Month: February

Legal “deeming fictions” are assumptions treated as true by law, regardless of reality. Under the Income Tax Act, these provisions have evolved from narrow anti-abuse tools into central components governing residency, deemed dividends, and income characterization. For example, Section 50 deems gains on depreciable assets as short-term for computation purposes, though it does not alter the asset’s inherent nature. Significant contention surrounds Section 56(2)(x), which taxes property receipts for inadequate consideration, leading to debates over its application to bonus and rights issues. Furthermore, the Finance Act 2024 shifted buyback taxation from companies to shareholders, treating proceeds as deemed dividends. Complexities also arise when domestic fictions, such as indirect transfer rules, conflict with Double Taxation Avoidance Agreements (DTAAs), which generally prevail. While essential for plugging loopholes, the expansive use of these fictions increasingly triggers interpretational challenges and litigation.

INTRODUCTION

Fiction is something invented by the imagination, i.e., ‘make believe’. The term ‘legal fiction’ can in the simplest of forms be explained as an assumption believed to be true and present in the eyes of the law. Once a particular assumption by way of a legal fiction is made, it is irrelevant as to whether the same is line with the actual truth or not.¹

A famous American author once remarked that “The difference between fiction and reality? Fiction has to make sense”. But do the deeming fictions under the Income Tax Act, 1961 (‘the Income Tax Act’) really make sense?

The immediate mention of the term “deeming fiction” springs to mind provisions such as section 56(2)(x), explanations 5 to 7 of Section 9(1)(i) [‘Indirect Transfer’], or the much-beleaguered section 56(2)(viib)². Below are some examples such as residency, characterization of losses, timing of taxation, etc. illustrating the various types of deeming fictions embedded within the Income Tax Act:

• Deemed Resident– Sub-section 1A of section 6 provides that an individual who is a citizen of India, has total income (other than income from foreign sources) exceeding INR fifteen lakh rupees during and is not liable to tax in any other country on account of certain connected factors shall be deemed to be resident in India.
• Carry forward and set-off of losses and unabsorbed depreciation- Section 72A provides that upon satisfaction of certain conditions, in case of amalgamation³, the accumulated loss and the unabsorbed depreciation of the amalgamating company shall be deemed to be the loss and unabsorbed depreciation of the amalgamated company.⁴
• Timing of taxation– Section 45(5A) of the Income Tax Act provides for determining the timing of taxation in case of a joint development agreement entered into by an individual/HUF (deemed to be taxable in the year in which the certificate of completion is issued).
• Full value of consideration- Deeming fictions aimed at curbing tax avoidance and determining full value of consideration in case of certain transactions include section 50C (Transfer of land/building or both being capital asset), section 50CA (transfer of shares other than quoted share)
• Deemed Dividend- Whereby the statute aims to expand the meaning of the word ‘dividend’ to curb mechanisms used by taxpayers to repatriate cash or assets to their shareholders such as by way of loans or advances (applicable for closely held companies), capital reduction or distribution of assets pursuant to liquidation.
• Scope of total income- Clubbing provisions under section 64 of the Income Tax Act seek to expand the scope of total income of an individual to tax income arising to another individual (such as a minor child) in the hands of that particular individual.
• Computation of tax in case of specific transactions/ instruments- Sections such as section 50 (computation of capital gains in case of sale of a depreciable asset), section 50B (computation of capital gains in case of slump sale), section 50AA (computation of capital gains in case of Market Linked Debenture) are just some examples.

1 CIT vs. Swaroop Krishan [1985] 21 Taxman 404/153 ITR 1 (Pun & Har HC)

2 Section 56(2)(viib) was introduced by the Finance Act, 2012, to tax the share premium received by closely held 
companies when issued above fair market value. It was sunset by the Finance Act, 2024, 
and has been rendered inapplicable from 1 April 2025 (Assessment Year 2025–26 onward)

3 This section is also applicable on demerger and provides that in case of demerger, 
where the loss or unabsorbed depreciation is directly relatable to the undertakings transferred same shall 
be allowed to be carried forward and set off in the hands of the resulting company. 
In case of loss and UAD not directly relatable, same is apportioned between the demerged company and 
the resulting in the ratio of assets being transferred as part of the demerger

4 Finance Act 2025 had introduced an amendment seeking to confine the carry forward of losses to a total 
of eight years from the year in which such losses arose, rather than eight years from the previous year when such merger was undertaken

The above examples illustrate how the role of deeming fictions has evolved and now serves distinct purposes under the Income Tax Act which may range from taxing a particular instrument, item or transaction, prescribe methods of computation, or restrict/ allow carry-forward of losses. Let us examine how courts have interpreted some specific deeming fictions over time and some of the challenges posed in interpreting the same.

FROM FICTION TO FUNCTION: THE EVOLVING ROLE OF DEEMING PROVISIONS IN TAX LAW

• Decoding the section 50 conundrum:

Section 50 of the Act creates a deeming fiction that capital asset on which depreciation is allowed and it forms part of block of asset, then irrespective of definition in section 2(42A), gain from such asset would be deemed as gain from transfer of short term capital asset.

Further, section 50 prescribes a method of computation adjusting provisions of section 48 and 49. However, the provisions of section 50 do not expressly ascribe a rate of tax to the gains computed and also do not restrict the exercise of section 112.

The provisions of section 50 are relevant to be analyzed in case of itemized sale of assets on which depreciation has been allowed under the Income Tax Act. The operation of the provisions of section 50 of the Income Tax Act had rendered share sale or slump sales more attractive for tax efficiency considering possible elevated tax exposure (since section 50 would deem any gain on transfer of depreciable asset as gain from transfer of short term capital asset)

The above problem came up for consideration most recently before the special bench of the Mumbai Tribunal⁵ wherein the crux of the question revolved around rate of tax to be ascribed to sale of a capital asset of the nature referred to in section 50.

The Tribunal while adjudicating the matter in favour of the assessee relied on the decision of Ace Builders⁶ where the scope of the deeming fiction under section was interpreted by the Hon’ble Court in context of availability of benefit under section 54E of the Income Tax Act and it was observed that the deemed fiction created in sub-section (1) & (2) of section 50 is restricted only to the mode of computation of capital gains contained in Section 48 and 49 of the Income Tax Act. The judgement of the Tribunal was a majority decision and the Hon’ble Accounting Member had rendered a dissenting view holding that concessional rate under section 112 of the Income Tax Act shall not be available to the assessee inter alia for the reason that the above view would render provisions of section 50 redundant.

Conclusion:

The intent of section 50 of the Income Tax Act is to compute the capital gains in case of a depreciable asset by way of a deeming fiction overriding the provisions of section 48 and section 49. However, this insertion in section 50 does not alter the inherent nature of an asset.

The period of holding determines the inherent nature of a capital asset, i.e., whether long-term or short-term, which consequentially determines the applicable rate of tax. In my view, the above decision is correct in law and cements the settled principle that deeming fictions may be restricted to the section(s) for which they were originally intended for⁷.

5 SKF India Limited vs. Dy. Commissioner of Income Tax: [2025] 121 ITR(T) 307 (Mumbai - Trib.) (SB)

6 CIT vs. Ace Builders (P.) Ltd: [2006] 281 ITR 210 (Bom.)

7 CIT vs. Mother India Refrigeration Industries (P.) Ltd: [1985] 155 ITR 711 (SC); Imagic Creative Pvt. Ltd. vs. Commissioner of Commercial Taxes: Appeal (Civil) 252 of 2008 (SC)

•  The Gift That Isn’t- Understanding section 56(2)(x) on issue of shares:

Section 56(2)(x) was introduced vide Finance Act, 2017 expanding the scope of the erstwhile anti-abuse provisions. In simple terms, section 56(2)(x) seeks to tax receipt of property (including shares) for nil or inadequate consideration.

The language of the section begins with “where any person receives” and thereafter bifurcates into specific cases of receipt of sum of money/immoveable property and any other property (including shares and securities). Thus, from a bare reading of the provisions, for a transaction to fall within ambit of section 56(2)(x) of the Income Tax Act, it should constitute a ‘receipt’.

Thus, whether fresh issue of shares constitute a ‘receipt’ and accordingly can be said to be within ambit of section 56(2)(x) of the Income Tax Act. In case of fresh issue of shares, there cannot be any ‘receipt’ since the property in question being shares are brought into existence for the first time on issue. Support for the above can be firstly drawn from the explanatory notes to finance bill at the time of including transactions involving shares within ambit of section 56(2)(viic), which sought to curb “the practice of transferring unlisted shares at prices much below their fair market value”.

Thus, it can be said that there is a difference between issue of a share to a subscriber and the purchase of a share from an existing shareholder. The first case is that of creation whereas the second case is that of transfer.⁸

On the contrary, it has also been argued that the exact term used in section 56(2)(vii)(c) is ‘receive’ which cannot be restricted to ‘transfer’ or ‘receipt by way of transfer’ alone.⁹ Accordingly, limiting the scope of ‘receipt’ to transfer would tantamount to reading down the provision.¹⁰

8 Khoday Distilleries Ltd vs. CIT: [2008] 307 ITR 312 (SC)
9 Jigar Jashwantlal Shah vs. ACIT: [2022] 226 TTJ 161 (Ahd Trib) 
(Confirmed in PCIT vs. Jigar Jaswantlal Shah: [2024] 460 ITR 628)
10 Sudhir Menon HUF vs. ACIT: [2014] 148 ITD 260 (Mum Trib)

Given that fresh issue can be undertaken by many modes, i.e., rights issue or bonus issue or preferential issue, thus, it is at this stage critical to diverge and analyze applicability of section 56(2)(x) on some of the different modes of issue of shares, viz, rights issue and bonus issue. The same has been analyzed under:

11 PCIT vs. Dr Ranjan Pai : 431 ITR 250 (Ktk High Court)
12 SLP admitted in CIT vs. M/s Tangi Facility Pvt Ltd: SLP (C) Diary No. 57035/2025 
against Madras HC order in the case of CIT vs. M/s Tangi Facility Pvt Ltd: ITA No. 259/2024

THE CASE OF SUDHIR MENON- A DISPROPORTIONATE TAX?

As can be seen above, in case of rights issue of shares leading to a proportionate shareholding, it can be argued that provisions of section 56(2)(x) of the Income Tax Act may not be attracted. But what happens in case of fresh issue of shares leading to a lopsided shareholding, i.e., the proportionate ownership among shareholders becomes uneven after the rights issue. This scenario can be better explained with the help of the below scenario of Co A which is proposing to undertake a rights issue:

As seen above, Mr. AA, AB,AC and AD are four shareholders of Co A each holding 25% each. Co A decides to undertake a rights issue, and each shareholder is offered shares commensurate to its shareholding.

However, Mr. AA, AB and AC decide to renounce the right to subscribe to shares in favour of Mr.AD and accordingly Mr.AD subscribes to his rights shares as well as to the shares pursuant to renouncement of rights by all the other shareholders. As a result, the shareholding pre and post rights issue becomes skewed, i.e., Mr. AD’s shareholding increases from 25% to 62.50% granting him control of Co A pursuant to such allotment.

Considering that there is a shift in value in the hands of the shareholders because of the above issue, it can be said that as a result of the above allotment of shares, there is a disproportionate value shift in the hands of Mr. AD.

Thus, it can be said that if there is no disproportionate allotment, i.e., shares are allotted pro rata to the shareholders, based on their existing holdings, there is no scope for any property being received by them on the said allotment of shares.¹³

13 Sudhir Menon HUF vs. ACIT: [2014] 148 ITD 260 (Mum Trib)

Further, in an alternative scenario, where shares of Co A are not subscribed by Mr.AA, AB and AC but are also not renounced in favor of Mr.AD, which would still lead to increase in shareholding of Mr.AD from 25% to 40%, it maybe argued that due to non-renunciation of the rights to subscribe in favor of Mr.AD, section 56(2)(x) may not be applicable in the present case.

Conclusion:

While it may be a fresh issue of shares, the controversy around applicability of section 56(2)(x) remains age old. It can be safely said that even fresh issue is not truly out of the ambit of section 56(2)(x) of the Income Tax Act. In my view, the principle of taxing a value shift or a disproportionate allotment is not something in line with the original intent of the provisions of section 56(2)(x) of the Income Tax Act and is advocating of a ‘see-through’ approach.

While the Tribunal in the judgement of Sudhir Menon (above) has made findings to the contrary, in my view, the principles given in the above decision have lent a more investigative lens at of looking at transactions outreaching the existing provisions which brings into question even bona-fide transactions under the lens of the tax authorities.

INTERPLAY OF DEEMING FICTIONS WITH DOUBLE TAXATION AVOIDANCE AGREEMENTS (‘DTAA’):

In the foregoing sections, we had an overview of how the deeming fiction operates under the domestic Income Tax Act. But what happens in case of a transaction involving a non-resident?

THE CRUX OF THE QUESTION IS WHETHER A DEEMING FICTION UNDER THE INCOME TAX ACT CAN BE EXTENDED TO DTAA?

To answer this question, it is first important to understand the role of a DTAA. In layman’s terms, DTAA is an agreement for assigning taxing rights between two countries, while the domestic tax act (in this case the Income Tax Act) provides the rule of taxation within the jurisdiction of a nation.

In the Income Tax Act, section 90/90A provides the power to the Central Government to enter into agreements with other nations inter alia for: (i) Providing relief from the income charged in both the countries; (ii) Eliminate the double taxation in respect of income; (iii) Exchange of information for the prevention of evasion or avoidance of income tax; and (iv) For recovery of income under the ITA and corresponding law in other country.

In an ideal world, a domestic tax act and a DTAA would co-exist with the utmost harmony and there would be no contradictory provisions or need for intervention to interpret the said agreements.

Since this utopian assumption does not hold true, it becomes essential to understand that the purpose of DTAA and the Income Tax Act are overlapping and can be sometimes contradictory to each other. The Income Tax Act being an act of Parliament, while the DTAA being an agreement negotiated between two countries is not expected to be fully in harmony with each other.

Thus, what happens in case the provisions of the DTAA and the Income Tax Act are not complimentary to each other- CBDT had shed some light on the above issue in the past and stated that where a specific provision is made in the double taxation avoidance agreement, that provisions will prevail over the general provisions contained in the Income-tax Act.¹⁴

14 Circular No. 333 of 1982 dt 02.04.1982

The above issue also came up for consideration before the Hon’ble SC from time to time and it has been observed that the terms of the DTAs would override the provisions of the Income-tax Act in the matter of ascertainment of chargeability to income tax and ascertainment of total income, to the extent of inconsistent with the terms of the domestic tax act.¹⁵ Let us look at the below practical examples to understand the interplay between the Income Tax Act and DTAAs better.

15 [2003] UOI vs. Azadi Bachao Andolan: 263 ITR 706 (SC)

•  Indirect transfer of shares:

Background

Perhaps the most disputed use of the deeming fiction was exercised by the legislature in 2012 by way of taxation of indirect transfers. Essentially, the Indian legislature sought to tax sale of shares between two non-residents which involved value shifting of an Indian company. The above can be better understood with the following example:

FCo1, FCo2 and FCo3 are foreign companies. FCo1 has only one asset which is the shares held in the Indian company, viz, ICo. Similarly, FCo2 in-turn has only one asset, viz, shares held in FCo1. FCo3, another foreign company is keen to buy out the interest of FCo2 in ICo. Therefore, it is decided to sell the shares of FCo1 to FCo3 by FCo2 as against selling shares of ICo directly.

The Revenue, in the said case advocated the application of a ‘look through’ approach and contended that if there is a transfer of a capital asset situated in India ‘in consequence of’ an action taken overseas, then all income derived from such transfer should be taxable in India. The Hon’ble Apex Court, however, held that the transfer of shares of a foreign company which had an Indian Company as its subsidiary does not amount to transfer of any capital asset situated in India.

Thus, prior to 2012, the above transaction would not lead to any adverse tax implications in India as it is essentially sale of foreign company shares from non-resident to another non-resident. To bring such apparent value shift transactions within the tax net of India, the erstwhile government moved a retrospective amendment deeming that shares of a foreign company that derive their value substantially from Indian assets (in this case FCo1) shall be deemed to have their situs in India and overruling prevailing decisions in the favor of the taxpayer¹⁶

16 Vodafone International Holdings B.V. vs. UOI: [2012] 204 Taxman 408 (SC)

TAXATION OF INDIRECT TRANSFER UNDER THE INCOME TAX ACT

For a non-resident to be taxed in India, section 5 of the Income Tax Act provides that income which accrues/arises or received or is deemed to accrue/arise or received in India shall form part of total income taxable in India.

Explanation 5 to section 9 (1)(i) of the Income Tax Act, provides for levy of tax in India on gains arising on transfer of shares of a foreign company if shares of such foreign company derive substantial value from assets located in India. Given the threshold provided under explanation 6 to section 9(1)(i) of the Income Tax Act are satisfied, the sale of the shares of FCo1 would be taxable in India as the same would be deemed to have their situs in India.

INTERPLAY WITH DTAAs

The interplay of indirect transfer provisions with the provisions of DTAA has been an intensely debated one. This question came up for consideration before the Andhra Pradesh High Court¹⁷: whether sale of shares of a French company (which derived value substantially from shares of an Indian company) to another French company would be brought to tax as per the provisions of section 9(1)(i) of the Income Tax Act read with the provisions of the India-France DTAA.

17 Sanofi Pasteur Holding SA vs. Department of Revenue: [2013] 354 ITR 316 (AP)

The Revenue had put forth an argument that the provisions of article 14(5) of the India-France DTAA be interpreted to adopt a more see through approach, however, that was swiftly rejected by the Hon’ble Court on the ground that Article 14(5) does not provide for an enabling language to effect a see through and bring the tax of the same into India.

On the contrary, such indirect transfer maybe brought to tax had the criteria laid out in article 14(4) of the India-France DTAA be fulfilled. Article 14(4) of the India-France DTAA provides for taxing the gains arising out of sale of capital stock of a company the property of which consists directly or indirectly principally of immovable property situated in India. Similar enabling provisions are also captured in the India-UAE DTAA [Article 13(3)].

In the absence of fulfilling the above criteria, the provisions of indirect transfer would not be applicable on a foreign company. The tax authorities have also litigated the aspect of residency (which would directly impact the availability of DTAA benefit) and have urged the Courts to lift the corporate veil and differentiate between via the ‘head and brain test’. This issue has been recently adjudicated by the Apex Court¹⁸ in favour of the Revenue. The present article does not take into account the change brought in by such ruling.

18 The Authority for Advance Rulings vs. Tiger Global Internal II Holdings (Civil Appeal No. 262 of 2026)
The Authority for Advance Rulings vs. Tiger Global Internal IV Holdings (Civil Appeal No. 263 of 2026)
The Authority for Advance Rulings vs. Tiger Global Internal III Holdings (Civil Appeal No. 264 of 2026)

•  Period of holding and grandfathering benefit:

The above issue can be better understood with the help of an example. ICo is an Indian company and the entire share capital of ICo is held by FCo1, and in turn the entire share capital of FCo1 is held by FCo2.

FCo1 and FCo2 are residents of Mauritius. The shares of ICo were acquired by FCo1 on 01.04.2015 and thus are eligible for grandfathering benefit under the India-Mauritius DTAA. The transaction structure, transaction mechanics and resulting structure are as under:

As part of an internal group restructuring exercise undertaken on 01.04.2025, FCo1 is proposed to be amalgamated with ICo and accordingly, ICo would issue fresh shares to FCo2. The proposed transaction mechanics and resulting structure are as under:

Let us first examine the implications under the Income Tax Act on the above transaction- In the above amalgamation, there would be no tax in the hands of FCo2, i.e., the shareholder of the Amalgamation Company, the Income Tax Act provides specific exemption under section 47(vii).

At the time of sale of shares of ICo, FCo2 would be granted the period of holding of FCo1 as well, i.e., period of holding of the previous owner by virtue of section 2(42A) r.w. section 49(1) of the Income Tax Act. Thus, considering the above, the question arises whether the period of holding in the hands of FCo2 of shares of ICo for the purposes of the India-Mauritius DTAA would be considered from 01.04.2016 or 01.04.2025.

The Indian Income Tax Act provides the continuity of period of holding in case of transfer by way of amalgamation. Thus, for the purposes of the Income Tax Act, the period of holding shall be taken from 01.04.2016, i.e., date of original acquisition by FCo1. Thus, the taxpayer can contend on these lines to argue availability of grandfathering benefit on the above shares.

While on the other hand, the tax authorities can place reliance on the provisions of article 13(3A) of the India-Mauritius DTAA, which are operative on the shares acquired on or before 01.04.2017. The tax authorities may further contend that ‘to acquire’ would mean to simply ‘be in control or possession’. In the present case, while the original shares were acquired by FCo1 prior to 01.04.2017, there being a fresh issue pursuant to the merger may result in diluting the position of the taxpayer in claiming the benefit of grandfathering.

Conclusion

Given the language used in the DTAA, the above view to avail grandfathering would in my opinion be extremely litigative considering that there is no enabling provisions replicating the benefit of period of holding granted under the Income Tax Act in the DTAAs.

•  Section 2(22)(f)- The Buyback Maze:

Most recently, Infosys, announced a plan to buyback approx. 2.41% of its total share capital for a total consideration of ₹1,800 crores with an aim to boost EPS and market value. Let us look at the implications in the hands of the shareholder(s)/ in the hands of the company in case of a buyback from a tax point of view.

As per the Income Tax Act, buy-back means purchase by a company of its own shares. Prior to Finance Act, 2024, buyback was taxed in the hands of the company under section 115QA of the Income Tax Act. Tax was levied at 20% (plus 12% surcharge and cess) and the buyback would be exempt in the hands of the shareholder.

FINANCE ACT, 2024- POLICY SHIFT:

Finance Act, 2024 introduced a paradigm shift in buyback taxation. By way of Finance Act 2024, the government announced that buyback done post October 1, 2024 would be exempt in the hands of the company undertaking the buyback and would be taxed in the hands of the shareholder as dividend under section 2(22)(f) per their applicable slab rates.

Further, cost of acquisition of the shares would be allowed as capital loss in the hands of the shareholder. This policy shift has brought buyback on par with dividend but has taken away the sheen of buyback being a lucrative choice of cash repatriation. In many DTAAs such as the India-Netherlands DTAA, it can be argued that given the meaning ascribed to dividend, the proceeds from buyback shall fall within the ambit of the same.

CAN ANTI-ABUSE PROVISIONS SUCH AS SECTION 56(2)(x) OR SECTION 50CA BE APPLIED ON BUYBACK POST FINANCE 2024?

Section 50CA of the Income Tax Act is applicable in case of transfer of unquoted shares at a value less than the fair market value of such shares determined in accordance with the provisions of Rule 11UAA of the Income Tax Rules, 1962 (‘the Income Tax Rules’). Therefore, section 50CA provides for substituting the consideration with the fair market value (determined as per Rule 11UAA of the Income Tax Rules) for the purposes of section 48 and is applicable in the hands of the Seller.

While as discussed above, section 56(2)(x) of the Income Tax Act seeks to tax receipt of property (including shares) for nil or inadequate consideration. Therefore, a key differentiating factor is that section 56(2)(x) is applicable in the hands of the ‘recipient’ of shares (i.e., buyer in case of a transaction of sale/purchase of shares) and section 50CA of the Income Tax Act is applicable in the hands of the seller of shares (in case of a transaction of sale/purchase of shares).

In the present case, the risk of buyback being engulfed under the ambit of section 56(2)(x)/section 50CA of the Income Tax Act is enumerating from the plain reading of provisions of the said sections. The crux of the problem- can two deeming fictions be read on a conjoint basis? Or can a deeming fiction be read into another deeming fiction?

SECTION 50CA AND BUYBACK:

In case of section 50CA of the Income Tax Act, as discussed above, it is applicable in case of ‘transfer’ of unquoted shares. The term ‘transfer’ has been
defined under section 2(47) of the Income Tax Act and includes the relinquishment of any asset or extinguishment of any rights therein. In case where a company buys back its own shares for the
purpose of cancellation/extinguishment, the same can be said to fall within section 2(47) of the Income Tax Act and thus within ambit of section 50CA of the Income Tax Act.

However, since payment made a company on buyback of its own shares from a shareholder in accordance with the provisions of section 68 of the Companies Act, 2013 is covered within section 2(22)(f) of the Income Tax Act, the same may not be taxed again under the head capital gains in line with the provisions of section 46A of the Income Tax Act. Thus, where section 50CA is sought to be invoked by the tax authorities, the same may leave the provisions of section 46A (supra) otiose.

SECTION 56(2)(x) AND BUYBACK:

In case of section 56(2)(x) of the Income Tax Act, the company receives its shares from the shareholder for the purpose of cancellation of the same. At the outset, arguments can be made that receipt of shares for the purposes of cancellation may not fall within purview of section 56(2)(x) of the Income Tax Act keeping in mind the intent for which the provisions of section 56(2)(x) were introduced.

Further arguments can also be made that in case of buyback, the shares are being tendered which would constitute consideration. The action of a deeming fiction is to be restricted to the section(s) for which they were originally intended for and the extension of the said scope under the Act is not permissible.

However, alternative arguments may be advanced by the departments that on a bare reading of section 56(2)(x) of the Income Tax Act, only trigger(s) required are receipt of property (including shares) for inadequate consideration. The intent of receipt (in the present case for cancellation) may not be principally examined for application of section 56(2)(x) of the Income Tax Act.

In my view, the above anti-abuse provisions also no longer find any application in case of a buyback for the plain reason that post Finance Act, 2024, the companies undertaking a buyback would need to incentivize the shareholders to tender their shares by way of a premium on prices (as seen in the case of Infosys). Thus, there would not be any practical applicability of the above anti-abuse provisions.

CONCLUDING REMARKS

Deeming fictions under the Income Tax Act have transitioned from being narrow anti-abuse tools to becoming a cornerstone of tax legislation, influencing computation, timing, and characterisation of income.

While they serve the purpose of plugging loopholes and ensuring uniformity, their expansive use has also introduced interpretational challenges and litigation risks. Like in mathematics, in a world full of variables it is essential to introduce and keep constants as a balancing factor, likewise in law interpretation to keep up with our dynamic world, it is important to keep some constant premise for a meaningful and desired interpretation.

BCAJ Admin

Segment reporting under IFRS 8 and Ind AS 108 adopts a “management approach,” allowing investors to view a business through the lens of its Chief Operating Decision Maker (CODM). This framework reveals how management allocates resources and assesses performance across various operating components, rather than just legal structures. Key requirements include segment-specific disclosures and entity-wide data regarding products, geography, and major customers contributing over 10% of revenue. Such insights help stakeholders map performance against peers, understand strategic direction, and evaluate exposure to geographical risks. High-quality reporting reduces information asymmetry and enhances transparency. However, common oversights include omitting major customer details or failing to provide entity-wide disclosures for single-segment entities. Ultimately, these disclosures provide a vital analytical tool for assessing enterprise resilience and long-term value creation.

INTRODUCTION: BEYOND MERE DISCLOSURE

Consolidated financial statements show the big picture. But investors want more. Earnings calls prove this every quarter. Analysts routinely break down results by business segment and evaluate key performance indicators such as segment revenues, margins, capital employed and capital expenditure—information that is primarily drawn from segment disclosures and complemented by other parts of the financial statements. Management works the same way. Key decisions on funding, marketing and cost control happen at the segment level. Investors follow product trends, geographic shifts and new business wins for this reason. These patterns point to one conclusion: segment information is not just disclosure. It reveals how the business runs and how management thinks.

USE OF ‘MANAGEMENT APPROACH’ FOR SEGMENT REPORTING:

Segment reporting under IFRS 8 and Ind AS 108 follows the ‘management approach’, introduced when IFRS 8 replaced IAS 14 and aligned with US GAAP’s SFAS 131. The management approach presents segments as management sees them, giving investors insight into how decisions are made and resources are allocated. This shift moved reporting away from predefined categories and required disclosures that reflect how management itself views and manages the business. As a result, segment information goes beyond simple product or geographic splits and provides insight into real decision-making structures. The management approach drives both segment identification and measurement, ensuring external reporting is consistent with internal performance reviews and the MD&A. Because segment results must reconcile to consolidated figures, it effectively links internal management reporting with external financial statements. This enables investors to see the business through management’s lens and assess prospects based on the performance of its key operating components. These also enable users to derive relevant segment-level ratios and performance indicators from the disclosed information, without the standard prescribing uniform ratios that may not reflect management’s internal decision-making framework.

KEY DISCLOSURE COMPONENTS UNDER IND AS 108/IFRS 8:

Broadly, the standard requires the following disclosures:

1) Segment wise disclosure

Segment reporting is fundamentally built on identifying operating segments—the level within the entity where management allocates resources and evaluates performance through the Chief Operating Decision Maker (CODM). The CODM represents a decision-making function rather than a specific designation. Identifying the CODM determines the operating segments, which in turn leads to the determination of reportable segments and the related reportable amounts and reconciliations. Each reportable segment requires disclosures such as segment revenue, results, assets, liabilities and other material items, including significant non-cash expenditures. These disclosures reflect the information provided to the CODM and are reconciled to the corresponding figures in the financial statements, thereby linking internal reporting with external reporting.

2) Entity-wide Disclosures

Even single-segment companies must provide entity-wide disclosures, which are often overlooked. Unlike reportable segments, these are simple disaggregations of financial statement amounts rather than based on the management approach. Disclosures are required for:

FROM COMPLIANCE TO INSIGHT: UNLOCKING THE VALUE OF SEGMENT REPORTING

1) Mapping and Peer Comparison

Segment reporting enables stakeholders to map a company’s performance at the business level, offering a clearer view of how individual segments contribute to overall results. This enhances
transparency and supports a more informed assessment of competitive strengths and weaknesses. For investors analysing a diversified company, such information is indispensable, as each segment may have a different set of peers and competitors.

2) Understanding Strategic Direction

Disaggregated segment information also offers valuable insight into the company’s strategic direction. For diversified entities, such disclosures reveal the relative growth drivers across businesses and the areas where management is focusing its resources. Investors can thus assess whether the company’s strategy aligns with evolving market opportunities and risk exposures, rather than relying solely on consolidated results that may obscure segment-specific trends.

3) Geographical Insights and Risk Assessment

In today’s volatile geopolitical and economic environment, segment information by geography provides critical visibility into an entity’s revenue and resource dependencies. Understanding the geographic composition of revenues and assets helps stakeholders gauge exposure to regional risks — for instance, how trade policies such as U.S. tariffs on Indian pharmaceutical exports or operational dependencies in ports like Adani Ports’ overseas ventures might influence performance. These may also become a relevant consideration for policymakers while framing India’s international trade and diplomatic strategy. Such insights are not merely analytical; they can be pivotal in assessing key accounting judgments, including going concern, impairment testing, and valuation.

Together, these dimensions demonstrate that segment reporting extends well beyond compliance and serves as a practical analytical lens into how management evaluates strategy, risk and performance sustainability. For example, where an entity operates both a core manufacturing activity and a related financing operation, segment reporting reflects whether these activities are monitored together or separately for decision-making purposes. Importantly, segments are not defined by legal structure or subsidiary boundaries, but by the internal management view. Legally separate entities may form part of a single segment if managed on an integrated basis, while closely linked activities may be reported separately if performance and risks are assessed independently. Segment information should therefore be read as a reflection of how the business is actually run, rather than as a mirror of the group’s legal organisation.

LESSONS FROM PRACTICE: MISSED DISCLOSURES

Companies sometimes omit important details when complying with Ind AS 108; a few common oversights, as observed by the Financial Reporting Review Board of ICAI, are listed below:

•  Some entities incorrectly claimed that Ind AS 108 was not applicable in cases of a single reportable segment, overlooking the requirement to provide entity-wide disclosures
•  In several cases, segment reportingdisclosures were inappropriately included under “Significant Accounting Policies” instead of being presented separately in the Notes to Accounts.
•  General disclosures were either missing or inappropriate, including relating to:

1. Identification of the CODM, and
2. Criteria and judgements applied in segment identification and aggregation

• Information about major customers contributing 10% or more of revenue was not disclosed. For instance, media reports on an MCA probe indicated that Everfin Financial Services Private Limited did not separately disclose revenue of ₹134 crore from a single customer, BluSmart, as a major customer exposure under Ind AS 108.

CONCLUDING THOUGHTS:

Segment reporting is far more than a compliance exercise; it is a powerful tool for enhancing transparency and reducing information asymmetry. By reflecting how management views performance and allocates resources, it gives users a clear picture of risks, opportunities and strategic direction. These insights help assess the sustainability of business strategies across varied operating environments. In a period shaped by rapid technological change, geopolitical tension and shifting economic conditions, high-quality segment disclosures enable investors and policymakers to judge enterprise resilience, value creation and future performance with far greater clarity.

Beyond compliance lies clarity. Segment reporting reveals the signals that shape strategy, risk and performance.

BCAJ Admin

In recent years, a number of large technology firms (for example Meta Platforms, Inc., Microsoft Corporation, Alphabet Inc. (Google) and others) have announced extensions in the useful lives applied to their server and network infrastructure (data-centre hardware) for depreciation purposes. On the face of it, the accounting manoeuvre has the effect of lowering annual depreciation expense, thereby increasing recognised profit, earnings per share (EPS) and various ratios (return on assets, etc.). The key question is: does this practice align with sound accounting principles, especially when economic life (or technological obsolescence) may be much shorter than the extended depreciation period? And if not, what do the applicable Indian standards (Ind AS) say and what risks arise for investors and auditors?

This paper discusses the accounting framework under Indian GAAP / Ind AS for depreciation and useful life, elaborates the concept of “useful life” (economic life) and obsolescence, explains the practice of life-extension for server assets by large tech companies and provides a critical assessment: risks, accounting concerns and whether the practice is consistent with standards. Finally, it examines the implications for Indian-context companies, auditors, and investors.

INTRODUCTION

1. Accounting Framework under Indian GAAP / Ind AS for Depreciation

1.1 Ind AS 16 (and Companies Act Schedule II)

Under Indian accounting standards, the treatment of property, plant and equipment (PPE) is governed by Ind AS 16 “Property, Plant and Equipment”. The standard outlines recognition, measurement, depreciation, componentisation, and review of useful lives.

Key extracts:

•  Paragraph 50 of Ind AS 16 states: “The depreciable amount of an asset shall be allocated on a systematic basis over its useful life.”
•  Paragraph 56 of Ind AS 16 lists the factors to be considered in determining useful life: (a) expected usage of the asset; (b) expected physical wear and tear; (c) technical or commercial obsolescence arising from changes or improvements in production or from a change in market demand; (d) legal or similar limits on the use of the asset.
• Paragraph 51 of Ind AS 16 requires that the residual value and useful life of an asset shall be reviewed at least at each financial year-end, and if expectations differ from previous estimates, the change shall be accounted for as a change in accounting estimate in accordance with Ind AS 8.
• Disclosure requirements: Ind AS 16 requires disclosure for each class of PPE of the depreciation method, useful lives or depreciation rates, gross carrying amount, accumulated depreciation/impairment, reconciliation of changes, etc.

Additionally, under Indian law, the Companies Act, 2013 Schedule II (Part A) states that “Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life” and that the useful life of an asset is the period over which the asset is expected to be available for use by the entity or the number of production or similar units expected to be obtained from the asset.

1.2 What constitutes a change in useful life / accounting estimate

When an entity changes its estimate of the useful life of an asset (for example, extends the life from 4 years to 6 years), this is a change in accounting estimate under Ind AS 8 — accounted for prospectively (i.e., the carrying amount of the asset is depreciated over the revised remaining useful life). Ind AS 16 para 61-62 (and Ind AS 8) require such changes to be disclosed.

1.3 Comparison to IFRS / other jurisdictions

Globally, under IAS 16 (the IFRS equivalent) similar concepts apply: useful life must reflect expected consumption of future economic benefits. For example, IAS 16 paragraph 56 outlines that “The useful life of an asset is the period over which an asset is expected to be available for use by an entity.” Moreover, many technical publications note that although US GAAP (ASC 360-10) requires depreciation over useful life, it does not specify how useful life should be determined — hence judgment is required.

In short: Indian (and IFRS) standards require that useful life be determined on the basis of expected economic benefits, usage, obsolescence etc., not simply management convenience.

2. Useful Life, Economic Life and Obsolescence

2.1 Useful life vs physical (economic) life

A frequent misconception is to equate “useful life” with the maximum physical life of an asset. The standards clarify that the useful life is the period over which the asset is expected to be available for use by the entity, not necessarily the total physical life of the asset. Ind AS 16 para 57 states: “The useful life of an asset is defined in terms of the asset’s expected utility to the entity. … Therefore, the useful life of an asset may be shorter than its economic life.”

Hence, while a server rack might physically function for 10 years, its useful economic life (the period over which it yields future economic benefits to the entity) might be much shorter — especially in technology contexts of rapid refresh or obsolescence.

2.2 Technological and commercial obsolescence

Both Ind AS 16 and IAS 16 explicitly require entities to consider technical or commercial obsolescence when estimating useful life. For example, Ind AS 16 para 56(c) refers to “technical or commercial obsolescence arising from changes or improvements in production, or from a change in the market demand for the output of the asset.”

Technical obsolescence is especially relevant for server and networking equipment: newer generations of GPUs, faster processors, more efficient architectures mean that older hardware becomes economically unattractive even if physically operational. If a server continues to operate but its capacity, energy consumption, or performance is no longer competitive, the future economic benefits may fall significantly below initial expectations.

2.3 Review of useful life and residual value

Ind AS 16 para 51 mandates review of useful life and residual value at each reporting date (or earlier if there are indications) and adjust prospectively. Failure to do so may mean carrying amounts and depreciation charges are not updated to reflect reality.

Indeed in practice many companies manage asset refresh cycles and update useful life accordingly. For example, technical guidance notes cite as a common error: “Failing to update assessment of useful lives (depreciation rates) and residual values.”

2.4 Componentisation

Ind AS 16 para 43/46 states that if an asset has parts (components) with different useful lives, each significant part should be depreciated separately. For example, a server chassis may have a cooling unit, a storage array, a GPU blade each with different life cycles.

2.5 Impairment vs depreciation

If indicators of impairment exist (e.g., hardware assets no longer yield the expected benefits, or accelerated obsolescence), then the entity must apply Ind AS 36 (“Impairment of Assets”) and possibly write down the carrying amount. The depreciation process does not replace the requirement to test for recoverability if needed.

3. Practice of Useful Life Extension by Large Tech Companies

The occurrence of major tech companies extending the useful life of servers and network equipment — is documented publicly. I would like give below few examples.

3.1 Example: Meta Platforms, Inc.

In the 2022 annual report (Form 10-K) of Meta, the company states:

“In connection with our periodic reviews of the estimated useful lives of property and equipment, we extended the estimated average useful lives of a majority of the servers and network assets from four
years to 4.5 years, effective the second quarter of 2022, and further extended the useful lives to five years effective the fourth quarter of 2022… The financial impact of the changes in estimates was a reduction in depreciation expense of US$860 million and an increase in net income of US$693 million, or US$0.26 per diluted share for the year ended December 31, 2022.”

That disclosure appears in Note 1 (Summary of Significant Accounting Policies) in Part II, Item 8 of the 10-K (page ~67) of Meta’s 2022 report.

In the half-year (30 June 2022) Meta also reported that the change in estimate reduced depreciation expense by US$252 million and increased net income by US$206 million for that quarter.

In more recent disclosures (2023 10-K) Meta again notes the same useful life policy and that depreciation expense was US$8.50 billion in 2022 (servers and network assets ~US$5.29 billion) and details of the revisions.

3.2 Example: Microsoft Corporation

Public commentary (e.g., on the data centre industry) reports that Microsoft extended the life span of its server and network equipment from four to six years.

It is indicated that Microsoft estimated savings of ~$1.1 billion in Q1 2023 and ~$3.7 billion over full year due to the life extension.

3.3 Example: Alphabet / Google

Google (Alphabet) in 2021 adjusted the useful life of servers from 3 to 4 years and networking equipment from 3 to 5 years, which reportedly led to ~US$2 billion increase in netincome and ~US$2.6 billion reduction in depreciation expense.

3.4 Summary of impact

From the above:

•  The companies have publicly disclosed that they have changed the estimated useful lives of their infrastructure assets (servers, network) — and have quantified the impact of those changes on depreciation and profits.
•  The change is accounted for prospectively (i.e., future depreciation is charged over the revised remaining life).
•  The effect is to reduce annual depreciation charges, thereby increasing reported profits, EPS, and (other things equal) ROA, asset-turnover metrics etc.

4. Critical Assessment: Are These Extensions Consistent with Sound Accounting?

4.1 Is it permitted to change useful life?

Yes — as explained above, standards permit entities to change an estimate of useful life. That by itself is not improper. Ind AS 16/IAS 16 require that the revised estimate be based on current facts and be reviewed at each year end. A change in estimate is accounted for prospectively. So if a company genuinely has evidence that its servers will deliver useful economic benefits for a longer period (e.g., due to improved cooling, better utilisation, more efficient architecture), then extending the useful life is within the accounting framework.

4.2 But the extension must reflect consumption of future economic benefits

The key question is the reasonableness of the estimate. Standards emphasise that the useful life should reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity. Ind AS 16 para 60 and IAS 16 para 60 require that the depreciation method (and implicitly life) reflect that pattern.

Hence, if the asset will become technologically obsolete rapidly (e.g., GPU refresh every 12-18 months, or workloads needing new hardware), then extending a depreciation life from 3 to 6 years may not reflect realistic consumption of benefits. In that sense the extension may be inconsistent with the standard. Indeed a technical article points out as a common error: “Assuming useful life is the total economic life (potential life) of the asset” rather than the period the asset will actually yield economic benefits.

4.3 Specific concerns in server / data-centre context

Above concern is especially valid for server and networking infrastructure because:

•  The pace of hardware innovation (GPUs, accelerators, AI training hardware) is extremely rapid — product cycles may be 12-18 months.
• Energy efficiency, performance per watt, cooling advances, and usage patterns may mean older servers provide less value (or become less competitive).
•  Even if physically usable, the economic life (the period over which they generate net economic benefits) could be significantly shorter than physical life.
•  If management extends useful lives but does not reflect obsolescence or reduced output potential, then depreciation expense may be understated and profits overstated.

4.4 Disclosure and transparency issues

From a governance and investor-protection angle, the extension is problematic if it is not supported by realistic assumptions or clear disclosures of key judgments. While companies like Meta have disclosed the change and the quantitative impact (which is good governance), investor vigilance is required: the note might still not show the underlying assumptions (e.g., what refresh cycle, expected capacity utilisation, residual value), and the rationale may be management¬-biased.

4.5 In India / Ind AS context — special considerations

In the Indian context:

•  Under Schedule II to the Companies Act, if a company uses a useful life different from that prescribed, it must disclose the difference and justification (including technical advice).
•  Ind AS entities must review useful life and residual value each year, and change must be treated as an estimate change — not a change in policy.
•  Auditors and regulators (for Indian entities) must ensure that asset lives reflect actual usage, obsolescence and consumption of benefits, especially for high-tech assets where obsolescence is rapid.

4.6 Legal / regulatory pronouncements

From IFRS/UK/Australia commentary: for example, a BDO (Australia) article on “More common errors when accounting for property, plant and equipment” warns that failing to review useful life and residual values each year is a common error and may lead to over- or under-stated depreciation.

Therefore, while not a “legal ruling”, there is strong regulatory/standards-based expectation that life estimates reflect realistic economic lives.

4.7 Summary of whether the practices highlighted above are permissible

In summary:

•  It is permissible for a company to extend the useful life of an asset (provided it is an estimate change, prospectively applied, and disclosures made).
•  It is not permissible (or would be inconsistent with standards) if the extension is arbitrary, ignores the reality of obsolescence, or fails to reflect that the asset’s economic benefits will be consumed sooner than the extended life.
•  In a rapidly evolving technology environment (servers, AI infrastructure), extending from 3 years to 6 years raises red flags: are the underlying facts (refresh cycle, performance degradation, capacity utilisation) being properly considered? If not, profits may be inflated, and depreciation understated, thereby misleading investors.
•  From an Indian standpoint, companies using a non-prescribed life must disclose the difference and provide justification supported by technical advice. Ind AS also requires annual review of assumptions.

Hence the above concern—that companies may extend depreciation windows, thereby reducing expenses, boosting profitability and EPS, while the actual economic life may be much shorter—is a legitimate one for investors, auditors and regulators.

5. Implications for Indian Companies, Auditors and Investors

5.1 What Indian companies should do

For Indian entities investing in server/data-centre infrastructure (or any rapidly changing technology assets):

 They must assess useful life realistically, considering physical usage, technological change, output capacity, and replacement cycles.

•  They should document the basis for useful life assumptions (e.g., refresh policy, utilisation, benchmarking).
•  They should review the assumptions each year, and where the estimate is changed, provide adequate disclosure as required under Ind AS 8.
• If a departure from the useful lives specified in Schedule II of the Companies Act is made, they must justify the difference and disclose it.
•  They should ensure componentisation where relevant (e.g., major hardware components, cooling systems, GPUs) and depreciate accordingly.
•  Auditors must challenge management assumptions especially in asset-intensive, high-technology investments, and verify whether obsolescence (technical or commercial) has been appropriately factored.

5.2 What investors should watch for

•  Note disclosures in the “Significant Accounting Policies” or in the PPE notes: what useful lives have been assumed? Have they changed recently? If yes, what is the quantitative impact?
•  Review the company’s hardware refresh policy, data-centre strategy, server-upgrade cycle. If management is extending lives while the industry refresh cycle is short (12–18 months), that’s a potential red flag.
•  Check whether the residual value assumptions are realistic; whether impairment indicators exist (e.g., asset under-utilisation, new generation hardware replacing older).
•  Compare depreciation expense / gross PPE balance / age of assets over time (e.g., is the average age of servers increasing but utilisation/capacity growth flattening?)
•  Be alert that an extended useful life means lower annual depreciation, hence higher current profit, but it may also mean lower future capital expenditure — or an eventual impairment risk.
•  Read the footnotes: e.g., Meta’s disclosure that changing the useful life reduced depreciation expense by US$860 million and increased net income by US$693 million in 2022.

5.3 For auditors / regulators

•  Challenge whether management has credible evidence to support longer useful lives (e.g., improved cooling, higher workload, extension of refresh cycles).
•  Verify that review of useful lives and residual values has been carried out at each year end.
•  Check for indicators of impairment (older servers with significantly lower performance, being superseded by new hardware) and ensure that any impairment losses have been recognised.
•  Confirm disclosures are adequate as per Ind AS 16 and Ind AS 8 (i.e., nature and effect of change in estimate, justification for life extension if deviation from Schedule II).
•  Assess whether componentisation is appropriate (e.g., the server hardware may have components with different lives) and whether depreciation reflects the consumption of economic benefits.
•  Monitor whether the company’s refresh cycle or technology lifecycle has shortened (e.g., new GPUs every 18 months) and whether the useful life assumed reflects that shortening.

CONCLUSION

In conclusion, extending depreciation lives for server and data-centre infrastructure in a rapidly evolving technology environment can materially affect profits, EPS, ratios, and investor perceptions. While the accounting standards allow for changes in useful life, the key requirement is that such estimates must be based on realistic assessment of future economic benefits, consumption patterns, technological obsolescence and usage, and be reviewed annually.

In the Indian context, under Ind AS 16 and Schedule II, these requirements are explicit (useful life must reflect consumption, changes must be accounted as estimates, disclosures must be made). If a company, for example, extends the useful life of server infrastructure from 3 years to 6 years without adequate justification in the face of rapidly renewing technology, then the depreciation expense may be understated, and profit and EPS may appear stronger than the underlying economics justify. From an investor’s point of view, that creates a risk of “earnings inflation”.

Auditors, regulators and investors must thus pay careful attention to the assumptions underlying useful lives and refresh cycles, to ensure that asset carrying amounts and depreciation charges reflect economic reality

BCAJ Admin

This article analyses the tax implications of Section 56(2)(x) of the Income-tax Act when a partner contributes capital assets to a partnership firm or LLP. The author argues that this “gift-tax” provision, originally designed to prevent money laundering, is being incorrectly applied to bona fide business transfers where the recorded book value is less than the fair market value. Drawing on various Supreme Court precedents, the article explains that such transactions should not be taxed because the actual consideration received by a partner is legally indeterminate and only matures upon retirement or dissolution. Since the firm and its partners share a joint interest in the property, the firm cannot be viewed as a distinct recipient of a gift. Ultimately, the article concludes that without a specific legislative fiction to value these contributions, the tax charge fails due to an impossible computation mechanism. This reasoning applies equally to Limited Liability Partnerships, which are treated as traditional firms for tax purposes.

BACKGROUND

Section 56(2)(x) of the Income-tax Act, 1961 (“the Act”) — often referred to as the gift-tax provision — seeks to bring to tax, under the head Income from Other Sources, any sum or specified property received without consideration or for inadequate consideration. Section 56(2)(x)(c) provides that where any person receives any specified property (other than immovable property) for a consideration less than its fair market value (“FMV”) determined under Rule 11UA, the difference between the FMV and the consideration actually paid, if any, shall be deemed to be the income of the recipient.

Section 56(2)(x) is a successor to sections 56(2)(vii) and 56(2)(viia) of the Act. A review of the legislative history and the Explanatory Memorandum to the Finance Bill, 2010, and subsequent CBDT Circulars¹ — makes it abundantly clear that these provisions were introduced as anti-abuse measures, intended to curb the laundering and circulation of unaccounted money through the guise of gifts or under-valued transfers. This legislative intent has also found judicial affirmation in several precedents².

1 Circular No. 5 of 2005 dated 15 July 2005, Circular No. 5 of 2010 dated 3 June 2010, Circular No. 1 of 2011 dated 6 April 2011
2 Sudhir Menon HUF vs. ACIT [2014] 148 ITD 260 (Mumbai Trib.), 

Vora Financial Services (P) Ltd vs. ACIT [2018] 171 ITD 646 (Mumbai Trib.), 

ACIT vs. Subodh Menon [TS-718-ITAT-2018] (Mumbai Trib.), 

Kumar Pappu Singh vs. DCIT [TS-722-ITAT-2018] (Viz Trib.), 

Vaani Estate (P) Ltd vs. ITO [2018] 172 ITD 629 (Chennai Trib.), 

ACIT vs. Subodh Menon [2019] 175 ITD 449 (Mumbai Trib.), 

ITO vs. Rajeev Ratan Tushyan [2022] 193 ITD 860 (Mumbai Trib.)

However, in practical administration, the operation of section 56(2)(x) has often been extended beyond its intended anti-abuse scope. Rather than being confined to cases of tax evasion or money
laundering, it has increasingly been invoked as a revenue-generating provision, resulting in unintended taxation of bona fide commercial and capital transactions.

TRANSACTION UNDER EVALUATION

Consider a situation where a partner contributes a capital asset to a partnership firm as his capital contribution. In recognition of such contribution, a corresponding credit is recorded
in the partner’s capital account in the books of the firm.

For instance, assume that a partner contributes listed equity shares to the firm, the fair market value (“FMV”) of which, determined in accordance with Rule 11UA, is ₹1,000. The firm, however, records the contribution at ₹ 400 in its books of account. In such a case, the partner would be liable to capital gains tax on ₹400, being the value recorded in the firm’s books, as per section 45(3) of ITA.

While the capital gains implications in the hands of the partner are not the subject of this discussion, the issue under consideration is whether, in the hands of the firm, the provisions of section 56(2)(x) of ITA could be invoked on the premise that the consideration “discharged” by the firm, namely, the credit to the partner’s capital account, is lower than the FMV determined under Rule 11UA

• PROVISIONS OF SECTION 56(2)(X) APPLY ONLY IF THE FIRM RECEIVES THE SPECIFIED PROPERTYSection 56(2)(x) of ITA contemplates a receipt-based charge. The provision is attracted only where a person receives a specified property, either without consideration or for inadequate consideration. Accordingly, in the context of a partnership firm, it becomes crucial to examine who, in law, can be regarded as the recipient of the specified property contributed by a partner.
• In this regard, reference may be made to the ruling of the Gujarat High Court in CIT vs. Mohanbhai Pamabhai [1973] 91 ITR 393, as affirmed by the Supreme Court in Addl. CIT vs. Mohanbhai Pamabhai [1987] 165 ITR 166 (SC). The Court held that when a partner contributes a personal asset to the partnership as capital, the partner’s exclusive ownership in that asset is converted into a shared ownership interest held jointly by all partners of the firm. Supreme Court reiterated this principle in Sunil Siddharthbhai vs. CIT [1985] 156 ITR 509 (SC), observing that when a partner introduces a personal capital asset into the firm, his individual right in the asset is substituted by a collective interest in the partnership property — an interest that extends to all partners jointly.
• Reliance can also be placed on SC ruling in case of Addanki Narayanappa vs. Bhaskara Krishnappa [1966] 3 SCR 400, wherein SC made following observations:

“From a perusal of these provisions it would be abundantly clear that whatever may be the character of the property which is brought in by the partners when the partnership is formed or which may be acquired in the course of the business of the partnership it becomes the property of the firm and what a partner is entitled to is his share of profits, if any, accruing to the partnership from the realization of this property, and upon dissolution of the partnership to a share in the money representing the value of the property. No doubt, since a firm has no legal existence, the partnership property will vest in all the partners and in that sense every partner has an interest in the property of the partnership. During the subsistence of the partnership, however, no partner can deal with any portion of the property as his own. Nor can he assign his interest in a specific item of the partnership property to anyone. His right is to obtain such profits, if any, as fall to his share from time to time and upon the dissolution of the firm to a share in the assets of the firm which remain after satisfying the liabilities set out in clause (a) and sub-clauses (i), (ii), and (iii) of clause (b) of section 48.”

•  Thus, the contribution of an asset by a partner results in the transformation of ownership from an exclusive individual interest to a joint partnership interest. The firm, being merely a compendious name for all partners together, cannot be regarded as a distinct recipient of such property for the purposes of section 56(2)(x) of ITA.

IN CASE CAPITAL CONTRIBUTION BY PARTNER, CONSIDERATION DISCHARGED BY FIRM IS NOT DETERMINABLE

•  The issue concerning the transfer of a capital asset by way of capital contribution to a partnership firm, and the consequent chargeability of capital gains, has long been a matter of significant judicial deliberation. The controversy was conclusively addressed by the Supreme Court in Sunil Siddharthbhai vs. CIT [1985] 156 ITR 509 (SC). In that case, the Court held that when a partner contributes a personal asset to the partnership as capital, such contribution constitutes a transfer within the meaning of section 2(47) of ITA, since the partner’s exclusive ownership in the asset is replaced by a shared interest held jointly by all partners. However, the Supreme Court held that the consideration received by the partner (transferor) in such a transaction is not capable of determination. The credit to the partner’s capital account is merely a notional entry, recorded for the purpose of adjusting partners’ mutual rights, and cannot be regarded as the full value of consideration for the transfer. Relevant observations from SC ruling are as under:

“It is apparent, therefore, that when a partner brings in his personal asset into a partnership firm as his contribution to its capital, an asset which originally was subject to the entire ownership of the partner becomes now subject to the rights of other partners in it. It is not an interest which can be evaluated immediately, it is an interest which is subject to the operation of future transactions of the partnership, and it may diminish in value depending on accumulating liabilities and losses with a fall in the prosperity of the partnership firm. The evaluation of a partner’s interest takes place only when there is a dissolution of the firm or upon his retirement from it.”

“The consideration, as we have observed, is the right of a partner during the subsistence of the partnership to get his share of profits from time to time and after the dissolution of the partnership or with his retirement from the partnership, to receive the value of the share in the net partnership assets as on the date of dissolution or retirement after deduction of liabilities and prior charges. When his personal asset merges into the capital of the partnership firm, a corresponding credit entry is made in the partner’s capital account in the books of the partnership firm, but that entry is made merely for the purpose of adjusting the rights of the partners inter se when the partnership is dissolved or the partner retires. It evidences no debt due by the firm to the partner. Indeed, the capital represented by the notional entry to the credit of the partner’s account may be completely wiped out by losses which may be subsequently incurred by the firm, even in the very accounting year in which the capital account is credited.”

It is evident from the above judicial extracts that the measure of consideration flowing from the firm to the partner, upon contribution of a capital asset, is inherently indeterminate and incapable of valuation. The amount credited to the partner’s capital account does not represent an enforceable debt due from the firm to the partner; it is merely a notional adjustment reflecting the partner’s participation in the firm. Consequently, where the consideration is not capable of being quantified, the computation mechanism prescribed under section 48 of ITA fails. As laid down by the Supreme Court in CIT vs. B.C. Srinivasa Setty [1981] 128 ITR 294 (SC), when the computation provision cannot be applied, the charging provision itself collapses. This principle applies with equal force in the context of section 56(2)(x)(b) / (c) of ITA. In the absence of a determinable measure of consideration discharged by the firm, the comparison between such consideration and the fair market value under Rule 11UA becomes impossible. Accordingly, just as the capital gains charge failed prior to the introduction of section 45(3), the charge under section 56(2)(x) too must fail for want of a workable computation mechanism

• When an asset is contributed to a partnership firm, the actual consideration paid by the firm to the partner—whether in money or money’s worth—is fundamentally different from a mere notional credit entry made to the partner’s capital account. For the purposes of section 56(2)(x) of ITA, consideration which is discharged by the firm ought to be determined having regard to the obligation that the firm has to hand over share of profit from time to time over the life of the firm and to pay the value on retirement or dissolution. The money value of such obligation will equate the present fair value of the property. Refer, in this behalf extracts from Gujarat HC ruling in case of Mohanbhai Pamabhai [1973] 91 ITR 393 as approved in SC ruling in case of CIT vs. Mohanbhai Pamabhai [1987] 165 ITR 166

“…..interest of a partner in the partnership is not interest in any specific item of the partnership property, but as pointed out by the Supreme Court and the Full Bench of this court, it is a right to obtain his share of profits from time to time during the subsistence of the partnership and on dissolution of the partnership or his retirement from the partnership, to get the value of his share in the net partnership assets which remain after satisfying the debts and liabilities of the partnership. When, therefore, a partner retires from a partnership and the amount of his share in the net partnership assets after deduction of liabilities and prior charges is determined on taking accounts on the footing of notional sale of the partnership assets and given to him, what he receives is his share in the partnership and not any consideration for transfer of his interest in the partnership to the continuing partners…..It is impossible to contend, in view of this decision of the Supreme Court, that when a partner retires from the partnership, there is relinquishment or extinguishment of his interest in the partnership assets. We must, therefore, hold it to be clear beyond doubt that, even if goodwill be assumed to be capital asset within the charging provision enacted in section 45, there was, in the present case, no transfer of interest of any assessee in the goodwill within the meaning of section 2(47) when the assessee retired from the firm. Each assessee, undoubtedly, received certain amount on retirement, but this amount represented his share in the net partnership assets after deduction of liabilities and prior charges and it was received in satisfaction of his share in the partnership”

Considering the above, even in case where the consideration discharged by the firm is determinable on contribution of asset by partner, such consideration cannot be equated with the credit entry passed in the books of firm but it shall be equal to right of a partner to obtain his share of profit from time to time and to get value of his interest at the time of retirement or dissolution. Accordingly, the acquisition of asset / receipt of asset is for adequate consideration.

Under erstwhile Gift Tax Act, 1957 also, it has been held that on contribution of asset by partner to firm, consideration payable by partner cannot be determined and hence there cannot be any Gift tax liability.

• Section 4(1)(a) of the Gift-tax Act reads as under:

“For the purposes of this Act, where the property is transferred otherwise than for adequate consideration, the amount by which the market value of the property at the date of transfer exceeds the value of the consideration shall be deemed to be a gift made by the transferor to the transferee.

In order to trigger provisions of Gift-tax Act, the property was to be transferred otherwise than by adequate consideration.

• The erstwhile provisions of the Gift Tax Act do also bear out (a) that conversion of personal asset into asset of the firm can involve a transfer only to the extent of diminution of exclusive interest into a shared interest without consideration; (b) that, the value of inadequacy, if any, of such transfer is incapable of determination. The issue under consideration i.e. when the asset is contributed by the partner to firm whether such transaction involves adequacy of consideration has been examined by the Court. Reference may be made to CIT vs. Marudhar Hotel (P) Ltd. [2004] 269 ITR 310. This judgement is directly an authority on the proposition that for Gift Tax Act also consideration accruing from firm to partner on contribution of asset was held to be not determinable (refer following extracts from the said judgement). Similar conclusion shall apply with equal force in the context of section 56(2)(x)(b) / (c) of ITA.

“It is only where a transfer of property is for ‘inadequate consideration’, than only the question of finding market price can arise. As noticed above when an asset is brought in partnership the contributor partner acquires in consideration right to obtain his share in profits from time to time and also right to share in the net assets of the firm on its dissolution or on his retirement in accordance with the provisions of Partnership Act and terms of partnership agreement. All these rights fructify in future. The credit to his capital account is only notional value and not the value of consideration as the same is incapable of determination.”
……………………………

The Court clarified that the notional amount credited to the account of capital of the firm as contribution by partner as a value of asset brought into the firm account does not represent the correct and true value of consideration because on that date, it is impossible to determine the value of consideration, which lies in the womb of future. This value can only be computed in future when the partnership is dissolved or the partner retires and the asset of the firm are distributed to the partners on a future date.”

• This decision of the Rajasthan HC was also followed by the Karnataka HC in the case of CIT and Anr. vs. Jayalakshmamma, N. Dayanand Reddy and N. Shamalamma [2011] 339 ITR 546. In this case, assessee entered into a partnership with nine other partners. Partnership was constituted on 1-4-1993. Each of the assessee contributed the land owned by him/her into the partnership firm as his/her contribution. After five months, i.e., on 31-8-1993 three assessee partners retired from the firm receiving certain amounts as their share in the interest of the firm. The amount standing in the capital account of each of the partner was much lower than amount received on retirement. In other words, the retiring partner received excess amount as compared to book value. The Assessing Officer proceeded to hold that the assessee had adopted a device in order to avoid tax. Assessing officer held since the contribution value was less than the amount at which partners retired from firm, the difference in the aforesaid amount was held to be a deemed gift under section 4(1). Karnataka HC held that at time of transfer of property by assessees into partnership firm, there was no consideration and book value mentioned was a notional value, in such circumstances, in absence of any monetary consideration, question of deemed gift under section 4(1)(a) did not arise. Relevant observations from HC ruling are as under:

“When a partner brings in his asset into a partnership firm by way of contribution it amounts to transfer of property as defined under the Act. Though it amounts to transfer of property, yet as a consideration for that transfer, he becomes entitled to the profits in the partnership firm. It is not a case of complete divesting of his interest in the property brought in as capital asset. Partially, the property is transferred and as a partner he continues to have interest in the said partnership asset. Not only he continues to have interest in the property brought by him to the partnership firm as a partner but if there are other partners who have brought in similar properties into the firm by way of assets, he will also have an interest in those properties. If at the time of constitution of partnership or at the time of his entry into the partnership, if a value is mentioned in the books of the partnership firm representing the interest he has brought into the partnership, it does not truly reflect the market value of the property which he has brought into the partnership firm. It is purely a notional value. The said notional value is only for the purpose of distributing the profits of the said partnership firm, either at the time of dissolution or at the time of retirement. When a partner brings his property into the partnership firm, though the consideration is that he will acquire the status of a partner and he continues to have interest in the partnership assets, yet there is no monetary consideration for such a transfer of the property and the book value mentioned is not the consideration for such a transfer. Section 4(1)(a) is attracted only in a case where there is a monetary consideration for transfer and that consideration is less than the market value of the property. In such a case, difference in the amount is treated as a deemed gift under section 4(1)(a). The share to which a partner is entitled to at the time of dissolution or retirement has no bearing on the question regarding the value of the property which he would have brought into the partnership at its inception. In that view of the matter, when there is transfer of property into a firm there is no consideration and the book value mentioned is a notional value. The share to which a partner is entitled to at the time of retirement or a dissolution of a partnership firm depends upon various other factors. The quantification of a partner’s share cannot by any stretch of imagination be taken into consideration to hold that there is inadequacy of consideration at the time of the partner bringing in the property into the partnership firm. On that basis, it cannot be held that the difference in the consideration constitutes a consideration for the deemed gift.”

• The Kerala HC in the case of CGT vs. A.C. Raghava Menon [2000] 243 ITR 167, in the context of Gift-tax Act also held that the credit entry in the capital account does not represent the true value of the consideration and that such entry simply represents the notional value of the asset. Inadequacy of consideration cannot be judged vis-a-vis a credit entry made in the capital account of the books of the firm. Except the credit entry made in the capital account, there was nothing also on record to conclude that the assessee had transferred the asset to the firm for inadequate consideration. This judgment also supports that unless a fiction similar to section 45(3) of ITA is brought into section 56(2)(x) of ITA, the consideration discharged by firm to partner cannot be determined and hence the charge cannot survive. Relevant observations from HC ruling are as under:

“The credit entry in the capital account does not represent the true value of the consideration and that such entry simply represents the notional value of the asset. Inadequacy of consideration cannot be judged vis-a-vis a credit entry made in the capital account of the books of the firm.

Except the credit entry made in the capital account, there was nothing else on record to conclude that the assessee had transferred the asset to the firm for inadequate consideration. In order to attract the provisions of section 4(1) (a) several conditions have to be fulfilled, i.e., (a) there must be a transfer of property; (b) consideration for the transfer must be inadequate; and (c) the market value of the property should be more than the consideration for which the transfer was effected. Only one factor seemed to have been stressed upon by the revenue, i.e., that there had been a transfer, but the remaining ingredients had not been established. That being the position, section 4(1) (a) could not be applied and no inference of deemed gift could be drawn.

Consideration for a transfer is unascertainable until dissolution of the partnership.”

In the context of section 56(2)(viia) (predecessor of section 56(2)(x)), it has been held that the in respect of asset contributed by partner to firm, no consideration can be determined and hence the charge fails

• Hyderabad Tribunal in the case of ITO vs. Shrilekha Business Consultancy (P.) Ltd [2020] 121 taxmann.com 150, section 56(2)(x) held that provisions of section 56(2)(viia) can apply only in a case where a transaction envisages payment of consideration as part of a contract. The amount can constitute consideration if it is payable as a debt due to the transferor and there is enforceable right with transferor to recover enforceable debt from the transferee. Unlike that, as held by Supreme Court in Sunil Siddharthbhai (supra), credit to account of a partner evidences no debt due by the firm to the partner. The amount credited to capital account is not recoverable as an enforceable debt by a partner. According to the Tribunal, such a notional credit would not at all answer to the description of consideration in the nature of a debt due to the transferor.
• Tribunal also held that, at the stage of formation of the partnership, the firm is not yet in existence. There can be no transaction which a firm can have with a prospective partner. Absent the possibility of a contract, the notion of consideration cannot exist inasmuch as that the element of consideration is connected with contractual relationship of whose consideration is a requisite element

The measure of consideration on contribution of capital asset by partner to firm is restricted to section 45(3) of ITA only. Measure of consideration by way of book entry provided in section 45(3) of ITA cannot be extended to section 56(2)(x) of ITA.

• Despite being aware that the value of consideration received by a partner in lieu of contribution of his asset is not measurable, the Legislature has, unlike in case of section 45(3) of ITA made no fiction with regard to yardstick of measurement applicable to section 56(2)(x) of ITA. In this regard, it is important to understand the intention behind introduction of the section 45(3) which is explained in Circular No. 495 dated 22 September 1987.

Capital gains on transfer of firms’ assets to partners and vice versa and by way of compulsory acquisition:

One of the devices used by assessees to evade tax on capital gains is to convert an asset held individually into an asset of the firm in which the individual is a partner. The decision of the Supreme Court in Kartikeya V. Sarabhai vs. CIT [1985] 156 ITR 509 has set at rest the controversy as to whether such a conversion amounts to transfer. The court held that such conversion fell outside the scope of capital gain taxation. The rationale advanced by the court is, that the consideration for the transfer of the personal asset is indeterminate, being the right which arises or accrues to the partner during the subsistence of the partnership to get his share of the profits from time to time and on dissolution of the partnership to get his share of the profits from time to time and on dissolution of the partnership to get the value of his share from the net partnership assets.

With a view to blocking this escape route for avoiding capital gains tax, the Finance Act, 1987, has inserted new sub-section (3) in section 45. The effect of this amendment is that profits and gains arising from the transfer of a capital asset by a partner to a firm shall be chargeable as the partner’s income of the previous year in which the transfer took place. For purposes of computing the capital gains, the value of the asset recorded in the books of the firm on the date of the transfer shall be deemed to be the full value of the consideration received or accrued as a result of the transfer of the capital asset.”

The Circular does also acknowledge that no debt becomes due from a firm to a partner in lieu of contribution of asset by a partner by way of capital and that the consideration payable is indeterminate. Indeed, there is no back up provision forming part of section 56(2)(x) of ITA which bridges the gap of indeterminate consideration.

• The provisions of section 45(3) of ITA are restricted in its application to determination of capital gains tax liability of a partner contributing asset to the firm; the fiction is limited in its application to the purpose of determining consideration received by a contributing partner for the purposes of section 48 of ITA and can have no influence whatever on text or interpretation of section 56(2)(x) of ITA
• It is a trite law that a deeming fiction cannot be extended beyond its legitimate field. It can merely be applied in determination of capital gains income in the hands of partner. But, in our view, it would be incorrect to apply the fiction for any other purpose³.

3 Reference may be made to SC ruling in case of CIT vs. V S Dempo Company Ltd [2016] [2016] 387 ITR 354 (SC) 
wherein SC held that the fiction created for the purpose of section 50 of ITA 
cannot be extended to any other provisions of capital gains chapter also.

SUMMATION OF THE CONTENTIONS:

• In order to create an effective charge under section 56(2)(x) of ITA, (a) there should be receipt of asset, (b) the receipt of asset should be without consideration or inadequate consideration. In section 56(2)(x) of ITA, the determination of consideration is necessary as same is required to be compared with Rule 11UA value. Only when the consideration can be effectively determined, it can be compared with Rule 11UA value. In the context of capital gains, Gift-Tax Act and section 56(2)(viia) of ITA, which have consistently held that when the partner contributes an asset to firm, consideration cannot be determined. Once an element of charging provision is absent (consideration in present case), the charge fails.
• Reference may also be made to SC ruling in case of Govind Saran Ganga Saran vs. CST [1985] 155 ITR 144⁴ rendered under Bengal Finance (Sales Tax) Act, 1941 (‘Sales Tax Act’) as applied to the Union Territory of Delhi. The case revolved around the interpretation of sections 14 and 15 of the Sales Tax Act. Cotton yarn was classified as one of the goods of special importance in inter-state trade or commerce as envisaged by section 14 of the Sales Tax Act. Section 15 of the Sales Tax Act provided that sales tax on goods of special importance should not exceed a specified rate and further that they should not be taxed at more than one stage. The issue arose because the stage itself had not been clearly specified, and accordingly, it was not clear at what stage the sales tax shall be levied. The Financial Commissioner held that in the absence of any stage, there was a lacuna in the law and consequently, cotton yarn could not be taxed under the sales tax regime. The Delhi High Court reversed the decision of the Financial Commissioner. However, SC held that the single point at which the tax may be imposed must be a definite ascertainable point, and in the absence of the same, tax shall not be levied. SC ruling in the case of Govind Saran Ganga Saran (supra) has been quoted with approval by the Constitution Bench of SC in case of CIT vs. Vatika Township (P.) Ltd. [2014] 367 ITR 466.
• In view of the above discussion, in absence of determination of consideration payable by firm where partner contributes an asset to firm, there cannot be comparison between consideration discharged and Rule 11UA value. In absence thereof, there is no effective charge and accordingly, firm cannot be liable / subjected to tax under section 56(2)(x)(c) of ITA.

4 Approved by the Constitution Bench of SC in case of CIT vs. Vatika Township (P.) Ltd. [2014] 367 ITR 466

In view of the above discussion, in absence of determination of consideration payable by firm where partner contributes an asset to firm, there cannot be comparison between consideration discharged and Rule 11UA value. In absence thereof, there is no effective charge and accordingly, firm cannot be liable / subjected to tax under section 56(2)(x)(c) of ITA. Additional issue which requires examination is whether conclusion drawn in the context of firm can equally apply for LLP.

On a holistic reading of the LLP Act, 2008 and ITA, an LLP is intended to be treated as substantially equivalent to a partnership firm for tax purposes, notwithstanding its separate legal personality under general law. The legislative intent behind introducing the LLP structure was not to alter the scheme of taxation applicable to partnerships, but merely to provide a business form with limited liability while retaining partnership-style mutual rights and obligations. This is evident from the core features of an LLP: it is constituted by partners associating with a common profit motive; partners enjoy management rights and stand in an agency relationship vis-à-vis the LLP; their mutual rights and duties are governed by a partnership agreement that is statutorily recognised and enforceable; and, upon cessation, a partner is entitled as of right to capital and his right to share in accumulated profits and surplus. Crucially, section 2(23) of the ITA expressly equates an LLP with a “firm” and an LLP partner with a “partner” for all purposes of the Act, a position reinforced by CBDT Circular No. 5 of 2010 and the Explanatory Memorandum, which clarify that LLPs and general partnerships are to be accorded the same tax treatment, except for recovery provisions. The Circular further confirms that even conversion of a firm into an LLP carries no tax consequences, underscoring that the separate legal entity character of an LLP is not determinative for income-tax purposes. Therefore, for purposes of interpreting charging, computation, and incidence provisions under the ITA, including those relating to partners’ rights and firm-level taxation, an LLP must be read harmoniously and fictionally as a partnership firm.

BCAJ Admin

A Real Estate Investment Trust (REIT) is a business trust that owns or finances income-producing real estate, such as commercial offices or malls, functioning similarly to a mutual fund. Investors purchase units, and the capital is used to invest in properties directly or through Special Purpose Vehicles (SPVs), with generated rent distributed as dividends. Key parties include the sponsor, manager, trustee, and unit holders. While established globally since 1960, India’s REIT market is transitioning from a “nascent” to a “growth” stage. As of 2025, India has five listed REITs covering 175 million square feet of assets. A significant regulatory shift occurred in September 2025 when SEBI reclassified REITs as equity instruments, removing previous allocation caps and enabling wider institutional participation. REITs provide developers with liquidity and an “asset-light” model, while offering investors stable income, high-yield returns (6%–10%), and transparency. Taxation has also evolved; the 2024 Union Budget aligned REITs with equity funds, setting capital gains tax at 12.5% for long-term and 20% for short-term holdings. Additionally, “atypical” distributions, such as debt repayments, now reduce the cost of acquisition or are taxed as “income from other sources” if they exceed the original issue price.

OVERVIEW – WHAT ARE REITs

A REIT is a business trust that owns or finances income-producing real estate which may be in the form of a commercial or any other rent generating property (malls, residential projects, etc).

The basic model of REIT can be considered as similar to a mutual fund wherein the investors shall buy REIT units based on an offer document and the REIT shall then list on the stock exchange. The money so raised would be used by the REIT either to buy into Special Purpose Vehicles (SPVs) which invest in property or the REIT may directly invest in real estate projects.

The rent income generated from the properties shall be distributed as dividend to the REIT unit holder. REITs would be traded on a stock exchange and just like shares, REIT units may trade at a discount or premium to the company’s intrinsic value.

As can be seen from the above, a REIT shall consist of a Sponsor, Manager, Trustee, SPV and unit holder which are defined in the SEBI regulations for REITs as “parties to the REIT”. Additionally, a REIT shall have a valuer and an auditor. The meaning of the aforementioned terms is summarized hereinbelow:

• Sponsor(s): Who set(s) up the REIT and is designated as such at the time of application to SEBI. Sponsor is mandated to hold minimum prescribed stake of the REIT units.
• Manager : One who holds the operational responsibility of the REIT
• Trustee : Holds the assets of the REIT on behalf of the investor
• Unit holders: Investors (including Sponsors) who hold REIT units. Unit holders could be either resident or nonresident unit holders.
• Special Purpose Vehicle [‘SPV’]: Holds the real estate properties and is engaged in incidental activities. SPV is held by REIT directly or through a Holding Company
• Real Estate property: Real estate properties that a REIT is permitted to hold

Global Scenario

Globally, REITs have been in existence since decades. The Dutch regime was the first REIT look alike regime in the Euro region. Further, the United States boasts of the oldest formal REIT regime, having been enacted in 1960 and effective from 1961.

Over the last decade, REITs have developed into a mature market world over, providing easy access to high-quality assets and enabling a stable return on investments.

The number of countries offering REITs as an investment vehicle has increased manifold. Several countries worldwide such as USA, UK, Australia, Malysia, Hong Kong, Singapore, Japan and Germany are said to have established REIT markets. With REIT’s introduction in the United States in 1960, it can be said to have a ‘mature’ REITs market.

India Story

India can be considered as a late entrant in the REIT market with its introduction by the SEBI in 2014.  when Securities and Exchange Board of India (SEBI) enacted Real Estate Investment Trusts Regulations, 2014 (REIT Regulations) on 26th September 2014 and the first REIT being listed in India in March 2019.However, thereafter the REIT theme in India has picked up with multiple listings like Embassy REIT, Mindspace REIT, Brookfield India REIT, Nexus Select Trust and Knowledge Realty Trust between 2019 to 2025.

India’s Real Estate Investment Trust (REIT) market is steadily progressing from a “Nascent” to “Growth” stage, with close to 175 million sq ft of real estate assets including office and retail spaces already getting listed through the above mentioned five listed REITs. Additionally, about 371 million sq ft of office assets, accounting for about 46% of the existing Grade A stock, can potentially come under future REITs. Overall, Indian REITs continue to pick pace, especially in the office sector, supported by new listings, broadening of occupier base and growing institutionalization in the segment.

Below is a chart depicting the Indian REIT performance against global peers¹

1.Source -0020CREDAI and Anarock report on Indian REITs – September 2025

2. Source : Fund raising by REITs and InvITs https://www.sebi.gov.in/statistics/reitsinvits/funds-raised-reits-invits.htm

INCOME AS REFERRED UNDER SEC. 115UA OTHER THAN THE ABOVE

4. Period of holding to be considered at 12 months or more for LTCG. Assuming STT has been paid by the unit holder upon acquisition of units.

BCAJ Admin