Year: 2025

The Income Tax Act, 2025 (effective 1 April 2026) restructures the taxation of charitable and religious organisations while largely retaining the substantive framework of the 1961 Act. The concept of “trusts” is replaced by “registered non-profit organisations” (NPOs), with detailed eligibility and registration requirements under section 332. Provisions earlier treated as exemptions are now computation provisions, classifying income into regular, specified, and residual categories, with differential tax treatment. Anonymous donations, impermissible investments, and violations in commercial activity attract strict tax consequences, including 30% levy and possible cancellation of registration. Key exemptions, such as corpus donations and reinvested capital gains, remain, while accumulations are permitted for up to five years. Compliance obligations relating to books, audit, returns, and investments are tightened, with harsher penalties for violations. The exit tax on accreted income and donation approval rules under section 133 also continue. Despite restructuring, complexity persists, raising risks of litigation

The Income Tax Act 2025 (“new Act”), which comes into force from 1st April 2026, has by and large retained the substance of the manner of taxation of charitable and religious organisations as existed in the Income Tax Act, 1961 (“existing Act”), but has significantly changed the structure of the provisions relating to taxation of charitable and religious organisations.

At the stage of the draft Bill, there had been a few major changes suggested in the provisions – withdrawal of the exemption for reinvestment of capital gains [current s.11(1A)] and of the option to spend the income in the subsequent year [current explanation to s.11(1)], extending the taxability of anonymous donations to all charitable-cum-religious trusts are some of the proposals. Fortunately, at the time of passing the Revised Bill, these proposals were withdrawn, and the existing exemptions broadly continue to operate.

In this article, an attempt is being made to analyse how the new provisions need to be read, and some of the changes that may apply on account of the changed structure of the law or changes in the language of the new law. While all major aspects are sought to be covered, it may not be possible to cover all the provisions, which run into 21 pages of the new Act, besides the items contained in the Schedules.

The new provisions are contained in part B of Chapter XVII, which consists of 7 sub-parts – registration, Income of regd NPO, commercial activities by regd NPOs, compliances, violations, approval for purposes of section 133, and interpretation.

1. SIGNIFICANT CHANGES

The significant changes to the structure are analysed below:

1. The concept of a trust or institution holding property in trust for charitable or religious purposes has been replaced by a concept of registered non-profit organisation (“regd NPO”). A list of types of entities which can apply for registration as a regd NPO is laid down in s.332(1), which was not present in the current ITA. These are:

(a) A public trust;

(b) A society registered under Societies Registration Act, 1860 or under any law in force in India;

(c) A company registered under s.8 of Companies Act 2013 or under s.25 of Companies Act 1956 and deemed to have been registered under s.465(2)(g) of Companies Act 2013;

(d) A University established by law or any other educational institution affiliated thereto or recognized by the Government;

(e)An institution financed wholly or in part by the Government or a local authority;

(f) Investor Protection Funds set up by recognized stock exchanges, commodity exchanges or depositories, notified bodies administering any activity for the benefit of the general public, Prime Minister’s National Relief Fund, PM CARES Fund, Chief Minister’s Relief Fund, Swachh Bharat Kosh, Clean Ganga Fund, university/educational institutions and hospitals/medical institutions wholly or substantially financed by the Government or with annual receipts of less than Rs 5 crore, and notified bodies set up under a Central/State Act for dealing with housing accommodation, planning, development or improvement of cities, towns and villages, regulating or regulating and developing any activity for the benefit of the general public or regulating any matter for the benefit of the general public;

(g) Any other person notified by the CBDT.

Section 332(2) provides that such a person shall be eligible for registration if:

(a) It is constituted, registered or incorporated in India for carrying out one or more charitable purposes, or one or more public religious purposes, and

(b) The properties of such person are held for the benefit of the general public under an irrevocable trust –

i. Wholly for charitable or religious purposes in India; or

ii. Partly for charitable or religious purposes in India, if such person was constituted, registered or incorporated prior to 1.4.1962.

Therefore, a trust created after 1.4.1962 cannot apply for registration as a regd NPO if it is not constituted, registered or incorporated in India or any of its objects are for the benefit of the public or any persons outside India. This requirement is not contained in the current Act. This also seems to contradict the provisions of section 338 (analysed later), where income can be applied outside India with the prior approval of the CBDT. One fails to understand how an NPO can apply income outside India, if it does not have such an object permitting application outside India, in which case it would not be eligible for registration.

Further, in case of an NPO set up after 1.4.1962, it can only be wholly for charitable and religious purposes, as is the case under the existing law.

2. The earlier provisions of exemption contained in sections 10 and sections 11 to 13 were contained in Chapter III – Incomes which do not Form Part of Total Income. These were therefore exemption provisions. Under the new Act, the provisions are contained in sections 332 to 355, which are contained in Part B – Special Provisions for Registered Non-Profit Organisations of Chapter XVII – Special Provisions Relating to Certain Persons. These are now therefore computation provisions, and not exemption provisions. Certain specific provisions, such as those contained in clauses (iiiab), (iiiac), (iiiad) and (iiiae) of section 10(23C) continue as complete exemptions, being part of Schedule III, read with section 11 of the new Act, which deals with incomes not to be included in total income.

The switchover from a scheme of exemption to a scheme of computation may not have any significant impact, given that:

(a)  the provisions of section 14 (current section 14A) relating to disallowance of expenditure incurred for earning exempt income apply for the purposes of computing income under Chapter IV (i.e. under the heads of income) and not under Chapter XVII-B; and

(b)  the provisions of Alternate Minimum Tax under section 206 specifically provide for reduction of “regular income” of a regd NPO referred to in section 355 from the profits as per profit and loss account, in the definition of “book profit” in section 206(1)(c).

3. The exemption provisions contained for some specific types of important institutions, educational and medical institutions in clauses (iv), (v), (vi) and (via) of section 10(23C) have been merged with the general computation provisions for regd NPOs. Therefore, there is now only one regime of computation for regd NPOs under the new Act, as opposed to two exemption regimes under the current Act. A beginning for the merger of the two regimes had been made earlier under the current Act, by providing that with effect from 1.10.2024, no application for renewal of s.10(23C) approval would be made under that section, but would have to be made under section 12A, and by bringing the two exemption regimes almost on par with each other. Section 355(g) of the new Act provides that an approval under section 10(23C) would be a registration for the purposes of the new Act, and therefore an entity approved under section 10(23C) would be a regd NPO under the new Act.

4. Instead of all income from property held under trust, including donations, being considered for computation of exemption, and with loss of exemption for certain incomes under sections 11(3), 13 or section 115BBC,  incomes of a trust would now be categorised into 3 categories – regular income (85% of which is required to be applied), specified income (which is taxable at a flat rate of 30%) and residual income.

“Regular income” is defined in section 335 as:

(a) Income from any charitable or religious activity for which the NPO is registered, carried out by it in such tax year;

(b) Income derived from any property, deposit or investment held wholly for charitable or religious purposes by such regd NPO in such tax year;

(c) Income derived from any property, deposit or investment held in part for religious and charitable purposes by NPOs set up prior to 1.4.1962;

(d) Voluntary contributions received by such regd NPO in such tax year; and

(e) Gains of any permitted commercial activity carried out by such regd NPO in such tax year.

In the draft Bill, the word “receipts” had been used in place of the word “income” in items (a), (b) and (c), and in (b), the term used was “receipts, whether capital or revenue”. Fortunately, the language in the new Act has been rectified, with the term used now being “income”.

“Specified income” consists of anonymous donations and income which was so far taxable under section 115BBI, and includes the following:

(a) Taxable anonymous donations;

(b) Income applied for the benefit of specified persons;

(c) Income applied outside India without CBDT approval;

(d) Investment made in contravention of permitted investment pattern;

(e)Accumulated income, applied to purposes other than purposes of accumulation, or ceasing to be accumulated or set apart, or not applied within the period of accumulation, or credited or paid to another regd NPO;

(f) Income applied to purposes other than purposes for which it is registered;

(g) Business income determined by the AO in excess of income shown in books of account of the business undertaking.

Here too, in the draft Bill, the scope of anonymous donations had been proposed to include all anonymous donations received by a charitable-cum-religious trust. The new Act finally covers only anonymous donations received for a university/educational institution or hospital/medical/institution by such religious-cum-charitable trusts, besides all anonymous donations received by a charitable trust, as is the position under the current Act. Anonymous donations received by religious trusts continue to remain outside the purview of taxation as anonymous donations.

“Residual Income” is defined in section 355(j) to mean the total income without giving effect to the provisions of Part B of Chapter XVII, as reduced by regular income and specified income. Incidentally, the term “total income” is not defined in this Chapter. Section 2(108) defines total income as the total amount of income referred to in section 5, computed in the manner as laid down under this Act. Given that the headwise computation provisions would not apply (as discussed below), this would probably mean the sum total of all the incomes as computed after deductions and exclusions under Part B of Chapter XVII.

2. REGISTRATION

The provisions for registration of an NPO are contained in section 332(3), and are identical to those currently applicable under section 12A(1)(ac). Section 332(3) has a table listing out the 7 types of cases [currently found in clauses (i) to (vi)(A) and (B) of current section 12A(1)(ac)], giving the time limit for furnishing the application, time limit for passing the order by the CIT, and the period of validity of registration. The enhanced period of registration of 10 years for small NPOs having gross income of less than ₹5 crores in each of the preceding two years, introduced by the Finance Act 2025, has also been provided for in section 332(5).

As under the current Act, the CIT has been empowered to condone delay in making of the application if he finds that it was for a reasonable cause. There is now a specific provision in section 332(6) to the effect that if an application for registration is not made within the specified time and the delay in filing such application is not condoned, the NPO shall be liable to pay tax on accreted income under section 352.

The provisions of current section 11(7), which prohibit claim of exemption under section 10 except certain specific sub-sections, and which provide a regime for one-time switchover from section 10(23C) to section 11, are continued in section 333.

3. CANCELLATION OF REGISTRATION

Section 12AB(4) of the current Act lists out the “specified violations” on the noticing of which, the CIT can cancel the registration of a trust, and the procedures for the same. Section 12AB(5) provides the time limit within which such order of cancellation, or refusal of cancellation, has to be passed.

Section 351 of the new Act now contains these provisions relating to specified violations, the procedure to be followed for cancellation and the time limits for passing of order by the CIT.

The list of specified violations is identical, except that it now covers violation of section 346. Section 346 deals with commercial activity by GPU trusts, and prohibits such activity unless carried out in course of GPU objects, aggregate receipts from such activity do not exceed 20% of total receipts of the regd NPO and separate books of account are maintained for such commercial activity. Therefore, if the receipts from commercial activity of a GPU trust exceed 20% of the aggregate receipts, this can result in cancellation of registration, which was not the position under the current Act.

4. COMPUTATION OF INCOME AND TAX LIABILITY

Section 334 provides that the tax payable by a regd NPO on its total income for a tax year shall be the aggregate of tax calculated at 30% of the specified income and calculated at the applicable rate for taxable regular income and residual income for the tax year.

As per section 334(2), the provisions of Chapter XVII would override all other provisions of the new Act, except the clubbing provisions contained in sections 96 to 98 of the new Act. Therefore, the computation provisions contained under the respective heads of income would not apply to a regd NPO. This is similar to the position prevailing under the current Act, where the CBDT had clarified vide its Circular No. 5-P (LXX-6) dated 19th June, 1968, that the income, for the purpose of computation of exemption, has to be taken on a commercial basis (as per books of account). One area of difference from the current Act would be in a situation where the entire income of the regd NPO is not exempt from tax, the income would be computed and taxed under this Chapter. Under the current Act, in some Tribunal decisions, a view had been taken that income which was not exempt was to be computed under the respective heads of income.

This would also mean that the tax computation contained in section 334 would apply irrespective of the nature of income. For instance, the tax on long term capital gains would be as per the provisions of section 334, and not at the rate of 12.5% prescribed under section 197 (section 112 of the current Act). Section 334 refers to the rate applicable on taxable regular income and any residual income. This rate is not spelt out in the new Act – it would probably be prescribed under the Finance Act each year. But, in case the regd NPO is a company, it will not be eligible for the concessional rate of tax for companies under section 200 (section 115BAA of the current Act).

A. Taxable Regular Income

Section 336 defines taxable regular income. Taxable regular income is nil, where 85% or more of the regular income has been applied or accumulated for charitable or religious purposes. Where less than 85% of the regular income has been applied or accumulated, the taxable regular income would be 85% of the regular income, less income applied for charitable or religious purposes or accumulated.

Voluntary contributions received by a regd NPO are included in the definition of income under section 2(49)(c).

B. Deemed Accumulated Income

This 15% of regular income (or unspent amount up to 15% where more than 85% of the regular income is spent), is treated as deemed accumulated income [section 343(1)]. As per the draft Bill, such deemed accumulated income was to be invested in modes permitted under section 350. This could have created difficulty, as such amount may not necessarily be available with the regd NPO (e.g. if 100 is donated to another regd NPO, 85% is treated as application and balance 15% may fall under deemed accumulation, but would not be available for investment, having already been donated). Fortunately, in the new Act, the provision is that if invested, it has to be invested in modes permitted under section 350 [current section 11(5)]. In other words, such investment is not mandatory, but only the modes of investment are mandatory. It is specifically provided in section 343(2) that deemed accumulated income is different from accumulated income under section 342 [current section 11(2)].

C. Exclusions from Regular Income

Section 338 provides that certain incomes shall not be included in the regular income. These are:

(a)  Income applied outside India where the CBDT has directed that such income shall not be included in the total income (i.e. income applied outside India with the approval of the CBDT). This approval can be granted for an NPO created before 1st April 1952 for charitable or religious purposes, or for an NPO created on or after 1st April 1952 for charitable purposes where such application of income outside India tend to promote international welfare in which India is interested.

(b) Corpus donations received by the regd NPO.

The language of the new Act in effect settles the controversy existing under the current Act as to whether, to claim exemption, the application has to be in India or charitable purposes has to be in India. The current Act uses the phrase “applied to such purposes in India”, which gave rise to this controversy. The Delhi High Court in National Association of Software & Services Companies, 345 ITR 362, had held that the application had to be in India, while the Karnataka High Court in Ohio University Christ College, 408 ITR 352, had held that the exemption was available if the purposes was in India. Since the new Act uses the term “income applied outside India”, where any application of income is to be made outside India, it would be excluded from income only if prior CBDT approval is obtained for such expenditure.

The exclusion of such income applied outside India (with CBDT approval) and corpus donations, implies that such incomes would not be considered for computing the deemed accumulated income of 15% (i.e. for computing 85% of regular income) in determining the taxable regular income.

D. Corpus Donations

“Corpus donation” is defined in section 339 to mean any donation made with a specific direction that it shall form part of the corpus of the regd NPO, provided that such donation is invested or deposited in one of the modes permitted under section 350 maintained specifically for such corpus. This is similar to the current section 11(1)(d), which requires investment of corpus donations in permitted modes and earmarking of investments.

E. Application of Income

What is considered as allowable application of income is contained in section 341. Sums applied for charitable or religious purposes in India for which the NPO is registered and paid during the year, are allowable as application of income. In case of donations paid to another regd NPO, 85% of the donations are allowable. If such donations are towards the corpus of the other regd NPO, the donation will not be allowable as application of income. As under the current Act, adjustments are required to be made for payments made out of corpus or out of loans or borrowings (not to be considered in the year of payment), and reinvestment back in corpus investments or repayment of such loan or borrowing (to be considered as application in the year of reinvestment or repayment). Cash payments exceeding ₹10,000 and amounts on which TDS which was deductible, but are not deducted, are not allowable as application of income. Similarly, deficit of earlier years is also not allowable as an application of income.

F. Deemed Application of Income- Option to Spend and Capital Gains

The option to spend income in subsequent year (or the year of receipt of income), currently contained in the explanation to section 11(1), which was proposed to be done away with in the draft Bill, has been finally retained in the new Act. This is contained in section 341(5), and is deemed to be an application of income. Similarly, the exemption for capital gains, currently in section 11(1A) of the current Act, which was also sought to be removed in the draft Bill, has been retained in the new Act. It will now be treated as a deemed application under section 341(9). Interestingly, while sub-section (8) of section 341 provides that application under sub-section (1) shall include deemed application where option is exercised under sub-section (5), similar provision is absent in respect of deemed application under sub-section (9) in respect of capital gains. However, the absence of such specific provision should not impact the allowability of capital gains as a deduction in computing taxable regular income.

G. Accumulated Income

As under the current Act, under the new Act also, a regd NPO has the option to accumulate its regular income for a period of up to 5 years. Here also, a form has to be filed stating the purpose and period of accumulation. The amount of accumulation has also to be invested in the modes permitted under section 350, as under the current Act.

Under the current Act, there has been a controversy raging for the last 34 years as to what can be stated to be the purposes of accumulation – whether some or all of the objects of the trust can be stated to be the purposes of accumulation has been a matter of litigation. Unfortunately, this controversy may continue even under the new law, given that it also does not bring about clarity on the issue.

On the contrary, a new issue could arise as to whether the accumulation can only be for a single purpose or whether it can be for multiple purposes, as permitted under the current law. This issue is on account of the use of the word in singular “purpose” in the new Act and not the plural “purposes” as in the current Act. It appears that the intention is not to restrict it to a single purpose, as the objective of the new Act is merely to use simpler language and not to bring about policy changes.

In the new Act also, change in purpose is permissible with the approval of the Assessing Officer (“AO”). Besides, the amount of accumulation cannot be utilized by donating to another regd NPO as under the current Act. Similarly, as under the current Act, on dissolution of the regd NPO, an application can be made to the AO to donate the amount of application to another regd NPO.

As mentioned earlier, the unspent accumulation or accumulation ceasing to be kept apart or that is donated to another regd NPO would be taxable as specified income.

5. COMMERCIAL ACTIVITY

Section 11(4) of the current Act applies to a business undertaking held in trust, and provides that the term “property held under trust” includes a business undertaking so held. Courts have taken the view that section 11(4) applied to a situation where the business itself was held in trust, while section 11(4A) applied in other cases where business was carried on. Therefore, the requirements of section 11(4A) of incidental business and separate books of account did not apply to cases covered by section 11(4). Section 344 of the new Act corresponds to section 11(4). It provides that where the property held by a regd NPO includes a business undertaking, and if a claim is made for benefits under these provisions, then the AO has the power to determine the income of such business undertaking as per the provisions of the new Act. The definition of “specified income” includes the addition made by the AO to the book income of such business undertaking – only the book income would qualify as regular income, eligible for deduction of application, deemed application and accumulation of income.

Under the current Act, the proviso to section 2(15) used the term “activity in the nature of trade, commerce or business or activity of rendering any service in relation to trade, commerce or business”. This applied only to trusts engaged in the object of advancement of general public utility (GPU trusts). Section 11(4A) used the term “business”. Section 11(4A) applies to both GPU trusts as well as non-GPU trusts. There was accordingly a distinction between the proviso to section 2(15), which uses broader terminology, and section 11(4A), which uses the term “business”. The new Act uses the term “commercial activity” in the context of both of these, and does not distinguish between these.

The term “commercial activity” has been defined in section 355(e) as means any activity in the nature of trade, commerce or business, or any activity of rendering any service in relation to trade, commerce or business, for a cess or fee or any other consideration, irrespective of the nature of use or application or retention of the income from such activity. This is identical to the language of the current proviso to section 2(15), which was interpreted by the Supreme Court in the case of ACIT(E) vs. Ahmedabad Urban Development Authority [2022] 449 ITR 1 (SC). In that case, the Supreme Court held that any activity in furtherance of GPU objects where there was substantial mark up over cost would be regarded as in the nature of trade, commerce or business.

Two sections apply to trusts carrying on commercial activity – section 346 deals with GPU trusts, and section 345 deals with non-GPU trusts. In case of GPU trusts, the position under section 346 is the same as was earlier prevalent under the proviso to section 2(15). It provides that a regd NPO, carrying on advancement of any other object of general public utility, shall not carry out any commercial activity unless:

(a) Such commercial activity is undertaken in the course of actual carrying out of advancement of any object of general public utility;

(b) The aggregate receipts from such commercial activity/activities do not exceed 20% of the total receipts of such regd NPO of the relevant tax year; and

(c) Separate books of account are maintained by such regd NPO for such activities.

Section 345, applicable to non-GPU trusts or activities, provides that a regd NPO (other than that referred to in section 346) shall not carry out any commercial activity, unless:

(a)  Such commercial activity is incidental to the attainment of the objectives of the regd NPO; and

(b) Separate books of account are maintained for such activities.

Section 345 was meant to be the equivalent of section 11(4A), with the difference that section 11(4A) as applicable to GPU trusts has been incorporated in section 346. However, section 11(4A) used the term “business”, as opposed to the term “activity in the nature of trade, commerce or business or activity of rendering any service in relation to any trade, commerce or business”, which is a much broader term. Given that the same definition of “commercial activity” would apply to both section 346 (GPU trusts) as well as section 345 (non-GPU trusts), which definition is identical to that contained in the current proviso to section 2(15), it appears that the same meaning which earlier applied only to GPU trusts would now apply to non-GPU trusts as well. The interpretation of the Supreme Court in the case of Ahmedabad Urban Development Authority (supra) may now apply not only to GPU trusts, but also to non-GPU trusts. Therefore, some activities of non-GPU trusts, which resulted in surplus but were not considered as business for the purposes of section 11(4A), may now be covered by section 345. This would require maintenance of separate books of account for such activities.

What are the consequences of violation of sections 345 or 346? Violation of either of these provisions is regarded as a “specified violation” under section 351(1)(b), which can result in cancellation of registration of the NPO. Under the current Act, while violation of section 11(4A) is a “specified violation”, which can attract cancellation of registration, applicability of the proviso to section 2(15) is not such a specified violation and does not result in cancellation of registration. Therefore, under the new Act, if a regd NPO carries on a GPU activity which results in substantial surplus, and the  gross receipts from such activity exceeds 20% of the total receipts of the NPO, its registration can be cancelled, with consequent applicability of tax on accreted income. This is a drastic change from the current position, where there is only a loss of exemption for the year. This seems to be an unintended consequence of merger of the proviso to section 2(15) with section 11(4A) in so far as GPU NPOs are concerned.

Besides, currently, section 13(8) read with section 13(10) provides that in case the proviso to section 2(15) is attracted, while exemption would not be available, only the net income of the trust would be taxable. Section 353(1), corresponding to current section 13(10), provides for taxation of net income of a GPU trust which has violated section 346. However, there is no similar provision for violation of section 345 by a non-GPU trust, which may suffer tax on its gross income.

6. COMPLIANCES

A. Books of Account

Currently, the exemption under sections 11 and 12 is subject to the requirements of section 12A. Clause (b)(i) of section 12A requires the maintenance of books and other documents in the form and manner and at the place, as may be prescribed, where the income exceeds the maximum amount not chargeable to tax. Violation of this condition can result in loss of tax exemption for the relevant year.

Under the new Act, section 347 contains the requirement to maintain the books of accounts and other documents in prescribed form and manner and at the prescribed place. Section 353 provides that the consequence of failure to maintain books of account under section 347 shall be that the regular income as reduced by the expenditure referred to in section 353(3) shall be the taxable regular income, i.e. in other words, the benefit of accumulation, deemed accumulation, deduction for capital expenditure, corpus donations and donations to other NPOs shall not be available. It may be noted that the consequence is only for failure to maintain books of account, and not failure to maintain other documents.

B. Audit

Similarly, current section 12A(b) requires accounts to be audited if the income is above the income exemption threshold limit and the audit report to be filed, in order to get the benefit of exemption. This requirement of audit is now contained in section 348, with the consequences of failure to get books of account audited contained in section 353(1) being taxation of net income without certain deductions, similar to the consequences
of failure to maintain books of account. Here also, section 353(1) is attracted only for failure to get the books of account audited, and not for failure to furnish audit report.

C. Return of Income

Under the current Act, under section 139(4A), a charitable or religious trust claiming exemption under section 11 is required to file a return of income, if its income (before exemption under sections 11 & 12) exceeds the threshold exemption limit. This obligation is now contained in section 263(1)(iii) of the new Act, which requires a person other than a company or a firm to file its return of income if its income (before  giving effect to provisions of Chapter XVII-B)  exceeds the maximum amount not chargeable to tax (“threshold limit”). Current section 139(4C)(e) also requires institutions claiming exemption under clauses (iiiab), (iiiac), (iiiad), (iiiae), (iv), (v), (vi) and (via) of section 10(23C) to file their returns of income. Educational and medical institutions falling under the current clauses (iiiab), (iiiac), (iiiad), and (iiiae) of section 10(23C) would fall within the definition of “specified entity” under the new section 263(1)(iv) and will also be subject to the same obligation. There are no separate exemptions under the new Act corresponding to clauses (iv), (v), (vi) and (via) of the current Act, and these would therefore fall within the general exemption for regd NPOs, also covered by section 263(1)(iii).

Section 349 of the new Act provides that where the total income of a regd NPO exceeds the threshold limit, it has to furnish the return of income as per the provisions of section 263(1)(a)(iii) and (2), within the time limit allowed under section 263(1)(c). This time limit continues to be 31st October for persons whose accounts are required to be audited. Under the current Act, trusts are permitted to file returns within the time limits specified in sub-sections (1) and (4) of section 139 – i.e. even belated returns are permitted.

Section 353 provides that where any regd NPO fails to furnish its return under section 349, its taxable regular income shall be the net income without certain deductions (the same as in cases of failure to maintain books of account or failure to get books of account audited). Would this cover only cases of failure to file the return of income, or even delay in filing the return of income?  While section 353 refers only to failure to file a return under section 349, section 349 requires the return to be filed within the time allowed under section 263(1)(c). Therefore, even cases of delay may invite applicability of these provisions, unlike under the current law where filing of a belated return of income within the time limit under section 139(4) does not attract such consequence.

D. Permitted Modes of Investment

Section 350(1) of the new Act provides that the modes of investing or depositing the money under Chapter XVII-B shall be those specified in Schedule XVI. Section 350(2) further permits notification by the Central Government of other modes of investing or depositing money.

Schedule XVI lists out all the modes currently listed in section 11(5), including immovable property.
It even includes the other modes notified for the purposes of section 11(5) under rule 17C, such as units of mutual funds, equity shares of a depository, equity shares of an incubatee by an incubator, units of Powergrid Infrastructure Investment Trust, etc.

The permissible investments/deposits list in this Schedule also contains the exceptions which are currently listed under section 13(1)(d) and under clause (b) of the third proviso to section 10 (23C), such as:

(a) Assets held as part of the corpus as at 1st June 1973;

(b) Equity shares of a public company held by a university/educational institution/hospital/ medical institution as part of the corpus as of 1st June 1998;

(c) Bonus shares allotted on such shares held as corpus;

(d) Donations received and maintained in the form of jewellery, furniture or any other notified article;

(e) Any asset, other than those permitted under other clauses of this Schedule, if not held beyond one year from the end of the year in which the asset was acquired;

(f) Funds representing profits and gains of business.

Schedule XVI also has an interpretation clause, where various terms used in the Schedule are defined.

The consequences of violation of the provisions of section 350 are contained in S.No.4 of the table of specified income in section 337. It provides that any investment or deposit made in contravention of the provisions of section 350 out of any income, accumulated income, deemed accumulated income, corpus, deemed corpus or any other fund would be taxable as specified income in the year in which such investment or deposit is made.

Under the current provisions of section 13(1)(d), while exemption was lost on account of the impermissible investment to the extent of the impermissible investment, such loss of exemption could only be to the extent of income for the year. Therefore, if the gross income of the trust for the year was Rs 10 lakh, and an impermissible investment of Rs 1 crore was made out of the corpus or past accumulation, the income that could be taxed so far was only Rs 10 lakh (income for that year which suffered loss of exemption). Under the new Act, the entire Rs 1 crore would be treated as specified income and taxed at 30%. The consequences under the new Act are therefore far more stringent.

7. TAX ON ACCRETED INCOME

The provisions for tax on accreted income, a form of exit tax, currently contained in Chapter XII-EB, sections 115TD to 115TF, are now also part of Chapter XVII-B, being contained in section 352. The computation of accreted income is set out in the form of a formula in section 352(2). Section 352(4) contains a table specifying the cases attracting tax on accreted income, the specified date on which accreted income is to be computed, and the due date for payment of tax on accreted income in each case.

Delay in filing an application for renewal of registration continues to attract tax on accreted income, as under the current Act.

8. APPROVAL FOR PURPOSES OF SECTION 133 (CURRENT SECTION 80G)

The provisions for approval for purposes of section 133 (corresponding to section 80G of the current Act) is also contained in Chapter XVII-B in section 354. The conditions for such registration under the new section 354 are the same as those contained in section 80G(5), except that the condition contained in clause (i) that the income is not liable to income tax by virtue of section 11 and 12 or section 10(23C) is omitted.

Section 354(2) contains a table, stating the types of cases, time limits for furnishing application, time limit for passing the order and validity of approval in each case. These are the same as those contained in the current Act.

The requirement of filing a statement of donations and for furnishing a certificate to the donor in respect of such donations continues under the new Act.

9. PENALTY & FEES

The existing penalty and fees applicable to religious and charitable trusts continue under the new Act – penalty for provision of benefit to related persons (current section 271AAE, new section 445), penalty for failure to deliver statement of donations or furnish certificate to donors (current section 271K, new section 464), and fees for failure to deliver statement of donations or certificate to donors within time (current section 234G, new section 429).

CONCLUSION

All in all, while the general provisions relating to charitable and religious organisations have remained broadly the same, the manner in which some of the changes have been carried out could possibly cause difficulty in some cases. One hopes that these are just drafting mistakes, which will be corrected in the forthcoming Budget.

However, the complexity of the provisions and procedures relating to regd NPOs still continues, with harsh consequences for even minor mistakes. Under such circumstances, unless the provisions are really simplified and made more reasonable, the large scale litigation in this area of income tax is likely to continue.

In recent years, shareholder activism has emerged as a significant force reshaping corporate governance across the globe. This paper explores how active shareholders are increasingly pushing for greater transparency, accountability, and strategic realignment within companies. Shareholder activism now serves as a vital mechanism through which investors—particularly institutional and minority shareholders—exercise their rights to influence corporate policies, leadership decisions, and long-term strategies. The study demonstrates how activism enhances investor participation while acting as an important check on managerial discretion. It highlights the expanding role of institutional investors, the prevalence of proxy battles, and the growing impact of ESG-focused campaigns in redefining governance practices. Various forms of shareholder action are examined, including voting against management proposals, raising public concerns, engaging directly with boards, and seeking legal remedies where necessary. Special attention is given to the rise of ESG-driven activism, reflecting the shifting priorities of today’s investors. The paper also analyses the evolution of shareholder activism in India, shaped by regulatory reforms and changing market dynamics. Additionally, it considers the implications of activism for capital markets and discusses some potential drawbacks associated with shareholder interventions.

OBJECTIVES OF THIS RESEARCH ARTICLE

• To trace the historical development of shareholder activism globally and in India, identifying the major drivers behind its growth.
•  To explore how shareholders exercise influence through voting rights, proxy battles, litigation, engagement, and media campaigns.
•  To highlight in brief the limitations, potential misuse, and regulatory hurdles associated with shareholder activism.

RESEARCH METHODOLOGY

This study follows a qualitative, descriptive, and exploratory research design to analyze the role of shareholder activism in modern corporate governance. It relies entirely on secondary data sourced from academic journals, books, SEBI guidelines, the Companies Act, 2013, stewardship codes, and proxy advisory firm reports. Case studies such as Invesco–Zee, Tata Motors, and Elliott Management campaigns are examined to understand strategies and outcomes. Content and thematic analysis techniques are applied to categorize activism into governance, financial, proxy, legal, and ESG-driven forms. The study focuses on listed companies, with emphasis on India, while acknowledging limitations of secondary data reliability.

INTRODUCTION & CONCEPTUAL FRAMEWORK

Corporate governance refers to the framework of rules, practices, and processes through which companies are directed and controlled to ensure fairness, accountability, and protection of stakeholder interests. One of the most significant shifts in this field has been the rise of shareholder activism, which has redefined the relationship between companies and their investors. Traditionally, shareholders played a largely passive role, limited to receiving dividends and casting occasional votes. Today, however, they actively participate in shaping corporate policies and governance structures.
Shareholder activism represents deliberate and organized efforts by investors—whether individuals or institutions—to influence corporate decision-making. These efforts may take the form of private engagement with management, filing shareholder resolutions, launching public campaigns, or pursuing legal action. The objective extends beyond safeguarding shareholder value; it seeks to enhance governance standards, strengthen accountability, and promote sustainable long-term performance. Activists commonly focus on issues such as board independence, executive compensation, financial performance, ESG (environmental, social, and governance) practices, and corporate social responsibility.

Modern activism increasingly addresses pressing global concerns such as climate change, diversity, and business ethics, reflecting the evolving priorities of investors. By promoting transparency and accountability, shareholder activism acts as an effective system of checks and balances, discouraging managerial misconduct and unethical behaviour. It helps mitigate the agency problem—where managers prioritise personal gain over shareholder interests—by aligning corporate actions with the goals of shareholders and other stakeholders. Activism also compels companies to enhance disclosures on executive pay, related-party transactions, and risk management practices, thereby building investor confidence. Ultimately, it fosters ethical conduct, drives long-term value creation, and contributes to the development of a healthier and more resilient corporate ecosystem.

GLOBAL CONTEXT AND ORIGIN

Shareholder activism originated in the early 20th century in the United States, when minority investors began raising concerns over corporate mismanagement. It gained prominence in the 1980s during a wave of takeovers and restructuring led by activist investors and hedge funds, initially focusing on unlocking short-term financial gains. By the 1990s and 2000s, the scope of activism expanded, with institutional investors such as pension and mutual funds influencing corporate behaviour through proxy voting and shareholder resolutions. The 2008 global financial crisis further amplified calls for stronger governance, transparency, and risk management, solidifying activism as a mainstream mechanism for holding management accountable. More recently, activism has shifted toward environmental, social, and governance (ESG) issues, with investors demanding corporate responsibility and sustainability. While the U.S. and U.K. remain leaders due to strong regulatory frameworks, emerging markets like India, Brazil, and South Africa are witnessing growing activism, driven by legal reforms and rising investor awareness. Despite variations across regions, the core goal remains to enhance shareholder value while promoting ethical and sustainable business practices.

TYPES OF SHAREHOLDER ACTIVISM

Shareholder activism has evolved into a diverse and powerful mechanism through which investors influence corporate governance, strategy, and performance. Governance activism seeks to strengthen internal governance frameworks by advocating changes in board composition, removing underperforming directors, appointing independent directors, and enhancing board diversity, often urging separation of the CEO and Chair roles to avoid concentration of power. Its primary aim is to improve board oversight, promote accountability, and protect minority shareholder rights, thereby preventing mismanagement and insider abuse. Financial or performance-based activism, typically driven by hedge funds and institutional investors, focuses on unlocking value through restructuring, divestment of non-core assets, spin-offs, improving cost efficiencies, or revising dividend and buyback policies. Proxy activism leverages shareholder voting rights to challenge management proposals, propose resolutions, and mobilize support to influence decisions on mergers, executive pay, or governance reforms, often resulting in board changes or blocking unfavourable actions. Legal activism uses courts and regulators to address fraud, insider trading, related-party transactions, or breaches of law, with frameworks like India’s Companies Act, 2013 and SEBI rules strengthening minority protection. ESG activism, now a global trend, pushes companies toward responsible practices by demanding lower carbon emissions, improved labour standards, greater diversity, and transparent sustainability reporting, aligning business strategies with long-term societal goals. Public or media-based activism amplifies pressure by publishing open letters, releasing reports, or using social media to mobilize investor and public opinion, forcing management to act when private engagement fails. Collaborative activism, by contrast, relies on constructive dialogue between investors and management to achieve gradual improvements in governance and ESG practices without confrontation, fostering long-term relationships. Hostile or aggressive activism represents the most confrontational form, where shareholders acquire significant stakes to force major changes such as board replacement, management overhaul, or mergers, combining proxy fights, litigation, and public campaigns to achieve results. While sometimes criticized for prioritizing short-term gains, this approach can catalyse rapid reform in poorly governed companies, as seen in Carl Icahn’s 2013 campaign against Dell Inc., where he opposed Michael Dell’s buyout plan, rallied shareholder support, and used aggressive tactics to influence the outcome. Together, these forms of activism reflect the expanding role of shareholders as catalysts for accountability, strategic realignment, and sustainable value creation.

MECHANISMS & TOOLS OF SHAREHOLDER ACTIVISM

HOW SHAREHOLDERS INFLUENCE DECISIONS

Shareholder activism mechanisms empower investors to influence corporate decisions through voting, engagement, proposals, litigation, and campaigns, aiming to enhance governance, accountability, transparency, and long-term shareholder value within companies. The following table encapsulates the mechanisms and tools of shareholder activism –

Table 1 – Mechanisms & Tools of Shareholder Activism, Source – Authors

ROLE OF PROXY ADVISORY FIRMS

Proxy advisory firms are independent entities that analyze corporate governance matters and provide voting recommendations to institutional investors. They play a vital role in influencing shareholder decisions, particularly in large publicly listed companies where ownership is widely dispersed and no single investor has controlling power. Globally, leading players include Institutional Shareholder Services (ISS) and Glass Lewis, while in India, prominent firms include InGovern Research Services, Stakeholders Empowerment Services (SES), and Institutional Investor Advisory Services (IIAS). The primary function of proxy advisors is to evaluate shareholder proposals—covering issues such as board appointments, executive pay, mergers and acquisitions, and ESG-related resolutions—and issue voting recommendations. Since institutional investors oversee vast pools of capital and may lack the resources to thoroughly analyze every agenda item, these recommendations often exert significant influence on final voting outcomes.

Table 3 – Examples for Indian Proxy Advisors, Source – Authors

 

USE OF SOCIAL MEDIA & TECHNOLOGY

Social media and digital technology have become powerful tools for shareholder activism, enabling investors to communicate, coordinate, and influence corporate decisions more effectively than ever. Activists now use platforms like Twitter, LinkedIn, YouTube, and dedicated campaign websites to directly engage both institutional and retail shareholders. These channels serve multiple purposes. They simplify complex corporate issues, making it easier for small investors to understand and participate in voting. They also support pressure campaigns, using public exposure and reputational risk to push companies to address governance lapses or strategic errors. Additionally, they allow activists to shape narratives and influence investor sentiment ahead of key events such as Annual General Meetings (AGMs). Real-world cases highlight this trend. In the U.S., Tesla shareholder activists have used Twitter to advocate for greater board independence and stronger governance. In India, retail investors on Telegram and WhatsApp have coordinated AGM voting strategies, enabling dispersed shareholders to act collectively and increase their influence.

ROLE OF INSTITUTIONAL & RETAIL INVESTORS IN SHAREHOLDER ACTIVISM

Shareholder activism refers to the efforts of investors to influence a company’s policies, governance practices, and strategic direction by exercising their rights as owners. In recent years, activism has surged globally, reflecting the growing influence of shareholders in shaping corporate decisions. Both institutional investors—such as mutual funds, pension funds, and insurers—and retail investors—individual shareholders increasingly active through digital trading platforms—play important but distinct roles in this transformation. The following section explores how each group contributes to activism, the growing influence of retail shareholders, and the relative strengths and limitations of each.

INSTITUTIONAL INVESTORS IN SHAREHOLDER ACTIVISM

Institutional investors now play a central role in corporate governance due to the significant stakes they hold in publicly listed companies. Their large shareholdings give them considerable voting power, allowing them to influence outcomes at shareholder meetings far more effectively than dispersed retail investors. Unlike individuals, institutional investors engage actively in “stewardship” activities, monitoring the companies they invest in and intervening when governance or performance concerns arise. Their influence is most visible through proxy voting, where they routinely support or oppose proposals on executive compensation, mergers, board composition, and governance reforms. Many major asset managers have adopted formal policies to vote against boards that fail on critical issues such as diversity, independence, or ESG performance. Because institutional investors—particularly index funds—typically hold long-term positions, they often prefer engagement over divestment, using private discussions, open letters, voting campaigns, and even collaborations with activist hedge funds to drive change. Regulatory reforms have further encouraged institutional participation. For instance, India’s stewardship codes mandate institutional investors to monitor investee companies and engage constructively with management, signalling a shift from passive shareholding to proactive governance oversight.

RETAIL SHAREHOLDERS AND ACTIVISM

Historically, retail investors were considered passive participants in corporate governance, exhibiting what is often called “rational apathy”—the reluctance to invest time and resources in voting given their relatively small stakes. Traditionally, only about 25% of retail-owned shares were voted, compared with over 90% for institutional investors. However, this pattern is changing. Since 2020, retail participation in equity markets has surged worldwide, including in India, where retail investors’ share of NSE trading volumes rose from 33% pre-2020 to over 45% by 2023. Many of these new investors are younger, more financially aware, and increasingly willing to engage with corporate governance issues. Nonetheless, retail activism faces challenges: holdings are fragmented, coordination is difficult, and many investors lack the time or expertise to assess complex matters such as mergers or board nominations. Technology is helping to overcome these barriers. Social media platforms like Reddit, Twitter, and investor forums now enable retail shareholders to share information, coordinate voting, and exert collective influence. Online voting systems have also simplified participation, reducing procedural hurdles and making corporate engagement more inclusive.

EMERGING TRENDS & DIMENSIONS OF SHAREHOLDERS’ ACTIVISM IN CORPORATE GOVERNANCE

Shareholder activism, once confined to concerns over dividends and board appointments, has evolved into a powerful driver of global corporate governance. Over the past decade, the scope of activism has broadened significantly, with both institutional and retail investors now engaging on deeper issues such as sustainability, ethical leadership, executive compensation, and board diversity. This shift reflects a move from purely profit-driven motives to purpose-driven investing. A major dimension of this evolution is the rise of Environmental, Social, and Governance (ESG) activism. Shareholders increasingly demand reduced carbon footprints, enhanced gender and ethnic diversity, respect for human rights across supply chains, and stronger governance standards. These demands are not merely symbolic—they are backed by shareholder resolutions, proxy voting, and public campaigns. Executive pay has also become a focal point, with investors pressing for pay-performance alignment, tying incentives to ESG targets, increasing transparency in stock options, and curbing excessive compensation. Retail investors, empowered by digital platforms, online voting tools, and social media, have emerged as an influential force. They collaborate, participate in AGMs, submit resolutions, and raise governance issues publicly, effectively democratizing shareholder activism beyond large institutional funds. Companies that resist these evolving expectations face reputational damage, investor exits, and even leadership challenges, whereas those that embrace transparency, sustainability, and shareholder engagement are better positioned to achieve long-term competitive advantage. The convergence of ESG priorities, executive pay scrutiny, retail investor empowerment, and assertive hedge fund campaigns underscores how shareholder activism has become a multidimensional force—shaping financial performance while driving corporate accountability, inclusivity, and sustainable value creation.

IMPACT OF SHAREHOLDER ACTIVISM ON THE SECURITIES MARKETS

Shareholder activism plays a pivotal role in shaping securities markets by fostering stronger corporate governance, greater transparency, and enhanced accountability. Activist interventions often prompt strategic shifts—such as restructuring, capital reallocation, or changes in leadership—that can boost investor confidence and attract new capital. These developments frequently lead to short-term stock price gains as markets anticipate improved performance. At the same time, activism can introduce volatility, particularly when campaigns become contentious or create uncertainty about a company’s future direction. Over the long run, however, activism generally strengthens corporate efficiency, supports sustainable growth, and aligns business decisions with the interests of both shareholders and stakeholders, ultimately contributing to healthier and more resilient markets.

RISKS AND CHALLENGES OF SHAREHOLDER ACTIVISM IN INDIA

Shareholder activism is increasingly recognised as an important tool for strengthening corporate governance in India, yet it faces significant challenges due to the country’s unique ownership patterns, regulatory environment, and market conditions. One major concern is short-termism, as some activists push for quick returns, pressuring management to focus on quarterly results at the expense of long-term investments in research, innovation, and expansion. The promoter-dominated structure of most Indian companies further limits the impact of activism, as controlling families often hold majority stakes, making it difficult for minority shareholders—even with institutional backing—to effect meaningful change. Proxy advisory firms, though influential, may issue recommendations based on incomplete data or face conflicts of interest, potentially distorting voting outcomes. Legal barriers add to these challenges: under the Companies Act, shareholders must hold at least 10% ownership to initiate mismanagement cases, a threshold many retail investors cannot meet, while slow judicial processes weaken timely intervention.

Activism also carries the risk of misuse. Some investors may spread misleading information, engage in “empty voting” by temporarily acquiring shares, or pursue agendas that harm market fairness. ESG activism, though rising, sometimes results in symbolic compliance, with companies adopting check-the-box measures rather than implementing meaningful environmental or social reforms. Furthermore, activist campaigns can trigger internal board conflicts, delay decision-making, and lead management to adopt defensive measures that reduce transparency. At a broader level, high-profile activist campaigns can create market volatility, impose significant financial and reputational costs, and distract companies from core operations. In some instances, activism may even be initiated by competitors seeking to disrupt business, undermining long-term shareholder value and employee morale.

Thus, while shareholder activism has the potential to improve governance and protect investor interests in India, it requires balanced regulation, transparency, and responsible engagement to prevent misuse, safeguard long-term value creation, and maintain trust in corporate systems.

CASE STUDY: INVESCO VS. ZEE ENTERTAINMENT ENTERPRISES LIMITED

The clash between Invesco and Zee Entertainment Enterprises Ltd. (ZEEL) is one of India’s most notable cases of shareholder activism, highlighting the rising assertiveness of institutional investors in demanding accountability and transparency when shareholder value is at risk. In 2021, Invesco Developing Markets Fund, which owned 17.88% of ZEEL, raised concerns over weak governance practices, related-party transactions, lack of transparency, and what it perceived as strategic drift under CEO Punit Goenka. With ZEEL’s stock underperforming and concerns about promoter dominance growing, Invesco requisitioned an Extraordinary General Meeting (EGM) seeking the removal of Goenka and two other directors, while proposing six independent directors to improve oversight and governance. ZEEL’s board rejected the requisition, questioning its legality and the nominees’ suitability, escalating the matter into a legal battle before the Bombay High Court. During the standoff, ZEEL announced a merger with Sony Pictures Networks India, seen as a strategic move to secure Goenka’s position and counter Invesco’s challenge. Invesco ultimately withdrew its EGM request, viewed as a tactical retreat rather than a defeat. The episode underscored the influence of institutional investors, the challenges of activism in promoter-driven companies, and the potential of activism to reshape governance and corporate strategy.

CASE STUDY: ELLIOTT MANAGEMENT CORPORATION

Elliott Management Corporation, founded by Paul Singer, is one of the world’s most influential activist hedge funds, known for its assertive and highly strategic campaigns to influence corporate direction. The firm typically acquires significant minority stakes in underperforming or undervalued companies and then pushes for changes aimed at unlocking shareholder value. Elliott’s approach combines private negotiations with public activism, often through open letters, proxy battles, and, when necessary, litigation. Its philosophy revolves around identifying structural inefficiencies, governance weaknesses, or flawed strategies and advocating for reforms such as divestitures, leadership changes, capital reallocation, or improved shareholder returns. Unlike passive investors, Elliott is prepared for prolonged engagements, sometimes holding its positions for years until meaningful reforms are implemented. A well-known example of Elliott’s activism was its 2019 campaign against AT&T. After building a $3.2 billion stake, Elliott released a detailed letter criticizing AT&T’s acquisition strategy and capital deployment, urging a strategic review including asset sales and cost-cutting measures. The pressure prompted AT&T to announce a three-year plan to streamline operations, reduce debt, and refocus on core businesses. Similar campaigns at Twitter, SoftBank, and Hyundai Motor further underscore Elliott’s reputation as a determined, sophisticated activist capable of driving significant governance and strategic change.

WAY FORWARD FOR CORPORATE GOVERNANCE IN INDIA

Corporate governance in India has made notable progress in recent years with the introduction of stronger laws, SEBI regulations, and increasing investor awareness. Yet, further reforms are essential to make governance more transparent, effective, and geared toward long-term value creation. Strengthening the role of independent directors is a key priority. While they are tasked with protecting shareholder interests, many are neither fully independent nor actively engaged. A more transparent appointment process, coupled with regular training and capacity-building programs, would ensure they discharge their duties responsibly. Enhancing shareholder participation, particularly for retail investors, is equally important. Companies should leverage digital platforms—such as e-voting and virtual meetings—to simplify participation and enable small investors to influence decisions meaningfully. Legal processes also require streamlining. Lowering the minimum shareholding threshold for filing complaints and establishing faster, cost-effective dispute resolution channels would empower minority investors to raise concerns without delay. Stronger coordination between regulators like SEBI and the MCA is necessary to improve monitoring and ensure swift enforcement of governance standards. Finally, integrating ESG principles into board strategies, encouraging ethical leadership, and promoting investor education will foster a culture of good governance, ultimately boosting trust, competitiveness, and long-term corporate performance.

CONCLUSION

Shareholder activism has evolved into a powerful force in modern corporate governance, moving far beyond passive voting at annual general meetings to include proxy contests, litigation, public campaigns, and direct engagement with management. Both institutional and retail investors are now demanding greater transparency, accountability, and long-term value creation, making activism not only a reaction to governance lapses but also a catalyst for sustainable business practices. By holding boards and executives accountable, activism encourages responsible decision-making and strategic realignment that aligns with stakeholder interests. However, activism must be balanced carefully, as excessive pressure can lead to short-term decision-making or hinder long-term growth initiatives. In India and globally, its success will depend on strong regulatory frameworks, informed and active shareholders, and companies’ willingness to engage in constructive dialogue. Ultimately, shareholder activism reinforces the principle that corporations are not merely vehicles for profit but engines of sustainable value creation—representing both a challenge and an opportunity in today’s dynamic corporate landscape.

REFERENCES –

Marco Becht, Patrick Bolton, Ailsa Röell, (2003), Chapter 1 – Corporate Governance and Control, Handbook of the Economics of Finance Volume 1

https://www.sciencedirect.com/science/article/abs/pii/S1574010203010057

Kose John, Lemma W Senbet, (1998), “Corporate governance and board effectiveness”, Journal of Banking & Finance

https://www.sciencedirect.com/science/article/pii/S0378426698000053

Kevin Chuah, Mark R. DesJardine, Maria Goranova and Witold J. Henisz, (2024), “Shareholder Activism Research: A System-Level View”

https://journals.aom.org/doi/abs/10.5465/annals.2022.0069

Emma Sjostrom, (2008), “Shareholder activism for corporate social responsibility: what do we know?”

https://onlinelibrary.wiley.com/doi/abs/10.1002/sd.361

Ulya Yasmine Prisandani, (2021), “Shareholder activism in Indonesia: revisiting shareholder rights implementation and future challenges”

https://www.researchgate.net/profile/Ulya-Yasmine Prisandani/publication/354390418_Shareholder_activism_in_Indonesia_revisiting_shareholder_rights_implementation_and_future_challenges/links/6699e87202e9686cd10dc3b3/Shareholder-activism-in-Indonesia-revisiting-shareholder-rights-implementation-and-future-challenges.pdf

The Income-tax Act, 2025 replaces the 1961 law, effective from 1 April 2026, with the stated aim of simplification, modernisation, and digital alignment. It introduces a single “Tax Year”, logical reorganisation of provisions, removal of redundant clauses, and greater use of tables and formulae. The Act codifies faceless governance, modernises residence rules, streamlines assessment timelines, strengthens dispute resolution, and consolidates deductions and retirement benefits. It explicitly taxes Virtual Digital Assets (VDAs) and empowers authorities to access digital space during searches. While the Act improves readability and aligns with global practices, critics argue it largely preserves old complexities. Transitional provisions on losses, MAT credits, and incentives may trigger litigation. Key pain points—complex TDS/TCS rules, refund delays, weak taxpayer rights, and lack of automatic indexation—remain unresolved. Thus, the Act represents progress in design and digital readiness but is viewed as a missed opportunity for deeper structural reform.

 

The Income-tax Act, 2025(‘Act’) is introduced as a significant legislative reform in India’s direct tax landscape, replacing the six and a half decade old Income-tax Act, 1961(‘ITA’). While the core
principles of taxation and the scheme of taxation of income remain broadly the same, the 2025 legislation has the objective of introducing clarity, simplicity, and modernity to align with present-day business realities and digital compliance needs. The focus of the Act is on reducing complexity, consolidating provisions, and strengthening the governance framework.

It has attempted to improve taxpayer access and compliance by reorganising provisions logically besides removing obsolete provisions, consolidating duplicate rules, harmonising definitions, and introducing a formal “tax year” concept to align administrative and accounting practices. Special emphasis on use of plain English, sequential numbering, avoiding alphanumeric clauses is clearly visible.

The Act comes into effect from 1 April 2026 (Tax Year 2026-27 onwards). It contains the mandatory transitional provisions that ensures the continuity for pending matters under the ITA. It saves the applicability of the otherwise repealed provisions of the ITA for the ongoing assessments, appeals, and proceedings pending or initiated under the ITA, which will continue under the old law until concluded. New filings and compliances w.e.f. 1^st April 2026 will fall under the framework of the Act. This phased transition has the effect of ensuring stability and avoiding disruption for taxpayers and the administration.

In 2017, the Prime Minister proposed replacing the Income-tax Act, 1961, echoing Kanga and Palkhiwala’s concern in their Eighth Edition of 1990, warning that excessive amendments had made the law a “national disgrace”. The revered authors also cautioned against mistaking constant change for progress and stressed stability in fiscal policy. The 2025 Act, while not a radical departure, represents a modernization of direct tax law. It emphasizes simplicity, digital readiness, global alignment, and dispute reduction. Key features include the tax year, consolidated deductions, faceless governance, and recognition of digital assets. Though concerns remain over search powers and delegated legislation, the Act promises clarity, stability, and reduced complexity.

For statistically oriented readers, the Timeline of the journey of the Bill to Act in 2025 is tabulated below:

The important recommendations of the PSC that made it into the final Act are consolidation of the faceless schemes and administration, enabling powers of the search party to access the virtual digital space, clarifying the rules for the tax treaty interpretation for undefined terms, need for DRP to pass a reasoned order, maintaining the status quo for determination of the annual value of the vacant house property, saving small taxpayers from penalties and continuity of rates and structure. The Legislature accepted the suggestions that the act of fixing the drafting anomalies in the ITA under the Act should not be construed as a policy change and the core architecture of the ITA is retained.

Structurally, the Act reorganises chapters and sections to group related concepts (residence, charge, exemptions, computation, assessments, appeals and penalties) in a more logical order. The Act replaces many legacy cross-references with self-contained provisions and removes archaic language.

A visible drafting change is sequential numeric sectioning (no “80C(a)(i)”) and an attempt to shorten and standardise definitions. The section count changed (some commentators note fewer words but reorganised numbering), but substance is largely intended to be continuous with earlier law unless expressly altered. The Act also reorganises timelines for assessment, reassessment and collection to be more consistent with modern IT systems and taxpayer needs.

Use of tables (increased to 57 from 18) and formulae (increased to 46 from 6) and illustrations in many sections instead of long textual (proviso/explanation) clauses are laudable and will have the effect in simplifying the otherwise complex provisions of law. This is intended to make computation / interpretation more straightforward. More use of schedules to group related items, clearer definition sections make the law easier to understand. Explanations / provisos are replaced by sub-sections or clauses, making the law modular.

Income tax in India began in 1860 to meet post-1857 financial needs, evolving through license and certificate taxes, and regular income tax in 1869, which was soon abolished. The 1886 and 1918 Acts formalized taxation, introducing six heads of income. The 1922 Act centralized administration, and was later replaced by the Income-tax Act, 1961, which became dense, amendment-heavy, and litigation-prone. Attempts to replace it with the Direct Tax Code (2012) failed. The Task Force appointed attempted to draft a modern, simplified tax law addressing global practices, faceless assessments, compliance reduction, and dispute minimization. The Income-tax Act, 2025 was enacted, modernizing and replacing the 1961 framework.

Territorial connection, and extraterritorial operation of the Act. The Bill introduced as a Money Bill, on enactment is made applicable to the whole of India, including the Union territories and the state of Jammu & Kashmir, as also to the Continental Shelf of India and the Exclusive Economic Zone of India for the extraction and production of mineral oils and the specified services, with the intended application to extra-territorial transactions. The extra-territorial operation of some of the deeming provisions of the Act should not render such provisions invalid or ultra vires the Indian legislature. Given a sufficient territorial connection or nexus between the person sought to be charged and India, levy of income-tax is validly extended to that person in respect of his foreign income. Like under the ITA, once the connection to the Indian territory is real, its extent is not relevant in considering the validity of the legislation. The connection under the Act is founded on the residence of the person or business connection within the Indian territory and the situation within India, of the money or property from which the taxable income is derived. These factors of the Act are sufficient to establish a territorial connection.

Constitutional validity: At first blush, the Act imposing the tax is constitutionally valid in as much as it has been passed by the legislature that was competent to pass it; and does not prima facie in its overall form contravene any of the fundamental rights guaranteed by Part III of the Constitution. Being a law relating to economic activities, it will be viewed with greater latitude than laws touching civil rights, such as freedom of speech, freedom of religion, etc. Unless and until a Court declares any provision to be ultra vires, the Act appears to be constitutionally valid and would be treated as such. In any case, there is always a presumption in favour of the constitutionality of a statute passed by the legislature, and the burden is upon him who attacks it to show that there has been a clear transgression of the constitutional principles.

Legislative Competence: In ‘pith and substance’ the legislation passed falls within the Seventh Schedule, List I and III of the Constitution of India. The four essential ingredients in a taxing statute namely: – (a) subject of tax; (b) person liable to pay the tax; (c) rate at which tax is to be paid, and (d) measure or value on which the rate is to be applied, are present in the Act. The Act that has been passed by the Legislature is within its competence to levy tax. Provisions carry the mechanisms and machinery for assessment of income and do not appear to be arbitrary. Provisions of presumptive taxation provide for opting out. Adequate transitional provisions are put in place and the classifications appear to be fair and reasonable. It contains the necessary machinery for levy of tax and its collection.

Article 246 read with Entry 82 of List I; Seventh Schedule of the Constitution empowers Parliament to levy taxes on income other than agricultural income. Article 265 requires that no tax be levied or collected except by authority of law. The 2025 Act, being a duly enacted parliamentary statute, satisfies this requirement. Article 14 (Equality clause) and Article 19 (1) (g) (Right to trade) place limits: taxation must not be arbitrary, discriminatory, or confiscatory. Classification for taxation under the Act appears to be valid as it is based on an intelligible differentia and has a rational nexus with the object of the law.

Thus, while particular provisions may face judicial scrutiny (especially transitional and incentive-related clauses), the Act as a whole stands on solid constitutional footing.

The Act is Exhaustive: The Act is Exhaustive in as much as it is a self-contained code, exhaustive of the matters dealt with therein. It however does not override the power of the Supreme Court under Article 32 of the Constitution, and of the High Courts under Article 226 of the Constitution, to issue, in appropriate cases, writs in the nature of certiorari, prohibition or mandamus or other directions or orders to examine the vires of the Act.

CONCEPTUAL & IMPORTANT CHANGES

1. Structural Overhaul and Simplification: The most visible feature of the Act is the streamlined structure. The ITA had around 819 sections spread across 47 chapters with a word count of nearly 500,000. The Act consolidates the provisions into 536 clauses under 23 chapters, reducing the word count to approximately 260,000.

•  About 650 Provisos and 490 Explanations have been eliminated and are replaced by formula-based and tabular presentation wherever possible and/or are captured as sub-sections and sections.
•  Presentation of the chapters follows a more logical sequence by first covering charging, compliance, assessments, TDS, TCS, taxes, recovery and dispute resolutions including the appeals followed by the penalty and prosecutions chapters in a linear manner.
•  The simplification reduces interpretational ambiguities and ensures easier navigation for taxpayers, practitioners, and judicial authorities.

This design move alone is expected by the Government to improve compliance and cut down on litigation, which was often driven by complexity and multiple provisos.

2. Introduction of the “Tax Year”: One of the most important conceptual innovations is the replacement of the dual concept of “Previous Year” and “Assessment Year” with a unified “Tax Year.”

•  Under the old regime, income was earned in the “Previous Year” but taxed in the “Assessment Year.”
•  The new Act simplifies this by taxing income in the same Tax Year in which it accrues or arises.

This global best practice reduces confusion for taxpayers and aligns India with international tax systems. It also eliminates several interpretational disputes that arose from mismatches between the two years.

3. Emphasis on Digital Governance and Faceless Regime: The Act codifies India’s transition towards technology-driven administration.

•  Faceless assessments, reassessments, appeals, and penalty proceedings are given a consolidated statutory foundation.
• All schemes for reducing interface between taxpayers and officials are brought under one enabling provision, subject to parliamentary oversight.
• E-filing of reports, returns, online payment of taxes, and digital communication of notices and responses are made the norm, reinforcing transparency and reducing subjectivity.

This shift supports the government’s vision of “minimum government, maximum governance” in tax administration.

4 Scope of taxation: One important conceptual strand in the Act is emphasis on “taxation on receipt” for certain items, and clearer rules for deemed income; the Act expressly addresses the issue of when income is to be treated as arising or being received. This clarity is intended to limit disputes over accrual versus receipt.

5. Residence: Residence rules have been rewritten to reflect modern mobility. The definitions and thresholds for residence and ordinarily resident status are rationalised to reduce uncertainty for digital nomads, expatriates and cross-border workers. Practitioners must check transitional rules carefully for individuals who change residence around the enactment date.

6. Deeming fictions: For particular classes of income (certain transfers of capital assets, stock-in-trade receipts from specified persons/entities) the Act contains express deeming provisions to tax amounts on receipt or on specified events — a shift intended to close gaps that previously caused mismatch and litigation.

7. Timelines and procedures for assessment, etc: The Act shortens and clarifies assessment and reassessment timelines, introduces clearer grounds and procedures for reopening assessments, and puts emphasis on pre-deposit and fast track dispute resolution mechanisms in some categories. It requires dispute panels to state points of determination and reasons for decisions.

These procedural changes aim to reduce lengthy litigation and multiple revisits of facts, but they also shift pressure onto initial fact-finding and show-cause stages. If case records are incomplete or notices poorly drafted, taxpayers may face hard choices within shorter windows.

8. Expanded Search and Seizure Provisions: The Act modernizes the powers of the revenue authorities in conducting the search and seizure operations.

•  The Act explicitly empowers officers to access “virtual digital space” during searches.
•  Tax authorities can access emails, social-media accounts, online trading platforms, and cloud storage, even by bypassing access codes.
•  These powers aim to curb tax evasion in an era where digital transactions are widespread.

While such provisions strengthen enforcement, they also raise privacy and constitutional concerns, requiring careful implementation and judicial oversight.

9. Virtual Digital Assets (VDAs) Brought Within the Net: Unlike the ITA, the new law explicitly recognizes Virtual Digital Assets (VDAs) such as cryptocurrencies, NFTs, and digital tokens as capital assets or stock-in-trade.

•  VDAs are included in the definitions of “property” and “income.”
•  They are also covered under provisions relating to undisclosed income and search powers.
•  The Act, while explicitly widening the coverage for “virtual digital assets” (VDAs), cryptocurrencies and income generated through online platforms, aims to update the tax-base, define reporting obligations, and (in some cases) prescribe withholding rules. The aim is to reduce ambiguity that existed under piecemeal amendments to the ITA.
•  Simultaneously, withholding, reporting and data exchange rules are strengthened to leverage digital reporting (AIS, TDS/TCS modernisation). Practical implementation depends heavily on IT systems and data quality. That reliance both enables better compliance and creates operational risk if systems or guidance lag.

By acknowledging digital wealth, the Act ensures that taxation keeps pace with financial innovation, while providing clarity to investors and businesses dealing in such instruments.

10. Rule-Making Powers and Delegated Legislation: The Act strengthens the hands of the Central Board of Direct Taxes (CBDT).

•  CBDT has been given wider authority to frame schemes, rules, and notifications to operationalise provisions.
•  This reduces the need for constant legislative amendments while ensuring adaptability to changing circumstances.

At the same time, these rules must be placed before both the houses of the Parliament, preserving accountability and checks on delegated legislation.

11. Rationalisation of Deductions and Exemptions: The Act consolidates numerous deductions and exemptions which were earlier scattered across multiple sections.

•  Benefits relating to gratuity, leave encashment, voluntary retirement, and commuted pension are grouped under one head for ease of reference.
•  Deductions under sections like 80G (donations) and 80TTA/80TTB (interest income) are rationalised and clarified.
•  Formula-based ceilings and tabular presentation make the provisions more user-friendly.

This rationalisation reduces duplication and ensures that taxpayers understand eligibility in a straightforward manner.

12. Modernised Dispute Resolution Framework: The Act seeks to address the chronic problem of tax litigation through enhanced dispute resolution mechanisms.

•  The Dispute Resolution Panel (DRP) must now record specific points for determination and provide reasoned directions.
•  Provisions for Dispute Resolution Committees (‘DRC’s) offer relief to small taxpayers by enabling faster settlements.

By providing multiple forums and streamlining procedures, the Act aims to reduce prolonged litigation and increase certainty.

13. Anti-Avoidance and International Taxation: The General Anti-Avoidance Rule (GAAR) has been retained but clarified. Arrangements lacking commercial substance and aimed primarily at tax benefits will be disregarded.

•  Treaty interpretation is codified: if a term is undefined in the treaty, the Act, or relevant notifications, it’s meaning may be sourced from other central laws.
•  The Act attempts to update many international tax linkage points: residence tests, source rules, permanent establishment concepts and rules addressing cross-border digital supplies. It attempts to harmonise domestic law with BEPS/follow-up OECD standards and recent treaty models, but practical divergence and map-ping to treaty text will remain a complex exercise.
• Issues will arise in interpreting domestic withholding obligations where treaties provide differing attribution rules; practitioners should watch guidance on treaty override, operation of tax credits and thin-capitalisation or withholding rules that interact with treaty relief.
• This hierarchy of interpretation provides clarity and consistency in cross-border tax matters.

Such provisions strengthen India’s stance against aggressive tax planning while ensuring harmony with international tax laws.

14. Privacy, Safeguards, and Checks: While the Act grants sweeping powers for search and seizure, including access to digital devices, it simultaneously emphasizes transparency and accountability.

•  Schemes for faceless procedures must be notified and laid before Parliament.
•  The DRP’s requirement of speaking orders increases judicial discipline.
•  Penalties are rationalised to ensure that taxpayers are not punished for minor or technical defaults.

Balancing enforcement with rights protection remains a key theme of the new Act.

15. Pension and Retirement Benefits: Retirement benefits have been streamlined for clarity.

•  Provisions relating to pension, gratuity, and commuted pension are now consolidated.
•  Exemptions are clearly defined with formula-based thresholds and moved into schedules for easier reference.
•  The Act ensures that salaried employees and retirees can understand their entitlements without navigating through scattered provisions.

This will benefit senior citizens, a category often affected by interpretational challenges under the old law.

16. Transition: The devil lies in the details. Any new codification requires transitional rules. The Act contains express transitional provisions for pending assessments, appeals, unabsorbed losses, credits, and ongoing litigations. These provisions are crucial because they determine whether prior tax positions will be preserved or reinterpreted under the new drafting.

Practitioners must scrutinise each transitional clause: loss carryovers, depreciation bases, pending notices and the status of settled legal interpretation under the ITA may be dealt with differently. Early commentary warns that insufficiently precise transitional wording can spawn fresh litigation.

17. Penalties, compliance costs and rationalisation: The Act retains penalties but seeks to rationalise and tier them to reduce disproportionate fines for technical defaults. Nonetheless, new reporting obligations (especially for VDAs and platform economy) may increase compliance costs, particularly for small-medium enterprises and individuals unfamiliar with digital reporting.

Where no tax is payable or refund is due, the provisions for levy of penalty are relaxed to exempt such cases from levy of penalty in MSME and other small cases. Where levy of penalties is administrative and automated, appeals will likely increase if taxpayers perceive disproportionate enforcement; hence the interplay between automated data matching and human oversight is a systemic risk.

What Remains /Conserved: Some core principles remain unchanged and are retained:

•  Tax rates/slabs have largely been retained; the new Act is not introducing new rates drastically in many segments.
•  Fundamental heads of income (salaries, house property, business/profession, capital gains and other sources) remain but are refined.

REPEALS & SAVINGS AND TRANSITIONAL PROVISIONS FOR RETAINING THE LEGACY

Section 536 of the Act explicitly repeals the ITA. At the same time, it contains the savings clause for protecting the past operations. Actions already taken, rights acquired, or obligations incurred under the ITA remain unaffected by the repeal. Pending proceedings for example, assessments, reopening, reassessments, rectifications, appeals, penalties, references, revisions, or any related proceedings related to tax years beginning before 1 April 2026 would continue under the ITA; procedures. penalties and proceedings for the earlier years in respect of pre -1^st April 2026 tax years would continue to be initiated and pursued as if the ITA has not been repealed but is continued and has remained in force. Pending proceedings before the tax authorities, initiated under the ITA and pending on 1 April 2026, will be adjudicated under the ITA. Refunds or defaults transiting into the Act after 1 April 2026, but relating to the proceeding under the ITA, shall be governed by the ITA for the period up to 31^st March, 2025 and thereafter under the Act.

Importantly, no revival or reopening of the lapsed opportunities would be possible under the Act where the time limit to file an application, appeal, reference, or revision has already expired under the ITA on or before 1 April 2026; the Act does not revive or reopen any of them even if it offers longer periods. To reiterate, the legacy law of the ITA shall remain in force in the above referred cases even though the law is otherwise repealed w.e.f 01.04.2026. Law of limitation of the ITA shall apply to the filings, including of the appeals, and where such limitation had expired under the ITA before 1^st April 2026, will not get the fresh lease of time under the Act, even if the latter provides more generous timelines.

Express provisions that save the application of the ITA ensures the legal continuity, guarantee a smooth transition without legal uncertainty and render fairness to taxpayers in as much as no pending matters or rights are disrupted or lost due to the repeal of the ITA. Importantly, administrative clarity is achieved with the clear demarcation between old and new regiments.

The principle underlying s. 6 of the General Clauses Act, 1897 providing for the savings for proceedings for liabilities incurred during the currency of the previous law may apply to a law that is repealed. Section 24 of the General Clauses Act, 1897 provides for continuation of orders, notifications etc., issued under enactments repealed and re-enacted. In such instances, if repealed and re-enacted provisions are not inconsistent with each other, any order or notification made under the repealed provisions is deemed to be an order made under the reenacted provisions. Having noted the process, it appears that the prescription will fall short of ensuring the litigation free transition as is highlighted, while dealing with the shortfalls of the exercise.

KEY TRANSITIONAL AREAS AND CHALLENGES

During the transition from the ITA to the Act, several key areas, particularly the following require careful consideration;

•  Pending assessments and reassessments initiated under ITA will continue under that law or may be deemed under the Act in specified cases. However, disputes may arise on whether the old or new procedure applies, particularly where reassessment timelines differ.
•  Appeals already filed under the ITA will proceed before the existing appellate forums, but issues of forum shopping and jurisdictional objections may surface if the new Act alters hierarchy or timelines.
•  Unabsorbed losses and depreciation under the ITA are intended to be carried forward into the new Act. Nonetheless, disagreements may occur regarding speculative or business losses, and whether the restrictions of the old law or the new law would govern such carry forwards.
•  Similarly, MAT/AMT credits and tax credits such as TDS, TCS, and foreign tax credits accumulated under the ITA will be permitted under the new Act, though timing mismatches – especially for foreign tax credits claimed on accrual—could lead to litigation.
•  Exemptions and deductions available under the ITA, including SEZ, start-up, and infrastructure incentives, will be grandfathered until expiry. Yet, ambiguity is likely where such benefits are linked to repealed provisions, leading to potential disputes on preservation of benefits.
•  Corporate restructurings commenced under the ITA but completed after 2025 are intended to retain tax neutrality, though gaps may arise if the new Act omits certain neutralisation provisions, such as those relating to demergers or dividend upstreaming.
•  Lastly, penalties and prosecutions for defaults committed under the ITA remain punishable under that law. Complications may occur where defaults span both the regiments, and constitutional challenges could arise if penal consequences differ between the two laws.

INTERPRETATION OF THE ACT

The Act of 2025 must be interpreted strictly according to its express words, with no tax imposed without clear legislative authority. Implied intentions or “spirit of the law” cannot create liability. The principle “there is no equity in taxation” applies, so equity cannot override statutory language. Ambiguities favour the taxpayer, and taxation cannot be extended by inference, analogy, or implication. Interpretation is confined to what is explicitly stated in the statute.

The Act of 2025 must be interpreted as a whole, ensuring harmonious construction so that no section renders another redundant and apparent inconsistencies are reconciled within the Act or with related statutes. Beneficial interpretation applies: where two meanings exist, the one most favourable to the taxpayer prevails, recognizing the power imbalance with authorities. Natural justice principles also apply unless explicitly excluded, requiring meaningful opportunity to be heard and substantive consideration of submissions. Ritualistic hearings or orders ignoring taxpayer arguments are unsustainable. Overall, interpretation must balance consistency, fairness, and protection of the taxpayer while furthering the Act’s purpose.

Legislative Simplification – Reality or Illusion? The Act has been presented as a major simplification exercise. Provisos, Explanations, and Non-obstante clauses have been formally removed, and definitions consolidated into a single section. The term ‘as maybe prescribed’ is replaced with ‘as prescribed’. The government has argued that this will reduce complexity and litigation.

Many of these important aids to interpretation, the meaning whereof is judicially settled, have merely been reintroduced as sub-sections or substantive provisions. If their language remains, but in a different form, it is debatable whether genuine simplification has been achieved. Historically, provisos, explanations, and non-obstante clauses served special interpretive functions. By converting them into sub-sections, the Act may blur distinctions and give rise to fresh interpretive disputes. Judicial rulings on the role and effect of these interpretive devices may or may not remain applicable. It is, therefore, premature to conclude that the changes will reduce litigation. Courts will ultimately determine their true import.

Provisos. Traditionally, a proviso carves out exceptions or qualifies the main provision. It cannot nullify the substantive enactment, but it may provide conditions or remedy unintended consequences. A proviso may:

1.  Qualify or except certain cases from the main enactment.
2. Impose mandatory conditions necessary to make the enactment workable.
3. Become so integral as to acquire the colour of the main enactment.
4. Serve as an explanatory addendum clarifying legislative intent.

Provisos must always be construed harmoniously with the main provision. In some cases, where necessary to give effect to legislative intent, a proviso may even operate retrospectively. In the circumstances, it is difficult to concur with the Government that the Provisos were a burden under the ITA and shifting them to the sub-sections shall retain the same meaning, more so where the understanding of the true import of the Provisos has been justified by the courts.

Explanations. An Explanation is designed to clarify ambiguities, widen scope, or reinforce the object of the Act. Generally, clarificatory and retrospective in effect, Explanations cannot override substantive provisions but can guide interpretation. They may explain phrases, supply missing links, or resolve vagueness in language.

Although ordinarily not substantive, Explanations can sometimes expand the scope of a section, depending on legislative intent. Courts will give effect to such intention even if the provision is labelled as an “Explanation.” It is again difficult to concur with the Government that the Explanations were redundant and its purpose is served by shifting to the main provisions; shifting them to the sub-sections may not retain the same meaning, more so where their understanding of the true import has been justified by the courts.

Non-Obstante Clauses. A non-obstante clause, typically beginning with “notwithstanding anything,” gives overriding effect to the section it qualifies, in case of conflict with other provisions. It is a legislative device to ensure primacy in specified circumstances. The scope of a non-obstante clause is determined by its context and the scheme of the Act. While it provides clarity in resolving conflicts, excessive reliance may undermine coherence.

The Act has replaced everywhere the term ‘notwithstanding’ with the new term ‘irrespective of’. Dictionary meaning of both the terms is interchangeable and therefore neither any harm nor any gain is perceived by the change; it does not complicate the act nor simplify the same.

Definitions and Undefined Words. The Act adopts a novel approach by consolidating definitions into a central section, while also retaining section-specific definitions where necessary. This is intended to create uniformity in interpretation.

However, contextual interpretation remains vital. Defined words ordinarily carry the statutory meaning unless context dictates otherwise. Extended definitions cannot override ordinary meaning unless compelling language demands it. One must ensure that definitions do not destroy the essence of the concept being defined. Thus, while the consolidated definition clause aids clarity, interpretation must remain context-sensitive.

As may be prescribed and As prescribed. At several places the Act, in the name of simplification, has used the term ‘ as prescribed’ in place of the term ‘ as may be prescribed’. It is not possible to corelate with the understanding of the government here. The two terms differ in its meaning as one used under the ITA was futuristic and the other used under the Act has its roots in present. The later requires that the prescription is mandatory and the failure to prescribe may not be made up by the later day prescription.

Deeming Provisions and Legal Fictions: The Act continues to extensively rely on deeming fictions. The best solution would have been to do away with such fictions by using such language that does not require fictions, and instead explains the intent in simple language for creating the effective charge of taxation. Use of legal fictions in the Act is an admission of the legislature of its’ inability to create a specific charge in simple terms. A deeming provision enlarges the meaning of a word or phrase beyond its ordinary sense. Legal fictions must be given full effect, carried to their logical conclusion, but only within the limits of the purpose for which they are created. Courts cannot extend them beyond their defined scope.

While legal fictions may include the obvious, uncertain, or even impossible, they cannot be applied in a way that causes injustice. They are legislative tools to remove doubt, broaden scope, or simplify administration, but require strict interpretation.

Relevance of Legislative History and Judicial Precedent: Legislative history, surrounding circumstances, and background may be considered to understand the object of the Act, though not to alter the plain meaning. Historical context helps identify the mischief the law seeks to remedy. Previous judicial interpretations of similar provisions may also be relevant, particularly where identical wording has been carried forward.

Where Parliament repeats phrases already judicially interpreted, one may infer that the same meaning was intended. At the same time, judicial interpretations under the 1961 Act will not automatically apply; their relevance must be tested in the context of the 2025 Act.

Rules, Circulars and Notifications issued in the context of the ITA may not automatically apply unless specifically provided by the legislature or accepted by the Central Board of Direct Taxes. Recommendation of the Parliamentary Select Committee on this aspect may be seen to understand the position of these useful aids of constructing the Act.

Key Litigation Issues Under the 2025 Act. Despite claims of simplification, several interpretive disputes are anticipated:

1.  Ambiguity of Key Terms: Definitions of “business connection,” “virtual digital asset,” and “tax year” may give rise to litigation over scope and application.
2.  Transition from ITA to Act: Whether facts arising before enactment are governed by the repealed Act or the newly enacted Act will be contested. Saving clauses, retrospective application, and transitional provisions will require judicial resolution.
3. Set-off and Depreciation: Treatment of losses and unabsorbed depreciation carried forward from the ITA involving high-value cash-flow implications, will be fertile grounds for disputes.
4. Corporate Restructuring: Lack of explicit provisions for tax neutrality in reorganisations, fast-track mergers, demergers, and dividend upstreaming may create asymmetries, leading to corporate tax litigation, more so in cases where the restructuring initiated under the ITA is concluded under the Act.
5. AIS and Automated Matching: The Act relies heavily on Annual Information Statements (AIS) and automated data matching. Errors in data, lack of human oversight, and limited correction mechanisms may lead to unfair assessments. Taxpayers are expected to challenge these on grounds of accuracy and procedural fairness.

The Act of 2025 represents an ambitious attempt at simplification, but its true test will lie in judicial interpretation. While the express words of the statute remain paramount, the removal and reclassification of interpretive devices, such as provisos and explanations, may lead to fresh uncertainty. Courts will play a crucial role in shaping how the Act functions in practice.

Ambiguities in definitions, transitional provisions, and reliance on technology-driven assessments are likely to drive the first wave of litigation. Until judicial clarity emerges, taxpayers and advisors must proceed with caution, guided by the long-settled interpretive principles that taxation depends strictly on the language of the law, nothing more and nothing less.

IN THE END – MISSED OPPORTUNITY & ROAD AHEAD

Whether the Act of 2025 is a case of a missed opportunity, and what more could / should have been done which the reform did not quite deliver, is the question. While the Act of 2025 is a step forward in reformation of the income-tax law, many observers feel it could have gone further or could have addressed certain areas more fully. Let us first summarise what seem to be the gaps and then suggest what might have been done better.

WHERE THE ACT FALLS SHORT — WHAT IT MISSED

1.  Incomplete simplification of core tax base and dispute-prone provisions

•  Some core concepts like income, scope of total income, deemed income, capital receipts, revenue and capital expenditure and overlapping heads of income remain substantially unchanged, continuing old complexities and challenges.
•  Deletion of the deeming fictions that provide for taxation of a receipt that is not an income by any stretch of imagination or of the provisions that presume higher income than the actual or real income.
•  Making provisions redundant that provide for disallowance of the legitimate expenditure incurred in earning an income for defaults unrelated to income of a person.
•  Scrapping of the provisions that mandate for compulsory payment in cases of persons following the mercantile system of accounting for a legitimate deduction.
•  Removal of unfair limitations like mandatory filing of reports, return of loss or income including the revised return of income by due dates. All such provisions that limit the legitimate right to be assessed on the true and correct income irrespective of the date of filing should have been withdrawn.
•  Provisions for reopening assessments (which are a large source of litigation and uncertainty), which have largely been retained.
•  TDS/TCS rules remain complex; for example, TDS on partner’s salary, interest, drawings in partnership firms is retained, which leads to practical difficulties (many firms lack TAN, etc.).

     2. Refunds, late filing, fairness issues

• No mandatory timelines for disposal of appeals / grievance petitions or revisional orders by the authorities. Delays in timely disposal continue to be pardoned.
• Provisions for exemption from liability to pay interest for the period where the disposal of appeals are delayed by any appellate authority, including the courts.

     3. Uneven treatment, inequity, mismatch of incentives

•  Savings-/investment-friendly incentives have not been significantly strengthened; some observers think the new tax regime doesn’t sufficiently reward long-term savings or investment relative to old regime obligations or expectations.
•  Marginal relief under the Old Tax Regime (OTR) is less favourable compared to the New Tax Regime (NTR) in some respects, which may push taxpayers into making choices that are sub-optimal for their financial planning.

    4. Privacy, oversight and risk of overreach

• The moulding of digital / algorithmic / data-driven triggers for reassessment and compliance is stronger in the 2025 Act but are not backed by the procedural safeguards, definitions, limits, oversight mechanisms; these are not sufficiently built in. This raises risks of arbitrary or heavy-handed action.

    5. Lack of clarity / roadmap in implementation

• Though the law reduces sections, changes language etc., actual implementation (IT systems, staffing, training, taxpayer interface, etc.) might lag. Observers worry about capacity to handle digital records, data matching, appeals.
• Transition rules (for those who have made long-term commitments under the old law, or whose income/assets fall across regimes) could have been more clearly spelt out.

     6. Missed opportunity in broadening tax base / reducing exemptions

• Though the law claims simplification, many exemptions, deductions, overlapping rules remain. Some think the tax base hasn’t been meaningfully broadened in certain areas (like real estate, informal receipts, etc.).
•  More progressive changes in rates or rebalancing burden could have been considered, especially as inflation erodes real thresholds. Tax slabs etc., still leave some taxpayers in discomfort.

    7. Support for smaller firms / MSMEs / those with low capacity

•  Many of data requirements, reporting, TDS, digital obligations impose fixed overheads. Small businesses, partners without formal structures etc. find compliance burdens high relative to their capacity. Observers feel more relief provisions or simplified rules for such groups could have been included.

    8. Transparency, legislative oversight

•  Some key provisions (like faceless assessments / appeals etc.) are moved to be governed by rules rather than being embedded in the law itself. This gives administrative flexibility, but reduces parliamentary visibility and makes redress harder.

The temptation to suggest what could have been done differently is irresistible; suggestions that may pave way for additional reforms. Some of them are;

1.  Stronger deadlines mandating fixed timelines for every stage: issuance of notices, disposal of appeals by CIT (Appeals) and ITAT; grievance/redressal mechanisms; timeline for refunds etc.
2.  Procedural fairness by ensuring the automatic stay of demands / assessments where appeals or rectification petitions are pending, to reduce hardship.
3.  Wider margin of relief / incentives for savings and investments or simplified exemptions for retirement savings, health insurance, education etc., especially in the new regime. Possibly rebalancing marginal relief to make old regime less penalising for those with existing obligations.
4.  Simplified regime for small businesses / partnerships including the presumptive taxation and lighter reporting (less frequent TDS / less frequent returns) for small firms or partners.
5. Removal or postponement of the TDS obligations that create cash flow burdens (e.g. on partner salaries or drawings) especially where profit is uncertain.
6.  Greater clarity on data / digital enforcement / rights by defining the safe harbour thresholds and introducing the de minimis rules for “unexplained income / assets / credits” so ordinary informal transactions aren’t penalised.
7.  Stronger privacy protections and oversight for use of personal / digital data.
8.  Meaningful expansion of the tax base by outreach to a good part of the population by covering the informal sectors, digital / gig economy more comprehensively.
9.  Introducing transparency in the effective rate of taxation by pruning and consolidating the provisions for exemptions/deductions more aggressively.
10.  Auto Indexation of thresholds, rates, etc. to adjust for inflation, cost of living etc. so that taxpayers are not pushed into higher tax brackets simply due to inflation rather than real income growth.
11.  Transitional clarity, especially for those with investments, deductions etc under the old Act.
12.  Continuity of harmless clauses for some years for minimising the disputes arising from overlapping rules.
13.  Greater legislative embedding of taxpayer rights by including more rights of taxpayers (Taxpayer Charter) in the main body, not just in rules.
14.  Ensuring transparency in reopening, reassessment, and appeal (for example, reasons to be stated, officer escalations etc.).
15.  Continuous review mechanism that involves periodic review of the law, say every few years, involving stakeholders, to identify parts that are still overly burdensome or have led to disputes.
16. Mechanism for better feedback and active public consultation and solicitation at the pre-legislative stage. An exercise should be carried out to measure the effect of the legal and economic effect and the counter-productive consequences of the Act for posterity.

Putting it all together, yes, there was a strong case for the enactment of the new law, it could have been much more transformative. Many observers feel that the legislature missed a great opportunity to really reform the income-tax law in preference for presenting the old wine in a new bottle; may be there was a lack of will or the courage to take the bull by its horns or was it the tacit acceptance that the law of income tax is beyond simplification? The government took a cautious path, balancing simplification with retaining significant legacy structures, possibly to avoid revenue risk or political backlash. The law improves readability, removes redundant parts, modernises in parts, these are all commendable, but many classic pain points remain. A tax administration which disposes of appeals promptly and reaches a fair and final settlement speedily, is itself to be classed as a tax incentive. But: it’s not fair to say the Act is a failure; it achieves many important reforms and is likely to reduce compliance costs and increase clarity.

The Act has achieved simplicity, readability. cohesiveness, lesser verbosity, modernity, some best global practices and removal of archaic provisions, has missed the structural issues like TDS complexity, refund fairness generally, appeals delays, taxpayers’ rights, MSME reliefs, automatic indexation of slabs with the passage of time. Some of the long-standing issues that cause taxpayers anxiety or litigation remained unaddressed or only partially addressed. Importantly the absence of clarity in the transitional provisions leaves a high potential source of disputes. In essence the Act is a step forward in form and readability, but not a game-changer in substance.

The Act’s strengths lie in modern language, logical regrouping of provisions, and an explicit intention to address digital economy issues and reduce routine litigation. It is a long-needed structural reform that aligns statute design with 21st century record-keeping and digital reporting.

Risks remain in drafting gaps, transitional complexity, and the speed at which administrative guidance will be issued. Simplification of language does not automatically ensure simplification of outcome; poor transitional drafting or omissions create new ambiguity and litigation.

Practitioners should act now to: map exposures, check transitional rules for each client, engage with the tax department’s FAQs and circulars, and prepare to litigate strategic issues if administrative clarification is delayed. The next 24 months will determine whether the Act delivers the promised reduction in disputes or simply reshuffles controversies.

The inverted duty structure (IDS) under GST arises when inputs are taxed at higher rates than output supplies, leading to accumulation of unutilized input tax credit (ITC) and liquidity blockages. GST 1.0, with four tax slabs, intensified these anomalies, especially in sectors like textiles, footwear, pharmaceuticals, renewable energy, and EV manufacturing. GST 2.0, introduced after the 56th GST Council meeting in September 2025, rationalised rates into two slabs (5% and 18%), but IDS persists as inputs largely remain at 18% while many outputs fall to 5%. To ease working capital strain, the Council proposed provisional refunds of 90% and automatic refund mechanisms, though risks of fraud necessitate strong digital verification. Statutory provisions under Section 54 and Rule 89(5) govern refund eligibility, limited to input goods, with restrictions notified for certain sectors. Judicial rulings, including VKC Footsteps, Malabar Fuel Corporation, and Tirth Agro Technology, continue to shape the evolving refund landscape.

WHAT IS INVERTED DUTY STRUCTURE AND WHY IT OCCURS?

Inverted Duty Structure (IDS) means when the GST rate on inputs (input goods and/or raw materials used to manufacture final products) is higher than the tax rate on output supplies (finished goods) after manufacturing, processing or assembling goods. This situation results into the accumulation of unutilised Input Tax Credit (ITC), creating liquidity crunches and working capital shortages for manufacturers and suppliers.

Inverted Duty Structure is primarily a structural anomaly caused by the following factors:

• Higher GST Rate on Inputs: It refers to a situation where the GST paid on input goods or raw materials (e.g., at 18%) is higher than the GST rate applicable on the finished goods or output (e.g., at 5%). This leads to accumulation of unutilised Input Tax Credit (ITC), resulting in working capital blockage and refund claims under the Inverted Duty Structure.
• Changes in Tax Policy: Introduction of concessional or reduced GST rates on specific finished goods or services without proportionate reduction on their inputs can create an inverted duty structure. This disparity leads to accumulation of Input Tax Credit (ITC), causing cash flow challenges and frequent refund claims.
• Sector-specific anomalies: It occur when industries use a mix of inputs taxed at higher GST rates and produce outputs taxed at lower rates. This mismatch creates a recurring Inverted Duty Structure (IDS), where input taxes exceed output liability, leading to excess Input Tax Credit (ITC) and dependency on refunds.

INVERTED DUTY STRUCTURE UNDER GST 1.0

Introduction of Goods and Services Tax (GST) in India was one of the largest indirect tax reforms aimed at simplifying the tax structure and harmonizing indirect taxes. But one of the major issues with businesses in this multiple rate regime is the Inverted Duty Structure.

Under GST 1.0, the existence of four tax slabs – 28%, 18%, 12% and 5% has created structural challenges for businesses. The large gap between high input rates (28%/18%) and lower output rates (12%/5%) has led to severe working capital blockages and persistent liquidity stress.

The Government recognized these challenges, providing a statutory framework for refund of unutilised ITC under the CGST Act, 2017 and related rules. The correct interpretation and enforcement of these provisions are important to make sure that businesses can reduce the financial hardship caused by IDS and maintain healthy cash flows.

However, Businesses often face the challenge of claiming large refunds under the inverted duty structure, but the slow and complicated processing delays the release of funds for months. The 12% GST slab, in particular, continued to be a hotspot for disputes, classification mismatches, and compliance challenges. To address these issues, the GST Council recently held its 56th meeting, focusing on rate rationalisation and measures to streamline the refund process.

INVERTED DUTY STRUCTURE UNDER GST 2.0

The 56th meeting of the Goods and Services Tax (GST) Council, held on September 3, 2025 unveiled one of the most far-reaching revisions to India’s indirect tax framework since the launch of GST. Referred as “GST 2.0”, the reform collapses the earlier four-rate structure into just major two slabs of 5% and 18% along with a higher rate of 40% for sin and luxury goods. This overhaul is designed to simplify compliance, bring predictability, and align taxation with broader economic priorities. The implications are far-reaching, promising a significant reshaping of the industry landscape.

Yet, despite the clear benefits, the changes bring a major operational complication: a rise of the inverted duty structure (IDS). Under the new regime GST 2.0, inputs/raw materials used in production remain taxed at 18%, while many finished goods now fall into the 5% or Nil category. A 13% gap between rates still creates inverted duty structure for on output goods/services with 5% slab. This mismatch locks up working capital and creates cash flow pressures for manufacturers – an issue the industry has struggled with even under the previous regime.

To offset this strain, the Council has recommended a new relief mechanism: granting a provisional refund of 90% on IDS situations and Zero-Rated Supplies as well. This step is aimed at easing liquidity constraints, ensuring smoother tax credit utilization, and allowing industries to maintain uninterrupted supply chains in the face of the revised tax rates.

Process of Automatic Refunds as Given In GST 2.0:

RISK OF AUTOMATIC REFUND:

• Automatic refunds without strong checks increase risk of fraudulent claims.
• Fake registrations and manipulated invoices can exploit refund systems.
• Past GST frauds revealed massive input tax credit scams worth lakhs or crores.
• Large-scale illegitimate refunds may strain government revenue.
• Strong digital verification and AI-based monitoring are essential to prevent misuse.

SECTORS AFFECTED BY INVERTED DUTY STRUCTURE (IDS)

Inverted duty structure (IDS) under GST affects industries where the tax rate on inputs is higher than that on outputs, leading to accumulation of input tax credit. This, results into working capital issues. Addressing IDS is crucial to improve cash flow, boost manufacturing efficiency, and ensure a fair tax structure across the value chain. Following are illustrative examples of inverted duty structure

Example of calculation of Inversion of ITC (Renewable Sector)

STATUTORY PROVISIONS FOR IDS REFUND

Key sections of the CGST Act, 2017

• Section 54(1): Any person claiming refund of any tax and interest, if any, paid on such tax or any other amount paid by him, may make an application before the expiry of two years from the relevant date in such form and manner as may be prescribed:

This section allows any person to claim a refund of tax and interest paid, within two years from the relevant date.

• Section 54(3):  Subject to the provisions of sub-section (10), a registered person may claim refund of any unutilised input tax credit at the end of any tax period:

Provided that no refund of unutilised input tax credit shall be allowed in cases other than –

(i) zero rated supplies made without payment of tax;

(ii) where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies (other than nil rated or fully exempt supplies), except supplies of goods or services or both as may be notified by the Government on the recommendations of the Council:

This section specifically enables the refund of accumulated ITC at the end of any tax period, on account of either zero-rated supplies made without payment of tax, or where the tax rate on inputs is higher than the tax rate on output supplies (except in cases of NIL-rated or exempt supplies or as notified by the Government).

Relevant Rules of CGST Rules, 2017

• Rule 89-97A: Procedures for claiming refund of tax, interest, penalty, fees, or any other amount.
• Rule 89(5): Formula for calculation of maximum refund under IDS

RESTRICTION OF REFUND UNDER IDS FOR CERTAIN OUTPUT SUPPLY OF GOODS

In accordance with Notification No. 05/2017-CT(R) dated 28.06.2017, as amended from time to time by Notifications No. 29/2017, 44/2017, 20/2018, 09/2022 and 20/2023, the Government has notified a list of goods for which refund of unutilized input tax credit (ITC) under Inverted Duty Structure (IDS) is restricted. These restrictions are applicable where the rate of tax on input goods is higher than the rate on output supply, yet no refund is permitted for the accumulation of ITC. The rationale behind such restrictions is to curb excess refund outflows in certain sectors and streamline credit accumulation aligned with policy objectives.

As per the consolidated list, restriction on refund applies to various vegetable oils such as soya-bean oil, groundnut oil, olive oil, palm oil, sunflower oil, and coconut oil, including their chemically unmodified forms (Tariff Items 1507 to 1518). Similarly, refund has been disallowed for certain coal and petroleum-related products (Tariff Items 2701 to 2703), imitation yarns (5605), and an extensive list of railway locomotives and related parts (Tariff Items 8601 to 8608), with effective restriction dates ranging from 01.07.2017 to 20.10.2023.

Further, It is important to note that certain restrictions imposed earlier on woven fabrics (Tariff Items 5007, 5111 to 5113, 5208 to 5212, 5309 to 5311, 5407-5408, 5512 to 5516, 5608, 5801, 5806 & 60) were lifted later. The restriction period for refund claims on these goods ended on 31.07.2018, thereby allowing refunds for ITC accumulated due to IDS for fabrics post that date.

The restriction on IDS refunds for specified goods reflects the government’s intent to rationalise refund outflows and prevent revenue leakage. Taxpayers dealing in such notified goods must carefully evaluate their eligibility before claiming refunds. Continuous updates to the list also highlight the need for regular compliance checks and policy awareness.

REFUND UNDER IDS FOR CERTAIN OUTPUT SUPPLY OF SERVICES

REFUND RESTRICTED

• As per Notification No. 15/2017-Central Tax (Rate) dated 28.06.2017, as amended by Notification No. 15/2023-Central Tax (Rate) dated 20.10.2023, refund of accumulated Input Tax Credit (ITC) under the Inverted Duty Structure (IDS) is not available for Construction Services of a Complex/Building meant for sale covered under Schedule II, Para 5(b) where Input goods (e.g., cement @ 28% @18%, steel @ 18%, marble @ 18%) are taxed at a higher rate than output services (1% for affordable units, 5% for others). Refund of accumulated ITC is not allowed under IDS for the same.

REFUND ALLOWED

• Notification No. 15/2017 specified only para 5(b) of Schedule II (i.e., construction services), therefore, Works Contract Services covered under Schedule II, Para 6(b) read with Section 2(119) of the CGST Act is not restricted by the said notification. Hence, refund under IDS is allowed where works contract service involved public infrastructure and government projects taxed at concessional rates (e.g., 12%) before rate rationalisation and inputs for that is of higher rate.
• Further, Other Services like Job work where the output service is taxed at a lower rate (e.g., 5%) compared to input taxed at higher rates (18%), Refund is allowed under IDS.
• As per Circular No. 48/22/2018-GST, Fabric processors providing job work services (i.e., supply of services and not goods) are also eligible for refund under IDS.

It may be noted that the refund restriction under IDS applies only when the output is a supply of goods listed in the Notification, and not for all services. Thus, service providers, except those engaged in construction services under Para 5(b), remain eligible for IDS refunds.

RESTRICTION OF REFUND OF ITC OF INPUT SERVICE & CAPITAL GOODS

Section 54(3) of the CGST Act, 2017 provides that a registered person may claim a refund of any unutilized input tax credit (ITC) at the end of any tax period under two circumstances:

1. Zero-rated supplies made without payment of tax; or
2. Where credit has accumulated on account of the rate of tax on inputs being higher than the rate of tax on output supplies (i.e., Inverted Duty Structure or IDS).

The provision specifically mentions “on account of” higher tax on Inputs, which has raised questions about whether the refund is allowed only for input goods or also includes input services.

The term “inputs” under the CGST Act is defined in Section 2(59) as “any goods other than capital goods used or intended to be used by a supplier in the course or furtherance of business.” It does not include input services. This gave rise to confusion because Section 54(3)(ii) only refers to higher tax on inputs and is silent about services.

Initially, taxpayers interpreted that ITC on both input goods and input services could be included in the refund calculation under IDS. However, the government clarified this ambiguity through Circular No. 135/05/2020-GST dated 31st March 2020 and later re-clarified through Notification No. 14/2022-Central Tax dated 5th July 2022 (effective from 5th July 2022), and Rule 89(5) was amended.

These clarifications and amendments establish that:

• Refund of ITC under inverted duty structure is available only on “input goods”.
• Input services and capital goods are not eligible for refund under Section 54(3)(ii).
• The formula under Rule 89(5) of CGST Rules was also amended accordingly to allow refund of net ITC pertaining only to input goods, excluding input services from the calculation.

This legal position has been upheld by courts as well. For instance, the Gujarat High Court in VKC Footsteps India Pvt Ltd. vs. Union of India had ruled in Favor of taxpayers, allowing refund of ITC on input services under IDS. However, the Supreme Court in Union of India vs. VKC Footsteps India Pvt Ltd., in 2021, reversed the High Court decision, upholding the government’s view that only input goods are covered for refund under IDS.

As a result, currently, under the Inverted Duty Structure, a registered taxpayer is not eligible to claim refund of accumulated ITC attributable to input services or capital goods. Only input goods, which are taxed at a higher rate than the output supplies, qualify for refund under Section 54(3)(ii).

In conclusion, while Section 54(3) refers broadly to refund of unutilised ITC due to inverted duty, the restrictive interpretation and supporting rules/circulars clearly limit the refund eligibility to input goods only. Taxpayers should ensure proper classification and calculation while filing refund claims under IDS to avoid rejections or disputes.

REFUND OF ITC OF STOCK DUE TO RATE RATIONALISATION IN GST 2.0

The Government of India has recently announced its intent to rationalise GST rates across sectors to reduce complexities, broaden the tax base, and address revenue leakages. While such rationalisation is expected to bring uniformity and curb classification disputes, it also raises a practical challenge for businesses – what happens to input tax credits (ITC) accumulated on account of higher taxes already paid on inputs when output supplies suddenly face lower tax rates?

The key question is: Can taxpayers claim refund of such unutilized ITC under the Inverted Duty Structure, even though CBIC Circular No. 135/05/2020 restricts refunds where input and output goods are the same?

RESTRICTION BY CIRCULAR:

CBIC Circular No. 135/05/2020 dated 31-03-2020) disallowed refund of ITC under IDS where input and output goods are the same but taxed at different rates.

Further, as per the FAQ issued by the department on GST Rate Rationalisation based on the recommendations of the GST Council in its 56th meeting, it has been again clarified that the refund of Input Tax Credit (ITC) arising due to a difference in tax rates on the same input and output at different points will not be allowed under Section 54(3) of the CGST Act.

FAQ 10. Will I be allowed to take refund of accumulated credit arising out of inverted duty structure for supplies effected upto the date of effect of revised rate as notified?

The said issue has been clarified vide circular No. 135/05/2020-GST dated 31.03.2020 (as amended), which states that refund of accumulated ITC in terms of clause (ii) of first proviso to section 54(3) of the CGST Act, is available where the credit has accumulated on account of rate of tax on inputs being higher than the rate of tax on output supplies. However, the input and output being the same in such cases, though attracting different tax rates at different points in time, do not get covered under the provisions of clause (ii) of the first proviso to sub-section (3) of section 54 of the CGST Act.

FORMULA AND CALCULATION OF REFUND

Refund Calculation Formula – Rule 89(5)

The refund mechanism under the Inverted Duty Structure (IDS) continues to be a controversial issue under GST, with Rule 89(5) of the CGST Rules creating systemic disadvantages for taxpayers. While the intention is to grant refund of unutilised input tax credit where the rate of tax on inputs exceeds that on output supplies, the formulaic construction of refund calculation leads to a double blow – first, by excluding input services & capital goods from the scope of “Net ITC,” and second, by deducting total output tax payable on inverted rated supplies in earlier period. This design results in a gross under-calculation of refund, especially in service-intensive businesses.

Old Formula and Its Drawbacks:

Refund Amount = (Turnover of inverted rated supply of goods and services × Net ITC ÷ Adjusted Total Turnover) – Tax payable on such inverted rated supply of goods and services.

Rule 89(5) was retrospectively amended via Notification No. 26/2018-Central Tax dated 13-06-2018 (effective from 01-07-2017) to replace “turnover of inverted rated supply of goods” with “turnover of inverted rated supply of goods and services.” However, the definition of “Net ITC” remains restrictive, covering only input goods while excluding input services and capital goods. As a result, although businesses accumulate credit on both goods and services, refunds are permitted only on a limited portion relating to goods. This distortion deepens because the formula deducts the full output tax on inverted rated supplies from the reduced “Net ITC.” Such a method overstates the deduction, leading to under-refunds or nil refunds, disproportionately harming industries like pharmaceuticals, e-commerce and exporters with higher input-service credits. While the Supreme Court in VKC Footsteps upheld the formula’s validity, it recognised this inequity and urged the GST Council to review the policy.

New Formula and its Improvements:

The Government amended Rule 89(5) through Notification No. 14/2022 – Central Tax dated 05.07.2022. The revised formula continues to retain the exclusion of input services but attempts to provide some relief by modifying the manner of calculating “tax payable on such inverted rated supply” in the second part of the formula.

Specifically, the amendment introduced “{tax payable on such inverted rated supply of goods and services x (Net ITC/ITC availed on inputs and input services)}”
However, this change was cosmetic at best, as it did not resolve the core issue that Input services continue to be excluded from “Net ITC” for refund eligibility.

After amendment, the maximum refund amount for IDS is determined using the following formula:

Maximum Refund Amount = {(Net ITC × Turnover of Inverted Rated Supply of goods & Services / Adjusted Total Turnover) – [{Tax Payable on such inverted Rated Supply of goods & services x (Net ITC/ITC availed on inputs & input Services}]

Where:

• Net ITC: ITC availed on input goods during the relevant period.
• Adjusted Total Turnover: Domestic Supply+ Zero Rated Supply (excluding domestic exempt supplies)

Example of Refund amount: (Pre & Post amendment)

• Turnover of Inverted Rated Supply: ₹10,00,000
• Adjusted Total Turnover: ₹12,00,000
• ITC on Input Goods: ₹1,80,000
• ITC on Input Services: ₹60,000
• Output tax payable on Inverted Rated supply: ₹50,000

Pre amendment Refund amount

= (1,80,000 × 10,00,000/12,00,000) − 50,000
= 1,00,000

Post amendment Refund amount

= (1,80,000 × 10,00,000/12,00,000) – (50,000 x 1,80,000/2,40,000)
= 1,12,500

The refund is limited to the least of:

• Refund calculated as per formula
• Balance in electronic credit ledger after filing GSTR-3B for refund period
• Balance in electronic credit ledger at the time of filing refund application

[Circular 125 – Amount of Maximum Refund that can be claimed as per ECL

In case of refunds pertaining to items listed at (a), (c) and (e) in para 3 of Circular 125, the common portal calculates the refundable amount as the least of the following amounts:

a) The maximum refund amount as per the formula in rule 89(4) or rule 89(5) of the CGST Rules (formula is applied on the consolidated amount of ITC, i.e. Central tax + State tax/Union Territory tax + Integrated tax);

b) The balance in the electronic credit ledger of the applicant at the end of the tax period for which the refund claim is being filed after the return in FORM GSTR-3B for the said period has been filed; and

c) The balance in the electronic credit ledger of the applicant at the time of filing the refund application]

REFUND OF ITC IN CASE OF INPUTS TAXED AT SAME OR LOWER RATE THAN OUTPUT

As per Circular No. 125/44/2019-GST dated 18-11-2019, it was clarified that while computing the maximum refund under Rule 89(5) of the CGST Rules, “Net ITC” includes ITC availed on all inputs during the relevant period, regardless of their tax rates, even if some inputs are taxed at the same or lower rate than the outward supply.

Example:

From the above example, it is evident that even though Input A attracts a lower GST rate (5%) than the outward supply Y (12%), the ITC on such inputs cannot be excluded while calculating Net ITC. As clarified, the refund computation under Rule 89(5) requires inclusion of all eligible ITC on inputs, irrespective of whether the input GST rate is lower, equal to, or higher than the output GST rate. Therefore, the entire ITC of ₹385 (including ₹25 from Input A) must be considered for refund calculation.

TIME LIMITS AND RELEVANT DATES

As per Section 54 of the CGST Act, 2017, refund claims under Inverted Duty Structure must be filed within two years from the relevant date. The relevant date varies depending on the nature of refund claim. Below are the key timelines:

• For Refund of unutilized ITC under IDS: The relevant date is the due date for furnishing return u/s 39 (i.e. GSTR-3B) for the period in which such claim for refund arises.
• Refund arising from Judicial Orders (Court/Tribunal/Appellate Authority): The relevant date is the date of communication of the judgment, decree, order, or direction allowing the refund.
• In Case of Deficiency Memo (Form GST RFD-01): The time period from the original filing of Form GST RFD-01 till the date of issuance of RFD-03 (deficiency memo) is excluded from the two-year limitation. A fresh claim filed after rectification of deficiencies is considered within time if the original application was within two years.

DOCUMENTATION FOR CLAIMING IDS REFUND

INTEREST ON DELAYED REFUNDS

As per Section 56 of the CGST Act, read with Notification No. 13/2017-CT dated 28-06-2017, interest is payable on delayed GST refunds if not sanctioned within 60 days from the date of receipt of the refund application. The applicable rate and period of interest vary based on the type of refund and delay involved:

• No interest is payable if the refund is granted within 60 days of the application.
• For regular refund applications
  -6% p.a. interest is payable from the 61st day from date of original(1st) refund application till the actual date of refund credit.
• In cases where the refund arises from an order of adjudicating authority, appellate authority, tribunal, or court, interest is payable
  -at 6% p.a. from 61st day of original(1st) refund application till 60th day of fresh (2nd) refund application or date of refund credit
  -at 9% p.a. from 61st day of Fresh (2nd) Refund application till date of refund credit

In case of Lupin Limited [Writ Petition No.610 of 2024] (Bombay High Court – Goa Bench), held that GST refunds delayed beyond 60 days of an appellate order attract 9% interest, while delays beyond 60 days from the original order attract 6% under section 56 of the CGST Act.

Circular No. 125/44/2019-GST clarifies that the refund is deemed complete only when the amount is credited to the applicant’s bank account. Hence, the interest period starts after 60 days from the date of application and continues until the date of actual credit to the applicant’s account.

In case of Raghav Ventures [W.P.(C) No. 12209 of 2023] (Delhi High Court, 2024), it was held that interest @ 6% on delayed GST refunds is a statutory right, automatic, and not dependent on the petitioner’s claim. Even if interest is not specifically claimed, it is payable under Section 56 if the refund is delayed beyond the statutory period. The court emphasized that such interest is mandatory and automatic in terms of the Act’s provisions.

IMPORTANT CASE LAWS RELATED TO IDS REFUND

• VKC Footsteps India Pvt. Ltd. [Civil Appeal No 4810 of 2021] (Supreme Court, 2021) – Upheld validity of Rule 89(5); refund not allowed on Input Services
  The Supreme Court upheld the validity of Rule 89(5) of the CGST Rules, which restricts refund of unutilised input tax credit in cases of inverted duty structure to input goods only, excluding input services. It held that Section 54(3) of the CGST Act grants refund entitlement subject to restrictions, and the legislature is empowered to distinguish between goods and services for refund purposes. The Gujarat High Court’s decision striking down Rule 89(5) as ultra vires was set aside, while the similar view of the Madras High Court upholding the Rule was affirmed. The Court concluded that policy choices on refunds fall within the legislature’s domain and cannot be invalidated merely for being inequitable. Any remedy for inclusion of input services in refund must come from legislative amendment, not judicial intervention.
• Malabar Fuel Corporation [WP(C) Nos. 26112/2023, 20511/2023, 36699/2023] (Kerala High Court, 2024) – Refund allowed under IDS even with the same inward and outward supplies
  Company engaged in bottling LPG, paid GST at 18% on bulk LPG purchases but charged only 5% on domestic supplies after bottling. The Court examined whether a taxpayer can claim a refund under the inverted duty structure (IDS) when the input and output are the same goods, but the GST rate on the outward supply is lower than the GST rate paid on inward supplies.
• The department’s argument was that IDS refunds are not allowed if the same goods are supplied outward, since refunds should only apply when different goods are involved.
• The Court disagreed, holding that Section 54(3) of the CGST Act and Rule 89(5) only require one condition: that the rate of GST on inputs is higher than the rate on outward supplies. They do not require inputs and outputs to be different goods.
• It also clarified that a CBIC circular No. 135/05/2020-GST cannot override the law. If the Act and Rules allow refund based on rate difference, a circular cannot impose extra restrictions.
• As a result, the Court quashed the refund rejection order and directed the department to process the refund claim on its merits.
• This judgment affirms that IDS refunds are driven by rate disparity, not by product variation.
• Tirth Agro Technology Pvt Ltd [SCA No. 11630, 11635, 11647, 11649 of 2023) (Gujarat High Court, 2024) – Differential refund allowed as per new amended formula

The Court held that the amendment to Rule 89(5) of the CGST Rules, introduced by Notification No. 14/2022, is clarificatory and curative in nature and hence applicable retrospectively. It quashed CBIC Circular No. 181/13/2022, which had restricted the amendment’s benefit prospectively from 05.07.2022. Relying on its earlier decision in Ascent Meditech Ltd., the Court ruled that refund or rectification applications filed within the statutory two-year limit under Section 54(1) must be recomputed using the amended formula. Consequently, the rejection of petitioners’ claims for differential refund under the new formula was set aside. The respondents were directed to release the eligible refund amounts within three months.

The High Court’s decision is now even stronger because the Supreme Court, in Tirth Agro Technology Pvt. Ltd. (July 2025), refused to set aside it. The apex court noted that its earlier ruling in Ascent Meditech – which said the amended Rule 89(5) applies retrospectively—was already final. This means the High Court’s reasoning is not only valid within its own state but has also been effectively approved by the Supreme Court.

• Patanjali Foods [SCA No. 17298 of 2024] (Gujarat High Court, 2025) – Refund for restricted goods allowed for period before notification

The Court struck down para 2(2) of CBIC Circular No. 181/13/2022-GST dated 10.11.2022, which applied the refund restriction on specified goods under Notification No. 09/2022 (effective 18.07.2022) to all applications filed after 13.07.2022, even for periods before the notification. It held such retrospective application to be arbitrary, discriminatory, and ultra vires Section 54 of the GST Act, violating Article 14. Since the notification itself had prospective effect, refund claims for pre-13.07.2022 periods could not be denied merely because they were filed later within the statutory two-year limit. The Court also held that once refund was sanctioned by a quasi-judicial order and not appealed, it attained finality and could not be reopened via a Section 73 notice. The impugned recovery order was quashed, and the petition allowed in favour of the assessee.

BENEFICIAL CIRCULARS UNDER IDS REFUND

Circular No. 37/11/2018 – Suppliers having merchant export supplies @ 0.05% / 1% can also claim refund under Inverted Duty Structure as per provision of the first proviso to Section 54(3) of CGST Act.

Circular No. 48/22/2018 – Clarifies that fabric processors (job workers) supply services, not goods. Since their output is job work services, not fabrics, Notification No. 5/2017–CT (Rate) does not restrict their refund eligibility. The refund restriction under section 54(3) applies only when the output supply is the goods listed in the notification. Hence, fabric processors are eligible for refund of unutilised ITC under the inverted duty structure.

Circular No. 79/53/2018 – Net ITC includes all input goods used in the course of business, even if not directly consumed in manufacturing. Items like stores, spares, packing materials, and stationery qualify as inputs if not restricted under section 17(5) and not capitalised. Revenue expensed items cannot be treated as capital goods.

Circular No. 173/05/2022-GST – Refund under Inverted Duty Structure allowed in case of same rate of inputs and output goods provided the output is supplied at a lower rate due to a concessional notification.

Circular No. 181/13/2022-GST – The restriction imposed vide Notification No. 09/2022-CTR dated 13-07-2022 on refund of unutilised input tax credit on account of inverted duty structure in case of specified goods falling under chapter 15 and 27 would apply prospectively only.

CONCLUSION

Despite the GST Council’s 56th meeting taking significant steps towards rate rationalisation, the issue of Inverted Duty Structure continues to affect several sectors. While rationalisation has eased the burden for some industries, many businesses still face blocked input tax credits, resulting in liquidity crunches and operational strain. This underscores the fact that structural anomalies within the GST framework require a more comprehensive and sector-specific approach rather than piecemeal adjustments.

To address this challenge, policymakers must intensify efforts to simplify rates and ensure timely refunds for affected sectors. Businesses, on their part, need to maintain strict compliance, robust documentation, and close monitoring of regulatory changes to safeguard working capital. A collaborative approach between industry and government, with continuous evaluation of rate structures, is essential to resolve IDS fully and sustain the growth momentum envisaged under GST.

The National Financial Reporting Authority’s (NFRA) order dated 26 December 2024 concerning the audit of Zee Entertainment Enterprises Limited (ZEEL) underscores a significant expansion in the interpretation of “fraud” under the Companies Act, 2013. The controversy stemmed from Yes Bank prematurely appropriating ZEEL’s fixed deposits of ₹200 crore to entities linked with promoters. Though the funds were later restored with interest, NFRA held that the information available with auditor raised red flags that the auditors failed to address adequately. The order also highlights deficiencies such as reliance on limited internal inquiries, neglecting external confirmations and insufficient professional skepticism. It also juxtaposes the broader statutory fraud definition under Section 447 with the narrower auditing standard under SA 240, raising unsettled questions on thresholds like “reason to believe” and quantification of fraud. Ultimately, NFRA’s stance reinforces heightened auditor responsibility, especially regarding related-party transactions and concealed disclosures

INTRODUCTION:

Inquiries by the National Financial Reporting Authority (“NFRA”) into audits have resulted in important orders that clarify NFRA’s view of complex issues that come from the interpretation of the Companies Act, 2013 (“Act”) read with the Standards of Auditing. In this context, NFRA’s order dated December 26, 2024 (“Order”) regarding the statutory audit of Zee Entertainment Enterprises Limited (“ZEEL” or “the Company”) is significant.

The Order addresses an alleged fraud that did not result in a loss. ZEEL’s fixed deposit proceeds were credited to other entities. However, the funds were immediately recouped, and the involved parties had no grievances. In this case, the NFRA concluded that the auditor did not comply with the Standards of Auditing and failed to report fraud U/s 143(12) of the Act.

The Order deliberates upon a spectrum of issues stemming from the broad and expansive statutory definition of “fraud,” found in Section 447 of the Act, and the unresolved tension on the auditors’ obligation to report fraud U/s 143(12) of the Act. Ultimately, the inferences drawn from Order, can cast additional, and possibly onerous, obligations on the auditor.

BACKGROUND:

The facts presented to the auditor (before issuance of the audit report) are as follows. ZEEL’s fixed deposit (“FD”) of ₹200 crore with Yes Bank was prematurely closed by Yes Bank in July 2019 and the corresponding funds were credited (“FD Appropriation”) to entities linked to and associated (“PLE”) with a ZEEL promoter and director (“Promoter”). Around 2 months later, the PLEs intimated ZEEL that Yes Bank had unilaterally credited the FD Appropriation funds to their accounts without the PLE’s knowledge and consent, and offered to remit the FD Appropriation funds to ZEEL along with interest, which they did subsequently¹.

ZEEL sought explanations from Yes Bank on the FD Appropriation and, at the same time, acting on instructions from the Audit Committee, initiated an internal inquiry whose primary scope was assessing whether any authorised signatories had instructed Yes Bank to affect the FD Appropriation. The internal inquiry did not unearth any incriminating evidence². Thereafter, on July 22, 2020, ZEEL and Yes Bank issued a joint statement stating that the FD Appropriation issue was resolved³.

The auditors had issued qualified audit reports for the quarters ending in September 2019 and December 2019, citing paucity of relevant information, including the non-availability of responses from Yes Bank regarding the FD Appropriation.^4, On July 24, 2020, the auditors issued an audit report that did not cite any concerns or qualifications regarding the FD Appropriation.⁵ However, certain material facts that were not available to the auditor when the audit report was issued suggest that a fraud had occurred, as the FD Appropriation was effected by Yes Bank based on instructions issued by ZEEL’s Chairman, who had offered the FD as a security for loans availed by PLE’s.⁶

---

1 Para 18 and 19 of the Order

2  Para 20 of the Order

3   Para 21 of the Order

4   Para 27 of the Order

5   Para 21 of the Order

6   Para 23 and 25 of the Order

NFRA’S CRITICISM OF AUDITORS’ JUDGMENT

According to the Order, the auditor concluded that there was no basis to believe ZEEL’s officers or directors had committed fraud⁷. This conclusion appears to be based on the internal inquiry and the auditor’s procedures. Crucially, the internal inquiry focused on authorized signatories only and not on other officers or directors. This distinction becomes significant when viewed alongside subsequent evidence pointing to a broader circle of individuals who may have been involved or were aware of the true reasons for the FD Appropriation⁸.

NFRA has critiqued the auditor’s decisions on multiple fronts. First, it questioned the rationale for issuing a clean report without evaluating Yes Bank’s rationale and grounds for the FD Appropriation⁹. In NFRA’s view, the auditor should have formally sought external confirmation from Yes Bank, as the FD Appropriation was treated as a significant risk¹⁰. The Order also highlights that SA 330¹¹ issued by the ICAI calls for external corroboration in high-risk scenarios. The Order opines that obtaining clarification directly from Yes Bank was essential in light of the significant reliance on explanations offered by the management.

Moreover, the Order identifies multiple red flags embedded in the information available to the auditor, that, in NFRA’s view, warranted deeper scrutiny:

• The beneficiaries were PLEs, suggesting a heightened risk of inappropriate related-party transactions.
• The promoters’ own explanations that they were coordinating with Yes Bank raised questions regarding the implicit reasons behind the FD’s Appropriation¹².
• An email from ZEEL dated February 2, 2019, showed that ZEEL anticipated Yes Bank might attempt to offset the FD against promoter liabilities¹³.
• Yes Bank’s subsequent May 2020 letter (cited in the Order) included allegations against ZEEL’s management, hinting at broader corporate governance issues.¹⁴

According to NFRA, these red flags indicated a risk of unauthorized related party transactions, which should have led the auditor to exercise greater professional skepticism. NFRA opined that inquiries should have been expanded to evaluate the role and involvement of promoters and other officers. According to the NFRA, had the auditor insisted on explanations from Yes Bank and conducted a more thorough investigation, he/she could have uncovered evidence meeting the “reason to believe” threshold required for reporting under U/s 143(12) of the Act (“Section 143(12)”).

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7   Para 27 of the Order

8   Para 25 of the Order

9  Para 28 of the Order

10 Para 17 of the Order

11 Para 31 of the Order.

12  Para 41 of the Order

13  Para 37 of the Order

14  Para 51 of the Order

CONCEALMENT OF INFORMATION AND FRAUD – JUXTAPOSED

The Order highlights a response dated October 11, 2019, from Yes Bank (“Yes Bank Response”), provided as an explanation in response to ZEEL’s query regarding the FD Appropriation¹⁵. Crucially, the Yes Bank Response was not disclosed to the auditor. According to the Order, the Yes Bank Response included evidence which showed that the Promoter had on September 4, 2018, authorised Yes Bank to appropriate the FDs in case of a default by PLEs. Notably, it also suggested a certain level of awareness within the leadership team of the Essel Group, of which ZEEL was a part, about Yes Bank’s intent to appropriate the FD16. NFRA has opined that had the auditor been apprised of these details, there would likely have been a reasonable basis to believe the occurrence of a fraud meriting reporting under Section 143(12).

At this juncture, it would be pertinent to highlight the friction between fraud as defined in Section 447 of the Act (“Section 447”) and fraud as contemplated in SA 240 – The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements (“SA 240”)¹⁷ . Fraud under Section 447 includes “acts with an intent to injure the interests of the company or its shareholders or its creditors or any other person, whether or not there is any wrongful gain or wrongful loss”. Therefore, acts that do not represent, entail, or result in a financial effect would constitute fraud under Section 447.

ICAI, in its guidance note on Section 143(12) (“Guidance Note”), has noted this divergence and has acknowledged that an auditor may not be able to detect acts that fall under the broader scope of Section 447, especially if the financial effects of such acts are not recorded in the company’s books of account or financial statements¹⁸.

Given these limitations, the ICAI has opined that for the purpose of reporting on fraud under Section 143(12), auditors should primarily consider the requirements of the SAs, including the definition of fraud as stated in SA 240, and plan and perform audit procedures to address the risk of material misstatement due to fraud as it impacts the financial statements¹⁹. In other words, an auditor has no obligation to identify a fraud that has no impact on the books of accounts or financial statements. It appears that the FD Appropriation squarely falls within the meaning of fraud under SA 240, as the underlying transactions were recorded in the books of accounts, even though ZEEL did not, ultimately, incur any loss.

Importantly, NFRA has also suggested that the concealment of the Yes Bank Response from the Audit Committee, as well as the auditors, may tantamount to fraud under Section 448 of the Act²⁰, which criminalises “false statements” or “omissions of material facts” in documents or returns required under the Act. Conventionally, this provision is construed to apply to documented filings like annual returns, financial statements, or formal declarations. If this broader reading prevails, the statutory boundaries on what constitutes a “filing” or “document” for Section 448 purposes could expand significantly.

One may argue that nondisclosures or omissions during formal communications or Board-level deliberations that are affected under the framework of the Act but not in legally prescribed forms should not, on their own, be considered “false statements” under Section 448. NFRA’s interpretation suggests a more expansive scope that may expose directors and senior management to liability for any material omission in communications that fall within the framework of the Act.

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15 Para 25 of the Order

16  Para 24 of the Order

17 Para 11 of SA 240 – The Auditors Responsibilities Relating to Fraud in an Audit of Financial Statements

18 Para 31 of the Guidance Note on Reporting on Fraud under Section 143(12) of the Companies Act, 2013 (Revised 2016)

19 Para 32 of the Guidance Note on Reporting on Fraud under Section 143(12) of the Companies Act, 2013 (Revised 2016)

20 Para 25 of the Order

 

EVIDENTIARY STANDARDS – DICHOTOMY OF CONFUSION

A crucial topic not explored in depth is how NFRA’s characterization of the FD Appropriation as fraud under Section 447 compares with the rigorous criminal-law standard of “beyond reasonable doubt.” NFRA has asserted that the Promoter misused ZEEL’s funds²¹ to benefit the PLEs and that ZEEL’s management was complicit, basing this on delays in seeking explanations from Yes Bank and the concealment of the Yes Bank Response; actions NFRA deemed collectively suspicious²². However, proving an offense under Section 447, which is a criminal provision, requires meeting the high “beyond reasonable doubt” threshold, which is stringent than the “reason to believe” standard applicable to auditors under Section 143(12).

The Supreme Court²³ explained the reasonable doubt standard in a recent verdict as “the requirement of law in criminal trials is not to prove the case beyond all doubt but beyond reasonable doubt and such doubt cannot be imaginary, fanciful, trivial or merely a possible doubt but a fair doubt based on reason and common sense”. In essence, the reasonable doubt standard requires the prosecution to establish a high degree of certainty but not absolute certainty. Simplistically, reasonable doubt exists when the prosecution’s evidence fails to exclude reasonable alternative explanations that are consistent with innocence and arise naturally from the evidence presented.

Moreover, while the “beyond reasonable doubt” standard has substantial legal precedent, the “reason to believe” standard in relation to its application under Section 143(12) has not been vigorously tested. The Bharatiya Nyaya Sanhita defines “reason to believe”²⁴ as “a person is said to have “reason to believe” a thing, if he has sufficient cause to believe that thing but not otherwise”. Reason to believe straddles the middle ground between knowledge i.e. absolute certainty and suspicion characterised by conjecture or doubt. It is a state of mind arrived at through a process of probable reasoning based on available facts, circumstances, and indicators. A person may not know for certain that a fact is true, but he/she possess enough information that a reasonable person would conclude it to be true²⁵. As a result, sifting through and analysing discrete pieces of information—an inherently subjective exercise which at times would demand juristic knowledge—becomes more difficult in the absence of substantive guidance or case laws for an auditor.’ On the facts cited in the Order, it can be argued that the “reason to believe” standard was not satisfied as pivotal evidence i.e. the Yes Bank Response was not available to the auditor when the audit reports were issued.

Additionally, the Order also highlights the auditors’ views on the uncertainty surrounding the legal or contractual basis on which the FD Appropriation was affected²⁶. While Yes Bank cited the Promoter’s letter as justification, there is no clear indication that this letter amounted to formal authorisation. Instead, the documents suggest that the Board of ZEEL did not approve the alleged lien or security arrangement as required under the Act, leaving open the question of whether Yes Bank had lawful grounds to appropriate the FD for the PLEs. That being said, this uncertainty buttresses the NFRA’s contention that the internal inquiry did not address all substantive questions, thereby warranting a deeper inquiry.

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21 Para 53 of the Order.

22 Para 52 of the Order.

23 Goverdhan and Ors. vs. State of Chhattisgarh (09.01.2025 - SC) : MANU/SC/0069/2025

24 Section 2(29) of the Bharatiya Nyaya Sanhita

25 A.S. Krishnan and Ors. vs. State of Kerala (17.03.2004 - SC) : MANU/SC/0233/2004

26  Para 58 of the Order.

NFRA’S STANCE ON INTERNAL INVESTIGATIONS

Additionally, NFRA appears to have deemed all internal inquiries or investigations as inherently unreliable without clearly articulating the rationale for this broad conclusion²⁷. In this case, the internal inquiry was conducted by a longstanding ZEEL employee and was overseen by the Audit Committee. However, the Order does not appear to consider the involvement of the Audit Committee, which bears fiduciary responsibilities, including other institutional checks and balances that are typically instituted to mitigate potential biases and maintain objectivity. Furthermore, NFRA’s assertion that reliance on outcomes derived from internal inquiries would be tantamount to gross negligence may lead auditors to insist on engaging external investigators in most instances, which in turn can impose significant financial costs and operational challenges on companies.

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27 Para 51 of the Order.

AMBIGUITY IN QUANTIFYING “AMOUNT OF FRAUD”

Another legally unsettled question concerns how to measure the quantum of fraud, if any, when the entity ultimately sustains no net financial loss. This determination is crucial as frauds exceeding INR 1 Crore are to be reported by the auditor under Section 143(12) of the Act. For instance, if funds had been diverted or, in other terms, “loaned” to related parties without any intent to misappropriate, does the “amount of fraud” equates to the principal sum initially diverted, or merely the interest cost?

While the Order does not deliberate on the quantification, it hints that the FD Appropriation amounted to a misappropriation, even though it was transient. The Act does not prescribe a fixed methodology for quantifying “amount of fraud” in such scenarios, raising questions on whether intangible or temporary impairments of a company’s funds qualify as the basis for fraud calculations.

CONCLUSION: THE EXPANDING ROLE OF AUDITORS IN DETECTING AND REPORTING FRAUD

The Order highlights the evolving expectations placed on auditors, particularly in the context of detection and reporting of fraud under the Act. The Order reaffirms the broad sweep of “fraud” under the Act, whereby even transient or fully remedied misapplications of corporate assets may lead to a potential obligation to report under Section 143(12). Whether all acts falling within the ambit of Sections 447 and 448 must invariably be reported by the auditor remains an ongoing challenge.

The Order suggests that, whenever a plausible suspicion arises, particularly in related-party contexts, an auditor must either gather conclusive exculpatory evidence or fulfil the statutory mandate to report potential fraud.