By IndiaHub 
In FY2024-25, two co-founders sold their stakes in a start-up to a large corporation. One co-founder received Rs 75 lakh in total, while the other got Rs. 45 lakh. Both filed their income tax returns (ITRs) on time in ITR-2 and declared the capital gains.
Income Tax Dept’s algorithm is misreading capital gains from unlisted shares as business receipts, thus sending intimations; Know what to do
When December began, the first co-founder received an automated message from CPC about a significant mismatch in his tax return. To his surprise, the other co-founder got no such communication, and his ITR was processed smoothly. Automated Tax Matching Systems used by the CPC are the main reason for this difference in how the same transaction is treated.
The Automated Tax Matching Systems use machine-learning-based algorithms to reconcile the income and tax details reported by a taxpayer in their Income Tax Return (ITR) with a vast array of financial data and the AIS. In case of any mismatch, an automated notice is sent to the taxpayers. The mismatch could be due to many reasons, such as non-reporting of income or improper disclosure.
In the last few weeks, thousands of taxpayers have been confronted with sharply worded emails and SMS alerts from the Income Tax Department warning of a “significant mismatch” between their income tax returns and the data available with the Department. The communication is often accompanied by a firm deadline of December 31, 2025 to revise the return or respond online. For many recipients, the notice has created a stressful and confusing situation, as a return that fully complies with the law is still flagged as incorrect.
Despite complete and accurate disclosures, an automated notice is being triggered for a share sale transaction where tax is deducted under Section 194Q. The systems are misreading capital gains from unlisted share sales as business receipts, triggering widespread compliance alerts for FY 2024–25.
At the heart of the issue is Section 194Q, which is a withholding provision that requires buyers to deduct tax at source on the purchase of goods exceeding a specified threshold. This provision requires a buyer to deduct tax if he carries on a business and pays a resident seller for goods where the value or aggregate value exceeds Rs 50 lakh in any previous year.
Though the Income Tax Act does not explicitly define “goods” for this section, it is understood that “securities” (including shares, whether listed or unlisted) are not treated as “goods” in the broader tax context.
Also read: I-T dept clarifies why intimations on property deals, foreign assets and AIS mismatches are being sent
However, the CBDT has clarified that, as transactions in listed securities carried out through exchanges do not involve direct contact between buyers and sellers, the provisions of Section 194Q shall not apply to transactions in securities (and commodities) traded through recognised stock exchanges or settled by recognised clearing corporations.
Since unlisted shares are not traded through recognised stock exchanges or cleared by recognised clearing corporations, the specific exemption mentioned in the circular would not directly apply to them. Nevertheless, based on the general interpretation of “goods” in Indian tax laws and the specific nature of Section 194Q, TDS under Section 194Q is generally not required on the purchase of unlisted shares, as shares are typically not considered “goods”.
Still, in several unlisted share transactions, buyers deduct TDS under this Section either as a conservative compliance measure or due to internal interpretations of its scope.
When a buyer reports this deduction, it appears on the seller’s Annual Information Statement (AIS). The system’s logic treats the receipt as business turnover, even though the seller may have correctly disclosed the transaction as capital gains in the income tax return form.
This mechanical interpretation based on the TDS provision creates an apparent mismatch. The algorithm, designed to reconcile numbers rather than determine the income classification, flags the difference as an inconsistency. It completely ignores the fact that the Section under which tax is deducted, cannot determine the nature of income in the hands of the recipient.
Section 194Q governs withholding obligations. It does not convert a capital transaction into a business transaction.
Where unlisted shares are held as investments, their sale is governed by the capital gains framework under the Income-tax Act, regardless of how the buyer chooses to deduct tax. Yet automated systems cannot appreciate this nuance, leading to a growing number of false positives in compliance monitoring.
The tone of the notices has prompted many taxpayers to consider revising their returns as a precautionary measure. Instead, the more appropriate course is to respond through the Compliance Portal by providing feedback that the corresponding receipts have been offered to tax under the head of capital gains.
It is recommended that the CBDT should extend the scope of the circular by clarifying that Section 194Q will not apply to any security transaction, listed or unlisted.
Authors:
- CA Naveen Wadhwa, Vice-President, Taxmann
- CA Ankur Kamra,. Partner, Ankur Kamra and Company