Law Context): Issues prosecution guidelines prescribing monetary thresholds below which prosecution should ordinarily not be initiated. Courts enforce these strictly.
• DCC (Drug Regulation Context): Issues prosecution guidelines advising restraint (e.g., requiring proof of intent for Category B drugs). Courts refuse to treat these as binding.

The result: identical regulatory forms, opposite legal consequences.

This article explains why.

II. THE “STATUTORY TRANSMISSION BELT”: SECTION 119 OF THE INCOME TAX ACT

The answer lies in Section 119 of the Income Tax Act, 1961, which functions as what this article terms a statutory transmission belt—a mechanism that converts administrative instructions into binding legal directives.

Section 119(1): Binding Command

The Board may issue orders, instructions, and directions… and all income-tax authorities shall observe and follow them.

This is not advisory—it is mandatory.

Section 119(2): Power to Relax the Law

Section 119(2) goes further by expressly permitting CBDT to:

• “Tone down the rigour of the law”
• Grant relief in favour of taxpayers

This is a rare statutory design where Parliament authorises administrative softening of statutory enforcement.

Judicial Recognition

The Supreme Court has consistently upheld this framework:

• Navnit Lal C. Javeri (1965) — CBDT circulars are binding on officers
• Ellerman Lines (1971) — reaffirmed binding nature
• UCO Bank (1999) — beneficial circulars must be followed
• Ratan Melting (2008) — binding on the department even if inconsistent with statute (when beneficial)

Conclusion: Section 119 transforms CBDT circulars into enforceable legal obligations.

III. THE STRUCTURAL GAP IN THE DRUGS AND COSMETICS ACT, 1940

No equivalent provision exists in the Drugs and Cosmetics Act, 1940.

Nature of the DCC

• Constituted under Section 7
• Role: purely advisory
• Language: “shall advise” — not “shall bind”

Position of CDSCO

• No express statutory authority to issue binding directions

• Its own guidance documents acknowledge:

  “Intended for guidance… not legally binding”

Legal Consequence

• CBDT instructions → legally binding (due to Section 119)
• DCC/CDSCO guidelines → executive guidance only

Thus:

• A tax officer ignoring CBDT circulars → violates statute
• A drug inspector ignoring DCC guidelines → does not violate law

IV. JUDICIAL ENFORCEMENT: THE DIVERGENCE IN PRACTICE

A. CBDT Guidelines: Strict Judicial Enforcement

Courts actively enforce CBDT circulars:

• Prosecutions violating threshold guidelines are quashed
• Departments have been penalised with costs
• Non-compliance is termed “wilful”

Effect: CBDT guidelines operate as enforceable constraints on State power.

B. DCC Guidelines: No Legal Enforceability

Courts consistently hold:

Executive instructions cannot override statutory provisions.

Key implications:

• DCC prosecution filters are not mandatory
• Drug inspectors may bypass them without legal defect
• Courts refuse to treat such deviations as procedural illegality

Effect: DCC guidelines remain administrative, not legal.

V. THE “DIRECTION OF BENEFIT” DISTINCTION

Another critical distinction lies in who benefits.

CBDT Framework

• Benefits taxpayers
• Binding only on the Revenue, not on citizens
• Cannot impose additional burdens

DCC Framework

• Attempts to benefit manufacturers
• Reduces enforcement of strict liability offences
• Lacks statutory backing

Legislative Intent Matters

• Tax law: allows administrative leniency
• Drug law: enforces strict liability for public health protection

Result:
CBDT’s relaxation aligns with statutory design;
DCC’s relaxation contradicts it.

VI. THE FIVE-PART TEST FOR BINDING NATURE of CBDT Circulars  VS DCC Guidelines

Synthesising the Supreme Court jurisprudence from Sant Ram Sharma (AIR 1967 SC 1910), G.J. Fernandez (AIR 1967 SC 1753), Navnit Lal Javeri (1965) 56 ITR 198, Ratan Melting (2008) 13 SCC 1, and Bengal Iron Corporation (1993) 90 STC 47, the following five-part test emerges for determining whether an administrative instruction has binding legal force:

1. Statutory Authority: Is the instruction issued under an express statutory power to issue binding directions (like Section 119 IT Act, Section 37B Central Excise Act)? If yes — binding on the department.
   2. Subject Matter: Does the instruction cover a subject on which the parent statute is silent? If yes — the instruction can fill the gap and bind subordinate officers as a matter of executive power (Article 162/Article 73 of the Constitution).
   3. Contradiction Test: Does the instruction contradict an express statutory provision? If yes — the instruction has no legal existence (Ratan Melting).
   4. Quasi-Judicial Authority: Is the instruction being applied to a quasi-judicial proceeding? If yes — the instruction is not binding; the authority is bound only by law (Bengal Iron Corporation).
   5. Legitimate Expectation: Has consistent application of the instruction created a reasonable expectation in third parties? If yes — the issuing authority is bound by Article 14 to follow the instruction consistently or give reasons for departure.

Applying this test: CBDT prosecution guidelines pass the first test (Section 119). DCC prosecution guidelines fail the first test, fail the third test (they contradict strict liability), and are not saved by the second test (the statute is not silent — it affirmatively prescribes strict liability).

Application

Test	CBDT	DCC
Statutory Authority	Yes	No
Gap Filling	Yes	No
Contradiction	No	Fails (contradicts strict liability)
Result	Binding	Non-binding

VII. POLICY IMPLICATIONS

This is not a technical distinction—it has real-world consequences:

• Tax offenders may be legally shielded from prosecution
• Drug manufacturers may receive non-binding administrative leniency

This creates:

• Regulatory inconsistency
• Legal uncertainty
• Weak enforcement in public health

VIII. PROPOSED LEGISLATIVE REFORM

The solution is straightforward:

Amend the Drugs and Cosmetics Act to:

• Insert a provision equivalent to Section 119
• Authorise CDSCO to issue binding instructions
• Subject such power to safeguards and parliamentary oversight

Until then:

Any DCC guideline diluting statutory strict liability remains legally unenforceable.

IX. CONCLUSION

The CBDT–DCC divergence illustrates a foundational principle of Indian administrative law governing the binding nature of CBDT circulars and DCC guidelines.

Administrative instructions acquire binding force only through a statutory transmission belt.

• Section 119 is that belt for CBDT
• No such mechanism exists for DCC or CDSCO

The consequences are inevitable:

• CBDT circulars bind and are enforced
• DCC guidelines do not and cannot override statute

In the context of pharmaceutical regulation—already under scrutiny for quality failures—this structural gap is not merely doctrinal. It is a core reason why enforcement falls short of legislative intent.

Frequently Asked Questions (FAQs)

1. Are CBDT prosecution guidelines legally binding on tax authorities?

Yes. Under Section 119 of the Income Tax Act, 1961, CBDT circulars and instructions are legally binding on income-tax authorities. Courts have consistently held that prosecutions launched in violation of these guidelines can be quashed.

2. Are DCC prosecution guidelines binding on Drug Inspectors?

No. The Drugs and Cosmetics Act, 1940 does not grant the Drugs Consultative Committee (DCC) any statutory authority to issue binding instructions. Therefore, its prosecution guidelines are treated as advisory and not legally enforceable.

3. Why do courts treat CBDT and DCC guidelines differently?

The key difference lies in statutory backing. CBDT derives binding authority from Section 119 of the Income Tax Act, whereas no equivalent provision exists in the Drugs and Cosmetics Act for DCC or CDSCO. Without such statutory support, DCC guidelines cannot override the law.

4. Can administrative instructions override statutory provisions in India?

No. Administrative instructions cannot override or contradict statutory provisions. If an instruction conflicts with the law, courts will treat it as invalid or non-binding.

5. What is the “statutory transmission belt” doctrine?

It is a conceptual framework explaining that administrative instructions become legally binding only when a statute expressly authorizes the issuing body to issue binding directions. Section 119 of the Income Tax Act is an example of such a mechanism.

6. Can CBDT circulars relax the strict application of tax law?

Yes. Section 119(2) allows CBDT to “tone down the rigour of the law” in favour of taxpayers. Such beneficial circulars are binding on tax authorities.

7. Do DCC guidelines requiring proof of intent for substandard drugs have legal force?

No. Since the Drugs and Cosmetics Act imposes strict liability for certain offences, DCC guidelines introducing additional requirements like “intent” have no statutory basis and are not enforceable in court.

8. Can a drug prosecution be challenged for ignoring DCC guidelines?

Generally, no. Courts have held that failure to follow DCC or CDSCO guidelines does not invalidate prosecution if the statutory requirements under the Drugs and Cosmetics Act are satisfied.

9. What is the role of CDSCO in issuing guidelines?

The Central Drugs Standard Control Organization (CDSCO) issues regulatory guidance for administrative consistency. However, in the absence of statutory authority, such guidance remains advisory.

10. What reform is needed to make DCC guidelines binding?

A legislative amendment to the Drugs and Cosmetics Act is required—similar to Section 119 of the Income Tax Act—to expressly empower CDSCO or DCC to issue binding prosecution guidelines.

REFERENCES

[1] Income Tax Act, 1961, Section 119 — Income Tax Department, Government of India.  https://www.incometaxindia.gov.in

[2] Navnit Lal C. Javeri v. K.K. Sen, AAC, AIR 1965 SC 1375, (1965) 56 ITR 198 (SC) — Supreme Court of India.  https://itatonline.org/digest/navnitlal-c-javeri-v-k-k-sen-aac-1965-56-itr-198-sc/

[3] Ellerman Lines Ltd. v. CIT, AIR 1972 SC 524, (1971) 82 ITR 913 (SC) — Supreme Court of India.  https://lawlens.in/doc/92095513-ea85-4572-8e4c-0954426e574d

[4] UCO Bank, Calcutta v. Commissioner of Income Tax, W.B., (1999) 237 ITR 889 (SC) — Supreme Court of India.  https://www.casemine.com/search/in/UCO%20Bank%20Vs%20Commissioner%20of%20Income%20Tax

[5] Commissioner of Central Excise, Bolpur v. Ratan Melting and Wire Industries, (2008) 13 SCC 1 — Constitution Bench, Supreme Court of India.  https://www.casemine.com/judgement/in/56b48d51607dba348fff2555

[6] Sant Ram Sharma v. State of Rajasthan & Anr., AIR 1967 SC 1910 — Supreme Court of India.  https://lawlens.in/doc/5aa43bbb-095a-4ff0-96ac-f93abfc56ed5

[7] G.J. Fernandez v. State of Mysore & Ors., AIR 1967 SC 1753, [1967] 3 SCR 636 — Supreme Court of India.  https://www.legitquest.com/case/gj-fernandez-v-state-of-mysore-others/4C41

[8] Bengal Iron Corporation v. Commercial Tax Officer, 1993 AIR 2414, 1994 Supp (1) SCC 310 — Supreme Court of India.  https://vlex.in/vid/c-no-004474-004474-852342483

[9] CBDT Prosecution Guidelines, Circular dated April 24, 2008 — Income Tax Department.  https://itgoadelhi.org/upload/7c99471bc7d94166478c1593047e1b41Guideline%20dated%2024.04.2008.pdf

[10] Supreme Court quashes prosecution and imposes Rs. 2 lakh costs on IT Department for ignoring CBDT circular (August 2025) — A2Z Tax Corp.  https://a2ztaxcorp.net/supreme-court-quashes-tax-prosecution-fines-income-tax-department-%E2%82%B92-lakh-for-ignoring-cbdt-circular/

[11] The Drugs and Cosmetics Act, 1940, Sections 7, 16, 18, 27, 33, 33P.  https://www.indiacode.nic.in/bitstream/123456789/15278/1/drug_cosmeticsa1940-23.pdf

[12] Dinesh Thakur & Prashant Reddy T., ‘A Report on Fixing India’s Broken Drug Regulatory Framework’ (June 2016).  https://spicyip.com/wp-content/uploads/2016/06/Report_India-Drug-Regulatory-Framework_June-2016.pdf

The post Section 119 IT Act vs Section 7 D&C Act: Why CBDT Circulars Are Binding in Nature But DCC Guidelines Are Not appeared first on Bhatt & Joshi Associates.

On 1 February 2026, Finance Minister Nirmala Sitharaman presented the Indian Union Budget 2026-27 — her ninth consecutive Budget. As a result, the Finance Bill, 2026 (Bill No. 3 of 2026) proposes a calibrated set of direct tax reforms: no change to income tax slabs; the coming into force of the Income Tax Act, 2025 from 1 April 2026; and targeted amendments addressing TCS rationalisation, compliance timelines, TDS exemptions, and penalty restructuring.

For salaried individuals — the most compliant and numerically significant segment of India’s direct tax base — the Indian Union Budget 2026-27’s practical message is continuity with refinement. Specifically, the following three outcomes stand out:

• First, the zero-tax threshold of Rs 12,75,000 for salaried taxpayers in the new tax regime (applicable since TY 2025-26) continues unchanged.
• Second, Finance Bill 2026 adds procedural relief: extended revised return timelines, centralised lower-TDS declarations, relaxed TCS on foreign remittances, and full exemption for MACT interest.
• However, the proposed increase in Securities Transaction Tax on equity derivatives significantly raises the cost of F&O trading for salaried taxpayers who participate in derivative markets.

“This direct tax code was completed in record time and the Income Tax Act 2025 will come into effect from 1st April 2026.” — Finance Minister Nirmala Sitharaman, Budget Speech, 1 February 2026

I. Income Tax Act, 2025 — Legislative Transition

The Income Tax Act, 2025 (Act 30 of 2025, Presidential assent: 21 August 2025) comes into force on 1 April 2026, replacing the Income Tax Act, 1961. Consequently, this marks the most significant structural reform to India’s direct tax legislation in six decades.

A. Revenue Neutrality — Confirmed

The Finance Bill 2026 Memorandum confirms that the government proposes no change in tax rates. Moreover, every tax rate, deduction, exemption, and rebate that applied under the 1961 Act as at 31 March 2026 carries forward into the 2025 Act under reorganised section numbers. In addition, the 2025 Act consolidates the statute into:

• 536 sections across 23 chapters and 16 schedules — reduced from 819 sections across 47 chapters in the 1961 Act.
• Importantly, incremental amendments over six decades had produced layers of internally inconsistent provisos and explanations — the 2025 Act resolves these entirely.

B. Key Definitional Change: ‘Tax Year’

• Notably, the 2025 Act abolishes the terms ‘Previous Year’ and ‘Assessment Year’.
• Instead, it introduces a single operative concept: ‘Tax Year’ — defined as the 12-month period commencing 1 April of each calendar year.
• As a result, ‘Tax Year 2026-27’ is the precise statutory equivalent of ‘Financial Year 2026-27 / Assessment Year 2027-28’ under the old terminology.

C. Section Renumbering: Dual-Statute Context

• Furthermore, all familiar 1961 Act provisions — Section 87A (rebate), Section 80C (deductions), Section 115BAC (new tax regime), Section 206C (TCS) — now carry new numbers in the 2025 Act.
• To ensure alignment during the transition period, Finance Bill 2026 amends both statutes simultaneously: Clauses 4–26 amend the IT Act 1961; Clauses 27–113 amend the IT Act 2025.
• Nevertheless, proceedings, assessments, and appeals relating to financial years prior to Tax Year 2026-27 continue under the IT Act 1961. The 2025 Act applies prospectively from Tax Year 2026-27 onward.

D. Simplified Forms and Compliance Rules

• To support the transition, CBDT will notify revised ITR forms and rules aligned with the 2025 Act’s nomenclature before 1 April 2026.
• For salaried taxpayers, the substantive change in ITR filing is limited to updated section references — data fields and disclosure requirements remain unchanged for Tax Year 2026-27.

II. Income Tax Slabs & Rates — Tax Year 2026-27

Under the Indian Union Budget 2026-27, no changes to income tax rates, slabs, surcharge, or cess are proposed for Tax Year 2026-27. Therefore, both regimes continue to coexist, and the new tax regime remains the statutory default.

A. New Tax Regime (Section 202, IT Act 2025)

The new regime applies to individuals, HUFs, AOPs (other than co-operative societies), BOIs, and artificial juridical persons — unless the assessee actively opts out under Section 202(4).

Surcharge under the new tax regime:

• 10% on total income (including capital gains and dividends) exceeding Rs 50 lakh but not Rs 1 crore.
• 15% on total income (including capital gains and dividends) exceeding Rs 1 crore but not Rs 2 crore.
• 25% on total income (excluding capital gains and dividends) exceeding Rs 2 crore.
• Crucially, the 37% surcharge bracket that applies under the old regime does NOT apply here. As a result, the maximum surcharge under the new regime is capped at 25%.
• In addition, Health and Education Cess applies at 4% on the aggregate of income tax and surcharge, in all cases.
• Furthermore, marginal relief applies at each surcharge threshold.

B. Old Tax Regime (Section 202(4), IT Act 2025)

A salaried assessee who actively elects the old tax regime under Section 202(4) [corresponding to Section 115BAC(6) of the 1961 Act] faces the following rates:

Under the old regime, all four surcharge brackets apply — 10%, 15%, 25%, and 37%. Notably, the 37% bracket applies to total income (excluding capital gains and dividends) exceeding Rs 5 crore.

Critical distinctions — old vs. new regime:

• Standard deduction for salaried taxpayers: Rs 50,000 (old regime) vs. Rs 75,000 (new regime). The higher Rs 75,000 deduction is available exclusively under the new regime.
• Similarly, family pensioners receive only Rs 15,000 under the old regime, compared to Rs 25,000 under the new regime.
• Moreover, deductions under Section 80C (up to Rs 1,50,000), Section 80D (health insurance), Section 24(b) (home loan interest up to Rs 2,00,000 for self-occupied property), and HRA exemption under Section 10(13A) are available ONLY under the old regime.

III. Rs 12 Lakh Zero-Tax Threshold — Rebate & Marginal Relief

Under the new tax regime, a rebate of up to Rs 60,000 is available (Section 87A equivalent). Since tax on Rs 12,00,000 equals exactly Rs 60,000, the rebate fully absorbs the liability, resulting in NIL tax before cess.

A. Four Eligibility Conditions (all must be met)

• First, the taxpayer must be a resident individual — NRIs are not eligible.
• Second, the taxpayer must be under the new tax regime.
• Third, total income must not exceed Rs 12,00,000 after standard deduction and other new-regime deductions.
• Fourth, income taxable at special flat rates does not attract the rebate — specifically STCG on equity (20% under Sec 111A / Sec 196, IT Act 2025) and LTCG on listed equity exceeding Rs 1,25,000 (12.5% under Sec 112A / Sec 198, IT Act 2025). Importantly, where total income of Rs 12,00,000 includes such income, the rebate applies only to the non-special-rate component — not the full income.

B. Marginal Relief at Rs 12 Lakh Threshold

Where income marginally exceeds Rs 12L, the incremental tax cannot exceed the excess amount. For example, income of Rs 12,10,000 would otherwise attract tax of Rs 61,500; however, marginal relief caps the liability at Rs 10,000. Similarly, marginal relief applies at each surcharge threshold.

IV. Standard Deduction & Effective Rs 12,75,000 Threshold

The standard deduction of Rs 75,000 for salaried assessees and Rs 25,000 for recipients of family pension, which Finance Act 2024 introduced under the new tax regime, continues unchanged for Tax Year 2026-27. Importantly, it is a flat statutory deduction from income chargeable under the head ‘Salaries’ — taxpayers need no bills, vouchers, or proof of expenditure. Combined with the Rs 60,000 rebate, zero tax applies up to gross salary of Rs 12,75,000.

However, the nil-tax outcome holds only if all three of the following conditions are met:

• The assessee must be a resident individual.
• The total income must include no income taxable at special flat rates (e.g., STCG, LTCG).
• The assessee must earn no other income beyond the salary. Where any of these conditions are not met, the computation must be adjusted accordingly.

V. Employer NPS Contribution — Above-Threshold Deduction

• Section 80CCD(2) deduction works under BOTH the old and new tax regimes, and sits outside the Rs 1,50,000 aggregate ceiling under Section 80CCE.
• The rate stands at 14% of (Basic Pay + DA) for all employees including private sector — Finance Act 2024 raised this from 10%, effective 1 April 2024. Moreover, it continues unchanged for Tax Year 2026-27.
• This achieves parity: Central and State Government employees had enjoyed the 14% limit since Tax Year 2020-21. By extending it to private sector employees, Finance Act 2024 removed a structural disparity that had discouraged NPS adoption.
• To illustrate: Basic+DA = Rs 8,00,000 → employer NPS contribution = Rs 1,12,000 → the zero-tax threshold effectively extends to ~Rs 13,87,000 gross salary (before accounting for any other qualifying deductions).
• However, aggregate employer contributions to NPS, recognised provident funds, and approved superannuation funds exceeding Rs 7,50,000 per annum become taxable in the employee’s hands as a perquisite under Section 17(2) of the IT Act 1961. Therefore, senior executives whose total employer-side benefit contributions approach or exceed this threshold require active monitoring.

VI. TCS Rationalisation on Foreign Remittances (Finance Bill 2026)

One of the most taxpayer-friendly proposals in the Indian Union Budget 2026-27 is the TCS rationalisation on foreign remittances. TCS (Tax Collected at Source) is not a final tax liability — the government credits it to the taxpayer’s PAN, and the taxpayer adjusts it against assessed income tax at ITR filing. Nevertheless, the concern it addresses is liquidity: high TCS rates produce disproportionate upfront cash outflows that taxpayers recover only through the refund cycle, typically six to eighteen months later.

To address this, Finance Bill 2026 proposes amendments to Section 394 of the IT Act 2025 (corresponding to Section 206C of the IT Act 1961), effective 1 April 2026.

A. Overseas Tour Programme Packages — Tiered Structure Replaced by Flat 2%

• Currently, the structure charges TCS at 5% on package value up to Rs 10 lakh, and 20% on value exceeding Rs 10 lakh in a financial year.
• Instead, Finance Bill 2026 proposes a single flat rate of 2% with no threshold. Specifically, the Rs 10 lakh threshold is proposed for removal entirely under this category.
• To illustrate: a package costing Rs 15,00,000 currently attracts TCS of Rs 1,50,000. Under the proposed amendment, TCS would fall to Rs 30,000 — a reduction of Rs 1,20,000 in upfront withholding.

B. LRS — Education and Medical Remittances: Rate Reduced to 2%

• For remittances under the Liberalised Remittance Scheme (LRS — the RBI permits up to USD 2,50,000 per financial year) for education or medical treatment, the rate drops from 5% to 2%.
• Importantly, the Rs 10 lakh per-financial-year threshold is retained — remittances up to Rs 10 lakh for these purposes continue to attract nil TCS.
• Furthermore, remittances qualifying as loan repayments or interest deductible under Section 80E remain separately exempt from TCS under the existing framework.

C. LRS — All Other Purposes: Unchanged at 20%

• For LRS remittances for purposes other than education and medical treatment — including foreign portfolio investments, real estate acquisition, gifts, and general living expenses — the 20% TCS rate on amounts exceeding Rs 10 lakh per financial year stays unchanged.
• Finance Bill 2026 proposes no modification to this rate.

VII. Return Filing Timelines (Proposed Amendments)

Finance Bill 2026 proposes two key modifications to ITR filing timelines directly relevant to salaried assessees: (1) extension of the revised return deadline under Section 263(5) of the IT Act 2025 from 9 months to 12 months; and (2) introduction of a separate 31 August deadline for non-audit business taxpayers — thereby creating a cleaner separation between the salaried and self-employed filing windows. Notably, the ITR-1 and ITR-2 deadline of 31 July remains unchanged.

A. Revised Return — Extended Deadline and Fee Structure

• Finance Bill 2026, Clause 57 (amending Section 263(5), IT Act 2025) and Clause 5 (amending Section 139, IT Act 1961) extend the revision period from 9 months to 12 months — i.e., from 31 December to 31 March of the following year.
• Consequently, for Tax Year 2026-27, the proposed deadline for filing a revised return is 31 March 2028.
• Moreover, Clause 12 inserts new Section 234-I into the IT Act 1961 (Section 428(b) in IT Act 2025), creating a fee for revised returns filed after the initial 9-month window: Rs 1,000 where total income does not exceed Rs 5,00,000; Rs 5,000 where total income exceeds Rs 5,00,000.
• Importantly, returns filed on or before 31 December remain free of charge. The fee is not a penalty — it carries no interest and does not trigger prosecution.
• In practice, salaried assessees who discover discrepancies in their AIS after December — from late-updated dividend income, revised Form 16, or delayed reporting of interest income — gain three additional months to correct their returns without penalty exposure.

VIII. TDS Reforms — Targeted Exemptions & Compliance Simplification

A. MACT Interest — Full Exemption and Unconditional TDS Relief

• Finance Bill 2026 proposes a two-part relief for recipients of interest on compensation that Motor Accident Claims Tribunals (MACTs) award under the Motor Vehicles Act, 1988.
• First, such interest is proposed to be fully exempt from income tax in the hands of the individual recipient or their legal heirs.
• Second, and equally importantly, no TDS is to be deducted on such interest, irrespective of amount — overriding the threshold-based TDS under Section 194A of the IT Act 1961, which currently applies at 10% once annual interest exceeds Rs 10,000 (Rs 50,000 for senior citizens).
• CBDT Official FAQs confirm: ‘no tax would be required to be deducted on such interest awarded by MACT to the individual or legal heir, irrespective of the threshold.’
• Both changes take effect from 1 April 2026.

B. Centralised Form 15G / 15H — Single Depository Submission

• Under Finance Bill 2026, Clause 72 (amending Section 393, IT Act 2025), salaried assessees holding fixed deposits, bonds, or mutual fund units across multiple institutions may now submit a single Form 15G or Form 15H to their securities depository (NSDL or CDSL).
• In turn, the depository must make this declaration available to all registered deductors — banks, fund houses, companies — that pay income to the declarant.
• As a result, this eliminates the current practice of submitting separate declarations to each institution at the start of each financial year.
• Effective from 1 April 2026.

C. TAN Exemption for Property Purchase from Non-Resident Sellers

• Under Finance Bill 2026, Clause 75 (amending Section 397, IT Act 2025), a resident individual or HUF purchasing immovable property from a non-resident seller no longer needs to obtain a Tax Deduction and Collection Account Number (TAN).
• Instead, the buyer may deduct and remit tax using their own PAN, quoting the non-resident seller’s PAN in the challan-cum-statement filed with the Income Tax Department.
• Effective from 1 October 2026.

D. Electronic Applications for Lower / Nil TDS Certificates

• Finance Bill 2026, Clause 74 (amending Section 395, IT Act 2025) enables electronic applications for certificates authorising TDS deduction at nil or reduced rates.
• Previously, eligible assessees — including NRIs and small investors — had to engage with Assessing Officers’ offices, sometimes physically. Electronic processing now removes geographical barriers and reduces turnaround times.
• Effective from 1 April 2026.

E. Manpower Supply Payments Classified as ‘Work’ Under Section 393

• Finance Bill 2026 clarifies that payments for supply of manpower constitute ‘work’ for TDS purposes under Section 393 of the IT Act 2025.
• This resolves prior ambiguity — specifically, whether such payments attracted TDS as fees for professional services (10%) or as works contracts — which had caused inconsistent treatment across assessments.
• Going forward, the proposed TDS rate is 1% for payments to individuals or HUFs, and 2% for payments to other persons.
• This has limited direct relevance to salaried assessees, unless they also operate small businesses or consultancies in parallel.

IX. Proposed STT Increase on Equity Derivatives

Among the measures in the Indian Union Budget 2026-27 that impose additional costs, Finance Bill 2026 Clause 143 (amending Section 98 of the Finance (No. 2) Act, 2004) proposes a significant increase in Securities Transaction Tax rates on equity futures and options. Specifically, Finance Minister Sitharaman confirmed in her Budget Speech: ‘I propose to raise the STT on futures to 0.05% from the existing 0.02%. The STT on options premium and on the exercise of options is proposed to be increased to 0.15% from the current rates of 0.10% and 0.125%, respectively.’

• Commencement: Clause 143 falls within Chapter VI (Miscellaneous) — it is NOT effective from 1 April 2026 under Section 1(2)(a) of Finance Bill 2026. Instead, it takes effect on the date of Presidential assent (anticipated before 31 March 2026) and applies to all qualifying derivative transactions executed on or after that date.
• Furthermore, F&O income is assessed as business income — not capital gains — and therefore attracts tax at the applicable slab rate.
• As a result, higher STT raises the transaction cost component and increases the breakeven threshold per trade. Consequently, salaried assessees engaged in F&O trading should reassess their derivative strategies.
• The IT Department cites the policy rationale as follows: derivative market notional turnover has reached several hundred times India’s nominal GDP, and documented loss rates among retail traders justify moderating purely speculative activity.
• In contrast, long-term equity investors transacting in the delivery segment remain entirely unaffected.

X. Share Buyback Proceeds — Reclassified as Capital Gains

Finance Bill 2026 proposes that share buyback proceeds for all categories of shareholders are treated as capital gains — rather than dividend income — from 1 April 2026. This reclassification restores economic rationality: since the acquisition cost of shares tendered is deductible, only the economic profit attracts tax.

A. Impact on Retail and Salaried Investors

• For long-term holdings (over 12 months on listed equity), the government taxes gains exceeding Rs 1,25,000 as LTCG at 12.5% under Section 112A of the IT Act 1961 (Section 198, IT Act 2025).
• Similarly, for short-term holdings (up to 12 months), STCG at 20% applies under Section 111A (Section 196, IT Act 2025).
• Moreover, for retail investors in the 30% income tax bracket, both rates represent a material reduction from the prior dividend-characterisation framework, where buyback proceeds attracted full slab-rate tax with no deduction for acquisition cost.

B. Additional Tax on Promoters

• To prevent controlling shareholders from using the capital gains framework to extract value at concessional rates, Finance Bill 2026 proposes an additional buyback tax for promoter-category shareholders.
• According to PIB press release PRID 2221416, the effective rates are approximately 22% for corporate promoters and approximately 30% for non-corporate promoters (individuals, HUFs, and partnerships in the promoter group).
• As a result of this deliberate policy asymmetry, retail salaried investors holding listed equity sit unequivocally in the more advantageous category.

XI. Penalty & Prosecution Rationalisation

A. Unexplained Income — Tax Rate Reduced from 60% to 30%

• Section 195 of the IT Act 2025 levies a special tax rate on income under Sections 102 to 106 (corresponding to Sections 68 to 69D of the 1961 Act): unexplained cash credits, unexplained investments, unexplained expenditure, unexplained assets, and amounts borrowed or repaid in cash through hundis.
• Finance Bill 2026 proposes to reduce this rate from 60% to 30%. In support, CBDT Official FAQs confirm: ‘The tax rate on income reported by the taxpayer or determined by the Assessing Officer in respect of income referred to in sections 102 to 106… is reduced from 60 percent to 30 percent.’
• Simultaneously, Finance Bill 2026 Clause 86 proposes to omit Section 443 of the IT Act 2025, thereby removing the additional 10% levy on such income.
• As a result, the penalty framework consolidates into a single misreporting penalty of 200% under Section 439(11), reduced to 120% of the tax payable where immunity is claimed — bringing it more closely in line with the general income misreporting framework.

B. Employee Contribution Deduction — Aligned to ITR Filing Date

• Finance Bill 2026, Clause 31 (amending Section 29 of IT Act 2025) now allows employers to claim deductions for employee contributions to provident funds, ESI, and superannuation funds — provided the contributions are deposited on or before the employer’s ITR filing due date under Section 263(1).
• This resolves a persistent litigation issue: previously, contributions deposited before the ITR filing date but after the statutory deposit deadline were routinely disallowed at assessment stage.
• Consequently, this eliminates an asymmetry and aligns employee contribution deduction timing with the pre-existing treatment of employer contributions.

C. Decriminalisation of Technical Defaults

• Finance Bill 2026, Clauses 80–104 restructure the prosecution provisions of the IT Act 2025: multiple categories of technical procedural defaults — including non-production of documents in specified circumstances and minor delays in TDS filing — are converted from criminal offences attracting potential imprisonment into civil defaults attracting monetary penalties or fees.
• As a result, criminal prosecution is reserved for substantive acts of evasion only — not inadvertent procedural lapses.
• Therefore, for salaried assessees and their employers, this significantly reduces the legal risk profile of minor compliance irregularities without diminishing the deterrent effect against deliberate non-compliance.

XII. Foreign Assets of Small Taxpayers Disclosure Scheme, 2026 (FAST-DS 2026)

• Finance Bill 2026, Chapter IV (Clauses 114–128) introduces FAST-DS 2026 — a one-time, six-month voluntary disclosure facility proposed to run from 1 April 2026.
• Under this scheme, eligible assessees may declare undisclosed foreign assets or foreign income, pay a specified tax or fee, and thereby receive statutory immunity from penalty and prosecution under the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015.
• Importantly, the scheme targets small taxpayers — not high-net-worth capital exporters. The target population includes salaried professionals who received ESOPs in overseas group companies, individuals who briefly worked on international deputation and retained foreign bank accounts, and those who received minor inheritances from non-resident relatives.
• Furthermore, eligible asset thresholds are to be notified by CBDT under the scheme’s rules — assessees must therefore check their position against these thresholds once notified.
• Additionally, Finance Bill 2026, Clause 144 proposes that prosecution provisions of the Black Money Act shall not apply where the aggregate value of undisclosed foreign assets (other than immovable property) does not exceed Rs 20,00,000 — thereby extinguishing criminal exposure below this threshold.
• Action required: Assessees should assess their foreign asset position and initiate disclosure before the six-month window closes, in consultation with a qualified tax professional.

XIII. Tax Regime Selection — Framework for Tax Year 2026-27

Under the Indian Union Budget 2026-27, the new tax regime under Section 202 of the IT Act 2025 is the statutory default for Tax Year 2026-27. Consequently, a salaried assessee who does not communicate a contrary election to their employer before the commencement of the financial year will have TDS computed under the new regime. For assessees without business income, however, the regime election may also be exercised — or revised — at the time of ITR filing; no separate Form 10-IEA is required. Furthermore, the election does not bind the assessee in perpetuity — it may be reconsidered each tax year.

Analytical Framework for Regime Selection

• The new regime is structurally superior for assessees with limited deduction portfolios. Specifically, where aggregate old-regime deductions across Section 80C, Section 80D, HRA exemption, and home loan interest total less than approximately Rs 2,00,000, the new regime will almost invariably produce lower tax at all income levels.
• However, the old regime may be advantageous in the Rs 10L–Rs 15L income range for assessees with comprehensive deduction portfolios exceeding Rs 3,50,000 in aggregate — where the old regime’s 30% slab rate (applicable from Rs 10,00,001 onwards) is partly offset by the higher value of those deductions.
• Above Rs 24,00,000 income, on the other hand, the new regime’s flatter slab structure produces lower tax liabilities for the majority of assessees regardless of the size of their deduction portfolio.
• Notably, employer NPS under Section 80CCD(2) is the one deduction that operates identically under both regimes and requires no regime trade-off analysis. Therefore, maximising this benefit — where the employer’s NPS plan permits — is advisable under either regime.
• Finally, use the official IT Department tax calculator at incometaxindia.gov.in for a precise year-specific computation before communicating regime preference to your employer.

FAQ

Q1. What are the income tax slabs for salaried employees under the Indian Union Budget 2026-27?

No change from 2025-26. New regime slabs: Nil up to Rs 4L; 5% (Rs 4–8L); 10% (Rs 8–12L); 15% (Rs 12–16L); 20% (Rs 16–20L); 25% (Rs 20–24L); 30% above Rs 24L.

Q2. Is income up to Rs 12 lakh really tax-free for salaried employees in 2026-27?

Yes — for resident individuals under the new tax regime with no special-rate income. The Rs 60,000 rebate wipes out all tax on income up to Rs 12,00,000; with the Rs 75,000 standard deduction, gross salary up to Rs 12,75,000 is also tax-free.

Q3. Which is better — new vs old tax regime in 2026-27 for salaried employees?

New regime for most. Choose old regime only if total deductions (80C + 80D + HRA + home loan interest) exceed Rs 3,50,000 and income is in the Rs 10–15 lakh range.

Q4. What has changed in TCS on foreign remittances under Budget 2026?

Overseas tour packages: flat 2% (was 5%/20%). LRS for education/medical: 2% (was 5%) above Rs 10L. All other LRS remittances: unchanged at 20% above Rs 10L.

Q5. What is the standard deduction for salaried employees in Tax Year 2026-27?

Rs 75,000 (new regime) and Rs 50,000 (old regime). No bills or proof required — it is a flat statutory deduction.

Q6. When does the Income Tax Act 2025 come into force?

1 April 2026. It replaces the IT Act 1961 but is fully revenue-neutral — all rates, deductions, and exemptions are unchanged.

Q7. What is the deadline to file a revised income tax return for Tax Year 2026-27?

31 March 2028 (extended from 31 December 2027). A fee of Rs 1,000 or Rs 5,000 applies for revisions filed after 31 December — not a penalty, no interest.

Q8. What is the employer NPS deduction limit for salaried employees in 2026-27?

14% of (Basic Pay + DA) under Section 80CCD(2) — available under both regimes, outside the Rs 1,50,000 ceiling of Section 80CCE.

Q9. How are share buyback proceeds taxed after Indian union Budget 2026-27?

As capital gains from 1 April 2026. LTCG at 12.5% (holdings over 12 months, gains above Rs 1,25,000); STCG at 20% (holdings up to 12 months). Acquisition cost is deductible.

Q10. What is the new STT rate on futures and options after Budget 2026?

Futures: 0.05% (up from 0.02%). Options premium: 0.15% (up from 0.10%). Exercise of options: 0.15% (up from 0.125%). Delivery and intraday equity: unchanged.

Q11. What is FAST-DS 2026 and who should use it?

A one-time six-month voluntary scheme from 1 April 2026 for salaried individuals with minor undisclosed foreign assets (ESOPs, old foreign accounts, small inheritances). Provides immunity under the Black Money Act 2015.

Q12. Do I still need to submit Form 15G or 15H to every bank separately in 2026-27?

No. From 1 April 2026, submit once to NSDL or CDSL — the depository shares it with all banks, fund houses, and companies automatically.

The post Indian Union Budget 2026-27: Key Income Tax Changes and Their Impact on Salaried Individuals appeared first on Bhatt & Joshi Associates.

Few provisions in Indian income tax law generate as much sustained controversy, litigation, and legislative amendment as Section 50C of the Income Tax Act, 1961. At its core, it does something constitutionally arresting: it replaces what a seller actually received for their land or building with what the state government’s Stamp Valuation Authority (SVA) says it ought to be worth, and then taxes the seller on that notional figure. This is the classic structure of a deeming fiction — a legislative device that treats something as legally true regardless of factual reality. The question that has occupied taxpayers, assessing officers, tribunals, and High Courts for over two decades is whether such a fiction, when it inflates a seller’s capital gains liability beyond what they actually earned, can survive constitutional scrutiny under Articles 14, 19, and 265 of the Constitution of India. This article examines that question in depth, tracing the legislative history, the mechanics of the provision, the regulatory architecture around circle rates, and the key judicial pronouncements that have shaped its application [1].

Legislative History and the Problem Section 50C Was Designed to Solve

The Finance Act, 2002 inserted Section 50C into the Income Tax Act, 1961, operative from Assessment Year 2003-04. The Explanatory Memorandum to the Finance Bill, 2002 candidly stated the problem: sellers of land and buildings were systematically understating the sale consideration recorded in the sale deed, pocketing a large portion of the actual price in unaccounted cash, and thereby evading capital gains tax on the real profit. This practice not only eroded the tax base but was a major conduit for the generation and circulation of black money in the real estate sector [1].

The legislature’s solution was elegant in design if contentious in application. Under the pre-2003 regime, the Assessing Officer could compute capital gains only on the consideration actually declared in the sale deed, unless they had independent evidence to disturb it. This created a verification vacuum. Section 50C filled that vacuum by making the Stamp Valuation Authority’s assessed value the statutory floor for computing capital gains — a deemed full value of consideration — wherever the declared consideration was lower [2]. The provision interacts with Section 48 of the Income Tax Act, 1961, which is the general formula for computing capital gains: the full value of consideration received minus the cost of acquisition and improvement, with indexation in long-term cases. Section 50C intervenes at the “full value of consideration” stage, substituting the SVA’s value for the declared sale price when the latter falls below the circle rate benchmark.

Understanding the Statutory Text and the Regulatory Mechanism

Section 50C of the Income Tax Act, 1961, in its material portion, provides as follows:

“Where the consideration received or accruing as a result of the transfer by an assessee of a capital asset, being land or building or both, is less than the value adopted or assessed or assessable by any authority of a State Government for the purpose of payment of stamp duty in respect of such transfer, the value so adopted or assessed or assessable shall, for the purposes of section 48, be deemed to be the full value of the consideration received or accruing as a result of such transfer.”

The second and third sub-sections build in a safeguard. If the assessee claims that the SVA’s value exceeds the fair market value of the property on the date of transfer, the Assessing Officer may refer the property’s valuation to a Valuation Officer (VO). If the VO’s determination is lower than the stamp duty value, the VO’s figure is adopted for capital gains computation. However — and this is critical — if the VO’s figure is higher than the stamp duty value, the stamp duty value remains the ceiling. The AO cannot use the VO’s higher figure to further inflate the deemed consideration beyond what the SVA assessed [3].

The Stamp Valuation Authority is a state government body whose valuations are based on what are commonly called “circle rates” or “ready reckoner rates” or “guidance values” — area-specific per-unit rates for land and buildings periodically notified by state governments. These rates represent the state’s administrative estimate of prevailing market values in a given locality and form the basis on which stamp duty is charged on property registrations. They feed directly into the Section 50C calculus, making a creature of state administrative action the trigger for a central income tax liability [8].

Amendments: The Safe Harbour and the Evolution of the Provision

The original provision contained no tolerance band — any shortfall below the stamp duty value, however marginal, activated the deeming fiction. This produced genuine hardship in markets where circle rates lagged actual market declines and in transactions involving tenanted or encumbered properties. The Finance Act, 2018 introduced the first safe harbour: where the difference between the stamp duty value and the declared consideration did not exceed 5% of the declared consideration, the declared consideration would be treated as the full value of consideration for Section 48 purposes. The Finance Act, 2020 widened this tolerance to 10%, meaning that as the law stands today, Section 50C is triggered only where the stamp duty value exceeds 110% of the declared sale consideration [2].

A further amendment addressed the temporal mismatch problem: where the date of the agreement and the date of registration differ — a common feature of India’s real estate market, where sale agreements are frequently executed months or even years before the formal registration of the conveyance deed — the stamp duty value on the date of the agreement may be adopted for capital gains computation, provided the consideration or part thereof was paid through account payee cheque, bank draft, or prescribed electronic mode on or before the agreement date [10]. This amendment, introduced by the Finance Act, 2016, addressed the evident inequity of taxing a seller on the stamp duty value prevailing at the time of registration when the price was contractually fixed at the time of agreement under very different market conditions.

The Constitutional Challenge: K.R. Palaniswamy v. Union of India

The landmark constitutional test of Section 50C came before the Madras High Court in K.R. Palaniswamy v. Union of India, Writ Petition No. 4387 of 2003, decided on 5 August, 2008. The petitioner had sold plots of land in 2002 at a consideration of Rs. 3 lakhs each, but the guideline value for stamp duty purposes stood at approximately Rs. 9.89 lakhs and Rs. 9.90 lakhs respectively — more than three times the actual sale consideration, a disparity the petitioner attributed to a market recession in the relevant locality. The constitutional challenge was multi-pronged: the petitioner argued legislative incompetence of Parliament, violation of Article 14 of the Constitution of India on grounds of arbitrariness and discriminatory classification, violation of Article 265 on the ground that no tax may be levied except by authority of law, and the substantive argument that circle rates are arbitrary because they do not account for location-specific attributes of individual plots within the same survey number or area [5].

The Division Bench of the Madras High Court rejected each ground with detailed reasoning. On legislative competence, the Court held that Parliament’s power to levy tax on income other than agricultural income under Entry 82, List I, Schedule VII of the Constitution of India squarely encompasses the power to make provisions preventing the undervaluation of sale consideration in immovable property transactions. Citing the Supreme Court’s judgment in R.K. Garg v. Union of India, (1981) 4 SCC 675, the Court held that “laws relating to economic activities should be viewed with greater latitude than laws touching civil rights such as freedom of speech, religion etc. … the legislature should be allowed some play in the joints, because it has to deal with complex problems which do not admit of solution through any doctrinaire or strait-jacket formula.” [5]

On Article 14, the Court held that Section 50C embodies a valid and intelligible differentia: it applies to transfers of capital assets being land or buildings, and not to trading assets or stock-in-trade, reflecting a rational legislative policy distinction that runs through the entire framework of the Income Tax Act, 1961. This is not arbitrary discrimination but a classification grounded in the fundamentally different character of capital transactions and business transactions. Most importantly, the Court rejected the argument that Section 50C creates an irrebuttable and therefore arbitrary presumption. Sub-sections (2) and (3) of Section 50C together provide the assessee with a statutory opportunity to rebut the presumption by claiming and establishing a lower fair market value through the VO reference mechanism, after hearing by the AO. As the Court observed: “Thus, a complete full proof safeguard has been given to the assessee to establish before the authorities concerned the real value. Thus, what is stated in Section 50C as a real value cannot be regarded as a notional or artificial value and such real value is determinable only after hearing the assessee as per the statutory provisions stated supra.” [5]

The Rebuttability of the Deeming Fiction: Judicial Refinement

The constitutional question does not begin and end with Palaniswamy. The Allahabad High Court, in CIT v. Chandra Narain Chaudhary (ITAT No. 287 of 2011, decided 29 August, 2013), took the jurisprudence a step further by explicitly characterizing Section 50C as “a rule of evidence in assessing the valuation of property for calculating capital gains” and holding that “the deeming provision under Section 50C(1) of the Act is rebuttable.” The Court observed that an SVA is mandated to fix circle rates uniformly for survey numbers or entire localities and in doing so structurally cannot account for the full range of attributes, charges, encumbrances, limitations, and physical conditions affecting any specific property — tenancy, access constraints, litigation encumbrances, or locational disadvantages within the same zone [6].

The practical implications of this characterization are significant. An AO cannot simply apply the stamp duty value mechanically and close the assessment without engaging with the assessee’s objection. Where the assessee raises an objection to the stamp duty value and produces a valuation report from an approved valuer, the AO is legally bound to apply their mind to the objection. If the AO does not accept the assessee’s valuation, they must refer the matter to the Valuation Officer under Section 55A of the Income Tax Act, 1961, recording valid and legally defensible reasons for the reference. The adoption of the deeming provision as an automatic substitute for proper valuation, without engaging with the assessee’s case, is not permissible and will not survive appellate scrutiny [6].

The Bombay High Court, in its line of decisions, similarly upheld the constitutional validity of the provision while reinforcing that the legal fiction of Section 50C is bounded and cannot be stretched beyond capital gains computation. Courts have consistently held that the deemed consideration under Section 50C cannot be treated as generating actual funds in the assessee’s hands for the purpose of Sections 69, 69A, or 69B of the Income Tax Act, 1961, which create presumptions regarding unexplained investments and expenditures. The legal fiction ends at the boundary of Section 48; it cannot generate a further fiction that the deemed amount was actually received in cash [7].

The Double Taxation Problem and Section 56(2)(x)

A structural tension inherent in the deeming fiction regime becomes apparent when one examines Section 56(2)(x) of the Income Tax Act, 1961 alongside Section 50C. Where property is sold below the circle rate, Section 50C deems the stamp duty value to be the seller’s full consideration for capital gains purposes. Simultaneously, Section 56(2)(x) — introduced by the Finance Act, 2017, replacing the earlier Section 56(2)(vii) — deems the shortfall between the stamp duty value and the declared purchase price as income from other sources in the hands of the buyer, taxable in the year of purchase [4]. The result is that the same notional differential — the gap between the declared consideration and the circle rate — is taxed twice: once as deemed capital gains in the seller’s hands under Section 50C, and once as deemed income from other sources in the buyer’s hands under Section 56(2)(x).

Critics have argued, with considerable force, that this amounts to double taxation of income that neither party actually received, in direct contradiction of the foundational real income theory that underlies Indian income tax jurisprudence — the principle that income tax attaches to income that has actually accrued, arisen, or been received, not to a figure manufactured by administrative valuation. In a sluggish or distressed real estate market, where properties genuinely transact below circle rates, this double taxation falls on honest parties engaged in arms-length transactions. While this argument has found resonance in academic commentary and before some Income Tax Appellate Tribunals, courts have thus far sustained the framework on the ground that Parliament, exercising its anti-avoidance mandate under Article 246 and Entry 82, is entitled to make such structural choices in economic regulation [4].

Regulatory Framework: Circle Rates, Their Setting, and Their Limitations

Circle rates are notified by state governments through their revenue and registration departments following periodic surveys of property transaction data. The process varies significantly between states but typically involves the District Collector conducting market surveys, collating data from registered sale deeds, and proposing area-specific rates for government notification. The fundamental structural limitation of circle rates is that they are backward-looking administrative aggregates: they reflect historical transaction data, are revised at irregular intervals — sometimes years apart — and cannot possibly capture the micro-level characteristics of individual plots, including their access to arterial roads, width of the approach road, whether the plot is a corner plot or an interior one, legal encumbrances, tenancy status, or physical condition.

Under the Indian Stamp Act, 1899 and its state-level analogues, the SVA has an independent authority to challenge undervaluation in sale deeds. Section 47A of the Indian Stamp Act, 1899 empowers the Collector to reassess the market value of property for stamp duty purposes where the consideration stated in the instrument appears to be understated. The interaction between Section 47A proceedings and Section 50C proceedings creates a further layer of legal complexity: if the assessee successfully challenges the stamp duty valuation before the stamp authorities on appeal and it is revised downward, Section 50C(2) of the Income Tax Act, 1961 provides that the capital gains computation shall be amended accordingly by way of rectification under Section 154 to reflect the revised, lower stamp duty value [9]. This cross-referencing between the stamp law framework and the income tax framework is one of the more nuanced and operationally significant aspects of the regulatory architecture surrounding Section 50C.

Conclusion: A Constitutionally Valid but Structurally Imperfect Instrument

Section 50C of the Income Tax Act, 1961 survives constitutional scrutiny, and the Madras and Bombay High Courts have confirmed this in clear terms. Its legislative competence rests squarely on Parliament’s Entry 82 power, and its Article 14 challenges fail because the VO reference mechanism and the statutory hearing process convert the statutory presumption from irrebuttable to rebuttable. In the judicial framing, it is “a rule of evidence” rather than a conclusive deeming of the actual consideration, and the safeguards in sub-sections (2) and (3) provide sufficient procedural fairness.

But constitutionality is not the same as structural soundness or equitable application. Section 50C imposes on honest taxpayers who genuinely sold at distressed or arms-length prices below circle rates the burden of litigation, the cost of approved valuer reports, and the delay of VO references — merely to establish what they actually received. The progressive widening of the safe harbour from nil, to 5%, to 10%, and the date-of-agreement amendment, are Parliament’s own acknowledgements that the raw circle rate is an imperfect proxy for market value. The Income Tax Bill, 2025, proposing to carry forward the substance of Section 50C under Clause 78 with the existing safe harbour framework, confirms that Parliament is not yet ready to depart from the circle rate as the reference point for capital gains in property transactions [1]. The debate around real income theory, the double taxation problem under Section 56(2)(x), and the constitutional limits of deeming fictions in direct taxation will continue to animate Indian tax jurisprudence.

References

[1] ClearTax, Taxability of Sale of Land or Building – Section 50C of Income Tax Act, https://cleartax.in/s/taxability-sale-land-building-section-50c

[2] TaxTMI, Scope and Impact of Provisions of Section 50C of the Act, https://www.taxtmi.com/article/detailed?id=5271

[3] Tax2Win, Section 50C of Income Tax Act – Taxability of Sale of Land or Building, https://tax2win.in/guide/section-50c-of-income-tax-act

[4] TaxGuru, Time to Revisit Section 50C/43CA/56(2) – Adoption of Circle Rates, https://taxguru.in/income-tax/time-revisit-section-50c-43ca-562-adoption-circle-rates.html

[5] Indian Kanoon, K.R. Palanisamy v. Union of India, Writ Petition No. 4387 of 2003, Madras High Court, 5 August 2008, https://indiankanoon.org/doc/1382725/

[6] ITAT Online, CIT v. Chandra Narain Chaudhri (Allahabad High Court), https://itatonline.org/archives/cit-vs-chandra-narain-chaudhri-allahabad-high-court-s-50-c-extent-to-which-reliance-can-be-placed-by-ao-on-stamp-duty-valuation-explained/

[7] ITAT Online Digest, Section 50C: A Step Forward in Curbing Black Money – Digest of Case Laws, https://itatonline.org/digest/articles/section-50c-a-step-forward-in-curbing-black-money/

[8] Indian Kanoon, Shanmuga Sundaram Govindaraj v. The PCIT, 22 July 2022, https://indiankanoon.org/doc/31865560/

[9] Sapr Law, Section 50C: An In-Depth Analysis, https://saprlaw.com/taxblog/Article_50C_V2.pdf

[10] Chartered Club, Tax on Property Transaction Below Circle Rate: Sec 50C, Sec 56, https://www.charteredclub.com/tax-on-property-transaction-below-circle-rate-section-50c-sec-56/

The post Section 50C of the Income Tax Act, 1961 Stamp Duty Valuation vs. Circle Rates: The Constitutional Validity of Deeming Fictions in Capital Gains appeared first on Bhatt & Joshi Associates.

India’s creator economy has grown into a multi-billion-rupee ecosystem, where gaming streamers attract thousands of viewers, YouTubers monetize every upload, and influencers earn more in a month than many salaried employees do in a year. However, TDS on creator income in India remains a major unresolved issue. While the Income Tax Act, 1961, requires brands and companies to deduct TDS when paying creators, it does not cover the thousands of small monetary transfers from viewers via YouTube Super Chats, Twitch bits, Patreon pledges, or third-party donation links. This creates a system where structured income is taxed at source, but viewer donations bypass withholding entirely, leaving creators to rely on self-reporting — a process that has historically been ineffective in any tax framework.

How Creator Income Is Presently Classified

The starting point for any analysis of creator taxation in India is Section 28 of the Income Tax Act, 1961, which brings income from business or profession within the charge of income tax under the head “Profits and Gains from Business or Profession.” Tax authorities and practitioners alike have consistently treated income from YouTube, Twitch, or any streaming platform as falling under this head when content creation is the creator’s primary occupation. Where content creation is ancillary, income may be classified under “Income from Other Sources” under Section 56. In either case, the income is taxable at applicable slab rates. For the assessment year 2024-25, the Income Tax Department formalised this by introducing Profession Code 6023 for “Content Creators” in ITR-3, and a distinct code for social media influencers thereafter, effectively acknowledging that content creation is a recognised income-generating activity within the formal tax architecture [1].

Structured revenue streams — including AdSense earnings, sponsorships, brand collaborations, and merchandise sales — come from identifiable payers who can deduct TDS. GST obligations also apply: under the Goods and Services Tax Act, 2017, services by YouTubers, streamers, and influencers are classified as Online Information and Database Access or Retrieval Services (OIDAR). GST at 18% applies once annual turnover exceeds ₹20 lakh (₹10 lakh in special category states), and creators serving clients across states must register regardless of turnover. However, a critical gap remains: TDS on creator income is consistently applied only to payments from identifiable corporate payers, leaving viewer donations and small transfers outside the withholding framework. [2].

The TDS Framework That Does Apply — And Its Gaps

The TDS architecture that currently governs creator payments rests on three provisions: Sections 194J, 194C, and 194R. Section 194J mandates a 10% TDS on fees for professional services, which would cover a brand’s payment to an influencer for a sponsored integration. Section 194C covers payments under contracts, applicable to project-specific arrangements at 1%. These two sections operate cleanly when the payer is an identifiable Indian corporate or individual deductor above the turnover threshold.

Section 194R, inserted by the Finance Act, 2022, and effective from July 1, 2022, takes the analysis further. It mandates that “any person responsible for providing to a resident, any benefit or perquisite, whether convertible into money or not, arising from carrying out of any business or exercise of any profession by such resident, shall, before providing such benefit or perquisite… deduct an amount equal to ten per cent of the value or aggregate of value of such benefit or perquisite.” The threshold is ₹20,000 in aggregate per year. The Central Board of Direct Taxes (CBDT) issued Circular No. 12 of 2022 dated June 16, 2022, to clarify its application, confirming that TDS under Section 194R is required regardless of whether the benefit is taxable in the hands of the recipient, that valuation is at fair market value or purchase price, and crucially, that products given to social media influencers for review are subject to TDS if the influencer retains the product [3]. This was a significant development: it plugged a specific gap concerning in-kind benefits but left the question of viewer-directed cash donations entirely unaddressed.

The carve-out within Section 194R itself is telling. The provision does not apply to an individual or Hindu Undivided Family whose total sales, gross receipts, or turnover does not exceed ₹1 crore in business or ₹50 lakh in profession in the preceding financial year. This means individual viewers — the very people clicking “Super Chat” or sending ₹500 through a donation link — are entirely outside the deduction obligation [4]. No viewer is a “person responsible for providing benefit” in any organised commercial sense. There is no payer-side obligation, and no platform has been mandated by any CBDT circular or statutory provision to withhold tax on these micro-transactions before remitting them to the creator.

The Structural Void: Viewer Donations and the Absence of a Deductor

This is the heart of the problem. Tax deduction at source is a withholding mechanism that requires a legally identifiable deductor — the entity making the payment — to deduct and deposit tax to the government on behalf of the payee. In conventional professional transactions, this works because the payer is typically a company or a firm with tax compliance obligations. When a viewer sends a donation during a livestream, the payer is an individual who almost certainly falls below any threshold, has no compliance obligation to deduct TDS, and is not structured as a business in the relevant sense. Individually, these donations may be small — ₹50, ₹200, ₹1,000. Cumulatively, they can amount to lakhs of rupees over a financial year for popular streamers.

The Income Tax Act’s gift tax provisions under Section 56(2)(x), which were broadened significantly through the Finance Act, 2017, impose tax in the hands of the recipient when any sum of money exceeding ₹50,000 in aggregate is received from persons who are not “relatives” as defined under the Explanation to Section 56(2). The logic is clear: gifts from strangers that are beyond the ₹50,000 threshold become taxable income for the recipient. Viewer donations, by their very nature, come from strangers. The creator and the viewer have no familial relationship. If the aggregate value of donations received during a financial year crosses ₹50,000, they are taxable in the hands of the creator [5]. However — and this is the crux — there is no withholding mechanism. The obligation to report and pay falls entirely on the creator at the time of filing the Income Tax Return. Section 56(2)(x) has no corresponding TDS provision for this specific scenario.

This creates a significant self-reporting burden in an economy where informal income is historically underreported. Unlike AdSense payments, which pass through banking channels and are visible in Form 26AS or the Annual Information Statement (AIS), donations via Twitch, Kick, or third-party tools like StreamLabs are not systematically captured by the tax system, leaving TDS on creator income in India largely unenforced for these micro-transactions.

Judicial Observations and the “Business Income” Characterization

While no Indian court has directly adjudicated on the tax treatment of streaming donations, the broader jurisprudence on business income and gifts received in the course of carrying on a profession is instructive. The Supreme Court in CIT v. Mahindra & Mahindra Ltd. [1983] 144 ITR 225 (SC) held that a benefit received in kind in the course of business falls within the ambit of Section 28(iv) — income from business or profession — when it arises from the business relationship. This principle is directly relevant: if viewer donations are understood as arising from the act of streaming — which is the creator’s profession — they arguably fall within Section 28 rather than remaining purely within the gift framework of Section 56(2)(x). The Finance Act, 2022’s Explanatory Memorandum itself cited Mahindra & Mahindra when justifying the introduction of Section 194R, which confirms that the legislature acknowledged the Section 28(iv) pathway. Interestingly, the CBDT’s own Circular No. 12/2022 expanded the scope beyond Section 28(iv) to cover all benefits irrespective of taxability, arguably going further than the statute’s intent as understood from that judgment [3].

The Income Tax Appellate Tribunal in Helios Food Improvers (P.) Ltd. v. Dy. CIT [2007] 14 SOT 546 (Mum.) examined the meaning of “perquisite” broadly. Though this was not a streaming case, it established that the term “perquisite” has wide connotation in the context of business benefits. Applying this reasoning to streaming donations, one could argue that a viewer’s donation is a perquisite received in the course of the creator’s profession. This interpretation supports taxability but, again, says nothing about withholding.

GST and OIDAR: A Separate but Equally Fragmented Piece

On the indirect tax side, the classification of streaming and content creation services as OIDAR under the GST framework creates its own set of complications. Domestic streaming platforms facilitating viewer donations arguably have no obligation to collect GST on those donations unless the transaction is framed as a “service” by the creator to the viewer. In most cases, viewer donations are voluntary and do not correspond to a specific service delivery, which weakens the argument that GST is owed. However, when platforms charge subscription fees — such as YouTube Memberships or Twitch subscriptions — those are GST-applicable transactions.

Following the October 2023 amendment to the OIDAR definition under GST, the scope was expanded by removing restrictive conditions such as “minimal human intervention” and “services used for any purpose other than commerce or industry.” The Directorate General of GST Intelligence (DGGI) has since 2024 pushed for greater registration compliance by foreign platforms operating in India, noting that GST collected from OIDAR services rose from ₹80 crore in 2017-18 to ₹2,675 crore in 2023-24 [6]. But even an expanded GST net does not resolve the income tax withholding question on donations.

What Reform Would Look Like

The gap in the withholding framework for TDS on creator income in India is legislative, not judicial, and requires a clear policy fix. There are broadly three approaches worth considering. First, platforms themselves could be designated as “responsible persons” for TDS purposes — much as banks are responsible for deducting TDS on fixed deposit interest under Section 194A. A new provision analogous to Section 194A could require platforms to deduct 10% on cumulative creator earnings from viewer donations once they cross a threshold, say ₹50,000, in a financial year. This would shift the compliance burden from creators (who may not have the systems to track it) to platforms (who have the data). Second, the Annual Information Statement (AIS) framework could be expanded to require mandatory reporting by platforms of all creator earnings — donations included — even where no TDS is deducted. This would improve the tax department’s audit trail without requiring new TDS infrastructure. Third, the CBDT could issue a clarificatory circular applying Section 194R logic to platform-level disbursements of donations, treating the platform as the entity “providing the benefit” when it aggregates and remits viewer donations to creators.

The CBDT has previously shown willingness to use circular power to expand the practical reach of TDS provisions. Its track record with Section 194R Circular No. 12 of 2022 demonstrates that guidelines can be binding on income tax authorities and on “the person providing any such benefit,” which opens a textual pathway to designating platforms as deductors for donation flows [3][4].

The Self-Assessment Trap

Until any such reform materialises, creators bear the full self-assessment burden. A gaming streamer earning ₹8 lakh from AdSense (TDS deducted), ₹3 lakh from brand deals (TDS deducted under Section 194J), and ₹4 lakh from viewer donations (no TDS) receives very different treatment for tax purposes depending purely on the source. The first two are mirrored in Form 26AS, cross-referenced during ITR processing, and difficult to under-report. The third is invisible to the department unless the creator proactively discloses it. The legal obligation to disclose exists — Section 56(2)(x) and/or Section 28 apply — but the enforcement mechanism does not.

Advance tax obligations compound this. If aggregate tax liability exceeds ₹10,000 in a year, Section 208 requires quarterly advance tax payments. A creator who does not account for donation income may find themselves liable for interest under Sections 234B and 234C for failure to pay advance tax on time, in addition to the underlying tax [2]. These are quiet financial risks that creators, many of whom operate informally without chartered accountants, do not anticipate.

Conclusion

India’s TDS framework for the creator economy is structurally incomplete. While TDS is properly deducted, deposited, and reflected in tax records when there is an identifiable corporate payer, the system fails when the “payer” is a diffuse community of individual viewers sending voluntary donations through digital platforms. Sections 194R and 56(2)(x) partially address brand perquisites and recipient liability, but neither establishes a withholding mechanism at the point of payment. This gap leaves creators responsible for self-reporting donations, creating compliance risks. Until Parliament or the CBDT implements reforms — such as designating platforms as deductors, expanding AIS reporting, or introducing a new TDS provision for digital donation income — TDS on creator income in India will remain inconsistent, not due to tax evasion, but because the collection framework was never designed for the realities of the creator economy.

References

[1] Central Board of Direct Taxes, New ITR Code for Social Media Influencers, Taxscan (July 2025): https://www.taxscan.in/top-stories/cbdt-introduces-new-itr-code-for-social-media-influencers-sparking-debate-among-tax-experts-1428531

[2] Tax2Win, Taxation Rules for YouTubers & Influencers in India (2025): https://tax2win.in/guide/taxation-youtubers-social-media-influencers

[3] Lakshmikumaran & Sridharan Attorneys, TDS on Perquisites and Benefits — CBDT Issues Guidelines on New Section 194R (June 2022): https://www.lakshmisri.com/newsroom/news-briefings/tds-on-perquisites-and-benefits-cbdt-issues-guidelines-on-new-section-194r/

[4] TaxGuru, Assessment of CBDT Circular on Section 194R TDS on Benefits or Perquisites: https://taxguru.in/income-tax/assessment-cbdt-circular-section-194r-tds-benefits-perquisites.html

[5] ClearTax, Section 56 of the Income Tax Act: https://cleartax.in/s/section-56-of-the-income-tax-act

[6] A2Z Taxcorp, India Eyes New GST Revenue Stream from Burgeoning Digital Services Market (May 2025): https://a2ztaxcorp.net/india-eyes-new-gst-revenue-stream-from-burgeoning-digital-services-market/

[7] CAClubIndia, GST for Social Media Influencers: https://www.caclubindia.com/articles/gst-for-social-media-influencers-47058.asp

[8] TaxGuru, Tax Laws for YouTubers and Streamers in India (February 2024): https://taxguru.in/income-tax/tax-laws-youtubers-streamers-india-guide.html

[9] CAClubIndia, New Code for Social Media Influencers in ITR-3 — Is Content Creation Now a Profession? (July 2025): https://www.caclubindia.com/articles/new-code-for-social-media-influencers-in-itr3-is-content-creation-now-a-profession-53834.asp

[10] KPMG India, CBDT Releases Guidelines to Remove Difficulties for Deduction of Tax under Section 194R (2022): https://www.in.kpmg.com/taxflashnews/KPMG-Flash-News-CBDT-Guidelines-Section-194R.pdf

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India’s startup ecosystem has grown into one of the most dynamic in the world, yet founders and investors continue to grapple with a tax provision that was never designed with them in mind. Section 79 of the Income Tax Act, 1961 [1] is an anti-abuse rule, written to prevent profitable companies from buying loss-making shells purely to harvest accumulated tax losses. In practice, however, it frequently punishes genuine business reorganisations — investor funding rounds, internal group restructurings, and founder share transfers — that have nothing to do with tax avoidance. For closely held startups, which almost by definition undergo regular changes in shareholding as they move through successive rounds of venture capital, Section 79 can silently wipe out years of accumulated losses, destroying the very deferred tax asset that makes a young company attractive to future investors. This article examines what Section 79 provides verbatim, how it has been amended to accommodate startups, what the courts have said about it, and where the provision still falls dangerously short of protecting legitimate commercial restructuring.

What Section 79 of the Income Tax Act, 1961 Actually Says

The operative text of Section 79(1) of the Income Tax Act, 1961 reads as follows:

“Notwithstanding anything contained in this Chapter, where a change in shareholding has taken place during the previous year in the case of a company, not being a company in which the public are substantially interested, no loss incurred in any year prior to the previous year shall be carried forward and set off against the income of the previous year, unless on the last day of the previous year, the shares of the company carrying not less than fifty-one per cent of the voting power were beneficially held by persons who beneficially held shares of the company carrying not less than fifty-one per cent of the voting power on the last day of the year or years in which the loss was incurred.” [1]

The provision applies exclusively to closely held companies — those not substantially owned by the public. Its single operative test is whether persons who beneficially held shares carrying at least 51% of the voting power on the last day of the year in which the loss was incurred continue to hold that same 51% on the last day of the year in which set-off is claimed. If that continuity is broken, the accumulated business losses simply lapse. Critically, the section uses the phrase “beneficially held” and not merely “held,” a distinction that the courts have spent decades unpacking.

The section was introduced pursuant to the recommendations of the Taxation Inquiry Commission — the Mathai Commission — of 1953–54. Its stated purpose was to curb the practice of profitable enterprises acquiring loss-making undertakings solely to use accumulated tax losses to offset their own profits, what is colloquially known as “trafficking in losses.” [2]

The Startup Carve-Out: Finance Act 2017 and the Section 80-IAC Proviso

Recognising that startups raise capital through multiple rounds of dilutive equity funding and that founders frequently exit or reduce their holdings as the company matures, the Finance Act, 2017 inserted a specific proviso to Section 79(1). The proviso provides that even if the 51% continuity condition is not satisfied, an eligible startup as referred to in Section 80-IAC of the Act may still carry forward and set off its losses, provided that all shareholders who held shares carrying voting power on the last day of the year in which the loss was incurred continue to hold those shares on the last day of the year in which set-off is sought. [3] This exemption is available only for losses incurred during the seven years beginning from the year of incorporation.

The Finance (No. 2) Act, 2019, effective from 1 April 2020, substituted the entire Section 79 and introduced additional statutory exceptions — changes in shareholding arising from death of a shareholder, from a gift to a relative, from the amalgamation or demerger of a foreign parent company subject to 51% continuity of that foreign company’s shareholders, from a resolution plan approved under the Insolvency and Bankruptcy Code or under Section 242 of the Companies Act, 2013, and from the strategic disinvestment of a public sector company. [1]

The startup carve-out sounds generous on its face. But the condition that all original shareholders must continue to hold their shares is, in practice, far more restrictive than the general 51% test applicable to other companies. For ordinary closely held companies, new investors may acquire up to 49% of the voting power without triggering Section 79. For eligible startups, a single original shareholder who exits — even a minor angel investor who held 1% — can theoretically put the entire accumulated loss at risk. This asymmetry reflects a legislative choice to ensure that the startup exemption covers only situations where the founding group remains completely intact, but the real-world impact is that it excludes precisely the kind of early investor churn that is normal and healthy in startup financing.

The Concept of Beneficial Ownership: Where Courts Have Disagreed

The single most litigated question under Section 79 is what it means for shares to be “beneficially held.” Two High Courts have reached diametrically opposite conclusions on this question, and the resulting uncertainty continues to affect corporate restructurings across the country.

The Karnataka High Court addressed this in CIT v. AMCO Power Systems Ltd. [4], decided in 2015. In that case, all shares of AMCO Power Systems were originally held by AMCO Batteries Ltd. (“ABL”). ABL transferred a portion of its shares to its wholly owned subsidiary, AMCO Properties and Investments Ltd. (“APIL”), and later transferred 49% of its remaining shares to Tractors and Farm Equipments Limited (“TAFE”), an unrelated party. At that point, ABL directly held only 6%, APIL held 45%, and TAFE held 49%. The Revenue disallowed the carry forward of losses on the ground that ABL no longer held 51% of the voting power directly. The Karnataka High Court disagreed. It held that since ABL was the holding company of APIL and controlled APIL’s Board entirely, ABL effectively exercised voting power over APIL’s 45% stake, and together ABL and APIL controlled 51%, all ultimately under ABL’s direction. The Court ruled that Section 79 “speaks of 51% voting power” and that the purpose of the provision is to prevent losses from being misused by a new owner — a purpose entirely absent where control never left the ABL group. [4]

The Delhi High Court took a completely contrary view in Yum Restaurants (India) Pvt. Ltd. v. ITO [5], decided in January 2016. There, 100% of Yum India’s shares were transferred from Yum Asia Pte. Ltd. to Yum Restaurants International (Singapore) Pte. Ltd., with the ultimate parent throughout being Yum! Brands USA. The taxpayer argued that the ultimate beneficial owner was always Yum USA and that no real change in beneficial ownership had taken place. The Delhi High Court rejected this, holding that Yum Asia and Yum Singapore were distinct legal entities and that there was no agreement or arrangement on record demonstrating that the beneficial owner of the shares was Yum USA rather than the immediate holding entity. The Court found that there was “indeed a change of ownership of 100% shares of Yum India from Yum Asia to Yum Singapore, both of which were distinct entities” and that the “question of piercing the veil at the instance of Yum India does not arise.” [5] Section 79 was held applicable and Yum India was denied set-off of its accumulated losses.

These two cases represent the sharpest fault line in Section 79 jurisprudence. The Karnataka court applied a substance-over-form approach, treating consolidated group control as determinative. The Delhi court demanded explicit contractual or documentary evidence of beneficial ownership in an entity beyond the registered shareholder. Since neither decision has been overturned by the Supreme Court, taxpayers remain subject to different standards depending on the jurisdiction in which they are assessed — a situation that generates unpredictability in precisely the kind of cross-border group reorganisations that Indian startups most commonly undertake.

The Supreme Court’s Foundational Position

The Supreme Court laid down the foundational interpretation of Section 79 in Commissioner of Income Tax, Bombay v. Italindia Cotton Co. (P) Ltd. [6], decided on 5 September 1988. The question was whether the two conditions that save a company from Section 79 — that 51% of voting power continues to be beneficially held by the same persons, or that the change in shareholding was not effected with a view to avoiding tax — operate cumulatively or in the alternative. The Supreme Court held that they operate in the alternative. It stated that the benefit is available “notwithstanding the change in shareholding in the previous year, if shares representing not less than 51% of the voting power remain beneficially held by the same persons on the relevant dates” and equally available if “the change was not effected with a view to avoiding or reducing any liability to tax.” [6] Satisfaction of either condition is sufficient to negate the disallowance.

This principle means that even where genuine beneficial ownership has shifted beyond the 49% threshold, a taxpayer who can establish to the Assessing Officer that the restructuring was not tax-motivated can still preserve its accumulated losses. This second limb is, however, a factual determination susceptible to subjective assessment by Revenue officers, and in practice the burden of proof that the restructuring had no tax-avoidance motive rests heavily on the taxpayer.

The Mumbai ITAT: When Section 79 Is Triggered

The Mumbai Bench of the Income Tax Appellate Tribunal brought procedural clarity in Sodexo India Services Pvt. Ltd. [7], holding that Section 79 is attracted only in the year in which set-off is actually claimed, not in the year when the change in shareholding occurs. The Tribunal also reaffirmed that where the ultimate beneficial ownership of the company has remained unchanged, Section 79 cannot be invoked merely because the registered holder has changed. Since Sodexo India’s shares had moved between entities within the same group while the ultimate parent remained constant, the revisionary proceedings invoking Section 79 were held unsustainable. [7]

The timing clarification carries a double-edged consequence. It means that a restructuring that looks clean when executed could be reviewed under the shareholding composition that exists at the time set-off is eventually claimed, potentially years later. Careful monitoring of shareholder registers over the entire loss utilisation period is therefore essential for any closely held company with accumulated losses.

Where the Framework Falls Short

Despite the 2017 carve-out, Section 79 remains structurally inadequate for the startup funding lifecycle. The “all shareholders” condition is commercially unrealistic — early-stage investors, employee option-holders who exercise and sell, and seed-round angels routinely exit before a startup reaches profitability. The seven-year limitation compounds this: startups in capital-intensive industries — deep technology, life sciences, hardware, electric vehicles — commonly do not reach profitability within seven years, and once losses fall outside the seven-year window the startup carve-out ceases to apply. [8] The turnover threshold under Section 80-IAC adds a further complication, since a company that crosses the relevant threshold in a later year may find that it no longer qualifies as an eligible startup when it attempts to claim set-off, even though it unquestionably qualified when the losses were incurred.

For startups receiving foreign venture capital through offshore holding structures — near-universal in Indian tech startups — the Delhi High Court’s insistence on explicit documentary evidence of beneficial ownership creates structural risk. A fund manager sitting in Singapore who invested through a Mauritius SPV is the beneficial owner in any economic sense, but the Revenue may treat the SPV as the beneficial shareholder for Section 79 purposes. The PwC analysis of the Mumbai ITAT’s 2021 ruling, which denied Section 79’s application where voting power and beneficial ownership effectively remained unchanged after an intra-group merger, shows that taxpayers can succeed on these facts — but the litigation cost and uncertainty remain significant. [9]

Conclusion

Section 79 of the Income Tax Act, 1961 was designed to prevent tax trafficking in losses. Over six decades of litigation it has evolved into something considerably more complex — a provision that routinely catches legitimate group reorganisations and startup funding rounds within its net, while courts across the country disagree about whether and how beneficial ownership arguments can displace its application. The 2017 startup carve-out was well-intentioned but too narrowly drawn: the “all shareholders” condition is commercially impractical, the seven-year window is insufficient for many industries, and DPIIT recognition introduces administrative fragility into what ought to be a tax-stable relationship. Until Parliament revisits Section 79 with genuine attention to the startup funding lifecycle, or until the Supreme Court resolves the conflict between the Karnataka and Delhi High Courts on beneficial ownership, taxpayers will continue to face avoidable loss forfeitures that have nothing to do with tax avoidance.

References

[1] Section 79, Income Tax Act, 1961, as amended by Finance (No. 2) Act, 2019 — https://indiankanoon.org/doc/814605/

[2] PwC India, “Section 79 and its implications on global and domestic transactions/restructuring,” Tax Guru, June 2022 — https://taxguru.in/income-tax/section-79-implications-global-domestic-transactions-restructuring.html

[3] Argus Partners, “Extended Set Off and Carry Forward Period under Section 79 of the IT Act” — https://www.argus-p.com/updates/updates/extended-set-off-and-carry-forward-period-under-section-79-of-the-it-act/

[4] CIT v. AMCO Power Systems Ltd., Karnataka High Court, ITA Nos. 766, 765, 767, 769 of 2009 and 1046 of 2008 — https://itatonline.org/archives/cit-vs-amco-power-systems-ltd-karnataka-high-court-s-79-as-the-purpose-of-the-provision-is-to-prevent-misuse-of-losses-by-transferring-ownership-it-should-be-restricted-to-cases-of-transfer-of-be/

[5] Yum Restaurants (India) Pvt. Ltd. v. ITO, Delhi High Court, ITA Nos. 349 and 388 of 2015, decided 13 January 2016 — https://indiankanoon.org/doc/85916376/

[6] CIT, Bombay v. Italindia Cotton Co. (P) Ltd., Supreme Court of India, Civil Appeal No. 1520(NT) of 1986, decided 5 September 1988 — https://courtverdict.com/supreme-court-of-india/the-commissioner-of-income-tax-bombay-vs-ms-italindia-cotton-co-p-ltd

[7] S.R. Patnaik, “Section 79 cannot be invoked when there is no change in ultimate beneficial shareholding,” Cyril Amarchand Blogs, March 2023 — https://tax.cyrilamarchandblogs.com/2023/03/section-79-cannot-be-invoked-when-there-is-no-change-in-ultimate-beneficial-shareholding/

[8] “Section 79: Carry Forward and Set Off of Losses in Case of Eligible Startups,” Tax Guru, August 2019 — https://taxguru.in/income-tax/section-79-carry-set-loss-case-ofeligible-startups-condition-relaxed.html

[9] PwC India, “Applicability of Section 79 of the Act denied where there is no change in voting power and beneficial ownership,” Tax Insights, September 2021 — https://www.pwc.in/assets/pdfs/news-alert/tax-insights/2021/pwc_tax_insights_15_september_2021_applicability_of_section_79_of_the_act_denied_where_there_is_no_change_in_voting_power_and_beneficial_ownership.pdf

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Carbon credits — formally known as Certified Emission Reductions (CERs) — have occupied an increasingly contentious space in Indian tax jurisprudence over the past two decades. As an internationally recognised tradeable commodity under the Kyoto Protocol, a single carbon credit represents the verified reduction of one tonne of carbon dioxide or an equivalent greenhouse gas (GHG) emission. While the environmental rationale behind these instruments is well understood, their precise character under the Income-tax Act, 1961 (the “IT Act”) has been the subject of considerable dispute between taxpayers and the Income-tax Department. The central question — whether proceeds from the transfer of carbon credits constitute a capital receipt, a revenue receipt, or business income — carries profound tax consequences and has shaped India’s evolving regulatory posture toward emission trading markets [1].

The fundamental distinction in Indian income tax law is this: revenue receipts are taxable unless specifically exempted, while capital receipts are not taxable unless a specific charging provision brings them within the scope of income. This binary has defined every judicial and legislative intervention on the carbon credit question, culminating in the insertion of Section 115BBG into the IT Act by the Finance Act, 2017, operative from Assessment Year 2018-19 onwards. Even so, the legal controversy has not fully settled, and the matter in Principal Commissioner of Income Tax v. Lanco Tanjore Power Co. Ltd. remains pending before the Supreme Court of India, demonstrating that the final word has not yet been pronounced [2].

What Are Carbon Credits and How Are They Generated?

Under the United Nations Framework Convention on Climate Change (UNFCCC) and the Kyoto Protocol, industrialised countries committed to reducing their GHG emissions. The Clean Development Mechanism (CDM) is one of the market-based tools under the Protocol that allows developed-country entities to invest in emission-reduction projects in developing countries, including India, in exchange for CERs. Entities that achieve emission reductions below their baseline are issued these credits, which can then be sold to entities that have exceeded their permitted limits.

Critically, a carbon credit is not generated as a product or by-product of the taxpayer’s manufacturing or service operations. It arises entirely from the quantified reduction of atmospheric pollution — an act validated by the UNFCCC — rather than from the taxpayer’s normal course of business. This fundamental characteristic has been central to the argument that carbon credits partake of the nature of a capital entitlement, not a trading commodity. As the ITAT, Hyderabad Bench, held in its landmark decision in My Home Power Ltd. v. DCIT [ITA No. 1114/Hyd/2009, dated 02.11.2012], carbon credit is “in the nature of an entitlement received to improve world atmosphere and environment reducing carbon, heat and gas emissions” [3].

The Revenue’s Position: Business Income or Revenue Receipt

From the very first assessments involving CERs, the Income-tax Department took the position that proceeds from the sale of carbon credits were taxable as business income under the head “Profits and gains of business or profession” under Sections 28 and 2(24) of the IT Act. The Department’s reasoning rested on the premise that carbon credits were earned in the course of the assessee’s business operations — for instance, by switching fuel sources or using renewable energy — and that because they had a recognised market and were quoted on stock exchanges, they were akin to trading stock and therefore a revenue receipt.

The Assessing Officers further leaned on Section 28(iv) read with Section 2(24)(vd) of the IT Act, which brings to tax “the value of any benefit or perquisite arising from business or exercise of profession.” Since the carbon credit was received in the context of a business enterprise, the Revenue argued it fell squarely within this definition. The Cochin Bench of the ITAT, in Apollo Tyres Ltd. v. ACIT [(2014) 47 taxmann.com 416 (Cochin-Trib.)], sided with the Revenue on this basis, holding that CERs were obtained in the course of business activity and that income on their sale was a benefit arising out of business under Section 28(iv) [4]. This remains the strongest judicial articulation of the Revenue’s position, though it has not been widely followed by other benches or by any High Court.

The Assessee’s Position and the Weight of Judicial Authority: Capital Receipt

The overwhelming weight of judicial authority — beginning with the ITAT and confirmed by multiple High Courts — has held that sale proceeds of carbon credits are capital receipts not liable to tax under any head of income under the IT Act. The foundational reasoning was laid down in My Home Power Ltd. v. DCIT (supra), where the ITAT, Hyderabad, reasoned that carbon credits are not an offshoot of business but an offshoot of “world concern” regarding the environment. The Tribunal held: “Carbon credit is not generated or created due to carrying on business but it is accrued due to world concern. The source of carbon credit is world concern and environment. The amount received for carbon credits has no element of profit or gain and it cannot be subjected to tax in any manner under any head of income. It is not liable for tax for the assessment year under consideration in terms of sections 2(24), 28, 45 and 56 of the Income-tax Act, 1961.” [3]

The Tribunal further held that CERs are not “capital assets” within Section 2(14), and accordingly their transfer cannot give rise to capital gains under Section 45. The reason is that carbon credits carry no cost of acquisition, and the computation mechanism under Section 48 fails in their case. There is thus no head of income — whether business profits, capital gains, or income from other sources — under which CER proceeds can be brought to charge.

This view was confirmed by the Andhra Pradesh High Court in Commissioner of Income Tax v. My Home Power Ltd. [ITAT Appeal No. 60 of 2014, dated 19.02.2014], where the Division Bench held: “Carbon Credit is not an offshoot of business but an offshoot of environmental concerns. No asset is generated in the course of business but it is generated due to environmental concerns. The Carbon Credit is not even directly linked with power generation.” The High Court affirmed that the receipt was correctly classified as a capital receipt not liable to tax [3].

The Karnataka High Court followed suit in CIT v. Subhash Kabini Power Corporation Ltd. [(2016) 385 ITR 592 (Karn.)], explicitly endorsing the Andhra Pradesh High Court’s analysis [4]. The Madras High Court, in CIT v. Wescare (India) Ltd. [Tax Case Appeal No. 434 of 2021], dismissed the Revenue’s appeal and confirmed that CERs earned under the CDM mechanism in wind energy operations were a capital receipt, not taxable as business income. The Court relied on the Karnataka and Andhra Pradesh precedents and on S.P. Spinning Mills Pvt. Ltd. v. ACIT [2021 (1) TMI 1081 (Madras HC)] [5]. Multiple ITAT benches — at Jaipur in Shree Cement Ltd. v. ACIT [(31 ITR (Trib.) 513)], at Chennai in Ambica Cotton Mills Ltd. v. Dy. CIT [(27 ITR (Trib.) 44)], and at Ahmedabad in 2023 — consistently followed the same line [6].

Section 115BBG: The Legislative Intervention of 2017

To bring an end to years of protracted litigation, the Finance Act, 2017 inserted Section 115BBG into the IT Act, operative from 1 April 2018 (Assessment Year 2018-19 onwards). The stated objective was “to bring clarity on the issue of taxation of income from transfer of carbon credits and to encourage measures to protect the environment” [1].

The text of Section 115BBG reads as follows:

“115BBG. (1) Where the total income of an assessee includes any income by way of transfer of carbon credits, the income-tax payable shall be the aggregate of — (a) the amount of income-tax calculated on the income by way of transfer of carbon credits, at the rate of ten per cent; and (b) the amount of income-tax with which the assessee would have been chargeable had his total income been reduced by the amount of income referred to in clause (a). (2) Notwithstanding anything contained in this Act, no deduction in respect of any expenditure or allowance shall be allowed to the assessee under any provision of this Act in computing his income referred to in clause (a) of sub-section (1). Explanation — For the purposes of this section, ‘carbon credit’ in respect of one unit shall mean a reduction of one tonne of carbon dioxide emissions or emissions of its equivalent gases which is validated by the United Nations Framework on Climate Change and which can be traded in the market at its prevailing market price.” [7]

On a careful reading, Section 115BBG does not categorise carbon credit proceeds as either a capital receipt or a revenue receipt — it merely taxes “income by way of transfer of carbon credits.” There is no corresponding amendment to Section 2(24) or Section 28, meaning legal practitioners have argued that the existing case law holding CERs to be capital receipts remains relevant. The 10% rate operates on the gross amount with no deductions permitted — which imposes a higher effective burden than a normal profits-based tax. The section applies to both resident and non-resident assessees, though for non-residents, taxability arises only to the extent attributable to a business connection or permanent establishment in India [1].

The Voluntary Carbon Credit Problem and Satia Industries

A significant ambiguity stems from the narrow definition in the Explanation to Section 115BBG, which restricts “carbon credit” to reductions “validated by the United Nations Framework on Climate Change.” Voluntary carbon credits — validated by independent bodies such as Verra (formerly Verified Carbon Standard) or Gold Standard — are arguably outside Section 115BBG entirely. The ITAT, Amritsar, in Satia Industries Ltd. v. NFAC, held precisely this: Renewable Energy Certificates (RECs), regulated by the Central Electricity Regulatory Commission and not by the UNFCCC, are not “carbon credits” within the meaning of Section 115BBG, and proceeds from their transfer remain capital receipts exempt from tax [2]. This creates a notable divergence — entities trading UNFCCC-validated CERs face a 10% gross tax, while entities dealing in voluntary or REC markets may claim full capital receipt exemption.

The Regulatory Framework: Energy Conservation (Amendment) Act, 2022 and the CCTS

India’s engagement with carbon credits began under the Kyoto Protocol’s CDM. The institutional foundation for a domestic carbon trading market, however, took decades to develop. The Energy Conservation (Amendment) Act, 2022 — which amended the Energy Conservation Act, 2001 — provided the first statutory basis for a domestic Carbon Credit Trading Scheme (CCTS). Section 14(w) of the Energy Conservation Act (as amended) empowers the Central Government to “specify the carbon credit trading scheme,” while Section 2(da) allows the Central Government or any authorised agency to issue Carbon Credit Certificates (CCCs), with each CCC representing one tonne of CO2-equivalent reduction [8].

The Ministry of Power formally notified the CCTS in June 2023, establishing the Indian Carbon Market (ICM). The ICM has a two-tier structure — a compliance mechanism targeting energy-intensive sectors with mandatory GHG emission intensity targets, and a voluntary offset mechanism open to non-obligated entities. The Bureau of Energy Efficiency (BEE) acts as market administrator; the Grid Controller of India (GCI) serves as the central registry; and the Central Electricity Regulatory Commission (CERC) regulates trading through approved power exchanges [9]. On 8 October 2025, the Ministry of Environment, Forest and Climate Change notified the Greenhouse Gas Emission Intensity Target Rules, 2025, covering 282 entities across aluminium, cement, chlor-alkali and pulp and paper sectors — marking the transition from policy framework to operational compliance for India’s nascent carbon market.

Conclusion and Classification

The income tax treatment of carbon credits in India has moved through identifiable phases. For assessment years prior to 2018-19, courts have consistently held CERs to be capital receipts outside the scope of any head of income, and accordingly not liable to tax. For AY 2018-19 onwards, Section 115BBG imposes a 10% flat rate on gross income from UNFCCC-validated carbon credit transfers, with no deductions allowed. Voluntary credits outside the UNFCCC framework fall back into capital receipt territory under the pre-amendment case law. Carbon credits are best characterised as a sui generis instrument — neither a capital asset under Section 2(14) (because capital gains computation fails) nor a revenue receipt in the traditional sense (because they arise from environmental entitlement, not business output). Section 115BBG has carved out a special legislative category without resolving the underlying conceptual debate. The Supreme Court’s eventual ruling in Lanco Tanjore will be definitive.

References

[1] Sachin Kumar B P and Akella A.S. Prakasa Rao, “Conundrum of Taxing Carbon Credits in India,” Tax Sutra Expert Articles, available at: https://database.taxsutra.com/articles/247e49018231c072087302cf158168/expert_article

[2] AZB & Partners, “Sale of Renewable Energy Certificates Not Covered Under Section 115BBG,” AZB Legal Update, July 2023, available at: https://www.azbpartners.com/bank/sale-of-renewable-energy-certificates-not-covered-under-section-115bbg-oust-taxability-by-holding-it-a-capital-receipt/

[3] My Home Power Ltd. v. DCIT, ITA No. 1114/Hyd/2009, ITAT Hyderabad, 02.11.2012 (affirmed by A.P. High Court, ITAT Appeal No. 60 of 2014, 19.02.2014), available at: https://indiankanoon.org/doc/146055938/

[4] “Taxability of Carbon Credits,” BCA Journal Online, November 2023, available at: https://bcajonline.org/journal/taxability-of-carbon-credits/

[5] “Sale of Carbon Credits is Capital Receipt and Not Taxable” (CIT v. Wescare (India) Ltd., Madras HC, Tax Case Appeal No. 434 of 2021), Tax Guru, September 2021, available at: https://taxguru.in/income-tax/sale-carbon-credits-capital-receipt-taxable.html

[6] “Profit from Sale of Carbon Credit is Capital Receipt, Not Taxable: ITAT,” Tax Scan, January 2023, available at: https://www.taxscan.in/profit-from-sale-of-carbon-credit-is-capital-receipt-not-taxable-itat-read-order/249810/

[7] “Taxability of Carbon Credits — Full Text of Section 115BBG,” Tax Guru, December 2019, available at: https://taxguru.in/income-tax/taxability-carbon-credits.html

[8] PRS India, “The Energy Conservation (Amendment) Bill, 2022,” PRS Legislative Research, available at: https://prsindia.org/billtrack/the-energy-conservation-amendment-bill-2022

[9] Bureau of Energy Efficiency, Ministry of Power, “National Carbon Market Framework,” Government of India, available at: https://www.beeindia.gov.in/carbon-market.php

The post Income Tax Treatment of Carbon Credits: Asset, Income, or Capital Receipt Under the IT Act, 1961? appeared first on Bhatt & Joshi Associates.

When the Finance Act 2020 abolished the Dividend Distribution Tax (DDT) under Section 115-O of the Income Tax Act, 1961, India shifted from a company-level tax to the classical shareholder-level dividend taxation model.[1] At the core of this transition, Section 80M was reintroduced to prevent double taxation of inter-corporate dividends across multi-tier corporate structures. Despite its intent, Section 80M continues to face structural gaps, interpretive uncertainties, and unresolved cascading tax issues. This article explores how Section 80M dividend deduction works, the regulatory framework, key case law, and the ongoing challenges in corporate dividend taxation.

Historical Background: From Classical Taxation to DDT and Back

India’s approach to taxing dividends has been anything but linear. Prior to 1997, dividends were taxed in the hands of shareholders under the classical system — straightforward in principle but administratively cumbersome given the difficulty of tracking income across a dispersed shareholder base. The Finance Act, 1997 introduced Section 115-O, which imposed a Dividend Distribution Tax on domestic companies at the point of distribution, making dividends entirely exempt in shareholders’ hands under Section 10(34) [2]. Section 115-O charged an additional income-tax at 15% on any amount declared, distributed, or paid by way of dividend — eventually rising to an effective rate of 20.56% inclusive of surcharge and cess.

The original Section 80M — which allowed deductions for inter-corporate dividends — was made redundant under the DDT regime and was formally omitted by the Finance Act, 2003. DDT had its own internal mechanism to prevent cascading taxation: under Section 115-O(1A), a holding company was allowed to reduce the DDT base by the amount of dividend received from a subsidiary company, provided that subsidiary had already paid DDT on that same dividend [1]. This created a partial shield against layered taxation within holding-subsidiary structures, though it was limited only to the immediate holding-subsidiary relationship and did not travel up a multi-tier pyramid.

The Finance Act 2020 scrapped this entire architecture. With effect from April 1, 2020, dividends declared, distributed, or paid by domestic companies became entirely exempt from DDT. Section 10(34), which exempted dividend income in shareholders’ hands, was simultaneously withdrawn. Section 115BBDA — which imposed a 10% tax on dividend income exceeding ₹10 lakh in the hands of resident individuals — became redundant and was also withdrawn. Dividends were now fully taxable in the hands of recipients at their applicable slab rates or corporate tax rates [2]. And Section 80M was re-inserted to ensure that the same dividend income did not get taxed at every tier of a corporate pyramid.

Statutory Framework: What Section 80M Actually Says

Section 80M, inserted after Section 80LA by the Finance Act, 2020, with effect from Assessment Year 2021-22, reads materially as follows [3]:

“Where the gross total income of a domestic company in any previous year includes any income by way of dividends from any other domestic company or a foreign company or a business trust, there shall, in accordance with and subject to the provisions of this section, be allowed in computing the total income of such domestic company, a deduction of an amount equal to so much of the amount of income by way of dividends from such other domestic company or foreign company or business trust as does not exceed the amount of dividend distributed by it on or before the due date.”

 

The Explanation further clarifies: “For the purposes of this section, the expression ‘due date’ means the date one month prior to the date for furnishing the return of income under sub-section (1) of section 139.”

Sub-section (2) of Section 80M bars double-dipping: where a deduction has been allowed in any previous year in respect of dividend distributed, no deduction shall be allowed again in respect of the same amount in any other previous year [3]. This ensures that a single distribution event does not generate deductions across multiple assessment years.

Section 80M falls under Chapter VI-A of the Income Tax Act, 1961 — the chapter dealing with deductions from gross total income. This placement is significant because Section 80A(2) imposes a ceiling: the aggregate amount of deductions under Chapter VI-A cannot exceed the Gross Total Income of the assessee. Consequently, where a domestic company has a negative or nil Gross Total Income, no deduction under Section 80M is available even if substantial dividends have been distributed to shareholders — a limitation that has drawn considerable criticism from practitioners [4].

The Regulatory Architecture Around Section 80M

Section 80M does not operate in isolation. It interacts with a web of provisions that collectively determine the final tax incidence on inter-corporate dividends. Section 194 of the Income Tax Act was simultaneously amended by the Finance Act 2020 to require the payer company to withhold tax at 10% on dividends distributed to shareholders where the amount exceeds ₹5,000 [1]. This TDS mechanism replaces the administrative convenience that DDT offered, though at the cost of a considerably greater compliance burden across all distributing companies.

For dividends received by a domestic company from a foreign company in which the Indian company holds 26% or more equity shareholding, Section 115BBD provides for a concessional tax rate of 15% on a gross basis without allowing deduction for any expenditure. Section 80M deduction is, however, available even against such income — an amendment made at the final stage of the Finance Act 2020, expanding the provision beyond the original Finance Bill 2020’s scope, which had restricted the deduction only to dividends from domestic companies [2]. This expansion was necessary because the Finance Bill 2020 proposal had created a fresh anomaly: a domestic company receiving foreign dividend would have been taxed on it without any relief upon distribution, effectively replicating the very cascading effect that Section 80M was meant to cure.

Under Section 14A read with Rule 8D of the Income Tax Rules, 1962, the tax department retains the power to disallow expenditure incurred in relation to earning dividend income. The interaction between Section 14A and Section 80M — specifically, whether the deduction under Section 80M is to be computed against gross dividend income or net dividend income after applicable disallowances — is a contested area that the statute does not definitively resolve [4].

The Cascading Problem: What Remains Unresolved

The central failure of the Finance Act 2020’s treatment of Section 80M lies in what the provision does not address. The deduction mechanism is conditional: a domestic company can only claim the deduction if it has actually distributed dividends to its own shareholders on or before one month prior to the due date of filing its return of income. The Act makes clear that mere declaration is insufficient — actual distribution must have occurred [3]. This creates a structural trap for holding companies that receive dividend income in a particular financial year but, for legitimate business or treasury reasons, do not distribute that income within the prescribed window. In such a scenario, the same stream of income is taxed at the subsidiary level at the applicable corporate rate, then again at the holding company level with no Section 80M relief, and once more in the hands of the ultimate shareholders. The cascading effect reasserts itself the moment the timing condition is not met [8].

The problem is compounded in multi-tier structures. In a holding pyramid of A → B → C → D, at each intermediate tier, the deduction under Section 80M requires that tier’s company to have distributed dividends before the prescribed date. If any intermediate company fails to meet this condition, not only does that company lose the deduction, but the cascading effect reverberates upward through the entire chain. No provision in Section 80M or elsewhere in the Act addresses this cascading failure within pyramidal corporate groups — a structural gap that was flagged during analysis of the Finance Bill 2020 but left unaddressed [2].

The omission of Section 80AA is another silent but serious problem. The original Section 80M, prior to its removal in 2003, operated alongside Section 80AA which specifically clarified that the deduction was to be computed with reference to net dividend income — not gross. When Section 80M was re-inserted in 2020, Section 80AA was not restored. The resulting statutory silence has generated interpretive uncertainty that practitioners have struggled to resolve: the deduction potentially takes on very different values depending on which computation base applies, and neither CBDT nor the courts have definitively answered the question [4].

Constitutional Validity and the DDT Legacy: Key Case Law

The constitutional underpinning of the DDT regime — which Section 80M was designed to succeed — was conclusively settled by the Supreme Court of India in Union of India & Ors. v. M/s. Tata Tea Co. Ltd. & Ors. [AIR 2017 SC 4856]. The Supreme Court, upholding the constitutional validity of Section 115-O under Entry 82 of List I of the Seventh Schedule to the Constitution of India, held that once a dividend is declared and distributed to shareholders, it loses the character of the source income from which it was derived. Rejecting the contention that DDT could not be levied on dividends derived from agricultural income — a state subject — the Court applied the doctrine of pith and substance and held that the additional income-tax under Section 115-O was squarely within Parliament’s legislative competence [5]. This ruling is foundational to any understanding of dividend taxation in India because it resolved, definitively, that Parliament can levy tax on distributed dividends irrespective of the nature of the underlying source income — a principle that equally supports the legitimacy of the current classical model.

At the tribunal level, significant clarification emerged from the ITAT Kolkata in Purnasons Pvt. Ltd. v. ITO, which examined whether the deduction under Section 80M is available where dividends are distributed within the due date prescribed by the section. The Tribunal ruled in favour of the assessee, allowing the Section 80M deduction on dividends distributed before the statutory deadline [6]. Separately, the Delhi High Court, in proceedings arising out of a Section 80M disallowance, held that the disallowance of deductions to the extent of dividends distributed to shareholders was unsustainable in law and directed deletion of the addition — a decision that reinforces the taxpayer-friendly reading of the provision in cases of actual, timely distribution [6].

The question of deemed dividends under Section 2(22)(e) has also entered the debate. The Finance Bill 2020 Memorandum states explicitly that Section 80M was inserted to remove the cascading effect. A restricted interpretation that excludes deemed dividends from the ambit of Section 80M would defeat this legislative purpose. A Calcutta High Court decision under the pre-2003 Section 80M had held that the assessee was entitled to relief in respect of dividends received on reduction of company capital — pointing toward a broad reading of the term “dividend” [7]. Whether this reasoning extends to deemed dividends under the re-inserted provision remains contested and is almost certainly headed for further litigation.

TDS Obligations and Compliance Burden Post-Finance Act 2020

One of the practical consequences of the transition from DDT to the classical system is the dramatically increased compliance burden on distributing companies. Under the DDT regime, the company paid DDT as a single aggregate tax; there was no need to separately identify each shareholder’s tax residency or treaty status. Post Finance Act 2020, Section 194 requires TDS at 10% for resident shareholders on dividend exceeding ₹5,000, while for non-resident shareholders, Section 195 applies with the actual rate determined by the applicable Double Taxation Avoidance Agreement [2].

For non-resident shareholders, the transition was arguably a net positive in one important respect: DDT was a tax levied on the company, not on them personally, and therefore non-residents could not claim credit for it in their home jurisdiction in the absence of enabling treaty language. As Cyril Amarchand Mangaldas noted, under the DDT regime, non-resident shareholders were not able to claim foreign tax credit for DDT paid by the Indian company, whereas post-2020, TDS directly withheld on their dividend income makes it creditable under applicable DTAAs [9]. But this benefit came alongside an unacknowledged burden for high-income resident shareholders, whose effective marginal rate on dividend income can now reach 42.74% inclusive of surcharge — far exceeding what they bore collectively under the DDT era.

What the Finance Act 2020 Left Open

The statute provides no carry-forward mechanism for unclaimed Section 80M deductions. If a company cannot claim the deduction in Assessment Year 2021-22 because it did not distribute dividends before the prescribed date, the question of whether it may claim that deduction in the next year — in relation to distributions made then — has no definitive statutory answer. A plain reading of the provision arguably permits it: sub-section (2) only bars re-claim of deductions already allowed, not deductions never availed. But this interpretation is contested and likely to generate prolonged assessment disputes [4].

The Finance Act 2020 also failed to restore Section 80AA alongside Section 80M. Until the gross-versus-net computation question is settled by either amendment or authoritative judicial pronouncement, assessees and assessing officers will operate from opposing positions, and the resultant disputes will take years to work their way through the appellate machinery. The parliamentary intent — clearly reflected in the Finance Minister’s Budget Speech of 2020 — was that inter-corporate dividend taxation should not be punitive or duplicative. The legislative execution, however, left enough gaps that achieving this intent now depends on interpretive goodwill that tax administration historically has not reliably extended.

Conclusion

Section 80M, as re-inserted by the Finance Act 2020, represents a genuine attempt to prevent cascading dividend taxation in the post-DDT framework. Its last-minute extension to include foreign dividends and business trust distributions reflects some legislative responsiveness to structural deficiencies in the Finance Bill 2020 proposal. However, the provision as it stands carries forward a set of unresolved tensions: the strict timing condition for distribution, the absence of a carry-forward mechanism for unclaimed deductions, the unresolved gross-versus-net computation question, the gap left by the deletion of Section 80AA, the cascading exposure in multi-tier holding structures, and the open question of deemed dividends. These are not academic concerns — they are live issues affecting the tax liability of some of India’s largest corporate groups. Section 80M partially cures the problem it was designed to address. In doing so, it leaves the harder cases precisely where they were.

References

[1] ClearTax, Section 80M of the Income Tax Act – Inter-Corporate Dividends — https://cleartax.in/s/section-80m

[2] Cyril Amarchand Mangaldas, Abolition of Dividend Distribution Tax: A New Paradigm for Equity Investments (April 2020) — https://corporate.cyrilamarchandblogs.com/2020/04/abolition-of-dividend-distribution-tax-a-new-paradigm-for-equity-investments/

[3] AAP Tax Law, Section 80M of Income Tax Act – Deduction in Respect of Certain Inter-Corporate Dividends — https://www.aaptaxlaw.com/income-tax-act/section-80-m-income-tax-act-deduction-in-respect-of-certain-inter-corporate-dividends-sec-80m-of-income-tax-act-1961.html

[4] Lakshmikumaran & Sridharan Attorneys, Dissecting Section 80M of the Income Tax Act – The Known and the Unknown — https://www.lakshmisri.com/insights/articles/dissecting-section-80m-of-the-income-tax-act-the-known-and-the-unknown/

[5] ITAT Online, Union of India & Ors. v. Tata Tea Co. Ltd. (Supreme Court, September 2017) — https://itatonline.org/archives/uoi-vs-tata-tea-co-ltd-supreme-court-s-115-o-dividend-distribution-tax-entire-law-on-the-constitutional-validity-of-dividend-distribution-tax-ddt-under-article-246-of-the-constitution-read-with-en/

[6] Tax Guru, Section 80M Deduction Allowed for Dividend ‘Distributed’ on or Before Due Date – Purnasons Pvt. Ltd. v. ITO (ITAT Kolkata, June 2024) — https://taxguru.in/income-tax/section-80m-deduction-allowed-dividend-distributed-due-date.html

[7] Mondaq, The Conundrum of Deeming Provisions – Whether Deduction Under Section 80M is Available in Case of Deemed Dividend (June 2020) — https://www.mondaq.com/india/shareholders/952666/the-conundrum-of-deeming-provisions-whether-deduction-under-section-80m-is-available-in-case-of-deemed-dividend-untested-waters

[8] Tax Guru, Section 80M – Deduction – Inter-Corporate Dividends (July 2020) — https://taxguru.in/income-tax/section-80m-deduction-inter-corporate-dividends.html

[9] Cyril Amarchand Mangaldas, Dividend Distribution Tax Abolishment: Something Lost in Translation (February 2020) — https://tax.cyrilamarchandblogs.com/2020/02/dividend-distribution-tax-abolishment-heres-something-lost-in-translation/

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The rise of remote work in post-pandemic India has created a TDS on salary compliance challenge that neither the Income Tax Act, 1961 nor the CBDT has clearly addressed. Employers face uncertainty when an employee’s physical location differs from the registered office or when employees split their work across multiple states in a financial year. While Section 192 of the Income Tax Act mandates that employers deduct TDS on salary at the time of payment and deposit it with the central government, distributed workforces have exposed ambiguities in jurisdiction, professional tax obligations, and proper allocation of salary income. Errors in compliance can result in penalties, interest, or even criminal liability for employers.

Section 192 Explained: TDS on Salary Compliance for Employers

Section 192 of the Income Tax Act, 1961 is the primary charging mechanism for TDS on salary. It mandates that “any person responsible for paying any income chargeable under the head ‘Salaries’ shall, at the time of payment, deduct income-tax on the amount payable at the average rate of income-tax computed on the basis of the rates in force for the financial year in which the payment is made.” [1] The critical phrase is “at the time of payment” — unlike most other TDS provisions, Section 192 does not require deduction at accrual. The deduction obligation crystallises the moment salary is actually disbursed.

The section is deliberately employer-agnostic. It applies to individuals, Hindu Undivided Families, companies, trusts, partnership firms, government bodies, and cooperative societies. Under Section 204 of the Act, in cases of salary other than those paid by the Central or State Government, the “person responsible for paying” is the employer itself, or in the case of a company, the company including its Principal Officer. [1]

CBDT issues annual circulars consolidating rates and procedures for TDS on salary. The most recent for FY 2024-25 is Circular No. 03/2025 dated February 20, 2025, which consolidates amendments from the Finance Act, 2023, Finance (No. 1) Act, 2024, and Finance (No. 2) Act, 2024. [2] In areas where no new amendments apply, the provisions of Circular No. 24/2022 dated December 7, 2022 continue to operate. [3] These circulars govern how employers compute TDS, handle perquisites, report in Form 24Q, and issue Form 16 — but neither circular addresses what an employer must do when an employee’s state of physical work changes mid-year or spans multiple states simultaneously.

The Multi-State Problem: Where It Gets Complicated

When an employee works from the same location every day, the employer’s payroll compliance is relatively contained. TDS goes to the central government regardless, and professional tax — a state-level levy — is deducted and deposited with the state in which the employee works. The moment that employee begins working from a different state, even temporarily, the compliance picture becomes murky on two fronts: professional tax registration and the question of which state’s rules govern the deduction.

Professional tax is a creature of state law, authorised by Article 276 of the Constitution of India, which provides for the levy of “a tax on professions, trades, callings and employments” not exceeding Rs. 2,500 per annum. [4] Each state that levies professional tax — currently Karnataka, Maharashtra, West Bengal, Andhra Pradesh, Telangana, Tamil Nadu, Gujarat, Kerala, Assam, Odisha, Jharkhand, Sikkim, Meghalaya, Tripura, Madhya Pradesh, Mizoram, and Bihar — establishes its own slab rates, payment cycles, and registration requirements. An employer must register separately in each state where it has a place of work. [4]

When an employee works from home in a different state from the employer’s registered office, the question of whether the employee’s home constitutes the employer’s “place of work” in that state does not have a definitive statutory answer. The employer arguably has a professional tax compliance obligation in the state where the employee is physically performing services, but without a formal office or registration there, this obligation exists in a practical and legal grey zone.

Section 9(1)(ii) and the Territorial Connection of Salary Income

Any analysis of TDS jurisdictional issues must begin with Section 9(1)(ii) of the Income Tax Act, 1961, which deems salary income to “accrue or arise in India” if it is earned in India. The Explanation to this clause, inserted by the Finance Act, 1983 with retrospective effect from April 1, 1979, clarifies that income under the head Salaries “payable for service rendered in India” shall be regarded as income earned in India. [5]

The operational significance of Section 9(1)(ii) cannot be understated for the multi-state scenario. If an employee’s work is geographically diffuse, the “place of rendering service” becomes the determinant of where salary income arises. For a remote worker alternating between Maharashtra and Goa, it is theoretically possible that salary accrues partly in both states. The Income Tax Act, at the central government level, does not make this distinction practically meaningful since all TDS ultimately flows to the Union, but it creates a valid conceptual problem for state-level professional tax compliance.

Landmark Case Law: CIT v. Eli Lilly and Co. (India) Pvt. Ltd. (2009)

The foundational judicial authority on the territorial reach of Section 192 is the Supreme Court’s judgment in Commissioner of Income Tax, New Delhi v. M/s Eli Lilly and Co. (India) Pvt. Ltd. and Others, decided on March 25, 2009, reported at (2009) 312 ITR 225 (SC). [5] The case arose from a batch of 104 appeals across various High Courts and tribunals on whether Indian joint venture companies were obligated to deduct TDS under Section 192(1) on “home salary” paid by foreign parent companies to expatriate employees outside India.

The Supreme Court held that Section 192 and Section 9(1)(ii), read together, form an “integrated code.” The Court ruled that if the payments of home salary abroad have “any connection or nexus with his rendition of service in India, then such payment would constitute income which is deemed to accrue or arise to the recipient in India as salary earned in India in terms of Section 9(1)(ii).” The Court further held that TDS provisions under Chapter XVII-B are not purely mechanical provisions operating in isolation from the charging provisions; they form part of a coherent legislative scheme that must be read purposively. [5]

The ratio firmly establishes that “territorial connection” — not just the place of payment — determines TDS liability. The physical location where services are rendered anchors the salary income to a jurisdiction. For domestic remote workers moving between states, this principle raises questions that the Supreme Court has not yet been asked to answer directly. If a software engineer renders services from Hyderabad for eight months and from Chandigarh for four months within a single financial year, under the Eli Lilly principle her salary income arguably has a territorial connection to both Telangana and Punjab/Haryana — but professional tax treatment of this scenario remains unarticulated in any binding authority. [9]

The Form 24Q Problem and the Employer’s TAN

Every employer deducting TDS under Section 192 must file quarterly TDS returns in Form 24Q with the Income Tax Department and issue Form 16 annually to employees. CBDT Circular No. 03/2025 introduced a new Column No. 388A in Form 24Q to capture TDS deducted under additional sections, ensuring complete reporting. [2] Employers file under a single Tax Deduction Account Number (TAN), registered at a fixed address. This creates a structural problem: the TAN does not track the employee’s shifting physical location, and Form 24Q does not require disclosure of the state(s) from which work was performed.

The practical result is that an employee who works from Maharashtra for six months and from Karnataka for six months in the same financial year has her entire TDS credited under the employer’s single central filing. The employer’s professional tax registration — and hence the state’s ability to collect professional tax — may be confined to Maharashtra, leaving Karnataka with no collection mechanism and no awareness of the liability. CBDT Notification No. 112/2024 dated October 15, 2024 introduced Form 12BAA, requiring employees to disclose TDS and TCS deducted on non-salary income to their employer, and expanded the scope of Section 192(2B) to allow employers to adjust salary TDS by taking into account TCS credits. [6] But even this notification is silent on the multi-state professional tax issue.

Professional Tax Across Multiple States: The Registration Trap

For employers with pan-India distributed workforces, professional tax registration is arguably the most under-addressed compliance risk. The applicable state professional tax legislation mandates that “application for the Registration Certificate has to be done separately to each authority with respect to the place of work coming under the jurisdiction of that authority.” [4] A Bengaluru-headquartered IT company whose engineering team suddenly works from their homes in Hyderabad, Pune, Chennai, and Bhubaneswar has, in theory, triggered registration obligations in Telangana, Maharashtra, Tamil Nadu, and Odisha simultaneously.

The slab rates differ significantly: Maharashtra charges Rs. 200 per month for employees earning above Rs. 10,000 per month, while Telangana operates different income bands. The maximum professional tax is constitutionally capped at Rs. 2,500 per annum per person, but non-registration and non-deduction attract penalties under each state’s statute. An employer using Maharashtra’s slabs for an employee working from Hyderabad is technically non-compliant in Telangana even if the quantum of deduction happens to be similar. The additional compliance burden for employers managing employees across multiple locations has been widely identified as a significant practical challenge — applying the wrong state’s rules is described by payroll practitioners as a common mistake particularly for employers managing employees across multiple locations. [4]

Section 192(2) and the Multiple Employer Rule: A Partial Analogy

Section 192(2) of the Income Tax Act, 1961 provides a partial mechanism for employees who have more than one employer. Where an employee is employed with more than one employer, she may furnish particulars of salary income from the other employer(s) in Form 12B, and the primary employer then deducts TDS on the aggregate income. This provision was designed for job-changers rather than multi-location workers, but it offers an indirect analogy: the Act does contemplate salary income arising from multiple sources and has a mechanism for aggregation before deduction.

The analogy breaks down for the multi-state problem because the issue there is not multiple employers but a single employer with a mobile employee. There is no corresponding provision requiring the employee or employer to declare or track states of physical work throughout the year. CBDT Circular No. 24/2022 notes that where an employee has more than one employer, each employer issues Part A of Form 16 for the period of employment with that employer. [3] This approach of apportioning Form 16 is not available for multi-state work within a single employment because TDS remains a single stream under one TAN.

Assessee-in-Default Risk: TDS on Salary Penalties Under Sections 201, 271C & 276B

An employer who fails to deduct TDS or deducts an incorrect amount becomes an “assessee in default” under Section 201 of the Income Tax Act, 1961. Section 201(1A) mandates interest at 1.5% per month from the date on which TDS should have been deducted to the date of actual deposit. Section 271C imposes a penalty equal to the amount of TDS that was not deducted. Section 276B provides for rigorous imprisonment of between three months and seven years and a fine for failure to deposit deducted TDS with the government. [2]

ITAT Patna’s ruling in the matter of Ashish Ranjan, affirmed by the Delhi High Court’s decisions in Sanjay Sudan and Chintan Bindra, clarified that Section 205 bars the tax department from recovering TDS from the employee if TDS was actually deducted by the employer — the liability for non-deposit remains squarely with the employer. [7] This creates an asymmetric risk for the multi-state scenario: the employee is protected if TDS was deducted, but the employer bears full default liability under both central and state law regardless of how genuinely ambiguous the jurisdictional question was.

The BDO India analysis of the Delhi ITAT’s ruling in a secondment context further makes clear that CBDT Circular 720, dated August 30, 1995, establishes that salary payments can be liable for TDS under only one section — i.e., the same salary cannot be subjected to TDS twice, once under Section 192 and again under Section 195. [8] While that principle addresses a cross-border rather than cross-state scenario, it reinforces the idea that the Indian TDS regime assumes a single point of withholding per payment, without mechanisms to apportion across multiple jurisdictions.

What Employers Are Actually Doing

In the absence of clear guidance, most large employers have adopted pragmatic positions. The dominant approach is to tie professional tax registration and deduction to the employer’s registered or principal office location, irrespective of where the employee physically works. A second common approach is to deduct professional tax based on the employee’s state of residence at onboarding, making no adjustments when the employee relocates. A third, more cautious approach — used by multinationals with large distributed teams — is to obtain professional tax registrations in every state where significant numbers of employees are resident, treating employees’ homes as places of work. None of these approaches is formally endorsed by any CBDT circular or state professional tax authority, and the compliance gap is systematically embedded in payroll systems used by millions of Indian employers.

Conclusion

TDS on salary under Section 192 of the Income Tax Act, 1961 is built on the assumption that an employee works from a fixed location. The Supreme Court in CIT v. Eli Lilly (2009) established that territorial connection — specifically the place of rendition of services — determines where salary income accrues and hence where TDS obligations arise. [5] CBDT’s Circular No. 03/2025 for FY 2024-25 has refined TDS computation mechanics but has not addressed the multi-state remote work scenario. [2] Professional tax, governed by Article 276 of the Constitution and individual state statutes, explicitly requires state-specific registration when a place of work spans multiple states. [4] These obligations carry the full weight of Sections 201, 271C, and 276B penalties irrespective of the amounts involved. Until India’s tax administration produces coherent guidance for the distributed workforce, employers are making risk-weighted decisions in a legal vacuum — and that problem will only grow as remote work becomes a permanent feature of Indian employment.

References

[1] CBDT / Income Tax India – TDS on Salaries (Official Booklet): https://incometaxindia.gov.in/booklets%20%20pamphlets/tds-on-salaries.pdf

[2] ASC Group – CBDT Circular No. 03/2025: TDS from Salaries for FY 2024-25: https://www.ascgroup.in/comprehensive-updates-on-tds-from-salaries-for-fy-2024-2025/

[3] Taxmann – CBDT Circular No. 24/2022 on Salary TDS for FY 2022-23: https://www.taxmann.com/post/blog/cbdt-issues-circular-on-tds-from-salaries-for-financial-year-2022-23/

[4] Tally Solutions – Professional Tax Calculation: State-wise Guide India 2025: https://tallysolutions.com/accounting/professional-tax-calculation-state-wise-india/

[5] Indian Kanoon – CIT v. Eli Lilly & Co. (India) Pvt. Ltd., (2009) 312 ITR 225 (SC): https://indiankanoon.org/doc/1160384/

[6] Tax at Hand (KPMG) – CBDT Notification No. 112/2024: Form 12BAA and TDS/TCS Credit on Salary: https://www.taxathand.com/article/38230/India/2024/CBDT-notification-updates-process-and-forms-for-claiming-TDSTCS-credit-on-salary-

[7] Ahuja & Ahuja – ITAT Patna: Employee Not Liable for Employer’s TDS Default under Section 205: https://www.ahujaandahuja.in/itat-patna-employee-not-liable-for-employers-tds-default-under-section-205/

[8] BDO India – Delhi ITAT Rules on Withholding Tax for Salary Reimbursement in Secondment Cases: https://www.bdo.in/en-gb/insights/alerts-updates/direct-tax-alert-delhi-tax-tribunal-gives-ruling-on-applicability-of-withholding-tax-provision-on

[9] itatonline.org – CIT v. Eli Lilly (Supreme Court): Case Summary and Ratio: https://itatonline.org/archives/cit-vs-eli-lilly-supreme-court/

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Employee Stock Option Plans (ESOPs) are among the most powerful instruments that Indian startups and companies use to attract, retain, and motivate talent. ESOPs give employees a stake in the company, aligning individual performance with long-term organisational success. In theory, an ESOP is a deferred financial reward that pays off when the company performs well. In practice, however, ESOP taxation in India turns what should be a straightforward reward into a complex process, where a single gain can be taxed at two points under two different heads of income, sometimes before the employee realises any cash.

This is not a quirk of tax administration. It is hardwired into the structure of the Income Tax Act, 1961, and it has real consequences — particularly for employees of private startups who exercise options in companies that have not yet gone public, leaving them to pay large tax bills on paper gains they cannot easily liquidate. Understanding how this works, why it is structurally problematic, what the law currently says, and what courts have held on connected questions is essential for anyone working in the Indian startup or corporate compensation space.

How ESOPs Are Structured: The Five-Stage Lifecycle

Before getting into the tax mechanics, it is worth mapping the lifecycle of an ESOP. The Karnataka High Court, in the context of a significant ruling on one-time voluntary payments made by parent companies to ESOP holders in India, described this lifecycle with clarity: ESOPs pass through five stages — issuance of options, vesting of options, exercise of options, issuance of shares, and sale of those shares [1]. Each of these stages has its own legal character, and tax arises not at every stage, but at two of the most financially significant ones.

At the grant stage, when an employer communicates that an employee is being awarded a certain number of options at a pre-determined exercise price, no tax arises. The employee has merely received a right, not a benefit. Similarly, at the vesting stage — when the option becomes exercisable after the employee satisfies service or performance conditions — no tax is triggered under current law for standard ESOPs. The taxable events arise at stage three and stage five: exercise and sale.

The First Tax: Perquisite at Exercise Under Section 17(2)(vi)

When an employee exercises a vested ESOP — meaning they pay the exercise price and receive shares — the Income Tax Act, 1961 treats the benefit arising at that moment as a “perquisite” falling under the head “Salaries.” The specific provision is Section 17(2)(vi) of the Act, which includes within the definition of perquisite “the value of any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer, or former employer, free of cost or at concessional rate to the assessee.”

The taxable value of this perquisite is the difference between the Fair Market Value (FMV) of the shares on the date of exercise and the exercise price paid by the employee [2]. If an employee exercises 1,000 options at ₹100 per share when the FMV is ₹400, a perquisite of ₹3,00,000 arises and is added to that employee’s salary income for the year, taxed at whatever slab rate applies. This is straightforward enough on paper. The problem is that the employee has not sold a single share — they are now a shareholder, but there is no liquidity event. They have received an asset, not cash, yet they owe income tax immediately.

Employers are required to deduct tax at source on this perquisite value under Section 192 of the Act and report it in Form 16 and Form 12BA. For listed companies, FMV is the average of the opening and closing price of the share on the date of exercise. For unlisted companies, it must be certified by a Category I Merchant Banker, and the certificate cannot be older than 180 days from the date of exercise [3]. This valuation mechanism is particularly problematic for startup employees whose companies are private — the merchant banker valuation may reflect high future-growth-based projections, creating a large paper perquisite that translates into a significant tax liability, even though there is no market to sell the shares into.

The Second Tax: Capital Gains at Sale Under Section 45 Read with Section 49(2AA)

When the employee eventually sells the shares received upon exercising ESOPs, the transaction attracts capital gains tax under Section 45 of the Income Tax Act, 1961. The question of cost of acquisition is critical here. Section 49(2AA) of the Act provides that where capital gain arises from the transfer of specified security or sweat equity shares referred to in Section 17(2)(vi), the cost of acquisition of such security or shares shall be the Fair Market Value on the date on which the option is exercised by the employee [3].

This means the FMV that was already used to compute the perquisite is now reused as the acquisition cost for capital gains purposes, preventing strict double-counting of the same spread. The capital gain is computed as the difference between the sale price and the FMV at exercise. So if those same 1,000 shares are later sold at ₹600 per share, the capital gain is ₹2,00,000 (₹600 minus ₹400, multiplied by 1,000). This gain is then subjected to capital gains tax — either short-term or long-term depending on the holding period [2].

For listed shares held for more than 12 months, Long-Term Capital Gains (LTCG) tax applies at 12.5% on gains exceeding ₹1.25 lakh. Shares held for 12 months or less attract Short-Term Capital Gains (STCG) tax at 20%. For unlisted shares, the threshold for long-term treatment is 24 months, and the LTCG rate is 12.5% without indexation, while short-term gains are taxed at applicable slab rates [4]. Foreign ESOPs received by Indian residents are also taxable in India under the same framework, though Double Taxation Avoidance Agreements may provide partial relief.

ESOP Double Taxation in India: How Perquisite and Capital Gains Create Stealth Taxation

Critics of the ESOP taxation framework in India argue that the so-called “two-stage taxation” is effectively double taxation. The logic is simple: the total economic gain from an ESOP is the difference between the exercise price and the sale price of the shares. For example, if the exercise price is ₹100 and the shares are later sold at ₹600, the ₹500 gain is split arbitrarily at the Fair Market Value (FMV) on the exercise date — ₹300 taxed as a salary perquisite and ₹200 as capital gains. Both taxes apply to the same underlying gain, just divided at an intermediate point, creating a structural mismatch.

This becomes particularly acute in scenarios where the share price drops between exercise and sale. An employee who exercises at an FMV of ₹400 and pays perquisite tax on the ₹300 spread, only to sell later at ₹350, has suffered an actual economic loss relative to their position at the time of exercise. Yet that employee has already paid income tax at salary slab rates on ₹300 of notional gain that never materialised into cash. The capital loss on sale is not automatically set off against the salary income already taxed. The asymmetry is pronounced and, many argue, fundamentally inequitable [5].

The liquidity problem is equally severe. Unlike salary, which arrives as cash, the perquisite from an ESOP arrives as equity. Employees must either sell a portion of their shares to cover the tax bill — a “sell-to-cover” approach that reduces their stake — or find cash elsewhere. For employees of private startups, where there is no public market and secondary sales are restricted or non-existent, this can mean paying a tax of several lakhs of rupees out of their regular salary, which may itself be insufficient to absorb the burden [5].

The Regulatory Framework: SEBI and Company Law Dimensions

ESOPs are not purely a taxation matter. The grant, vesting, and exercise of stock options by Indian companies are also governed under the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 (for listed companies) and the Companies (Share Capital and Debentures) Rules, 2014 (for unlisted companies). Under Rule 12 of the Companies (Share Capital and Debentures) Rules, permanent employees of the company, its subsidiaries, or associate companies — both in India and abroad — are eligible for ESOPs. Directors, whether whole-time or otherwise, are also eligible, though promoters and members of the promoter group are specifically excluded.

The accounting treatment of ESOPs adds another layer of complexity. Ind AS 102 (Share-Based Payment) mandates that companies recognise the fair value of ESOPs as an employee cost over the vesting period. This cost is recorded in the Profit and Loss Account and credited to an ESOP Outstanding Account under reserves. The FMV used for accounting purposes must be certified by a Registered Valuer under the Companies Act, 2013, and should align with the FMV used for tax purposes to avoid discrepancies during regulatory audits.

The Judicial Record: Key Case Law

Indian courts have had several opportunities to examine the mechanics and boundaries of ESOP taxation, and their rulings illuminate both the legislative intent and the structural problems in play.

The most significant case on the deductibility of ESOP costs for employers is CIT (LTU) v. Biocon Ltd. [2020] 430 ITR 151 (Karnataka High Court). Affirming the ruling of the ITAT Special Bench, Bangalore, the Karnataka High Court held that the discount on issue of ESOPs is an allowable business expenditure under Section 37(1) of the Income Tax Act, 1961. The Court held that Section 37(1) “permits deduction of expenditure laid out or expended and does not contain a requirement that there has to be a pay-out,” and that ESOP expense is “a definite legal liability” that must be debited to the books of accounts under the mercantile system of accounting [6]. This ruling confirmed that even though ESOPs do not involve a cash outflow, they generate a deductible expenditure for the employer.

The Delhi High Court took a similar position in the context of PVR Ltd., relying on Biocon. The Delhi High Court observed that the expression “expenditure” under Section 37 would include a loss, and that issuance of shares at a discount — where the company absorbs the difference between the market value and the issue price — constitutes expenditure incurred wholly and exclusively for the purposes of the business [7]. The Madras High Court had earlier reached the same conclusion in CIT v. PVP Ventures Ltd. [2012] 23 taxmann.com 286, confirming that ESOP expenses are allowable as revenue expenditure because their objective is retention and motivation of employees, not capital formation.

On the question of when a perquisite arises, the Karnataka High Court, in a separate matter involving one-time voluntary payments made by parent companies to compensate ESOP holders for diminution in value of unexercised options, reaffirmed that “the taxable event for ESOP perquisites under Section 17(2)(vi) of the Income-tax Act, 1961 is the ‘exercise’ of the option” [1]. In the absence of an exercise event, the statutory computation mechanism fails and no perquisite can be charged. This ruling has important implications for corporate restructurings, acquisitions, and ESOP cancellations where options are wound up without being formally exercised.

The Startup Relief: Section 192(1C) and the Finance Act, 2020

Recognising that the immediate perquisite tax creates a liquidity crisis for startup employees — who often hold equity in companies that are not publicly listed and cannot easily sell shares to cover their tax liability — the Finance Act, 2020 introduced a deferral mechanism specifically for eligible startups. The amendment to Section 192 of the Income Tax Act (introducing Section 192(1C)) allows eligible startups to defer the deduction of TDS on ESOP perquisites [8]. Under this mechanism, the tax on ESOP perquisites is deferred until the earliest of three events: 48 months from the end of the relevant assessment year, the date of sale of such shares by the employee, or the date on which the employee ceases to be in employment. Corresponding amendments were also made to Sections 191, 156, and 140A of the Act to align the direct tax payment and assessment framework with this deferral, effective from April 1, 2020.

However, this relief is not available to all startups. The deferral benefit under Section 192(1C) is available only to employers who qualify as “eligible startups” under Section 80-IAC. This requires DPIIT recognition, incorporation as a private limited company or LLP on or after April 1, 2016, and turnover below ₹100 crore in any financial year. The startup must additionally obtain separate certification from the Inter-Ministerial Board (IMB) under DPIIT [9]. As of early 2025, only approximately 3,700 startups had obtained this certification out of more than 1.9 lakh DPIIT-recognised startups — meaning the vast majority of startup employees in India cannot access the deferral and continue to face immediate perquisite taxation upon exercise.

The Structural Problem and the Policy Debate

The core tension at the heart of ESOP taxation in India is this: the law taxes a financial instrument at an intermediate stage — the exercise date — rather than at the final liquidation event. In most comparable jurisdictions, the tax is either deferred to the sale date or calculated only on the final economic gain. The Indian framework, by contrast, inserts a valuation-based perquisite tax at exercise that bears little relationship to what the employee will actually receive when shares are eventually sold.

The startup ecosystem has been vocal about this structural defect for years. Founders, investors, and industry bodies have called for ESOP taxation to be deferred to the point of actual sale across all DPIIT-recognised startups — not just the IMB-certified subset — and for the holding period to be calculated from the date of allotment rather than requiring a fresh clock at each exercise. The government’s reported consideration of expanding the deferral to all DPIIT-recognised startups ahead of the Union Budget 2026-27 reflects growing acknowledgment that the current regime does not serve the policy objective of incentivising long-term equity participation by employees [4].

Conclusion

ESOP taxation in India operates through a framework that is technically coherent but economically dissonant. Section 17(2)(vi) captures a notional gain at exercise as salary income. Section 49(2AA) then resets the cost of acquisition for capital gains, preventing the same spread from being taxed twice in a strict mathematical sense. But the overall effect — two tax events, two different heads of income, one underlying economic gain — creates a burden that is real, immediate, and often disproportionate to the liquidity available to the taxpayer. The perquisite tax is levied when the employee becomes a shareholder, not when they become wealthy. The capital gains tax is levied when they sell. Between those two events, the value of the shares may rise, fall, or become entirely illiquid.

The judicial record on ESOP taxation in India — spanning cases from Biocon Ltd. to PVP Ventures and the Karnataka High Court’s ruling on the exercise trigger — has helped clarify the legal boundaries of the framework. However, courts cannot amend the law; that remains the prerogative of Parliament. Until the Section 192(1C) deferral mechanism is extended more broadly, or the taxable event for ESOPs is definitively shifted to the sale of shares, startup employees and other ESOP holders in India will continue to face a system that taxes not on realised profits, but on promises that may only materialise much later.

References

[1] Nishith Desai Associates, Taxability of One-Time Voluntary Payment Received on Diminution of Value of ESOPs (Karnataka High Court — Section 17(2)(vi) exercise trigger, five-stage lifecycle): https://nishithdesai.com/NewsDetails/15377

[2] Treelife, ESOP Taxation in India — A Complete Guide (2025) (Perquisite computation formula, capital gains stages, LTCG/STCG rates): https://treelife.in/taxation/esop-taxation-in-india/

[3] ICMAI, ESOP — Income Tax Perspective (Section 49(2AA) cost of acquisition, FMV computation rules, merchant banker valuation for unlisted shares): https://icmai.in/TaxationPortal/upload/DT/Article/21.pdf

[4] Inc42, Centre Mulls Extending Tax Deferral On ESOPs For DPIIT Startups: Report (Policy background, LTCG/STCG rate update, 1.97 lakh DPIIT startups data): https://inc42.com/buzz/centre-mulls-extending-tax-deferral-on-esops-for-dpiit-startups-report/

[5] Vested Finance, ESOP Taxation Guide: Perquisite Tax & Capital Gains Explained (Liquidity problem at exercise, sell-to-cover mechanics, tax before cash): https://vestedfinance.com/blog/us-stocks/how-are-esops-taxed-a-complete-guide-to-stock-option-taxation/

[6] Cyril Amarchand Mangaldas Tax Blog, Karnataka HC Affirms Discount on Issue of ESOPs is a Tax-Deductible Business Expenditure — CIT (LTU) v. Biocon Ltd. [2020] 430 ITR 151 (Section 37(1) deductibility): https://tax.cyrilamarchandblogs.com/2020/12/karnataka-hc-affirms-discount-on-issue-of-esops-is-a-tax-deductible-business-expenditure/

[7] LiveLaw, Delhi High Court Allows Deduction To PVR On Difference Between Market Price & Issue Price Of ESOP (Section 37(1), PVR Ltd. ruling): https://www.livelaw.in/news-updates/delhi-high-court-income-tax-act-pvr-ltd-esop-207871

[8] TaxTMI, Deferring TDS or Tax Payment in Respect of Income Pertaining to ESOP of Start-Ups (Finance Act 2020, Section 192(1C) amendment, Sections 191, 156, 140A): https://www.taxtmi.com/tmi_notes?id=532

[9] EquityList, Section 80-IAC: Perquisite Tax Deferral for ESOPs and Sweat Equity (IMB certification criteria, 3,700 certified startups out of 1.9 lakh DPIIT-recognised): https://www.equitylist.co/blog-post/perquisite-tax-deferral-startups

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When the Finance Act, 2022 introduced Section 115BBH into the Income Tax Act, 1961, it created one of the most structurally aggressive tax provisions that India’s crypto ecosystem had ever seen. The provision imposes a flat 30% tax on any income arising from the transfer of Virtual Digital Assets (VDAs), including cryptocurrencies and non-fungible tokens, regardless of the investor’s income slab, holding period, or the broader financial position of the taxpayer in that year. While the government justified this framework as a mechanism to bring transparency and uniformity to an otherwise opaque sector, the provision carries a deeply problematic feature — it completely prohibits the set-off of losses from one VDA against gains from another, and bars the carry-forward of those losses to subsequent years.[1]

This article examines the legal architecture of Section 115BBH, places it in the context of the existing framework under Sections 70 and 71 of the Income Tax Act for set-off of losses, and argues that the no-set-off rule, as applied to a volatile asset class like cryptocurrency, effectively creates a tax on notional gains — gains that may not reflect the taxpayer’s actual economic position. The constitutional dimensions of this provision, particularly its tension with Article 14 of the Constitution of India, are brought into focus by tracing judicial precedents on the right to equality and the limits of legislative classification in tax law. The article also situates the provision within the broader trajectory of India’s regulatory approach to cryptocurrencies, anchored by the Supreme Court’s landmark ruling in Internet and Mobile Association of India v. Reserve Bank of India, Writ Petition (Civil) No. 528 of 2018, decided on March 4, 2020.[2]

The Legal Framework: Section 115BBH of the Income Tax Act, 1961

What Section 115BBH Says

Section 115BBH was inserted into the Income Tax Act, 1961 by the Finance Act, 2022, with effect from April 1, 2022. It provides that where the total income of an assessee includes any income from the transfer of any virtual digital asset, income tax shall be charged on such income at the rate of thirty percent. The provision explicitly states that no deduction in respect of any expenditure (other than the cost of acquisition) or allowance or set-off of any loss shall be allowed. Furthermore, it mandates that any loss arising from the transfer of a VDA shall not be set off against income computed under any other provision of the Act, and shall not be carried forward to subsequent assessment years.[1]

The definition of VDA is drawn from Section 2(47A) of the Income Tax Act, 1961, which reads: ‘virtual digital asset’ means any information or code or number or token (not being Indian currency or foreign currency), generated through cryptographic means or otherwise, by whatever name called, providing a digital representation of value exchanged with or without consideration, with the promise or representation of having inherent value, or functions as a store of value or a unit of account including its use in any financial transaction or investment, but not limited to investment scheme, and which can be transferred, stored or traded electronically.[3]

Complementing Section 115BBH is Section 194S of the Income Tax Act, inserted simultaneously by the Finance Act, 2022, which requires the deduction of Tax Deducted at Source (TDS) at the rate of 1% on the payment of any sum to any resident person on the transfer of a VDA, where such consideration exceeds Rs. 50,000 in a financial year (or Rs. 10,000 in specified cases). This TDS provision came into effect on July 1, 2022, and operates as a compliance and tracking mechanism layered on top of the primary tax charge under Section 115BBH.[3]

How the No-Set-Off Rule Works in Practice

To understand why the no-set-off rule is problematic, a practical illustration is necessary. Suppose a taxpayer purchases Bitcoin worth Rs. 1,00,000 and sells it during the same assessment year for Rs. 1,50,000, generating a gain of Rs. 50,000. In the same year, the same taxpayer purchases Ethereum worth Rs. 80,000 and sells it for Rs. 50,000, incurring a loss of Rs. 30,000. Under the normal tax framework governing capital assets — namely Sections 70 and 71 of the Income Tax Act — the taxpayer would be entitled to set off the Rs. 30,000 loss against the Rs. 50,000 gain, resulting in a net taxable income of Rs. 20,000. Section 115BBH strips away this possibility entirely. The taxpayer is liable to pay 30% tax on Rs. 50,000, amounting to Rs. 15,000 (plus 4% cess), while the Rs. 30,000 loss evaporates without any tax benefit, and cannot be carried forward either.[1]

This outcome is not confined to intra-VDA set-offs. Losses from VDA transactions also cannot be set off against income from salary, business, house property, or capital gains from other asset classes. This is in direct contrast to the treatment of most other income-generating assets. A person holding equity shares, for instance, can set off a short-term capital loss from one share against a short-term or long-term capital gain from another, and can carry forward unabsorbed capital losses for up to eight assessment years under Section 74 of the Income Tax Act.[4]

The Existing Framework for Set-Off of Losses

Sections 70 and 71: The General Scheme

The Income Tax Act, 1961 recognizes a well-established principle that income tax should be levied on net income rather than gross receipts. This principle is operationalized through the provisions on set-off and carry-forward of losses contained in Sections 70 to 80 of the Act. Section 70 governs intra-head or inter-source adjustments. It provides that where the net result for any assessment year in respect of any source falling under any head of income, other than ‘Capital Gains’, is a loss, the assessee shall be entitled to have the amount of such loss set off against income from any other source under the same head of income.[4]

Section 70(2) specifically addresses capital gains. It provides that where the result of computation in respect of any short-term capital asset is a loss, the assessee shall be entitled to set off such loss against income from any other capital asset, whether long-term or short-term. Section 70(3) limits the set-off of long-term capital losses to long-term capital gains only. Section 71, on the other hand, governs inter-head set-offs. It permits losses under any head of income (other than capital gains) to be adjusted against income from any other head of income in the same assessment year. Section 74 governs the carry-forward of unabsorbed capital losses for up to eight assessment years.[4]

The philosophical underpinning of this framework is the recognition that economic losses are real. Taxing gross gains without accounting for losses in the same economic activity results in a distorted picture of the taxpayer’s actual income. This principle has been judicially affirmed. In CIT v. Harprasad & Co. Pvt. Ltd., (1975) 99 ITR 118 (SC), the Supreme Court of India held that losses under exempted heads cannot be set off against taxable heads, drawing a principled distinction between categories of income — but within each category, the net income approach remained the default.[5]

The Carve-Out for Speculative Income

The Income Tax Act does create specific restrictions on set-off for certain categories. Under Section 73, losses from speculative business — defined as a business that consists of the purchase and sale of commodities, including stocks and shares, where delivery is not actually taken or given — can only be set off against income from another speculative business, and can be carried forward only for four years. The government’s implicit logic in designing Section 115BBH may have been to treat crypto similarly to speculative income.

However, VDA transactions under Section 115BBH are not classified as speculative business income. The provision does not refer to Section 73 or borrow its framework. VDA income is taxed at 30% regardless of whether the underlying transaction involves actual delivery, exchange for goods or services, gifting, or any other form of transfer. The comparison to speculative income is, therefore, analytically flawed, and the complete bar on set-off — which is even stricter than the speculative income regime — cannot be defended by analogy.

Constitutional Analysis: Does Section 115BBH Violate Article 14?

The Article 14 Framework

Article 14 of the Constitution of India reads: ‘The State shall not deny to any person equality before the law or the equal protection of the laws within the territory of India.’ The Supreme Court, in a line of cases beginning with E.P. Royappa v. State of Tamil Nadu, (1974) 4 SCC 3, held that equality is antithetic to arbitrariness, and that where an act is arbitrary, it is implicit that it is unequal both according to political logic and constitutional law. The Court further held in Maneka Gandhi v. Union of India, (1978) 1 SCC 248 that the fundamental rights under Chapter III of the Constitution are not to be read in isolation but as part of an integrated scheme, and that any State action must be just, fair, and reasonable.[6]

The doctrine of reasonable classification permits the legislature to classify persons, objects, or transactions for the purpose of achieving specific ends, provided two conditions are satisfied: first, that the classification is based on intelligible differentia — a real and substantial distinction that separates the class from those excluded from it; and second, that the differentia has a rational nexus with the object of the legislation. This two-pronged test was laid down authoritatively by the Supreme Court in Ram Krishna Dalmia v. Justice S.R. Tendolkar, AIR 1958 SC 538, and has remained the foundational standard for testing legislative classifications under Article 14.[7]

The Classification Problem in Section 115BBH

Section 115BBH creates a distinct class of taxpayers — those deriving income from VDA transfers — and subjects them to a tax regime that is materially inferior to that applicable to persons deriving income from other capital assets. The inferiority is not limited to the rate of tax (30% versus 15% or 20% for other capital assets). It extends to the denial of loss set-offs, the prohibition on carry-forward, and the exclusion of all deductions except the cost of acquisition. No other category of capital asset income suffers this combined deprivation.[3]

The question is whether this differentiation passes the two-pronged test under Article 14. The government’s rationale for the no-set-off rule appears to be twofold: first, to deter speculative trading in crypto markets, and second, to prevent tax avoidance through strategic loss booking in unregulated markets. These are legitimate policy objectives. The issue, however, is whether the complete bar on set-off — even within the same asset class, even for genuine economic losses — has a rational nexus with these objectives.

A prohibition on set-off of crypto losses against salary or business income might be defensible. But a prohibition on setting off a Bitcoin loss against an Ethereum gain, where both transactions occur in the same year, in the same economic context, within the same regulatory category, does not easily satisfy the nexus requirement. The taxpayer who loses Rs. 40,000 on Ethereum and gains Rs. 50,000 on Bitcoin has a real economic gain of Rs. 10,000. Taxing Rs. 50,000 at 30% — a tax of Rs. 15,000 on a real gain of Rs. 10,000 — is not merely aggressive; it is economically fictitious. It taxes notional gain, not actual enrichment.

The Proportionality Dimension

India’s constitutional jurisprudence has increasingly adopted the doctrine of proportionality as part of the Article 14 inquiry. The Supreme Court articulated this in Modern Dental College and Research Centre v. State of Madhya Pradesh, (2016) 7 SCC 353, holding that State action must be proportionate to the objective sought to be achieved. In the context of tax legislation, the Court has generally accorded a wider margin of discretion to Parliament, recognizing the complexity of fiscal policy. However, this deference is not unconditional. In R.K. Garg v. Union of India, AIR 1981 SC 2138, the Court held that reasonable classification must not be arbitrary, artificial or evasive, but must be based on some real and substantial distinction bearing a just and reasonable relation to the object sought to be achieved.[7]

A complete prohibition on loss set-off, which results in taxing a taxpayer on Rs. 50,000 when she has genuinely earned only Rs. 10,000 in net economic terms, appears disproportionate even against the government’s anti-speculation objective. Less restrictive alternatives exist — such as ring-fencing VDA losses to be set off only against VDA gains (as is done with capital losses generally), or allowing intra-VDA set-off while barring cross-class set-off — which would serve the same regulatory purpose without creating the distortionary outcome of taxing losses.

Regulatory Context: India’s Cryptocurrency Framework

The Supreme Court’s 2020 Ruling and Its Implications

The constitutional backdrop to Section 115BBH cannot be understood without reference to the Supreme Court’s ruling in Internet and Mobile Association of India v. Reserve Bank of India, Writ Petition (Civil) No. 528 of 2018, decided on March 4, 2020 by a bench comprising Justices Rohinton Fali Nariman, Aniruddha Bose, and V. Ramasubramanian. In this case, the Court set aside the Reserve Bank of India’s circular dated April 6, 2018, which had prohibited banks and other RBI-regulated entities from facilitating any transactions involving virtual currencies. The Court found that the RBI circular was a disproportionate restriction on the fundamental right to carry on any trade or profession under Article 19(1)(g) of the Constitution, since the RBI had not demonstrated actual harm to regulated entities from cryptocurrency activities.[2]

Justice V. Ramasubramanian, authoring the judgment, held: ‘When the consistent stand of RBI is that they have not banned Virtual currencies (VCs) and when the Government of India is unable to take a call despite several committees coming up with several proposals including two draft bills, both of which advocated exactly opposite positions, it is not possible for us to hold that the impugned measure is proportionate.’ This ruling had profound significance: it affirmed that cryptocurrency trading is a legitimate economic activity protected under the Constitution, and that regulatory responses must be calibrated and proportionate, not blunt prohibitions.[8]

The doctrinal importance of this ruling for Section 115BBH is significant. If an outright prohibition on crypto trading is unconstitutional on proportionality grounds, then a tax regime that effectively penalizes crypto traders by denying them the economic reality of net income computation — a right universally available to traders in every other asset class — raises parallel proportionality concerns. Taxation, like prohibition, can be an instrument of de facto regulation; and its proportionality must accordingly be scrutinized.

The Paradox of Taxing the Unregulated

One of the most striking features of India’s current approach is that the state taxes VDAs comprehensively under Section 115BBH while simultaneously refusing to accord them clear regulatory recognition. As of 2025, there is no dedicated cryptocurrency legislation in India. The Reserve Bank of India does not recognize cryptocurrency as legal tender. The Supreme Court itself, in a 2025 proceeding, declined to direct the government to formulate regulations for digital assets, holding that this fell within the domain of legislative and executive discretion.[9]

This creates a fiscal paradox that has been noted by commentators: the State extracts tax from an activity it does not officially sanction. VDA holders are obligated to comply with an extensive reporting regime under Schedule VDA in the Income Tax Return, face TDS deductions under Section 194S, and bear the 30% flat tax — yet they receive none of the regulatory protections that accompany the taxation of conventional financial instruments. This asymmetry further reinforces the constitutional critique of Section 115BBH: it imposes obligations without corresponding rights, and treats a heterogeneous and volatile asset class with greater punitiveness than any other recognized category of taxable income.

The Notional Gains Problem: Taxing What Does Not Exist

The phrase ‘notional gains’ in the context of Section 115BBH refers to the situation where the tax base created by the provision does not correspond to the taxpayer’s actual economic enrichment in the assessment year. This occurs when a taxpayer has both gains and losses from VDA transactions in the same year, and the denial of inter-VDA set-off results in a tax calculated on the gross gain rather than the net economic outcome.

Indian income tax law has traditionally resisted the taxation of notional income. The Supreme Court, in CIT v. B.C. Srinivasa Setty, (1981) 128 ITR 294 (SC), observed that the charging provisions of the Act must be read in a manner that imposes tax on real income. The Court held that where the charging provision and the computation provision cannot work harmoniously in relation to a particular transaction, the charging provision fails. The principle of taxing actual income over notional or fictitious income has been a consistent thread in Indian tax jurisprudence.[5]

Section 115BBH explicitly departs from this principle. By prohibiting loss set-off even within the VDA category, it creates a tax base that exceeds the taxpayer’s actual net income from VDA activity. A taxpayer who engages in 50 VDA transactions in a year, profiting on 25 and losing on 25, is taxed as if only the 25 profitable transactions occurred. The 25 loss-making transactions generate no tax benefit but represent real economic loss. The result is that the effective rate of taxation on actual net VDA income can far exceed 30% — and in years where losses exceed gains, a taxpayer may owe substantial tax despite being economically worse off at year-end.[1]

This is not a hypothetical concern. Cryptocurrency markets are characterized by extreme volatility. Price swings of 20–50% within a single trading day are not uncommon. An investor actively managing a portfolio of five to ten cryptocurrencies in a bear market may book gains on one coin coincidentally while sustaining deep losses on others. Under Section 115BBH, she pays 30% on each profitable transaction, receives no relief for any losing transaction, and carries no losses forward. The tax she pays may exceed the cash she has actually earned. This is not tax on income; it is tax on gross transaction receipts, partially offset only by cost of acquisition.

Conclusion

Section 115BBH of the Income Tax Act, 1961 represents Parliament’s attempt to bring the rapidly growing cryptocurrency sector into the formal tax net. As a revenue-raising measure, it is effective. As a policy instrument, it is deeply problematic. The absolute prohibition on loss set-off — even within the same asset category — produces tax liabilities that bear no rational relationship to the taxpayer’s actual economic gain. It taxes notional wealth rather than real enrichment, departs from the net-income principles that govern every other asset class in India, and imposes burdens on a class of taxpayers that are not merely disproportionate but arguably unconstitutional under Article 14.

The Supreme Court’s 2020 ruling in IAMAI v. RBI established that cryptocurrency trading is a constitutionally protected economic activity, and that regulatory responses targeting it must satisfy proportionality. The no-set-off rule under Section 115BBH does not satisfy this test. A reform that permits at least intra-VDA set-off — following the model of capital gains under Sections 70 and 74 — would address the constitutional concern without abandoning the revenue objective. Until such reform is undertaken, Section 115BBH remains a legal anomaly: a provision that taxes the phantom of profit while ignoring the reality of loss.

References

[1] Section 115BBH, Income Tax Act, 1961 (as inserted by Finance Act, 2022) — ClearTax Guide

[2] Internet and Mobile Association of India v. Reserve Bank of India, Writ Petition (Civil) No. 528 of 2018, Supreme Court of India (March 4, 2020) — Indian Kanoon

[3] Section 2(47A), Income Tax Act, 1961 — VDA Definition and Tax Treatment, Majmudar & Partners

[4] Sections 70, 71 and 74, Income Tax Act, 1961 — Set-off and Carry Forward of Losses, The Legal Lock

[5] CIT v. Harprasad & Co. Pvt. Ltd., (1975) 99 ITR 118 (SC); CIT v. B.C. Srinivasa Setty, (1981) 128 ITR 294 (SC) — Indian Kanoon

[6] Maneka Gandhi v. Union of India, (1978) 1 SCC 248 — Indian Kanoon

[7] Ram Krishna Dalmia v. Justice S.R. Tendolkar, AIR 1958 SC 538; R.K. Garg v. Union of India, AIR 1981 SC 2138 — Indian Kanoon

[8] SCC Times — SC Quashes RBI’s Ban on Cryptocurrency Trading (March 4, 2020)

[9] Supreme Court of India Declines Appeal on Crypto Regulation (2025) — CoinGeek

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