27 Feb 2025
Partners: Himanshu Sinha and Komal Dani, Senior Associate: Deepanshu Jhanwar, Associate: Harshita Nahata
The Finance Bill, 2025 (Bill) was introduced on 1 February 2025, proposing sweeping changes to the Income Tax Act, 1961 (ITA). The Bill aims to transform the tax landscape in India by simplifying tax regulations, enhancing taxpayer services, and fostering economic growth.
Accordingly, the proposed amendments focus on rationalising capital gains taxation for Sovereign Wealth Funds (SWF) and Pension Funds, simplifying tax rates for long-term capital gains, and providing clarity on the treatment of securities held by specified investment funds. With a key emphasis on enhancing tax uniformity and reducing ambiguities, these changes are expected to attract higher capital inflows, particularly in the financial and investment sectors.
The Bill further introduces a comprehensive set of incentives and reforms that highlight the government’s commitment to transforming the International Financial Services Centre (IFSC) into a global financial powerhouse. These measures are designed to attract greater foreign investment, particularly in the financial and ship-leasing sectors, while enhancing IFSC’s significance in treasury management and capital markets. The proposed amendments not only strengthen India’s standing as a leading global financial hub but also position Gujarat International Finance Tec-City (GIFT City) as a formidable competitor in the international financial landscape.
The key budget proposals impacting various funds and IFSC are discussed in detail below.
The definition of ‘capital asset’ under the ITA includes any assets held by an assessee, whether or not connected to his business or profession. It is trite law that gains made from the sale or transfer of capital assets can only be taxed as capital gains.
There has been controversy regarding whether gains on the sale or transfer of securities by Category I and Category II Alternative Investment Funds (AIF), as regulated by the Securities and Exchange Board of India or the IFSC Authority, are taxable as the business income of such fund or as capital gains accruing to the investors participating in the funds.
The proposed amendment seeks to clarify that securities held by Category I and Category II AIFs will be treated as capital assets. Thus, any income arising from the transfer of such securities would be taxed under the head capital gains and not business income.
This amendment will take effect from 1 April 2026 and will apply in relation to Assessment Year (AY) 2026-27 onwards.
The Finance (No. 2 Act) 2024 had initiated the simplification and harmonisation of long-term capital gains tax rates, including equalising rates of taxation for residents and non-residents.
Currently, long-term capital gains are taxed at 12.5% for residents and most non-residents. However, Foreign Institutional Investors (FII) and Category III AIFs are still taxed at a lower 10% rate for assets other than equity shares or units of equity-oriented funds or units of business trusts. To achieve parity between domestic and foreign investors, the Bill proposes to increase the long-term capital gains tax rate for FIIs and Category III AIFs to 12.5%.
This amendment will take effect from 1 April 2026 and will apply in relation to AY 2026-27 onwards.
The Bill proposes to rationalise the tax deducted at source on income from investments in securitisation trusts. Currently, these trusts must deduct tax at source on income payable to resident investors at a rate of 25% for individuals and Hindu Undivided Families, and 30% for other entities. The Bill aims to simplify this by establishing a uniform 10% tax deduction rate for all investors, improving their cash flow.
This amendment will take effect from 1 April 2025.
Recognising the potential of SWFs and Pension Funds to boost Foreign Direct Investment, the Indian government introduced income tax exemption for their investments in early 2020, establishing guidelines for availing this benefit.
At present, any income earned by SWFs or Pension Funds from investments in certain specified entities, including interest, dividends, and long-term capital gains, is exempt from tax. This exemption applies to investments made between 1 April 2020 and 31 March 2025. The Bill proposes to extend this exemption to investments made till 31 March 2030.
Further, the Bill proposes a clarification regarding Section 50AA of the ITA (as amended by the Finance (No. 2) Act 2024). The amended Section 50AA reclassified gains from the sale of unlisted debentures and bonds as short-term capital gains. The Bill proposes an amendment to Section 10(23FE) to clarify that the reclassification will not apply to investments made by SWFs and PFs. Therefore, any long-term capital gains accruing to these entities will continue to remain tax exempt, even if reclassified as short-term under Section 50AA.
However, an ambiguity remains regarding the application of the law. The amended Section 50AA came into effect on 23 July 2024, reclassifying all gains from the sale of unlisted debentures as short-term. Meanwhile, the proposed amendment under the Bill is set to take effect on 1 April 2025. This creates an anomaly where any unlisted debentures sold or redeemed by SWFs and Pension Funds between 23 July 2024 and 1 April 2025 will be treated as short-term gains and taxed accordingly.
Under the current provisions of the ITA, fund management activities conducted by an eligible manager for an eligible investment fund do not create a business connection or Permanent Establishment (PE) in India, subject to certain conditions. An eligible investment fund refers to a fund established outside India that meets specific criteria, including having a fund manager in India.
One of the conditions states that Indian residents cannot invest more than 5% in an eligible investment fund. This restriction applies to all eligible investment funds, regardless of whether their fund managers operate from an IFSC. Under the proposed amendment, the aggregate participation or investment in the fund will be assessed on 1 April and 1 October of the previous year. If the fund fails to meet this condition on either date, it will have a four-month window to comply.
Further, the Bill proposes to relax the other conditions (under sub-section (3) of section 9A) for eligible investment funds whose fund managers in IFSC begin operations on or before 31 March 2030. This move is expected to encourage more fund managers to set up operations in the IFSC, promoting the growth of the financial sector in India.
This amendment will take effect from 1 April 2025.
Under the current provisions, any transfer of shares, units, or interests by an investor from the original fund to a resultant fund in an IFSC is not considered a taxable transfer for capital gains tax purposes, provided the original fund is relocated before 31 March 2025. The resultant fund must be an AIF in the IFSC, registered as Category I, II, or III, and subject to certain conditions.
The proposed amendment in the Bill aims to expand the definition of ‘resultant fund’ to include Exchange-Traded Funds (ETF) and retail schemes, broadening the scope of this benefit.
The amendment will take effect from 1 April 2026.
Additionally, the sunset date for the relocation to avail of this tax benefit has been extended to 31 March 2030, offering more time for funds to benefit from this provision. This extension is expected to further encourage the relocation of funds to IFSCs and foster growth in the sector.
Currently, non-residents are exempt from tax on income derived from certain financial transactions, such as offshore derivative instruments (ODI) and non-deliverable forward contracts, if these transactions are executed through an offshore banking unit in an IFSC.
To further enhance the operations of IFSCs, the government proposes extending this tax exemption to similar transactions through Foreign Portfolio Investors (FPI) based in the IFSC, subject to certain conditions. This move aims to attract more international investment and promote the growth of financial services within IFSCs.
This amendment will take effect from 1 April 2026 and will, accordingly, apply in relation to the AY 2026-2027 and subsequent AYs.
Under the current provisions of the ITA, if a closely held company extends a loan or advance to (a) a shareholder holding at least 10% voting power, (b) a firm or concern in which such a shareholder has a substantial interest, or (c) pays any amount for the benefit of such a shareholder, the payment is treated as a deemed dividend and taxed to the extent of the company’s accumulated profits.
The Bill proposes an important amendment stating that any loan or advance between two group entities, where one of the entities is a ‘finance company’ or a ‘finance unit’ within an IFSC set up as a global or regional corporate treasury centre, will not be treated as deemed dividend. This exemption applies if the parent entity of the group is listed on a stock exchange in a specified country outside India.
This change is a welcome move as it ensures that borrowings by corporate treasury centres within the IFSC from group entities will not be subject to taxation under the deemed dividend provisions. This aligns with the goal of encouraging businesses to establish and operate in IFSCs by offering a more favourable tax treatment for corporate treasury activities and services.
This amendment will take effect from 1 April 2025.
(a) The sunset date for the commencement of operations to avail exemptions/deductions has been extended from 31 March 2025 to 31 March 2030 for the following:
(i) Investment divisions of offshore banking units: The exemption for investment divisions of offshore banking units will now be available if the operations were commenced before 31 March 2030, allowing continued tax benefits for these operations.
(ii) Income from transfer of aircraft or ship leased by an IFSC unit: The deduction on income arising from the transfer of an aircraft or ship leased by an IFSC unit to any person has been extended. The deduction will continue to be available for a 10-year period within a 15-year window, now extending until 31 March 2030.
(iii) Income of a non-resident by way of royalty or interest on account of lease of an aircraft/ship paid by a unit of an IFSC: Non-residents earning royalty or interest income from leasing an aircraft or ship to a unit of an IFSC will continue to benefit from a tax exemption under this provision until 31 March 2030.
(b) The deadline for commencing aircraft leasing operations to qualify for capital gains tax exemption has been extended from 31 March 2026 to 31 March 2030. Additionally, this exemption has now been extended to companies engaged in ship leasing as well.
These extensions aim to encourage investment and growth in the IFSCs, particularly in the sectors of aircraft and ship leasing, by providing a longer timeline for businesses to benefit from these exemptions and deductions.
The extension of sunset clauses will foster a more business-friendly environment for the IFSC, demonstrating the government’s commitment to long-term stability and attracting foreign investment. Additionally, the simplification of the regime for cross-border funds will be crucial in positioning the IFSC as a prime destination for asset managers globally.
In conclusion, the far-sighted proposals are welcome and commendable. The new Income Tax Bill introduced right after the Budget aims to simplify and rationalise the law, revamping the current legislation with the perspective of creating a more concise yet comprehensive law.
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