Unlisted Bonds Lose LTCG Benefit; No Capital Gains Exemption for Depreciable Assets under Income Tax Act 2025 – A Silent Policy Shift in Capital Gains under the Income-tax Act, 2025 – When Deeming Fiction Becomes Tax Reality
Continuity Promised, Change Delivered
The enactment of the Income-tax Act, 2025 was accompanied by a clear policy assurance from the Government — that the new law would largely retain the basic structure and principles of the Income-tax Act, 1961, while simplifying language and consolidating provisions.
However, a closer reading of Sections 76 and 85 of the new Act reveals that the changes go far beyond drafting simplification. These provisions introduce substantive shifts in the taxation of capital gains, particularly in two critical areas:
- Taxability and exemption eligibility of depreciable assets, and
- Tax treatment of unlisted bonds
These changes effectively override long-standing judicial precedents and alter the settled understanding of capital gains taxation.
The Legacy Position: Judicial Balance under the 1961 Act
Under the Income-tax Act, 1961, Section 50 created a deeming fiction whereby gains arising on transfer of depreciable assets were treated as short-term capital gains (STCG).
However, the judiciary consistently limited the scope of this fiction.
Judicial Position
- CIT v. Ace Builders (P.) Ltd.
- CIT v. V.S. Dempo Company Ltd.
These landmark rulings established that:
The deeming fiction under Section 50 is restricted to the mode of computation and does not extend to deny exemptions available under other provisions.
Thus, even where capital gains were deemed to be short-term, exemptions under provisions such as Section 54, 54EC, etc., remained available, provided the underlying asset was a long-term capital asset.
This interpretation ensured a harmonious construction, preventing computational provisions from overriding beneficial exemption provisions.
Section 76 of ITA, 2025: Expansion of Deeming Fiction
Section 76 of the new Act appears to expand the scope of the deeming fiction beyond its earlier computational boundary.
Unlike the 1961 framework, the provision now treats gains on depreciable assets as short-term capital gains for all purposes, not merely for computation.
The consequence is significant:
- The distinction between deeming fiction and actual character is effectively eliminated
- Gains are treated as pure STCG, not just deemed STCG
This marks a clear departure from the judicial principle that a legal fiction must be strictly confined to its purpose.
Section 85: Restrictive Framework for Exemptions
Section 85, dealing with capital gains exemptions, introduces more restrictive language compared to its predecessor provisions.
The structure suggests that exemptions are now limited to specifically defined eligible capital gains, implicitly excluding gains arising from:
- Depreciable assets treated as STCG, and
- Other categories where the nature of gain does not satisfy the revised eligibility conditions
The combined reading of Sections 76 and 85 leads to an inescapable conclusion:
Capital gains arising from depreciable assets are no longer eligible for exemption under the new regime.
This effectively nullifies the benefit that taxpayers enjoyed for decades based on judicial interpretation.
Taxation of Unlisted Bonds: From Concession to Compression
Another significant policy shift is seen in the taxation of unlisted bonds.
Earlier Position (1961 Act)
- Long-term holding → taxed as LTCG
- Eligible for concessional tax rates (10% or 20%, subject to conditions)
Position under ITA, 2025
- Gains on unlisted bonds are treated as short-term capital gains, irrespective of holding period
- Taxed at normal slab rates
This change effectively removes:
- The benefit of long-term classification, and
- The associated concessional tax regime
It represents a conscious move towards broadening the tax base and eliminating perceived arbitrage opportunities.
Legislative Override of Judicial Precedents
The combined effect of these provisions is a legislative override of well-settled judicial principles.
While it is within the competence of Parliament to override judicial decisions, such override must be:
- Explicit, and
- Reflective of a clear policy intent
In the present case, the drafting of Sections 76 and 85 indicates a deliberate attempt to:
Neutralize the ratio laid down in Ace Builders and subsequent rulings
Curtail the availability of exemptions in specific scenarios
Align taxation strictly with the statutory characterization of gains
Policy Implications: Simplification or Substantive Shift?
Although presented as part of a simplification exercise, these changes have far-reaching implications:
- Erosion of judicially settled positions
- Shift from interpretative flexibility to statutory rigidity
- Increased tax burden on specific classes of transactions
The transition reflects a broader policy approach:
Moving from “substance supported by judicial interpretation” to “form-driven statutory taxation.”
Constitutional Perspective: Limited Scope for Challenge
From a constitutional standpoint:
- The legislature is empowered to amend the law prospectively
- Courts generally refrain from interfering in tax policy decisions
However, potential areas of debate may include:
- Article 14 (Equality): Differential treatment between listed and unlisted instruments
- Legitimate Expectation: Based on assurances of structural continuity
That said, given the clarity of legislative intent, these provisions are likely to withstand judicial scrutiny.
Practical Takeaways for Professionals
Tax professionals must recalibrate advisory strategies in light of these changes:
- Re-evaluate transactions involving depreciable capital assets
- Reconsider investment allocation towards unlisted debt instruments
- Undertake pre- and post-2025 comparative tax impact analysis
- Focus on alternative tax-efficient instruments within the new framework
Conclusion: A Subtle Yet Significant Transformation
The changes introduced through Sections 76 and 85 of the Income-tax Act, 2025 signify more than a linguistic overhaul. They represent a clear shift in legislative philosophy, moving away from judicially moderated interpretations towards a strict statutory regime.
What was once a “deeming fiction” confined to computation has now evolved into a determinative tax reality.
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Author’s Note
“When the law changes the character of income itself, it does not merely simplify taxation — it redefines the very basis on which tax justice was built.”
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