Clause 197 Tax on long-term capital gains.

Income Tax Bill, 2025

Introduction

Clause 197 of the Income Tax Bill, 2025 introduces a revamped regime for the taxation of long-term capital gains (LTCG) arising from the transfer of long-term capital assets. This provision is intended to replace and streamline the existing framework under section 112 of the Income-tax Act, 1961. Both provisions are central to the taxation of capital gains in India, impacting a wide spectrum of taxpayers, including individuals, Hindu Undivided Families (HUFs), companies, and non-residents. The changes proposed in Clause 197 reflect a significant policy shift, particularly in terms of tax rates, indexation benefits, and the treatment of different classes of assets.

This commentary provides an in-depth analysis of Clause 197, explores its objectives and implications, and offers a comprehensive comparative analysis with Section 112 of the Income-tax Act, 1961. The focus is on the structural changes, the rationale behind legislative choices, and the practical consequences for stakeholders.

Objective and Purpose

The primary objective of Clause 197 is to rationalize and simplify the taxation of long-term capital gains, aligning the tax structure with contemporary economic realities and policy goals. The provision aims to:

• Reduce the long-term capital gains tax rate from 20% to 12.5% for most long-term capital assets, except for certain specified assets.
• Standardize the treatment of indexation benefits, particularly for assets acquired before a specified date.
• Ensure a smoother transition from the old regime to the new, mitigating adverse impacts on taxpayers who acquired assets under the previous rules.
• Clarify definitions and harmonize the treatment of securities, listed and unlisted assets, and deductions under other chapters.

The legislative history of Section 112 reveals a pattern of ad hoc amendments and provisos, often resulting in complexity and interpretational challenges. By consolidating and simplifying the regime, Clause 197 seeks to promote certainty, ease of compliance, and administrative efficiency.

Detailed Analysis of Clause 197 of the Income Tax Bill, 2025

Computation of Tax on LTCG

Clause 197(1) lays down the basic computation mechanism for tax payable by an assessee whose total income includes LTCG:

1. Tax on Other Income: The first component is income-tax payable on the total income, excluding the LTCG. This is calculated as if the remaining income is the total income of the assessee.
2. Tax on LTCG: The second component is income-tax on the LTCG at a flat rate of 12.5%.

This structure is a marked shift from the earlier 20% rate (with various exceptions and nuances) u/s 112. The flat rate is intended to simplify calculations and reduce the overall tax burden on LTCG, making India's capital gains regime more competitive internationally.

Relief for Individuals and HUFs Below Exemption Limit

Clause 197(2) provides relief for resident individuals and HUFs whose other income (i.e., total income excluding LTCG) falls below the basic exemption threshold. The mechanics are as follows:

1. The LTCG is reduced by the shortfall between the exemption limit and the other income.
2. Tax is then computed at 12.5% on the balance LTCG.

This ensures that the benefit of the exemption limit is fully utilized, and LTCG is only taxed to the extent total income exceeds the threshold. This mirrors the relief mechanism in Section 112, thereby ensuring continuity and fairness for low-income taxpayers.

Transitional Relief for Old Assets (Land/Building)

A key innovation in Clause 197(3) is the provision of transitional relief for individuals and HUFs who transfer land or building acquired before 23rd July 2024. The provision specifies that any excess income-tax (computed as per a formula) arising due to the new regime shall be ignored. The formula is:

• E = A - B, where:
• A is the tax computed at 12.5% on the LTCG (without indexation);
• B is the tax computed at 20% on the LTCG, but with indexation benefits.

If tax under the new regime (without indexation) exceeds what would have been payable under the old regime (with indexation), the excess is ignored. This ensures that taxpayers do not suffer a higher tax outgo simply due to the regime shift, particularly for assets acquired before the cut-off date. This transition mechanism is crucial to maintaining taxpayer confidence and preventing retrospective hardship.

Deductions under Chapter VIII

Clause 197(4) stipulates that for the purposes of deductions under Chapter VIII, the gross total income shall be reduced by the LTCG. Deductions are allowed as if the gross total income (excluding LTCG) is the gross total income of the assessee. This aligns with the general principle that capital gains are not eligible for most deductions (such as u/s 80C).

Definitions

Definitions are provided for key terms-"securities," "listed securities," "unlisted securities," "indexed cost of acquisition," and "indexed cost of improvement." These definitions are harmonized with the Securities Contracts (Regulation) Act, 1956, and relevant sections of the Bill, ensuring consistency across the statute.

Scope and Exclusions

It is specifically clarified that Clause 197 does not apply to equity shares in a company, units of an equity-oriented fund, or units of a business trust. These continue to be governed by separate provisions, reflecting the policy of concessional or exempt treatment for equity-oriented investments.

Practical Implications

For Individuals and HUFs

The reduction in tax rate to 12.5% (from 20%) for most LTCG will lower the effective tax liability for a large number of taxpayers. The continued benefit of the exemption limit ensures that small taxpayers are not adversely affected. The transitional relief for old assets is especially important for individuals who acquired land/building in earlier years, as it prevents penal taxation due to the withdrawal of indexation.

For Companies and Non-Residents

The absence of explicit provisions for companies and non-residents in Clause 197 (as compared to the detailed sub-clauses in Section 112) suggests a streamlining, possibly with separate sections addressing these categories. This could enhance clarity but also requires careful cross-referencing to ensure no category is inadvertently omitted.

On Indexation

The general withdrawal of indexation (except for transitional relief) simplifies compliance but may disadvantage taxpayers in periods of high inflation. The policy choice reflects a trade-off between simplicity (and lower rates) and the protection of real gains.

On Deductions

The explicit exclusion of LTCG from the computation of gross total income for deduction purposes maintains the long-standing policy of restricting tax incentives to ordinary income, not capital gains.

Comparative Analysis: Clause 197 vs. section 112

1. Tax Rates

• Section 112: Provided a 20% tax rate for LTCG, with exceptions (10% for certain gains, e.g., unlisted securities for non-residents). For transfers on or after 23rd July 2024, the rate is reduced to 12.5%.
• Clause 197: Imposes a uniform 12.5% rate for LTCG (other than specified excluded assets), streamlining the rate structure.

The shift to a flat 12.5% rate under Clause 197 eliminates the need to distinguish between types of assets and taxpayers for most cases, reducing complexity.

2. Indexation Benefit

• Section 112: Allowed indexation for most assets, except for certain categories (e.g., unlisted shares for non-residents). For listed securities and zero-coupon bonds, a choice between 10% without indexation and 20% with indexation was available.
• Clause 197: Generally removes indexation, except for transitional relief for land/building acquired before 23rd July 2024 (where excess tax due to withdrawal of indexation is ignored).

The new regime is simpler but may increase the effective tax on real gains in times of inflation. The transitional provision mitigates this for legacy assets.

3. Asset Categories and Exclusions

• Section 112: Covered all long-term capital assets, with special rates for certain securities, mutual fund units, and zero-coupon bonds. Equity shares and units of equity-oriented funds were largely governed by Section 112A or were exempt u/s 10(38) (earlier).
• Clause 197: Explicitly excludes equity shares, units of equity-oriented funds, and units of business trusts from its ambit, indicating continued separate treatment.

This clarification in Clause 197 avoids confusion and overlap, ensuring that the concessional/exempt regime for equity remains intact.

4. Relief for Small Taxpayers

• Section 112: Provided that if total income (excluding LTCG) is below the exemption limit, the shortfall can be reduced from LTCG before computing tax.
• Clause 197: Retains this relief mechanism, ensuring continuity for low-income taxpayers.

5. Transitional Provisions

• Section 112: For assets acquired before the cut-off, excess tax due to new rates or withdrawal of indexation is ignored.
• Clause 197: Contains a similar, but more formulaic and explicit, transitional relief for land/building acquired before 23rd July 2024.

The formula-based approach in Clause 197 increases transparency and predictability.

6. Treatment of Deductions

• Section 112: Deductions under Chapter VI-A not allowed against LTCG.
• Clause 197: Deductions under Chapter VIII allowed only on gross total income excluding LTCG.

This maintains the same substantive position.

7. Definitions and Clarity

• Section 112: Definitions provided, but scattered and sometimes ambiguous due to frequent amendments.
• Clause 197: Consolidates definitions, explicitly referencing the Securities Contracts (Regulation) Act, 1956, and internal definitions for indexation terms.

8. Provisions for Companies and Non-Residents

• Section 112: Contains detailed sub-clauses for domestic companies, non-residents, and foreign companies, with specific rates and exceptions.
• Clause 197: The main text focuses on individuals and HUFs, with companies and non-residents apparently addressed elsewhere or by implication.

This could be an area for further legislative clarification to avoid gaps or unintended exclusions.

9. Special Asset Classes

• Section 112: Specific provisions for listed securities, zero-coupon bonds, mutual fund units, and unlisted shares for non-residents.
• Clause 197: No specific carve-outs within the main text; instead, focuses on the general rule and transitional relief for land/building.

The move towards generalization may simplify the law but could also remove beneficial options for certain asset classes.

Comparative Summary Table

Ambiguities and Potential Issues

• Omission of Companies/Non-Residents: The absence of explicit provisions for these categories in Clause 197 could lead to interpretational disputes unless addressed elsewhere in the Bill.
• Indexation Withdrawal: The withdrawal of indexation for most assets may be challenged as regressive in high-inflation periods.
• Transitional Relief Scope: Limiting transitional relief to land/building (and not other assets) may be seen as arbitrary.
• Overlap with Other Provisions: The exclusion of equity shares and units requires careful cross-referencing to ensure no double taxation or unintended exemption.

Conclusion

Clause 197 of the Income Tax Bill, 2025 represents a significant overhaul of the long-term capital gains tax regime, aiming for simplicity, lower rates, and greater predictability. While the reduction in the LTCG rate to 12.5% is a welcome move, the withdrawal of indexation (except for transitional assets) marks a notable policy shift. The provision is broadly aligned with the intent of section 112 but streamlines and consolidates the law, removing many of the exceptions and complexities that had accumulated over the years.

The key strengths of Clause 197 are its clarity, transitional relief, and alignment with international best practices. Potential areas for refinement include explicit coverage of companies and non-residents, and reconsideration of the scope of indexation withdrawal. The provision is likely to reduce litigation and compliance costs, but its long-term impact on taxpayer behavior and revenue neutrality will depend on inflation trends and asset price movements.

Full Text:

Clause 197 Tax on long-term capital gains.