Union Budget 2026: Corporate India’s Expectations for Direct Tax Reforms
As the Union Budget 2026 draws near, corporate India is brimming with expectations, particularly with the impending implementation of the new Income-tax Act, 2025 (ITA 2025) set for April 1, 2026. This budget holds significant importance as it aims to address lingering ambiguities and policy gaps left by the previous Income-tax Act, 1961 (ITA 1961). Businesses are looking for targeted direct tax reforms that will enhance certainty, minimize litigation, and improve the overall ease of doing business in the country.
Tax Neutrality for Fast-Track Demergers
One of the key issues on the agenda is the tax treatment of fast-track demergers under Section 233 of the Companies Act, 2013. Previously, there was uncertainty regarding whether tax neutrality for demergers applied only to schemes sanctioned by the National Company Law Tribunal (NCLT) under Sections 230–232, effectively excluding fast-track demergers. These fast-track schemes were introduced to streamline and expedite restructuring processes for small companies and wholly owned subsidiaries by removing the need for judicial intervention.
While fast-track demergers share similarities with NCLT-approved schemes, the distinction lies in their approval mechanisms. Denying tax neutrality based solely on procedural differences creates an unnecessary barrier, undermining the purpose of the fast-track route. Although the Select Committee on ITA 2025 acknowledged industry concerns, the government clarified that fast-track demergers would not be considered tax neutral due to the absence of court oversight, which could lead to tax implications or avoidance. However, these issues could be effectively managed through existing anti-avoidance measures rather than a blanket denial. With the expansion of fast-track demergers in September 2025, it is crucial to amend the definition of “demerger” under Section 2(35) of the ITA 2025 to include these schemes.
Clarifying the Definition of Associated Enterprises
The definition of Associated Enterprises (AEs) is critical for transfer pricing compliance under ITA 2025. The current definition comprises two components: participation in “management,” “control,” or “capital,” and specified transactional relationships, such as loan arrangements and guarantees. However, ambiguity arises regarding whether the second component can independently establish an AE relationship without satisfying the foundational participation test.
The existing wording suggests a potentially broad interpretation that could lead to overreach. It is essential to clarify that transactional relationships alone, without participation in capital, control, or management, do not constitute an AE relationship. This clarification would help prevent unnecessary complications and ensure that businesses can navigate compliance requirements more effectively.
Taxation of Buyback Proceeds
Recent changes introduced by the Finance Act (No. 2) 2024 have shifted the tax burden of share buybacks from companies to shareholders. Under the new rules, all buyback proceeds are taxed as dividend income, regardless of accumulated profits, and without allowing deductions. This marks a departure from the previous deemed dividend framework, where taxation was limited to accumulated profits.
A more balanced approach would involve taxing buyback proceeds as dividends only to the extent of accumulated profits, with any excess treated as sale consideration and taxed as capital gains. Additionally, shareholders should be allowed to deduct expenses related to buyback proceeds, aligning this treatment with that of other dividend income. Such adjustments would create a fairer tax environment for shareholders and encourage more equitable financial practices.
Boosting Employment-Linked Deductions
The current provisions under Section 146 of ITA 2025, which allow a deduction of 30% of additional employee costs for three years, apply only to new employees earning up to INR 25,000 per month. This limit has remained unchanged since 2016, despite rising wage inflation. To ensure the effectiveness of this provision in promoting employment, it is crucial to revise this limit upward.
Moreover, the timelines for filing income tax returns in the context of business reorganizations pose challenges for taxpayers. Currently, modified returns can only be filed if the original return was submitted before the reorganization order. This creates compliance difficulties, especially when the order is issued close to the return filing deadline. Implementing a uniform six-month window from the order date for all cases would provide much-needed clarity and ease for taxpayers.
As the Budget 2026 approaches, these targeted reforms could significantly enhance India’s commitment to establishing a stable and business-friendly tax regime.
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