Direct Tax Code 2025: Section 112A Gone, 12.5% Tax on Equity Gains

Key Takeaways

• Increased Tax Rate: The concessional tax rate on long-term capital gains (LTCG) from listed equity shares and equity mutual funds is set to increase from 10% under Section 112A to a flat 12.5% under the new Direct Tax Code.
• Elimination of Exemption Threshold: The ₹1 lakh annual exemption currently available for LTCG under Section 112A will be removed, making all long-term gains from these specified assets taxable.
• Simplified Compliance: The new provisions aim to streamline the taxation process, notably by eliminating the mandatory requirement of the Securities Transaction Tax (STT) payment for the gains to be classified under this regime, which is expected to reduce litigation.
• Effective Date: The new tax rules are slated to come into effect on April 1, 2026, and will be applicable for the financial year 2026-27 onwards.

PART 1: EXECUTIVE SUMMARY

The transition from the Income Tax Act, 1961, to the Direct Tax Code (DTC) 2025 marks a pivotal shift in India's direct tax landscape. A key area of change for investors is the tax treatment of long-term capital gains arising from the sale of listed equity shares and units of equity-oriented mutual funds.

• The Old Law (1961): Section 112A of the Income Tax Act, 1961, currently governs the taxation of long-term capital gains from the transfer of a listed equity share or a unit of an equity-oriented fund. Under this section, such gains exceeding ₹1 lakh in a financial year are taxed at a concessional rate of 10%, provided that Securities Transaction Tax (STT) has been paid on both acquisition and transfer (with certain exceptions). This regime was reintroduced in 2018 to tax long-term gains from the equity market after a long period of exemption.

• The New Law (2025): The Direct Tax Code 2025 is expected to introduce a new provision, referred to in draft discussions as Clause 198, to replace Section 112A. This new clause will levy a flat tax of 12.5% on all long-term capital gains from these assets. A significant departure from the old law is the removal of the ₹1 lakh exemption limit. Consequently, the entire long-term capital gain from the first rupee will be subject to tax. Another crucial change is the proposed removal of the STT payment condition, simplifying compliance and reducing potential disputes.

• Who is Impacted: This change will affect a broad spectrum of taxpayers, from small retail investors to High Net-worth Individuals (HNIs) and institutional investors who have capital market exposure. Small investors, who previously benefited from the ₹1 lakh exemption, will now see their returns diminished by the new tax liability. For larger investors, the tax rate increase from 10% to 12.5% will directly impact their post-tax returns on equity investments. The removal of the STT condition will, however, provide relief and clarity, particularly for foreign investors and in cases of off-market transactions.

PART 2: DETAILED TAX ANALYSIS

1. Background & Legal Context

The introduction of Section 112A in the Finance Act, 2018, ended a 14-year exemption period for long-term capital gains from listed equities. The rationale was to rationalize the tax structure and expand the tax base. The provision included a "grandfathering" clause to protect gains accrued up to January 31, 2018.

The move towards the Direct Tax Code 2025 is driven by the government's objective to simplify and consolidate all direct tax laws into a single, modern framework. The aim is to enhance clarity, reduce litigation, and align India's tax system with global best practices. The proposed changes to capital gains taxation are a core component of this reform, seeking to create a more uniform and streamlined structure for taxing investment income.

2. Statutory Mapping: 1961 Act vs 2025 Act

To understand the precise nature of the transition, a comparative analysis of the existing and proposed legal frameworks is essential.

3. Practical Implications & Examples

The elimination of the ₹1 lakh exemption is the most impactful change for small and medium-sized investors. The increase in the tax rate will affect all investors realizing long-term capital gains from equity instruments.

Example 1: Small Investor

• Scenario: An individual investor sells equity mutual fund units held for over a year and realizes a long-term capital gain of ₹1,50,000.
• Under the 1961 Act (Current Law):
  • Taxable Gain: ₹1,50,000 - ₹1,00,000 (exemption) = ₹50,000
  • Tax Liability: 10% of ₹50,000 = ₹5,000 (plus applicable cess)
• Under the DTC 2025 (New Law):
  • Taxable Gain: ₹1,50,000 (no exemption)
  • Tax Liability: 12.5% of ₹1,50,000 = ₹18,750 (plus applicable cess)
• Impact: The investor's tax outgo increases by ₹13,750.

Example 2: HNI Investor

• Scenario: An HNI sells listed shares and realizes a long-term capital gain of ₹50,00,000.
• Under the 1961 Act (Current Law):
  • Taxable Gain: ₹50,00,000 - ₹1,00,000 = ₹49,00,000
  • Tax Liability: 10% of ₹49,00,000 = ₹4,90,000 (plus applicable surcharge and cess)
• Under the DTC 2025 (New Law):
  • Taxable Gain: ₹50,00,000
  • Tax Liability: 12.5% of ₹50,00,000 = ₹6,25,000 (plus applicable surcharge and cess)
• Impact: The investor's tax liability increases by ₹1,35,000.

4. Compliance & Transition Checklist

Taxpayers and advisors must prepare for a smooth transition. Our team recommends the following actions:

• Review Investment Portfolios: Evaluate existing equity portfolios to assess the potential impact of the new tax rules on future capital gains.
• Strategic Tax-Gain Harvesting: Consider realizing long-term capital gains up to the ₹1 lakh exemption limit before the new law takes effect, subject to individual financial goals and market conditions.
• Update Financial Models: Financial planners and advisors should update their models to reflect the new 12.5% tax rate and the absence of the exemption for post-transition return projections.
• Documentation and Record-Keeping: Maintain meticulous records of acquisition costs, especially for shares acquired before January 31, 2018, to correctly apply the grandfathering provisions.
• Stay Informed on Final Legislation: The Direct Tax Code is still in a proposal stage. It is imperative to monitor the final version of the law as enacted by Parliament for any modifications to the proposed changes discussed. The effective date is April 1, 2026.

5. Final Advisory

The proposed changes under the Direct Tax Code 2025 represent a significant recalibration of the tax on long-term capital gains from equity investments. While the new framework aims for simplification and uniformity, the immediate impact for investors will be a higher tax incidence. The removal of the ₹1 lakh exemption will particularly affect retail investors, while the rate hike will be a key consideration for all market participants.

The elimination of the STT requirement is a welcome move that will reduce compliance burdens and potential litigation. As the implementation date of April 1, 2026, approaches, proactive planning and a thorough understanding of the new provisions will be paramount for optimizing tax outcomes. This guide serves as a foundational resource, and we advise continuous monitoring of legislative developments and seeking professional guidance for specific financial situations.

💡 Transition Tip: Bookmark this page and share it with your clients for a seamless transition to the Direct Tax Code 2025.