Clause 198 Tax on long-term capital gains in certain cases.

Income Tax Bill, 2025

1. Introduction

Clause 198 of the Income Tax Bill, 2025 introduces a special regime for the taxation of long-term capital gains (LTCG) arising from the transfer of specific financial assets-namely, equity shares in companies, units of equity-oriented funds, and units of business trusts. This provision is positioned as a successor to, and substantial revision of, Section 112A of the Income Tax Act, 1961, which has governed the taxation of similar capital gains since its introduction by the Finance Act, 2018. The significance of Clause 198 lies in its attempt to recalibrate the tax treatment of LTCG in light of evolving market realities, revenue considerations, and policy objectives such as promoting investments through regulated exchanges and rationalizing the tax structure. A detailed analysis of Clause 198, juxtaposed with Section 112A, is essential to understand the legislative intent, operative mechanics, practical implications, and the direction of tax policy reform in India.

2. Objective and Purpose

The legislative intent behind Clause 198 is multifaceted:

• Revenue Augmentation: By increasing the tax rate on eligible LTCG and redefining thresholds, the provision aims to enhance government revenues while maintaining market competitiveness.
• Market Integrity: The continued linkage of concessional LTCG tax rates to the payment of Securities Transaction Tax (STT) seeks to incentivize transactions through recognized and regulated market mechanisms, thereby curbing tax evasion.
• Simplification and Modernization: The provision consolidates and clarifies the eligibility criteria, computational mechanics, and definitions, aiming for greater clarity and ease of enforcement.
• Alignment with International Standards: By refining the definition of equity-oriented funds and providing exemptions for transactions in International Financial Services Centres (IFSCs), the provision seeks to integrate Indian capital markets with global best practices.

Section 112A was originally enacted to reintroduce taxation of LTCG on listed equity shares and certain units, after such gains were made exempt by Section 10(38). The purpose was to balance the need for incentivizing equity investments with the imperative of broadening the tax base.

3. Detailed Analysis of Clause 198 of the Income Tax Bill, 2025 

3.1. Scope and Applicability

Clause 198(1) establishes the scope of the provision by stipulating three cumulative conditions:

• (a) The assessee's total income must include income chargeable under the head "Capital gains".
• (b) The capital gains must arise from the transfer of a long-term capital asset, specifically being an equity share in a company, a unit of an equity-oriented fund, or a unit of a business trust.
• (c) Securities Transaction Tax (STT) must have been paid:
  • (i) On both acquisition and transfer in the case of equity shares.
  • (ii) On transfer in the case of units of equity-oriented funds or business trusts.

This mirrors the structure of Section 112A(1), although the precise wording and cross-references are updated for the new legislative framework.

3.2. Computation of Tax (Sub-section 2)

Clause 198(2) provides the computational formula for tax liability:

• (a) Income-tax at 12.5% on LTCG exceeding INR 1,25,000.
• (b) Income-tax on the remainder of the total income (i.e., total income minus the eligible LTCG) as per normal rates.

This represents a notable increase from the earlier 10% rate (pre-July 2024) u/s 112A, aligning with the recent amendment under the Finance (No. 2) Act, 2024, which also moved to a 12.5% rate for transfers on or after July 23, 2024.

3.3. Marginal Relief for Individuals and HUFs (Sub-section 3)

Clause 198(3) provides relief for resident individuals and Hindu Undivided Families (HUFs):

• If the total income (excluding eligible LTCG) is below the basic exemption limit, the shortfall can be adjusted against LTCG, effectively providing a higher exemption to low-income taxpayers.

This mechanism is a direct carryover from the proviso to Section 112A(2), ensuring continuity of relief for small taxpayers.

3.4. Exemption for IFSC Transactions (Sub-section 4)

Clause 198(4) carves out an exception for transfers executed on recognized stock exchanges in IFSCs where consideration is received in foreign currency. In such cases, the STT condition does not apply. This provision is designed to incentivize international capital flows and bolster India's position as a global financial hub, mirroring Section 112A(3).

3.5. Central Government Notification Power (Sub-section 5)

Clause 198(5) empowers the Central Government to notify, by Gazette notification, specific types of acquisitions for which the STT-on-acquisition requirement may be waived. This is an enabling provision, paralleling Section 112A(4), and grants flexibility to address market anomalies or policy needs.

3.6. Interaction with Deductions and Rebates (Sub-sections 6 and 7)

• Clause 198(6): Deductions under Chapter VIII (analogous to Chapter VI-A in the 1961 Act) are allowed only from gross total income as reduced by the eligible LTCG. This prevents double benefit and maintains the integrity of the concessional rate regime.
• Clause 198(7): Rebate u/s 156 (corresponding to section 87A) is allowed from tax on total income as reduced by tax on such LTCG, again mirroring the mechanics of Section 112A(6).

3.7. Definition of Equity-Oriented Fund (Sub-section 8)

Clause 198(8) provides a detailed definition of "equity oriented fund", specifying:

• Minimum investment thresholds (90% or 65%) in equity shares of domestic companies listed on recognized exchanges.
• Special computation rules (annual average of monthly averages).
• Special requirements for unit linked insurance policies (ULIPs).

This definition is largely consistent with the explanation u/s 112A, with minor updates to references and schedules as per the new Bill's structure.

4. Ambiguities and Issues in Interpretation

While Clause 198 is largely modeled on Section 112A, certain areas may require further clarification:

• Threshold for Exemption: The exemption threshold for LTCG is set at INR 1,25,000, an increase from the earlier INR 1,00,000 u/s 112A (prior to recent amendments). This may require clear transitional provisions for ongoing assessments.
• Definition of "Equity Oriented Fund": The cross-references to new Schedules may create interpretational issues until the subordinate legislation is finalized.
• Interaction with Other Provisions: The relationship between Clause 198 and general capital gains provisions (e.g., for grandfathering, cost inflation index, etc.) needs to be explicitly addressed in the Bill or through subsequent clarifications.

5. Practical Implications

5.1. For Taxpayers

• Increased Tax Liability: The move from 10% to 12.5% on eligible LTCG will increase the effective tax outgo for investors, especially high-net-worth individuals and institutional investors.
• Compliance Requirements: The continued linkage to STT payment and the specific documentation required for proving eligible transactions will necessitate robust compliance mechanisms.
• Marginal Relief: Resident individuals and HUFs with income below the exemption limit continue to benefit from the ability to adjust the shortfall against LTCG, protecting low-income investors.

5.2. For Asset Managers and Market Intermediaries

• Fund Structuring: Asset managers of mutual funds and insurance companies must ensure ongoing compliance with the minimum investment thresholds for equity-oriented status, as the computation is now further clarified.
• Product Design: The definition of equity-oriented funds and the treatment of ULIPs may influence the design and marketing of investment products.

5.3. For Regulators and Policymakers

• Enforcement: The increased rate and continued conditionality on STT payment may require enhanced monitoring of transactions, especially in the context of cross-border trades and IFSCs.
• Policy Flexibility: The notification power allows the government to respond dynamically to market developments, but also introduces an element of administrative discretion.

6. Comparative Analysis: Clause 198 vs. Section 112A

A detailed comparison reveals both substantial similarities and key differences. The analysis below is structured by major themes:

6.1. Scope and Structure

Both provisions apply to LTCG arising from equity shares, units of equity-oriented funds, and business trusts, provided STT has been paid. Both carve out exceptions for IFSC transactions and empower the government to notify exceptions to the STT requirement.

6.2. Tax Rate and Threshold

• Section 112A: Originally provided for a 10% tax rate on LTCG exceeding Rs. 1 lakh. Amended (w.e.f. 23 July 2024) to 12.5% on gains exceeding Rs. 1,25,000 for transfers on or after that date.
• Clause 198: Directly provides for a 12.5% rate on LTCG exceeding Rs. 1,25,000, reflecting the updated policy and aligning with the most recent amendment to Section 112A.

The increase in both the rate and threshold reflects an attempt to balance revenue needs with investor protection.

6.3. STT Payment Requirement

Both provisions require STT to be paid on acquisition and transfer (for equity shares) and on transfer (for units of funds and business trusts). Both allow the government to notify exceptions, ensuring flexibility.

6.4. Adjustment for Basic Exemption Limit

Both provisions allow resident individuals and HUFs to adjust the shortfall in total income (excluding LTCG) below the basic exemption limit against LTCG, thus ensuring that low-income taxpayers are not unfairly penalized.

6.5. Deductions and Rebates

• Section 112A: Deductions under Chapter VI-A and rebate u/s 87A are allowed only after reducing LTCG and tax thereon, respectively.
• Clause 198: Adopts the same approach, referencing Chapter VIII (which may be a renumbered or equivalent provision) and section 156 (analogous to section 87A).

The effect is to prevent deductions and rebates from offsetting the tax on LTCG, maintaining the integrity of the concessional regime.

6.6. Definition of "Equity Oriented Fund"

The definitions in both provisions are nearly identical, with minor variations in cross-references (Schedule VII and II in Clause 198, versus section 10(23D) and 10(10D) in Section 112A). The substance-investment thresholds, computation method, and treatment of insurance-linked policies-remains consistent.

6.7. Notable Differences

• Threshold and Rate: Clause 198 directly incorporates the increased threshold (Rs. 1,25,000) and rate (12.5%), whereas Section 112A reflects these changes via recent amendments.
• Cross-References: Clause 198 refers to Chapter VIII and section 156, which may represent renumbered or reorganized provisions in the new Bill, while Section 112A refers to Chapter VI-A and section 87A.
• Drafting Language: Minor differences in language and structure, but the substantive legal effect is aligned.

6.8. Transitional and Policy Considerations

The alignment of Clause 198 with the amended Section 112A suggests a desire for continuity and predictability. However, the increase in tax rate and threshold may have distributional and behavioral effects, potentially encouraging tax planning or shifting investment patterns.

6.9 Difference between Section 112A Vs. Clause 198

6.1. Unique Features or Potential Conflicts

• Rate Structure: The codification of the 12.5% rate in the new Bill, as opposed to the earlier 10% u/s 112A, marks a significant policy shift towards higher capital gains taxation. This may affect investor sentiment, particularly in comparison to other jurisdictions with lower rates on equity LTCG.
• Reference Updates: The shift from Chapter VI-A to Chapter VIII and from section 87A to section 156 reflects the reorganization of the legislative framework, which may require stakeholders to update compliance and reporting processes.
• Transitional Issues: The transition from Section 112A to Clause 198 may raise issues regarding pending assessments, grandfathering of gains, and treatment of losses. Clear transitional rules will be necessary to avoid litigation.

7. Conclusion

Clause 198 of the Income Tax Bill, 2025 represents both a consolidation and a recalibration of the regime for taxing long-term capital gains on listed equities and related instruments. While the core structure and conditionalities of Section 112A are retained, the increase in the tax rate to 12.5% and minor definitional updates signal a shift towards greater revenue mobilization and policy alignment with international practices. The provision continues to balance the objectives of market integrity, investor protection, and administrative flexibility. The practical impact will be felt by a broad spectrum of stakeholders-from retail investors and HUFs to institutional asset managers and international market participants. While the continuity of marginal relief and the preservation of key definitions ensure stability, the higher rate and updated compliance requirements will necessitate careful planning and adaptation. As the provision comes into force, it will be essential for the government to issue clarificatory notifications, especially regarding transitional issues and the precise application of new schedules and definitions. Judicial interpretation may also be required to resolve ambiguities and ensure fair and consistent application.

Full Text:

Clause 198 Tax on long-term capital gains in certain cases.