India stands at a pivotal moment as Union Budget 2026 approaches, with expectations centered on comprehensive direct tax reforms aligned with the government's "VIKSIT BHARAT" vision. The budget is anticipated to focus on accelerating growth across sectors, promoting ease of doing business, and simplifying compliance, particularly in direct taxation. The significance of this year's budget is heightened by the imminent replacement of the six-decade-old Income Tax Act, 1961, with the Income Tax Act, 2025, effective from April 1, 2026.

Key Structural Reforms Expected

The proposed legislation introduces several fundamental changes designed to modernize India's tax framework. The most notable reform involves replacing the terms 'Assessment Year' and 'Previous Year' with a unified 'Tax Year' concept to eliminate confusion and make tax law more intuitive and accessible.

Consolidation of scattered provisions and clearer statutory language are expected to reduce interpretational disputes that have historically fueled litigation. The explicit recognition of virtual digital assets, including cryptocurrencies, within the statutory framework signals acknowledgment of evolving economic realities and the need for clarity in taxation.

Withholding Tax Rationalization

The current multiplicity of TDS and TCS rates has long been a source of compliance complexity and increased risks. Growing expectations suggest the budget will move towards a more streamlined structure, possibly by excluding transactions already subject to GST from withholding requirements and introducing standardized rates for remaining categories. Such changes would ease compliance burden and improve business cash flows without compromising revenue visibility for tax administration.

Significant Economic Presence Clarity

The existing Significant Economic Presence (SEP) provisions have raised concerns due to potentially wide coverage that risks including both physical and digital transactions within scope. Budget 2026 is expected to address these concerns by:

• Refining definitions to explicitly include "digital means"
• Clarifying disclosure and compliance obligations for non-residents
• Providing certainty where permanent establishments already exist in India

Investment and Innovation Incentives

Uniformity in deduction of stock-compensation expenses remains an area of uncertainty and litigation. Clear recognition of payments by Indian employers to foreign parents regarding share issuance to Indian employees as revenue expenditure would reduce disputes. The possible reintroduction of weighted deductions for research and development, extended beyond manufacturing to the service sector, is viewed as critical for fostering innovation.

Dispute Resolution Improvements

Expectations extend to resolving long-standing ambiguities in capital gains taxation, particularly for transactions involving contingent consideration. Procedural reforms such as prescribing timelines for disposal of first appeals could address prolonged litigation issues. The Dispute Resolution Panel (DRP), while constituted for settlement purposes, has not performed effectively as intended. A domestic settlement mechanism is needed to reduce litigation, building on India's successful unilateral APA program implementation.

Balanced Approach to Reform

As the budget date approaches, the underlying theme emerging from stakeholder expectations is balance. Rather than seeking blanket concessions, stakeholders want a coherent and predictable tax regime that supports growth while safeguarding revenues. Rationalizing tax provisions, extending concessional rates, and fostering research-driven enterprises can serve as key enablers for achieving the "MAKE IN INDIA" mission and the broader "VIKSIT BHARAT" vision.

The comprehensive nature of expected reforms reflects India's commitment to creating a modern, efficient tax system that meets contemporary business needs while maintaining fiscal discipline and revenue adequacy.

Tax professionals are urging the government to address a critical gap in India's taxation framework through Budget 2026, specifically regarding Employee Stock Ownership Plan (ESOP) taxation for employees with cross-border work experience. The current system creates significant uncertainty for expatriates and returning Indians who face disputes due to unclear guidelines on how stock option income should be apportioned across different countries.

Current ESOP taxation framework

Under India's existing tax structure, employee stock options are taxed at the time of exercise. The system calculates the taxable value as the difference between the fair market value of shares on the exercise date and the exercise price paid by the employee. This amount is treated as a perquisite and taxed under the salary head.

However, the framework fails to specify how this income should be treated when employees have earned options while working partially outside India, creating a significant regulatory gap.

Cross-border complications

Employee stock options typically vest over several years and are linked to continued employment, meaning the benefit often relates to services performed across multiple countries. Despite this reality, tax assessments frequently focus on where the employee is based at the time of exercise rather than where the actual work tied to the stock options was performed.

A Deloitte budget expectation report highlights that the absence of clear apportionment rules has resulted in inconsistent treatment by tax officers. In some cases, employees have faced demands on the full ESOP gain in India even when substantial portions of their service period were spent overseas.

Expert recommendations

Nupoor Maharaj, Advocate at Delhi High Court & Supreme Court of India, emphasizes that "clarity is crucial" and calls for a more predictable framework for ESOP taxation along with steps to reduce avoidable litigation. The issue has gained prominence as global assignments and remote work arrangements increase, with professionals often moving jurisdictions multiple times between grant and vesting periods.

Priyal Goel Jain, Partner and NRI Tax Expert at Dinesh Aarjav & Associates, notes that the lack of clarity exposes employees to overlapping tax claims and creates unnecessary stress for those returning to India after overseas assignments.

Proposed solutions

Tax experts believe Budget 2026 should address this issue without requiring major legislative changes. Deloitte has suggested that the Central Board of Direct Taxes issue administrative guidance that would:

• Establish a clear method to allocate ESOP income in cross-border situations
• Define documentation norms for employees
• Provide standardized approaches for determining India-attributable income
• Reduce disputes and bring certainty for globally mobile professionals

Impact on India's talent strategy

The current ambiguity affects both employees and employers, with companies facing challenges in determining appropriate tax withholding amounts due to the absence of specific guidance. Residential status adds another layer of complexity, as there is no standard approach to determine how much of an ESOP gain should be attributed to Indian services.

As India positions itself as a global talent hub, unresolved questions around ESOP taxation risk becoming a friction point, particularly when stock-based compensation has become central to executive pay and startup hiring strategies.