Direct Tax Proposals In Union Budget 2026: A Comprehensive Analysis

The Union Budget 2026 proposes significant amendments to the Direct Tax framework under the Income-tax Act, 2025 and the corresponding provisions of the Income-tax Act, 1961, with an emphasis on rationalisation, compliance simplification and voluntary disclosure.

This article analyses the proposed changes under the following heads: Business Income, Capital Gains, Income from Other Sources, Deductions and Exemptions, TDS/TCS, Return of Income, Penalty provisions, and the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015.

 BUSINESS INCOME

Deduction for contribution to the employees’ welfare fund to be allowed if paid by the due date of filing the return of income

[Applicable from Tax Year 2026-27]

Section 29(1)(e) of the Income-tax Act, 2025 (corresponding to Section 36(1)(va) of the Income-tax Act, 1961) presently allows deduction of employees’ contributions to PF, ESI and other welfare funds only if such amounts are deposited within the due dates prescribed under the respective fund laws. This has resulted in prolonged litigation on whether payments made up to the due date for filing the return of income could be allowed by applying Section 37 of the 2025 Act (corresponding to Section 43B of the 1961 Act).

To remove ambiguity, it is proposed to amend Section 29(1)(e) to clarify that the due date for deposit of employees’ contributions shall be the due date for filing the return of income under Section 263(1) of the 2025 Act (corresponding to Section 139(1) of the 1961 Act). Accordingly, deduction would be permissible where the contribution is paid on or before the return filing due date.

CAPITAL GAIN

 (i) Exemption for Sovereign Gold Bond to be allowed only to original holders if held till maturity

[Applicable from Tax Year 2026-27]

Earlier, Sovereign Gold Bonds offered tax-free capital gains to almost all investors on maturity. With the new amendment, this benefit is now limited to original subscribers who remain invested for the full tenure.

Under the amended provisions, capital gains on redemption will be exempt only if:

• • The bond was subscribed in the original RBI issue,
  • It is held continuously by the same individual, and
  • It is redeemed at maturity.

If any of these conditions is not satisfied, the exemption will not be available.

(ii) Buy-Back Taxation Shifted to Capital Gains Regime

[Applicable from Tax year 2026-27]

It is proposed to rationalise the taxation of share buy-backs by providing that consideration received on buy-back shall be chargeable to tax under the head “Capital gains” instead of being treated as dividend income. Further, having regard to the distinct position and influence of promoters in corporate decision-making, particularly in relation to buy-back transactions, it is proposed that, in the case of promoters, the effective tax liability on gains arising from buy-back shall be 30%, comprising tax payable at the applicable rates together with an additional tax. In case of promoter companies, the effective tax liability will be 22%.

These amendments shall take effect from the 1st day of April, 2026, and shall apply in relation to the tax year 2026-27 and subsequent tax years.

INCOME FROM OTHER SOURCE

 No deduction for interest against dividend and mutual fund income

[Applicable from Tax year 2025-26]

Section 93 of the Income-tax Act, 2025 (corresponding to Section 57 of the Income-tax Act, 1961) provides for deductions under the head “Income from other sources”. Section 93(2) (corresponding to the first proviso to Section 57 of the 1961 Act) presently permits deduction of interest expenditure against dividend income, restricted to 20% of such dividend income, and disallows any other expenditure.

It is proposed to substitute Section 93(2) to provide that no deduction, including interest, shall be allowed in respect of dividend income or income from units of mutual funds or specified UTI units.

EXEMPTION AND DEDUCTIONS

 (i) Tax holiday for foreign companies procuring data centreservices from India

[Applicable from Tax Year 2026-27]

Section 11 read with Schedule IV of the Income-tax Act, 2025 (corresponding to Section 10 of the Income-tax Act, 1961) provides for specified incomes of eligible non-residents and foreign companies that are excluded from total income.

The Finance Bill, 2026 proposes to insert Sl. No. 13C in Schedule IV to grant exemption to foreign companies in respect of income derived from procuring data centre services from a specified data centre in India. The exemption will apply to income accruing or arising, or deemed to accrue or arise, in India up to the tax year ending 31 March 2047, subject to the condition that services to customers located in India are rendered through an Indian reseller entity.

 (ii) Deduction in respect of dividends received and distributed by cooperative societies

[Applicable from Tax Year 2026–27]

Section 149(2)(d) of the ITA, 2025 [Corresponding to Section 80P(2)(d) of the ITA 1961], provides for a deduction in respect of the income of a cooperative society from interest or dividends received from another cooperative society. Currently, this deduction is only available under the old tax regime, and dividends received by a cooperative society from a company are taxable in its hands.

 It is proposed to permit deductions in the new tax regime for dividends received by a cooperative society from another cooperative society, to the extent that such dividends are subsequently distributed to its members.

 It is further proposed to allow deduction in respect of dividends received by notified federal cooperative societies from companies for a period of three years, up to tax year 2028–29, under both the old and new tax regimes. This deduction shall be available only in respect of dividends arising from investments made by such federal cooperative societies up to 31st January, 2026 and which are further distributed to their members.

(iii) Disability pension to armed forces and paramilitary personnel shall be exempt only where the individual is invalided out of service due to a service-related disability

[Applicable from Tax Year 2026-27]

Disability pension is granted to members of the Armed Forces who are invalided out of service due to a bodily disability attributable to, or aggravated by, military, naval or air force service. It comprises a service element and a disability element and is distinct from pension on superannuation or other retirement.

To remove ambiguity, it is proposed to amend Schedule III of the Income-tax Act, 2025 to clarify that exemption in respect of disability pension (including both service and disability elements) shall apply only where the individual is invalided out of service on account of a service-related disability, and not where retirement is on superannuation or otherwise. The exemption is also proposed to be extended to paramilitary personnel on the same basis.

(iv) Exemption of income arising from compulsory acquisition of land under the RFCTLARR Act

[Applicable from Tax Year 2026-27]

Section 11 read with Schedule III of the Income-tax Act, 2025 (corresponding to Section 10(37) of the Income-tax Act, 1961) grants exemption to an individual or HUF in respect of capital gains arising from compulsory acquisition of agricultural land, subject to conditions. However, the Act did not expressly provide exemption for income arising from compulsory acquisition under the Right to Fair Compensation and Transparency in Land Acquisition, Rehabilitation and Resettlement Act, 2013 (RFCTLARR Act), leading to interpretational issues, though Section 96 of the RFCTLARR Act provides that no income tax shall be levied on any award or agreement made thereunder (other than cases under Section 46).

To remove ambiguity and align the provisions, it is proposed to amend Schedule III to expressly exempt any income arising from an award or agreement pursuant to compulsory acquisition of land under the RFCTLARR Act, other than cases covered by Section 46 of that Act.

(v) Extension of deduction under Section 149 for ancillary activities related to cattle feed and cotton seeds

[Applicable from Tax Year 2026–27]

Section 149(2)(b) of the ITA 2025 [Corresponding to Section 80P(2)(b) of the ITA 1961] allows for the deduction of the entire profits and gains from business in the case of a primary cooperative society engaged in supplying milk, oilseeds, fruits, or vegetables grown or raised by its members to a federal cooperative society, the Government, a local authority, or to a Government company or corporation involved in the same business.

It is proposed to expand the scope of deduction under Section 149(2)(b) to include profits and gains from ancillary activities, such as supplying cattle feed and cotton seeds, carried out by members of the primary cooperative society.

TDS AND TCS

 (i) No tax and TDS on interest awarded under the Motor Vehicles Act, 1988

[Applicable from Tax year 2026-27]

Compensation received under the Motor Vehicles Act, 1988 on account of death or bodily injury is treated as a capital receipt and is not taxable. However, interest awarded on such compensation is presently taxable and subject to tax deduction at source where it exceeds ₹50,000.

It is proposed to amend Schedule III of the Income-tax Act, 2025 to exempt interest awarded under the Motor Vehicles Act, 1988 from tax. Consequently, such interest shall not be liable to tax or subject to TDS.

The exemption shall apply where the interest is awarded by a Motor Accident Claims Tribunal under the Motor Vehicles Act, 1988 to an individual.

(ii) Resident individuals and HUFs do not require a TAN to deduct tax from consideration paid to a non-resident for the purchase of immovable property

[Applicable from 01-10-2026]

Under the Income-tax Act, 2025, a buyer of immovable property from a resident is required to deduct tax at source without obtaining a TAN and may use PAN for compliance. However, where the seller is a non-resident, the buyer is required to obtain a TAN for deduction of tax at source, even in case of a one-time transaction, resulting in additional compliance burden.

To align similar transactions, it is proposed to amend Section 397 to provide that a resident individual or HUF shall not be required to obtain TAN for deduction of tax at source under Section 393(2) [Table Sl. No. 17] (corresponding to Section 195 of the Income-tax Act, 1961) on payment of consideration to a non-resident for transfer of immovable property.

(iii) Investors earning dividends/interest can file a declaration for non-deduction of tax with the depository instead of multiple payers

[Applicable from 01-04-2027]

Section 393(6) of the Income-tax Act, 2025 (corresponding to Section 197A of the Income-tax Act, 1961) presently requires an assessee to furnish a separate declaration for non-deduction of tax at source to each payer in respect of income such as dividends, interest on securities, and income from units of mutual funds. This leads to multiple filings where investments are held with different payers.

It is proposed to amend Section 393(6) to permit filing of such declarations with the depository, which shall transmit the same to the person responsible for paying the income. Further, the time limit for furnishing such declarations to the prescribed income-tax authority is proposed to be revised from monthly to quarterly. This facility shall apply only where the securities or units are held in dematerialised form with a depository and are listed on a recognised stock exchange in India.

(iv) TCS rates rationalisedto largely introduce a uniform rate of 2%

[Applicable from the 1^st April 2026]

Under the existing provisions of Section 394(1) of the ITA 2025 (corresponding to Section 206C of the ITA 1961), multiple rates of tax collection at source are prescribed for different transactions. To simplify the TCS framework, it is proposed to rationalisethe rates by prescribing largely uniform rates as follows.

RETURN OF INCOME

 (i) Due date for filing return extended from 31st July to 31st August for non-audit business taxpayers and partners of non-audit firms

[Applicable from Assessment year 2026-27 and Tax year 2026-27]

Section 263(1)(c) of the Income-tax Act, 2025 (corresponding to Explanation 2 to Section 139(1) of the Income-tax Act, 1961) presently prescribes 31st July as the due date for filing return of income for assessees other than corporate assessees, assessees subject to audit, partners of audit firms (and spouse where Section 10 applies), and assessees covered under Section 172 (corresponding to Section 92E of the 1961 Act).

It is proposed to amend Section 263(1)(c) to extend the due date from 31st July to 31st August for:

• assessees having income from business or profession whose accounts are not required to be audited; and
• partners of firms not subject to audit (and spouse where Section 10 applies).

The 31st July due date shall continue for assessees not having income from business or profession, including individuals or HUFs filing ITR-1 or ITR-2 and trusts without business income.

ii) The time limit for filing a revised return is extended to 12 months, with a fee applicable for returns filed beyond nine months

[Applicable from assessment year 2026-27 and tax year 2026-27]

Under Section 263(5) of the Income-tax Act, 2025 (corresponding to Section 139(5) of the Income-tax Act, 1961), a revised return may be filed within nine months from the end of the relevant tax year or before completion of assessment, whichever is earlier. Since the time limit for filing a belated return is also nine months, a belated return filed at the end of this period cannot presently be revised.

It is proposed to extend the time limit for filing a revised return to twelve months from the end of the relevant tax year or before completion of assessment, whichever is earlier. Further, a fee under Section 428(b) (corresponding to Section 234-I of the 1961 Act) is proposed where the revised return is filed beyond nine months, being ₹1,000 where total income does not exceed ₹5 lakh and ₹5,000 in other cases.

(iii)Updated return allowed where the loss originally claimed is reduced

[Applicable from assessment year 2026-27 and tax year 2026-27]

Under Section 263(6) of the Income-tax Act, 2025 (corresponding to Section 139(8A) of the Income-tax Act, 1961), an updated return cannot presently be filed where it is a return of loss or results in reduction of tax liability or increase of refund. Accordingly, reduction of loss declared in the original return was not permitted.

It is proposed to amend Section 263(6) to allow filing of an updated return where the taxpayer reduces the loss originally claimed in a return filed under Section 263(1). Corresponding amendments are proposed in Section 139(8A) of the 1961 Act.

The amendment shall apply from tax year 2026–27 under the ITA 2025 and assessment year 2026–27 under the ITA 1961.

(iv) An updated return can be filed after the issue of a reassessment notice

[Applicable from Tax Year 2026-27]

Section 263 of the Income-tax Act, 2025 (corresponding to Section 139 of the Income-tax Act, 1961) permits filing of updated returns within 48 months, subject to conditions that it is not a return of loss and does not reduce tax liability or increase refund. Further, Section 263(6)(c)(v) bars filing of an updated return where assessment, reassessment, recomputation or revision proceedings are pending or completed.

It is proposed to amend Section 263 to permit filing of an updated return in response to a notice under Section 280, within the time specified therein, and not otherwise. Section 267 (corresponding to Section 140B of the 1961 Act) is also proposed to be amended to levy an additional 10% of aggregate tax and interest payable in such cases, with immunity from penalty under Section 439 (corresponding to Section 270A of the 1961 Act) on the disclosed income.

Rationalisation of penalties into fees

[Applicable from Tax Year 2026-27]

 (i) Penalty for failure to get the books of accounts audited:

Section 446 of the ITA 2025 [corresponding to Section 271B of the ITA, 1961] provides for the levy of a penalty for failing to have accounts audited or obtain the audit report as required. The penalty is the lower of 0.5% of total sales, turnover, or gross receipts (orgross receipts in the case of a profession) for the relevant tax year, or Rs. 1,50,000.

The penalty for failure to get accounts audited is proposed to be replaced with a fee under Section 428(c), amounting to Rs. 75,000 for delays of up to one month and Rs. 1,50,000 thereafter.

(ii) Penalty for non-furnishing or furnishing incorrect information on crypto-asset transactions

The existing penalty under Section 446 is proposed to be omitted and substituted with a specific penalty for failure to furnish, or for furnishing inaccurate, information in respect of crypto-asset transactions.

The proposed provision prescribes a penalty of ₹200 per day for delay in filing the required statement. Further, a penalty of ₹50,000 may be levied for furnishing inaccurate information and failing to rectify it in accordance with Section 509(4) (corresponding to Section 285BAA(4) of the Income-tax Act, 1961) or for non-compliance with due diligence requirements under Section 509(5) (corresponding to Section 285BAA(5) of the 1961 Act).

(iii) Penalty for failure to furnish TP Report

Section 447 of the Income-tax Act, 2025 (corresponding to Section 271BA of the Income-tax Act, 1961) presently provides for a penalty of ₹1,00,000 for failure to furnish the report under Section 172 (corresponding to Section 92E of the 1961 Act).

It is proposed to replace this penalty with a fee under Section 428(d), being ₹50,000 where the delay does not exceed one month and ₹1,00,000 thereafter. Accordingly, Section 447 is proposed to be omitted, with consequential amendments in Section 470 (corresponding to Section 273B of the 1961 Act).

(iv) Penalty for failure to furnish a statement of financial transactions or a reportable account:

Section 454 of the Income-tax Act, 2025 (corresponding to Section 271FA of the Income-tax Act, 1961) presently provides for a penalty of ₹500 per day for failure to furnish a statement of financial transaction or reportable account within the due date, and ₹1,000 per day where such failure continues beyond the period specified in a notice under Section 508(7) (corresponding to Section 285BA(5) of the 1961 Act).

It is proposed to convert the penalty under Section 454(1) into a fee under Section 427(3) and omit sub-section (1). Further, a cap of ₹1,00,000 is proposed on the penalty leviable under Section 454(2).

TAX RATES

(i) Reduction in tax rate on unexplained income

[Applicable from Tax Year 2026-27]

Section 195 of the Income-tax Act, 2025 (corresponding to Section 115BBE of the Income-tax Act, 1961) provides for taxation of income referred to in Sections 102 to 106 at 60%. It is proposed to reduce the rate under Section 195 to 30%, thereby reducing the effective tax rate (after 25% surcharge and 4% cess) from 78% to 39%.

Section 443 of the Income-tax Act, 2025 (corresponding to Section 271AAC of the Income-tax Act, 1961), which presently levies a penalty of 10% of tax payable under Section 195(1)(i), is proposed to be omitted. Such income will instead be governed by the penalty framework for under-reporting in consequence of misreporting under Section 439(11) of the 2025 Act (corresponding to Section 270A(9) of the 1961 Act).

(ii) Rationalisation of Minimum Alternate Tax (MAT) provisions

Applicable from Tax Year 2026-27]

Section 206 of the Income-tax Act, 2025 (corresponding to Section 115JB of the Income-tax Act, 1961) provides for levy of Minimum Alternate Tax (MAT) at 15% of book profits where the tax payable under the normal provisions is lower, with the excess allowed to be carried forward as MAT credit for 15 assessment years. The MAT provisions presently apply only to companies under the old tax regime.

It is proposed to reduce the MAT rate to 14%, treat MAT paid under the old regime as final tax without allowing fresh MAT credit, and permit limited set-off of accumulated MAT credit up to 25% of the tax liability under the new tax regime.

BLACK MONEY (UNDISCLOSED FOREIGN INCOME AND ASSETS) AND IMPOSITION OF TAX ACT, 2015

 (i) Relaxed prosecution conditions under the Black Money Act

[Effective retrospectively from 01-10-2024]

The Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 contains stringent penal and prosecution provisions to deal with wilful non-disclosure of foreign income and assets by resident taxpayers. Under Sections 49 and 50, failure to furnish a return of income or willful omission of foreign income or assets in the return attracts prosecution, including rigorous imprisonment and monetary penalties.

Given that many cases involve minor or inadvertent non-disclosures, it is proposed to rationalise the prosecution framework under the Black Money Act. Accordingly, Sections 49 and 50 are proposed to be amended to exclude their applicability in cases where the aggregate value of foreign assets, other than immovable property, does not exceed Rs. 20 lakhs.

(ii) A new FOREIGN ASSETS OF SMALL TAXPAYERS DISCLOSURE SCHEME, 2026, is proposed.

Under the proposed Scheme, an individual who acquired foreign assets while being a non-resident and, upon returning to India, failed to disclose such foreign assets or foreign income, may regularise the default by paying tax at 30% of the value of the undisclosed foreign asset and 30% of the undisclosed foreign income, where the aggregate value does not exceed ₹1 crore. In cases where the value of foreign assets does not exceed ₹5 crore, a fee of ₹1 lakh is also payable. This provides relief in cases of inadvertent non-disclosure.

The Scheme may benefit, inter alia, employees of multinational companies holding ESOPs/RSUs, former students retaining foreign bank accounts, returning non-residents with undisclosed savings or insurance policies, and personnel deputed abroad.

For “undisclosed assets located outside India” or “undisclosed foreign income”, the Scheme applies where the aggregate value does not exceed ₹ 1 Crore as on 31st march 2026. For foreign assets acquired from disclosed income or during status as a non-resident, the value of the asset must not exceed ₹ 5 Crore as on 31st March 2026.

 The declarant is required to pay tax at the rate of 30 per cent of the value of the undisclosed foreign asset as on 31 March 2026 or of the undisclosed foreign income, as the case may be, together with an additional amount equal to 100 per cent of such tax. The total amount payable will be 60% of the value of the asset or foreign income, as the case may be.

 Where the foreign asset was acquired during non-resident status or from income already offered to tax in India but was not disclosed in the relevant return schedules, a flat fee of ₹ 1 Lakh is payable, subject to the value threshold.

Conclusion:

The Direct Tax proposals in Union Budget 2026 indicate a calibrated shift towards rationalisation of rates, reduction of litigation, facilitation of voluntary compliance, and simplification of procedural requirements. While certain amendments provide substantive relief and clarity, others strengthen reporting and compliance mechanisms.