Unlisted Shares and Debentures Capital Gains Tax Under Income-tax Act 2025

Summary: This article examines capital gains taxation of unlisted shares, debentures and convertible instruments across the transition from the Income-tax Act, 1961 to the Income-tax Act, 2025. It explains the savings provisions, holding-period rules, the 12.5% long-term capital gains rate without indexation, and the deemed short-term treatment of specified unlisted debt instruments. It also analyses the tax impact of exit timing, the valuation rules under Section 50CA and Rule 11UA, and the interaction of buyer-side and seller-side deemed consideration provisions. Practical comparisons address conversion versus redemption of CCDs, the treatment of CCPS, and potential differences in tax outcomes for domestic and foreign investors. For cross-border disposals, the article discusses foreign exchange computation, the Legatum Ventures ruling, treaty eligibility, withholding obligations and documentation. It concludes with capital-loss set-off and carry-forward rules, the continuing effect of pre-2026 liabilities, and sample contractual safeguards for private market transactions. All original numerical examples, tables and contractual clauses are retained below as supplied.

The Statutory Interface

The direct tax apparatus in India is undergoing its most comprehensive structural realignment in more than six decades. The repeal of the Income-tax Act, 1961, and the operational commencement of the Income-tax Act, 2025, effective 1 April 2026, marks the replacement of an accretive, highly litigated statute with a recodified framework designed to compress structural complexity. The 2025 Act reduces the volume of primary legislation from 819 sections to 536 sections and reorganises schedules from 14 to 16, embedding historical provisos and explanations directly into substantive statutory text.

A central operational modification is the systemic eradication of the dual-concept nomenclature of “Previous Year” and “Assessment Year”. The 2025 Act unifies these temporal coordinates into a singular concept: the “Tax Year,” defined as the financial year immediately preceding the cycle of income chargeability. This operational transition creates a bifurcated procedural reality across the 2025–26 and 2026–27 fiscal cycles.

During Financial Year (FY) 2025–26 (Previous Year 2025–26), the Income-tax Act, 1961 continues to govern substantive and procedural mandates for computation, withholding, and initial compliance. Capital transactions executed during this cycle will be formally reported in the return of income for Assessment Year (AY) 2026–27 under the 1961 Act architecture. Conversely, capital dispositions closing on or after 1 April 2026 fall under the codified provisions of the Income-tax Act, 2025, designated as Tax Year 2026–27.

The operational bridge between these two legislative regimes is Section 536 of the 2025 Act (“Repeals and Savings”), an exhaustive statutory saving clause containing four sub-sections and twenty-two specific sub-clauses in sub-section (2). Far from a ceremonial repeal, Section 536 establishes a dual-track framework under which the substantive jurisprudence of the 1961 Act remains legally operative for years into the future.

Under Section 536(2)(b), the repeal does not extinguish, impair, or alter any right, privilege, obligation, or liability acquired, accrued, or incurred under the 1961 Act. Section 536(2)(c) establishes that the provisions of the repealed 1961 Act shall continue to govern any proceeding pending on 1 April 2026, as well as any proceeding initiated on or after 1 April 2026 (including notices, assessments, reassessments, recomputations, rectifications, penalties, references, revisions, and appeals) in respect of any tax year beginning before 1 April 2026.

Consequently, a private equity share disposition executed in November 2025 (FY 2025–26) that faces audit scrutiny or reassessment in 2028 will be investigated, assessed, and litigated under the substantive provisions (e.g., Section 48, Section 50CA, Section 112) and procedural mechanisms (e.g., Section 148, Section 148A) of the 1961 Act.

Section 536(2)(j) preserves the validity of circulars, notifications, instructions, and approvals issued under the 1961 Act, provided they are not inconsistent with the express text of the 2025 Act. Section 536(3) establishes a universal mapping rule: any statutory reference in the 2025 Act to a “tax year” commencing on or before 1 April 2025 must be construed as a reference to the corresponding “previous year” under the 1961 Act.

Dimension	Income-tax Act, 1961 (FY 2025–26 / AY 2026–27)	Income-tax Act, 2025 (Tax Year 2026–27 Onwards)	Transitional Codification & Section 536 Mechanics
Chargeability & Temporal Unit	Previous Year income charged in Assessment Year (Sections 4, 5)	Unified “Tax Year” chargeability (Sections 4, 5)	Section 536(3) maps pre-2026 tax years to old previous years
Capital Gains Computation	Section 48 (Full value less cost and expenditure)	Section 72 (Rationalised computation mechanics)	Substantive computation follows the Act in force during execution date
Unquoted Share Valuation Trap	Section 50CA read with Rule 11UA(1)(c)(b)	Section 79 read with Rule 57 of Income-tax Rules, 2026	Section 536(2)(c) enforces Rule 11UA for FY 2025–26 transactions
Unlisted Debt Deeming Rule	Section 50AA (Deemed short-term capital asset)	Section 76 (Codified deemed short-term capital asset)	Substantive rule identical; introduced by FA (No. 2) 2024 w.r.e.f. 23-07-2024
LTCG Baseline Rate (Unlisted)	Section 112(1)(c): 12.5% without indexation	Section 197: 12.5% flat rate without indexation	Post-23 July 2024 regime carries seamlessly into Section 197
Loss Absorption & Migration	Section 70, 71, 74 (Intra-head, inter-head, carry-forward)	Sections 111, 112, 114 (Loss absorption and carry-forward)	Section 536(2)(m) & (n) preserve losses; 8-year clock does not reset
Appellate & Audit Proceedings	Sections 143(3), 147, 246A, 253, 260A	Reorganised procedural chapters	Section 536(2)(c) mandates 1961 Act procedures for pre-2026 audits

Temporal Categorisation and Holding Period Mechanics for Unlisted Instruments

The characterisation of an unlisted capital asset as either short-term or long-term controls computational methodology, headline tax rates, and allowable loss absorption rules. These statutory lines were restructured by the Finance (No. 2) Act, 2024, and have been codified within the 2025 Act.

Under the historical architecture of Section 2(42A) of the 1961 Act, holding period thresholds were fragmented across three tiers: 12 months, 24 months, and 36 months. The codified structure, preserved under Section 2(101) of the Income-tax Act, 2025, rationalises these into two distinct baselines: 12 months and 24 months.

For unlisted equities and closely held corporate securities, the holding period threshold is fixed at 24 months. Where an unlisted equity share is transferred after being held for not more than 24 months immediately preceding the date of transfer, it constitutes a Short-Term Capital Asset (STCA). If held for more than 24 months, it is treated as a Long-Term Capital Asset (LTCA). This 24-month horizon diverges sharply from the 12-month rule applicable to listed equity shares, units of equity-oriented funds, and units of business trusts traded on a recognised stock exchange where Securities Transaction Tax (STT) is discharged.

Within unlisted corporate debt instruments, statutory classification encounters an irreconcilable divergence. Before 23 July 2024, unlisted debentures and bonds were treated as LTCAs if held for more than 36 months. The Finance (No. 2) Act, 2024 amended Section 50AA with retrospective effect from 23 July 2024, expanding its scope beyond Market Linked Debentures (MLDs) and Specified Mutual Funds.

Under amended Section 50AA of the 1961 Act, re-codified as Section 76 of the 2025 Act, any capital asset being an unlisted bond or an unlisted debenture that is transferred, redeemed, or matures on or after 23 July 2024 is deemed to be a short-term capital asset, irrespective of its actual period of holding.

The legal fiction created by Section 50AA overrides Section 2(42A) and Section 48. The full value of consideration received or accruing on transfer, redemption, or maturity, reduced solely by the cost of acquisition and expenditure incurred wholly and exclusively in connection with such transfer or redemption, is deemed to be capital gains arising from a short-term capital asset. Consequently, traditional non-convertible debentures (NCDs), unlisted private credit paper, and debt securities cannot qualify for long-term capital gains treatment or the 12.5% tax rate, regardless of whether the investor held the instruments for three years or ten years.

Asset Classification	Statutory Holding Threshold (1961 Act)	Codified Threshold (2025 Act)	Nature of Capital Asset Post-Threshold	Tax Treatment & Rate Category
Unlisted Equity Shares	> 24 months (Section 2(42A))	> 24 months (Section 2(101))	Long-Term Capital Asset	12.5% flat without indexation (Section 112 / Section 197)
Unlisted Equity Shares	≤ 24 months (Section 2(42A))	≤ 24 months (Section 2(101))	Short-Term Capital Asset	Normal applicable slab / corporate rates
Compulsorily Convertible Preference Shares (CCPS)	> 24 months (Section 2(42A))	> 24 months (Section 2(101))	Long-Term Capital Asset	12.5% flat without indexation (Section 112 / Section 197)
Unlisted Non-Convertible Debentures (NCDs)	Deemed STCA post 23-07-2024 (Section 50AA)	Deemed STCA (Section 76)	Short-Term Capital Asset (irrespective of holding period)	Normal applicable slab / corporate rates
Market Linked Debentures (MLDs)	Deemed STCA (Section 50AA)	Deemed STCA (Section 76)	Short-Term Capital Asset (irrespective of holding period)	Normal applicable slab / corporate rates
Specified Mutual Funds (>65% Debt)	Deemed STCA (Section 50AA)	Deemed STCA (Section 76)	Short-Term Capital Asset (irrespective of holding period)	Normal applicable slab / corporate rates
Listed Equity Shares (STT Paid)	> 12 months (Section 2(42A))	> 12 months (Section 2(101))	Long-Term Capital Asset	12.5% exceeding ₹1.25 Lakh (Section 112A / Section 198)

The Flattened Rate Architecture: Post-Inflation Yield Dynamics and the Demise of Indexation

The structural core of the direct tax overhaul is the elimination of the Cost Inflation Index (CII) and the transition to a uniform 12.5% baseline tax rate for all long-term capital assets. The Second Proviso to Section 48 of the 1961 Act, which previously adjusted the cost of acquisition and improvement by the ratio of the transfer-year CII to the acquisition-year CII, was removed for asset transfers occurring on or after 23 July 2024. This policy has been codified within the computational architecture of Section 72 and Section 197 of the 2025 Act.

While Parliament extended a grandfathering election to resident individuals and Hindu Undivided Families (HUFs) disposing of qualifying immovable property (land or building) acquired before 23 July 2024—permitting a comparison between 12.5% without indexation and 20% with indexation, and abating any excess tax—this carve-out was excluded for unlisted shares and non-quoted securities. Investors holding unlisted shares acquired before 23 July 2024 must compute long-term capital gains at 12.5% on nominal gains, with zero indexation adjustment.

The elimination of the Cost Inflation Index alters the distribution of post-tax yields across venture capital syndicates, private equity funds, and early-stage angel syndicates. In historical unlisted transactions, indexation served as a statutory buffer against inflation-driven monetary expansion, ensuring that tax was levied only on real, accretive gains:

Indexed Cost of Acquisition (ICOA) = COA × (CII_Transfer/CII_Acquisition)

Under the historic regime, unlisted shares were taxed at 20% on the indexed gain (FVC – ICOA). Under the codified regime, they are taxed at 12.5% on the raw gain (FVC – COA). The break-even condition where the tax liability under both regimes is identical can be derived algebraically:

0.20 × (FVC-ICOA) = 0.125 × (FVC-COA)

0.20 FVC – 0.20 ICOA = 0.125 FVC – 0.125 COA

0.075 FVC = 0.20 ICOA – 0.125 COA

FVC/COA = (0.20 × (CII_Transfer/CII_Acquisition) – 0.125)/0.075

Assuming an average annual inflation rate of 5.5% over the holding horizon, (CII_Transfer/CII_Acquisition) expands exponentially over time:

• Over a 3-year holding period, CII_Transfer/CII_Acquisition ≈ (1.055)³= 1.1742. The break-even multiple FVC/COA is: (0.20 × 1.1742 – 0.125)/0.075 = 0.2348-0.125/0.075 = 1.464 ×

• Over a 7-year holding period, CII_Transfer/CII_Acquisition ≈ (1.055)⁷= 1.4547. The break-even multiple   FVC/COA is: (0.20 × 1.4547 – 0.125)/0.075 = 0.2909-0.125/0.075 = 2.212 ×

• Over a 10-year holding period, CII_Transfer/CII_Acquisition ≈ (1.055)¹⁰= 1.7081. The break-even multiple FVC/COA is: (0.20 × 1.7081 – 0.125)/0.075 = 0.3416-0.125/0.075 = 2.888 ×

When the realised exit multiple exceeds this threshold, the 12.5% unindexed regime is mathematically advantageous to the investor. When the realised exit multiple falls below this threshold, the 12.5% unindexed regime imposes a higher effective tax burden than the 20% indexed regime, taxing phantom gains driven entirely by monetary inflation.

Investment Profile & Horizon	Capital Invested (INR)	Final Exit Value (INR)	Pre-Tax CAGR	Old Indexed Gain (5.5% CII)	Old Tax Payable (20% + Cess)	New Raw Gain (No CII)	New Tax Payable (12.5% + Cess)	Variance (Old vs. New Tax)	Effective Tax on Real Gain
Modest Growth Private Equity (5 Years)	₹10,00,00,000	₹14,00,00,000	6.96%	₹9,30,400	₹1,93,523	₹4,00,00,000	₹52,00,000	+₹50,06,477 (Adverse)	55.89%
Mid-Market Growth Buyout (5 Years)	₹10,00,00,000	₹25,00,00,000	20.11%	₹11,93,04,000	₹2,48,152	₹15,00,00,000	₹1,95,00,000	-₹53,15,232 (Favourable)	16.34%
Venture Capital Growth Round (7 Years)	₹10,00,00,000	₹20,00,00,000	10.41%	₹5,45,300	₹1,13,422	₹10,00,00,000	₹1,30,00,000	+₹1,18,65,776 (Adverse)	23.84%
Early-Stage VC Unicorn Exit (7 Years)	₹10,00,00,000	₹100,00,00,000	38.95%	₹85,45,300	₹17,77,422	₹90,00,00,000	₹11,70,00,000	-₹6,07,42,240 (Favourable)	13.69%
Long-Horizon Family Office (10 Years)	₹10,00,00,000	₹22,00,00,000	8.20%	₹4,91,900	₹1,02,315	₹12,00,00,000	₹1,56,00,000	+₹1,54,97,685 (Adverse)	31.71%

Calculations reflect base tax rates plus standard 4% Health and Education Cess. Excludes entity-specific surcharge gradations for comparative baseline precision.

The data indicates that the statutory shift produces divergent outcomes depending on the underlying investment strategy. Early-stage venture capital syndicates and top-decile growth funds underwriting transactions for 5× to 10×

returns experience an expansion in net realised yields, benefiting from the reduction of the headline rate to 12.5%.

Conversely, defensive growth funds, private credit structures, infrastructure platforms, and family offices targeting stable, lower returns over extended holding periods face an increased effective tax rate. In underperforming assets where capital growth tracks general inflation, the flat 12.5% unindexed framework taxes capital preservation as if it were income, imposing capital charges on nominal recoveries.

The Short-Term Capital Gains Computational Matrix and Private Market Friction

Where an unlisted security fails to cross the 24-month holding threshold, it is subject to the Short-Term Capital Gains (STCG) computational matrix. The statutory architecture creates a division between STT-paid listed market transactions and non-STT private transactions.

Under Section 111A of the 1961 Act—re-codified as Section 196 of the 2025 Act—a concessional short-term capital gains tax rate of 20% (increased from 15% by Finance (No. 2) Act, 2024) is strictly conditioned on two factors: the asset must be an equity share in a company, a unit of an equity-oriented fund, or a unit of a business trust; and the transaction of sale must be chargeable to Securities Transaction Tax (STT).

Unlisted equities, off-market share transfers, private debt instruments, and non-quoted hybrid securities are statutorily excluded from Section 111A / Section 196 because they do not trade on recognised stock exchanges and cannot pay STT.

Consequently, short-term gains on unlisted securities are governed by general computation provisions, taxing them at normal applicable slab or corporate rates:

• Resident Individuals and HUFs: Taxed at progressive marginal slab rates (up to 30% base rate, reaching an effective top marginal rate of 39% under the old tax regime or 35.88% under the new regime including maximum surcharge and cess).
• Domestic Corporate Entities: Taxed at base corporate rates of 22% (under Section 115BAA, resulting in an effective tax rate of 25.168% inclusive of surcharge and cess) or 30% (for companies outside the concessional regimes, yielding an effective rate of up to 34.944%).
• Foreign Companies and Non-Resident Corporates: Historically taxed at a base rate of 40%, which was rationalised by the Finance (No. 2) Act, 2024 to a base corporate rate of 35% (yielding an effective tax rate of 38.22% with cess and peak 5% foreign company surcharge).

Taxpayer Persona / Entity Classification	STCG Rate: Unlisted Equity / Debentures (No STT)	STCG Rate: Listed Equity (STT Paid, Sec 111A / Sec 196)	LTCG Rate: Unlisted Equity (>24 Mos, Sec 112 / Sec 197)	Peak Effective Friction: STCG vs. LTCG (Unlisted)
Resident Individual (HNI – Peak Slab)	Slab Rate: Base 30% + 37% SC + 4% Cess = 39.00%	Concessional: Base 20% + 15% SC + 4% Cess = 23.92%	Base 12.5% + 15% SC + 4% Cess = 14.95%	24.05% Cliff Differential
Domestic Company (Section 115BAA)	Base 22% + 10% SC + 4% Cess = 25.17%	Concessional: Base 20% + 10% SC + 4% Cess = 22.88%	Base 12.5% + 10% SC + 4% Cess = 14.30%	10.87% Cliff Differential
Domestic Company (Standard Regime)	Base 30% + 12% SC + 4% Cess = 34.94%	Concessional: Base 20% + 12% SC + 4% Cess = 23.30%	Base 12.5% + 12% SC + 4% Cess = 16.25%	18.69% Cliff Differential
Foreign Company / Non-Resident Fund	Base 35% + 5% SC + 4% Cess = 38.22%	Concessional: Base 20% + 5% SC + 4% Cess = 21.84%	Base 12.5% + 5% SC + 4% Cess = 13.65%	24.57% Cliff Differential

SC = Surcharge; Cess = Health and Education Cess (4%). Surcharge on LTCG and Section 111A STCG is statutorily capped at 15% for individuals. Surcharge for domestic corporate under 115BAA is fixed at 10%.

This computational divergence introduces structural frictions in private market transactions, secondary block sales, and employee stock liquidation events. For an individual employee exercising and selling Employee Stock Options (ESOPs) in an unlisted entity, or a venture capital fund executing an off-market secondary sale, the difference between closing a transaction at 23 months and 29 days versus 24 months and 1 day represents a tax penalty of up to 24.05% of the total gain.

In employee stock options, the cost of acquisition is statutorily fixed under Section 49(2AA) as the Fair Market Value (FMV) adopted for perquisite tax withholding on the date of exercise. When an employee exercises options and subsequently sells those shares in an unlisted secondary round, the holding period is calculated exclusively from the date of allotment to the date of transfer.

If private equity secondary buyers compress closing timelines ahead of funding milestones, forcing an employee or early angel to transfer unlisted shares at 22 months from allotment, the entire gain above the exercise FMV is taxed at normal slab rates (up to 39%), while deferring the sale by eight weeks would drop the tax charge to 14.95%.

Deemed Consideration Doctrines: Statutory Friction of Section 50CA and Rule 11UA

Section 50CA of the 1961 Act—re-codified as Section 79 of the Income-tax Act, 2025—operates as a mandatory anti-avoidance provision governing transfers of unquoted equity shares.

Under Section 50CA, where the consideration received or accruing as a result of the transfer of a share of an unquoted company is less than the Fair Market Value (FMV) of such share determined in accordance with the prescribed rules, the FMV is deemed to be the full value of consideration for computing capital gains under Section 48 (Section 72 of the 2025 Act).

This provision creates a coordinated statutory trap when read alongside Section 56(2)(x) of the 1961 Act (Section 92(2)(m) of the 2025 Act). If an unquoted equity share is transferred at a price below the prescribed FMV:

• The transferor is subjected to capital gains tax on phantom income under Section 50CA / Section 79, substituting the higher FMV as the deemed full value of consideration.
• The transferee is simultaneously taxed on the same price differential under Section 56(2)(x) / Section 92(2)(m) as “Income from Other Sources” at normal slab or corporate rates, under the category of property received for inadequate consideration.

The statutory rules for determining FMV under Section 50CA are prescribed in Rule 11UAA read with Rule 11UA(1)(c)(b) of the Income-tax Rules, 1962, which have been re-codified into Rule 57 of the Income-tax Rules, 2026. For unquoted equity shares, the law prescribes a mandatory Net Asset Value (NAV) formulation based on an adjusted balance sheet break-up value.

The Discounted Cash Flow (DCF) method, previously available under Rule 11UA(2) for fresh share issuances under Section 56(2)(viib) (the “Angel Tax”), is not permissible for secondary transfers governed by Section 50CA. Following the abolition of Section 56(2)(viib) by the Finance (No. 2) Act, 2024, the DCF method was omitted from the 2026 Rules, leaving the adjusted NAV formula as the sole valuation method for secondary transactions.

FMV per unquoted equity share = (A-L) × (PV/PE)

In this formula:

• A represents the book value of assets in the balance sheet, subject to statutory adjustments:
  • Book value of immovable property must be substituted with the Stamp Duty Value (SDV) assessed or assessable by the state authority on the valuation date.
  • Value of quoted shares and securities must be substituted with their fair market value determined on a recognised stock exchange (average of lowest and highest trading price on the valuation date).
  • Value of unquoted shares held as investments by the target company must be substituted with their recursive FMV determined under Rule 11UA / Rule 57.
  • Value of jewellery, artistic work, and precious metals must be substituted with the value determined by an IBBI Registered Valuer.
  • Advance taxes paid, deferred tax assets, and unamortized debit balances of profit and loss accounts are excluded.
• L represents the book value of liabilities shown in the balance sheet, excluding paid-up equity capital, reserves and surplus, provisions for undeclared dividends, and provisions for unascertained liabilities (such as unapproved contingency provisions or deferred tax liabilities).
• PV represents the paid-up value of the equity share being transferred.
• PE represents the total amount of paid-up equity share capital as shown in the balance sheet.

The Balance Sheet Trap

A critical compliance vulnerability arises under Rule 11U(b) of the 1962 Rules (re-codified as Rule 56 of the 2026 Rules). The rule defines “balance sheet” as an audited balance sheet drawn up on the valuation date by an auditor appointed under the Companies Act. Where no such balance sheet is drawn up on the valuation date, it requires adopting the balance sheet drawn up on the date immediately preceding the valuation date which has been approved and adopted in the Annual General Meeting (AGM).

In commercial practice, secondary share acquisitions close mid-fiscal year (e.g., October 2025). Transacting parties often execute a Rule 11UA valuation certificate using the target company’s last annual audited balance sheet (e.g., 31 March 2025). This practice is legally vulnerable.

Where intermediate transactions, fresh equity raises, asset sales, or capital expenditure have occurred between 31 March and the transaction date, Assessing Officers have discarded valuations based on the prior year’s balance sheet, citing Rule 11U.

While certain judicial benches, such as the Chandigarh ITAT in Electra Paper and Board Pvt. Ltd. v. ITO, have accepted interim valuations based on unaudited figures provided there are no material variances, reliance on prior-year balance sheets creates tax exposure under Section 50CA. Defensible transaction structuring requires drawing up and auditing an interim balance sheet as on the execution/closing date, or securing a management representation and verification confirming zero material balance-sheet alterations.

The Safe Harbour Friction

A second point of friction is the absence of an express statutory safe harbour tolerance band within Section 50CA. Section 50C (governing transfer of land and buildings) contains a statutory third proviso providing that where the stamp duty value does not exceed 110% of the actual consideration received (a 10% safe harbour tolerance band), the actual consideration is deemed to be the full value. Section 50CA contains no such explicit tolerance band within its statutory text. In 2023, the Central Board of Direct Taxes (CBDT) introduced a 10% safe harbour tolerance band in Rule 11UA for Section 56(2)(x) issuances, but did not formally mirror this within the substantive text of Section 50CA.

In ACIT v. Shri Vishal Holani (ITA No. 1188/PUN/2024), the Pune Bench of the Income Tax Appellate Tribunal (ITAT) evaluated whether tolerance limits and valuation adjustments could be applied under Section 50CA and Section 56(2)(x). The ITAT upheld the CIT(A)’s deletion of additions under Section 50CA and Section 56(2)(x), confirming that:

• Valuation of unquoted shares is not an exact science and involves inherent commercial uncertainties.
• An adjustment or discount of 15% on account of lack of marketability and lack of liquidity in closely held unquoted equity shares was appropriate and legally defensible.
• Where the variance between the agreed transfer consideration and the mathematical Rule 11UA value falls within acceptable commercial tolerance thresholds, additions under Section 50CA should not be mechanically sustained.

Despite this ruling, Assessing Officers routinely enforce Section 50CA strictly. If a transaction price is even ₹1 below the mathematical NAV derived under Rule 11UA / Rule 57, the Assessing Officer will substitute the full Rule 11UA value, triggering deemed capital gains liabilities. Tax advisors must structure transaction pricing at or above the certified Rule 11UA NAV, avoiding unverified discounts or undocumented reliance on safe harbours.

Hybrid Instruments: CCDs, CCPS, and the Debt-versus-Equity Conundrum

Private equity and venture capital financing in India frequently relies on hybrid convertible instruments, primarily Compulsorily Convertible Debentures (CCDs) and Compulsorily Convertible Preference Shares (CCPS). These instruments provide contractual downside protection, liquidation preferences, and anti-dilution ratchets, while qualifying as foreign direct investment (FDI) equity-compliant instruments under Reserve Bank of India (RBI) Foreign Exchange Management regulations. Their tax treatment, however, requires careful alignment across characterisation, holding-period tracking, and conversion rules.

Under Section 47(x) of the 1961 Act, any transfer by way of conversion of bonds or debentures into shares or debentures of that company is expressly excluded from the definition of a taxable “transfer”. Similarly, under Section 47(xb), the conversion of preference shares into equity shares is non-taxable. Upon conversion:

• Cost of Acquisition: Governed by Section 49(2A) for debenture conversions and Section 49(2AE) for preference share conversions, the cost of the resulting equity shares is deemed to be that part of the cost of the original debenture or preference share represented by the shares received.
• Period of Holding: Governed by Section 2(42A)(hf) and Section 2(42A)(hb) of the 1961 Act, the period for which the investor held the original convertible instrument (CCD or CCPS) is tacked on to the holding period of the converted equity shares.

This statutory holding-period tacking creates a significant distinction between an equity conversion followed by sale versus a direct redemption or secondary sale of the unconverted CCD.

The critical tax risk arises under Section 50AA of the 1961 Act (Section 76 of the 2025 Act). Following the Finance (No. 2) Act, 2024 amendment effective 23 July 2024, unlisted debentures and bonds are deemed to be short-term capital assets upon transfer, redemption, or maturity.

Under corporate and securities jurisprudence, a CCD remains a debenture—and an instrument of indebtedness—until conversion occurs. If an investor seeks an exit by having the issuer redeem the CCD, or by selling the unconverted CCD to a secondary acquirer, the transaction is treated as a transfer or redemption of an unlisted debenture under Section 50AA.

Consequently, the entire gain is classified as STCG and taxed at full applicable corporate or slab rates (up to 39%), even if the CCD was held for five years.

Conversely, Compulsorily Convertible Preference Shares (CCPS) avoid Section 50AA exposure because a preference share is capital stock, not a debt security or debenture. However, CCPS redemptions must comply with the strict capital maintenance rules of Section 55 of the Companies Act, 2013, requiring redemption out of distributable profits or the proceeds of a fresh issue of shares.

Furthermore, where a company buys back or redeems its own shares, the post-2024 tax framework re-characterises the buyback consideration as deemed dividend income in the hands of the shareholder, taxed at applicable slab rates.

Conversion Versus Redemption Comparison

Consider an investor subscribing to INR 10 Crore of unlisted CCDs who exits at INR 30 Crore after 30 months:

• Alternative A (Direct Secondary Sale of CCD): The investor sells the unconverted CCDs to an incoming private equity sponsor. Under Section 50AA, the CCD is an unlisted debenture. The entire INR 20 Crore gain is deemed short-term capital gain, taxed at the investor’s marginal rate (e.g., 38.22% for a foreign company or 39% for a resident HNI), resulting in a tax liability of roughly INR 7.64 Crore to INR 7.80 Crore.
• Alternative B (Conversion into Equity Followed by Secondary Sale): The investor converts the CCDs into equity shares pursuant to Section 47(x). Under Section 2(42A)(hf), the holding period includes the 30 months the CCD was held, qualifying the shares as LTCAs (>24 months). The cost basis remains INR 10 Crore under Section 49(2A). The secondary sale of the converted shares is taxed under Section 112 / Section 197 at 12.5% (plus applicable surcharge and cess, yielding 13.65% to 14.95%), resulting in a tax liability of roughly INR 2.73 Crore to INR 2.99 Crore.

The procedural act of conversion before closing generates an absolute tax reduction exceeding INR 4.6 Crore on a ₹20 Crore gain. Deal documents must include automatic conversion mechanics triggered immediately before any secondary closing or transaction transfer date.

Cross-Border Tax Architecture: Non-Resident Mechanics, Forex Neutralisation, and DTAA Interplay

Cross-border investments into unlisted Indian corporate securities involve the interplay between statutory capital gains computation, non-resident foreign exchange neutralisation rules, and bilateral Double Taxation Avoidance Agreements (DTAAs).

The Forex Neutralisation Mechanism and Section 112(1)(c) Conflict

The First Proviso to Section 48 of the 1961 Act provides a neutralisation mechanism for non-residents who invest in shares or debentures of an Indian company using foreign currency. Under this mechanism:

1. The cost of acquisition, expenditure incurred wholly and exclusively in connection with the transfer, and the full value of consideration are converted into the original foreign currency using the average of the Telegraphic Transfer (TT) buying and selling rates on their respective transaction dates.

2. The resulting capital gain or loss is computed in that foreign currency.

3. The net foreign currency capital gain is converted back into Indian Rupees using the TT buying rate on the date of transfer.

This formula shields the foreign investor from paying Indian capital gains tax on phantom profits arising solely from the depreciation of the Indian Rupee against the US Dollar or other reference currencies.

However, non-resident taxation on unlisted securities faces a jurisdictional split regarding whether this foreign exchange adjustment can be claimed alongside the concessional 10% / 12.5% tax rate. Under Section 112(1)(c)(iii) of the 1961 Act—and its successor, Section 197 of the 2025 Act—long-term capital gains arising to a non-resident from the transfer of unlisted securities or shares are taxed at a concessional base rate (historically 10%, unified to 12.5% post-2024), computed “without giving effect to the first and second proviso to section 48”.

In Legatum Ventures Limited v. ACIT (ITA No. 1627/Mum/2022), the Mumbai Bench of the ITAT considered whether an offshore company disposing of unlisted Indian shares could first compute its capital gains under the First Proviso to Section 48 (yielding a loss in foreign currency due to Rupee depreciation) and then claim there were no capital gains to be taxed under Section 112(1)(c)(iii).

The ITAT ruled in favour of the Revenue, holding that:

• Section 112(1)(c)(iii) is not merely a charging section or rate prescriber; it constitutes a specific, self-contained computational code for non-residents transferring unlisted shares.
• The text of Section 112(1)(c)(iii) specifically mandates that capital gains must be computed without giving effect to the first proviso to Section 48.
• Under the doctrine of generalia specialibus non derogant, the specific computational method prescribed under Section 112(1)(c)(iii) overrides the general computation mechanism in Section 48.
• Consequently, the foreign corporate investor could not use foreign exchange neutralisation to convert an unindexed Rupee gain into a deductible foreign currency loss.

This ruling conflicts with aspects of the Delhi High Court’s reasoning in Cairns UK Holdings Ltd v. DIT, which addressed the availability of beneficial provisos to non-residents. As a result, cross-border deal structuring requires modelling whether the 12.5% unindexed Rupee computation under Section 112(1)(c)(iii) produces a lower tax charge than computing capital gains under the regular provisions with foreign currency neutralisation.

Bilateral Double Taxation Avoidance Agreements (DTAAs)

Under Section 90(2) of the 1961 Act (codified in Chapter XII of the 2025 Act), non-resident taxpayers may choose between the provisions of the domestic Income-tax Act and the applicable DTAA, whichever is more beneficial.

Historically, treaties with jurisdictions like Mauritius, Singapore, and Cyprus allocated exclusive taxing rights over capital gains to the country of the seller’s residence, exempting investments in Indian company shares from Indian direct tax. The 2016 Protocols to the India-Mauritius and India-Singapore treaties eliminated this source-taxation exemption, giving India source-taxing rights over shares acquired on or after 1 April 2017.

Investments acquired before 1 April 2017 remain grandfathered under Article 13(4) of the Mauritius DTAA and the corresponding Singapore protocol, preserving tax exemptions upon eventual exit, subject to general anti-abuse considerations.

However, the international tax landscape has tightened through the OECD Multilateral Instrument (MLI) and bilateral protocol revisions:

• The Principal Purpose Test (PPT): The India-Mauritius Protocol, ratified and notified into force in 2026, incorporated a PPT under Article 27A. Treaty relief will be denied if it is reasonable to conclude that obtaining the tax benefit was one of the principal purposes of the transaction or arrangement, unless granting the benefit is consistent with the object and purpose of the treaty. Even with a valid Tax Residency Certificate (TRC) under Section 90(4), entities lacking commercial rationale, operational infrastructure, and local economic substance risk treaty disqualification under the PPT and domestic General Anti-Avoidance Rules (GAAR).
• The Netherlands Treaty Route: Under Article 13(5) of the India-Netherlands DTAA, capital gains arising from the alienation of shares of an Indian unquoted company are generally taxable in the Netherlands, unless the alienation forms part of an internal corporate reorganisation or falls under specific exclusions. However, India preserves source-taxing rights if the Dutch seller holds more than a 10% interest in the Indian company and sells to an Indian resident buyer.

Treaty Partner Jurisdiction	Pre-2017 Investment Status	Post-2017 Unlisted Share Dispositions	Anti-Avoidance Architecture (PPT / GAAR / LOB)	Mandatory Withholding Tax Mechanics
Mauritius	Fully Grandfathered (Article 13(4): Exempt from Indian tax)	Fully Taxable in India under domestic law (12.5% LTCG / Slab STCG)	Bilateral PPT notified in 2026; domestic GAAR applies if lacking commercial substance	Section 195 withholding; Form 145/146 compliance; TRC mandatory
Singapore	Fully grandfathered (Protocol Article 6: Exempt from Indian tax)	Fully Taxable in India under domestic law (12.5% LTCG / Slab STCG)	Comprehensive Limitation of Benefits (LOB) + MLI PPT framework	Section 195 withholding; Lower Deduction Certificate under Section 197 recommended
Netherlands	Exempt from Indian tax under Article 13(5), subject to conditions	Taxable in India if Dutch resident holds >10% and transfers to Indian resident	Subject to PPT interpretation under MLI and judicial substance doctrine	Requires strict CA certification in Form 146 verifying the 10% shareholding threshold
United States / United Kingdom	Taxable in India under domestic rates (No share capital gain exemption)	Taxable in India under domestic rates (12.5% LTCG / Slab STCG)	Credit mechanism in home jurisdiction (Foreign Tax Credit against home tax)	Mandatory TDS under Section 195 at applicable effective statutory rates

Remittance Compliance and Withholding

Cross-border sales of unlisted shares require tax withholding under Section 195 of the 1961 Act. Any person responsible for paying to a non-resident any sum chargeable under the Act must deduct tax at source at the rates in force.

Because secondary share transfers are settled gross, buyers face personal liability as an “assessee-in-default” under Section 201 for failure to withhold sufficient tax, plus interest charges and penalty exposure.

The seller must obtain a Lower or Nil Deduction Certificate from the jurisdictional Assessing Officer under Section 197 to authorise withholding below the statutory rate. For foreign remittances, the documentation framework has been updated: the historical Form 15CA (remitter undertaking) and Form 15CB (Chartered Accountant certification) are transitioned under the 2025 Act to codified digital filings in Form 145 and Form 146.

Loss Absorption Mandates, Asymmetric Carry-Forward, and Grandfathering Caveats

The capital gains code contains rules regulating the set-off and carry-forward of capital losses. These provisions govern intra-head offsets, inter-head transfers, and cross-statutory loss carry-overs.

Intra-Head and Inter-Head Set-Off Mechanics

Under Section 70(2) and Section 70(3) of the 1961 Act—re-codified in Chapter VII of the 2025 Act—capital losses are governed by asymmetric intra-head set-off rules:

• Short-Term Capital Loss (STCL): Retains broader absorption flexibility. A short-term capital loss incurred in a given tax year can be set off against both short-term capital gains and long-term capital gains realised in that same year.
• Long-Term Capital Loss (LTCL): Subject to asymmetric ring-fencing. A long-term capital loss can be set off strictly and exclusively against long-term capital gains. An LTCL cannot be set off against short-term capital gains.
• Inter-Head Barrier: Under Section 71, capital losses (whether short-term or long-term) cannot be set off against income falling under any other head (such as Profits and Gains of Business or Profession, Income from Other Sources, or Salary). The loss must remain entirely within the capital gains category.

Carry-Forward Barriers and Section 536 Mechanics

Where a capital loss cannot be fully absorbed in the year it is incurred, its carry-forward is governed by Section 74 of the 1961 Act, as well as the transition provisions in Section 536(2)(m) and (n) of the 2025 Act.

During the legislative drafting of the Income-tax Act, 2025, draft iterations of Clause 536(n) lacked explicit language restricting brought-forward LTCL offsets to long-term gains, leading to speculation that taxpayers might receive a one-time transitional relief allowing pre-2026 LTCLs to offset STCGs. However, Parliament modified this language in the final statute.

Section 536(2)(n) of the 2025 Act explicitly directs that capital losses computed and brought forward from years before 1 April 2026 shall be set off against income chargeable under the head “Capital Gains” in the manner provided under Section 74 of the repealed Act.

Consequently, the legislative framework preserves existing restrictions:

• No Reclassification: Brought-forward long-term capital losses retain their character and can only be set off against long-term capital gains under the 2025 Act.
• Continuation of the 8-Year Clock: Section 536 does not restart the statutory carry-forward window. A capital loss incurred in AY 2022–23 (FY 2021–22) has an eight-year lifespan that expires in AY 2030–31 (Tax Year 2029–30). Transitioning across the 1 April 2026 statutory boundary grants no extension.
• The Section 139(1) Filing Mandate: Under Section 80 read with Section 139(3) of the 1961 Act, no loss will be carried forward unless the return of income for the year in which the loss was incurred was filed on or before the statutory due date prescribed under Section 139(1). Section 536 preserves only validly determined rights. If a taxpayer filed a belated return under Section 139(4) for FY 2024–25 or FY 2025–26, the capital loss cannot be carried forward under the 1961 Act, and Section 536 will not revive the forfeited loss.
• Corporate Restructuring and Section 79 Traps: For unlisted companies, change in shareholding can restrict loss carry-forwards under Section 79 of the 1961 Act (and its 2025 Act counterpart). If more than 49% of the voting power changes hands following a secondary buyout, brought-forward unabsorbed business losses lapse, though capital losses remain personal to the selling shareholder and do not reside within the corporate entity.

Transactional Structuring Blueprints, Contractual Covenants, and Risk Mitigation

Managing tax risks across secondary acquisitions, private equity exits, and venture rounds in unlisted securities requires specific contractual covenants and closing mechanisms. Discrepancies between commercial terms and statutory deemed values (such as Rule 11UA / Rule 57 FMVs) can trigger unexpected liabilities for both parties.

Pre-Closing Execution Protocols

• Interim Balance Sheet Audit: Rather than relying on the previous year-end balance sheet (e.g., 31 March 2025), parties should require an interim audited balance sheet drawn up precisely on the valuation/execution date. This neutralises the Rule 11U/Rule 56 balance sheet challenge and verifies the NAV asset base.
• Independent IBBI and Merchant Banker Certificates: Even though secondary equity transfers rely mathematically on the NAV break-up formula under Rule 11UA(1)(c)(b) / Rule 57, valuations for underlying real estate, listed equity portfolios, and artistic assets held by the target must be certified by registered specialists.

Model Contractual Clauses for Deal Documentation

Clause A: Section 50CA / Rule 11UA Valuation Adjustment Mechanism

“The Purchase Consideration per Equity Share payable by the Acquirer at the Closing shall be an amount equal to the agreed commercial value of INR; provided, however, that if the Fair Market Value (FMV) per Equity Share of the Company determined on the Valuation Date in accordance with Rule 11UA(1)(c)(b) of the Income-tax Rules, 1962 (or Rule 57 of the Income-tax Rules, 2026, as applicable) based on an audited balance sheet of the Company drawn up as of the Valuation Date, is determined to be higher than the agreed commercial value, the Purchase Consideration payable per Equity Share shall automatically be adjusted upwards to equal such certified FMV. The Transferor and the Acquirer mutually agree and covenant that neither party shall execute or deliver a transfer form, nor file any regulatory or tax return, reporting a consideration lower than the certified FMV, to ensure full compliance with Section 50CA (or Section 79 of the Income-tax Act, 2025) and Section 56(2)(x) (or Section 92(2)(m) of the Income-tax Act, 2025).”

Clause B: Section 536 Tax Indemnity and Cross-Regime Reassessment Covenant

“The Sellers hereby jointly and severally agree to defend, indemnify, and hold harmless the Acquirer and the Company from and against any Tax claims, liabilities, interest, and penalties arising from, or in connection with, any assessment, reassessment, or appellate proceedings initiated on or after 1 April 2026 under Section 536(2)(c) of the Income-tax Act, 2025 read with the provisions of the Income-tax Act, 1961, in respect of any transaction, undeclared liability, transfer pricing adjustment, or failure to withhold tax under Section 195 of the Income-tax Act, 1961 relating to Financial Year 2025–26 or any prior Tax Year. Any indemnity payment due under this Clause shall be paid clear of any deductions or withholdings, and if any such deduction or withholding is required by law, the Sellers shall pay such additional amount as will ensure that the Acquirer receives the full net amount it would have received had no such deduction or withholding been made.”

Clause C: Mandatory Automatic Conversion of Convertible Instruments

“Each holder of Compulsorily Convertible Debentures (CCDs) hereby covenants and agrees that immediately prior to the execution of the Share Purchase Agreement and in no event later than 24 hours prior to the Closing Date, all outstanding CCDs held by such holder shall be converted in full into validly issued, fully paid Equity Shares of the Company in accordance with Section 47(x) of the Income-tax Act, 1961. The Company shall register the allotment of such Equity Shares, update its register of members, and credit such shares to the depository account of the holder before the consummation of the secondary sale. The parties acknowledge and agree that this Clause is designed to preserve the continuity of holding period tracking under Section 2(42A)(hf) of the Income-tax Act, 1961 and to preclude the classification or taxation of gains under Section 50AA of the Income-tax Act, 1961 (or Section 76 of the Income-tax Act, 2025).”

Conclusion and Strategic Perspectives for Deal Architects

The transition from the Income-tax Act, 1961 to the Income-tax Act, 2025 changes the tax parameters governing unlisted investments, private equity structures, and venture transactions. By flattening the long-term capital gains tax rate to 12.5% and removing indexation adjustments across non-quoted securities, Parliament has altered how real returns are determined.

For growth investments that achieve high exit multiples, the 12.5% rate reduces the tax drag on realised returns. For defensive, capital-intensive investments with modest returns over extended holding periods, the elimination of inflation adjustments increases the effective tax burden, transforming nominal inflation gains into taxable income.

Navigating this changing landscape requires attention to structural and valuation mechanics:

• Managing Holding Period Thresholds: Dealmakers must account for the 24-month long-term threshold for unlisted equities, structuring exit timelines to avoid the steep tax cliff of short-term status.
• Addressing Section 50AA Debt Classifications: Unlisted debentures and hybrid debt instruments should be converted into equity shares before exit to prevent gains from being recharacterized as short-term capital gains under Section 50AA / Section 76.
• Complying with Valuation Timing Rules: Parties should avoid relying on outdated balance sheets for Rule 11UA / Rule 57 calculations, drawing up and auditing interim financials as of the transaction date to defend against Section 50CA deemed consideration adjustments and Section 56(2)(x) double taxation.
• Evaluating Cross-Border Mechanics: Cross-border structures must balance the concessional 12.5% non-resident rate against foreign currency neutralisation rules following Legatum Ventures, while verifying that holding structures meet economic substance requirements under the Principal Purpose Test.
• Preserving Loss Carry-Forwards: Fund managers must ensure strict compliance with Section 139(1) filing deadlines to preserve accumulated capital losses under Section 536(2)(n), noting that the 8-year statutory window continues to run uninterrupted across the statutory transition.

By incorporating these technical coordinates into deal structures, term sheets, and closing protocols, tax professionals and corporate finance advisors can manage latent exposures and achieve tax certitude across the 2025–26 and 2026–27 fiscal cycles.