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Amendment under Sec 10(38) of Income Tax Act 1961

March 17, 2017[2017] 79 168 (Article)


1. The Finance Bill 2017 (Herein after referred to as "The Bill" or "Bill") was introduced in the Lok Sabha on 1st February 2017. Overall, there are 87 clauses in the Direct Tax Portion of the Bill. Clause 6(e) of the Bill proposes to amend Sec 10(38) to provide additional condition to claim on account of sale of specified Long Term Capital Asset (LTCA). Apparently, it seems that the Government is willing to remedy the defect in the existing Law. Amendment u/sec. 271(1) (c) by the Finance Act 2015 is another example of application of Mischief Rule.

2. The article analyzes the following aspect:-

(I)   Existing Law.
(II)   Mischief-Law envisages to remedy. Is this a mischief at all?
(III)   Market Concepts (Bulk Deal, Block Deal)
(IV)   Proposed Amendment and likely implications.

Existing Law:-

2.1 For Income to be exempt under 10(38) under Income Tax Act 1961, following conditions should be fulfilled:-

(1)   Clause is applicable to any assessee.
(2)   Asset should be asset as specified under Sec 10(38), i.e.,
(i)   an equity share in a company or
(ii)   a unit of an equity oriented fund or
(iii)   a unit of a business trust.
(3)   Assessee should hold the Asset for a period of More than 12 Months (i.e,. Long Term Capital Asset-LTCA)
(4)   Assessee should have transferred the LTCA on a Recognized Stock Exchange on or after 01.10.2004.
(5)   Such transfer of Asset should be taxable under Head Income from Capital Gains.
(6)   Such transfer is chargeable to securities transaction tax(STT).

For the above transaction and income from Transaction to qualify as exempt, the above conditions have to be satisfied cumulatively.

Table capturing various scenarios - Taxability of Income from Transfer of Specified LTCA on or after 01.10.2004.

Scenario No. 1 2 3 4
Profit/Loss on transfer of LTCA? Profit Profit Loss Loss
Transfer on Recognized Stock Exchange i.e. STT Applicable Yes No Yes No
Taxability of Income Exempt Taxable @10% Exempt and hence not allowed to be set off Non Exempt, hence allowed to be set off.


(1)   The term `Income' includes Loss In case an Income is exempt, the same is excluded from the computation of Taxable Income. Similar treatment has to be given to loss from a transaction which would have otherwise resulted in Income, i.e., Loss has to be excluded for the purpose of computation of Taxable Income. (Scenario 1 and 3 in the table)
(2)   However, it can be noted that in case, one of the conditions of the Sec 10(38) is not satisfied, the transaction would be governed by provisions of Income from Capital Gains provisions and the income would be taxable @10%. (Scenario 2 in the table)
(3)   In case of Loss arising Transfer of specified LTCA, coupled with a scenario where the above conditions under section 10(38) are not satisfied, the same would be available for being setoff and carry forward under provisions of Chapter VI of the Income Tax Act 1961. (Scenario 4 in the table)

Mischief-Law envisages to remedy. Is this a mischief at all?

2.2 In a recently decided case law involving Mridu Hari Dalmia Parivar Trust1 v. Assessing Officer, Delhi ITAT concluded that by the virtue of transferring shares, held as LTCA through off Market transactions and incurring loss, assessee has endeavored to plan his taxes rather than avoid it and, hence, such genuine loss cannot be disallowed.

Let us consider the facts of the case law to further understand the Tax Planning modus operandi.

(1)   Assessee is a Trust formed for the benefits of family members, wherein certain members of family are also the Trustees of the Trust.
(2)   The specified LTCA was sold by Assessee to its trustees and beneficiaries of Trust.
(3)   The specified LTCA was sold at prevailing market Prices, i.e., FMV. This was demonstrated to the AO with help of copies of Quotations of the shares as on the date of sale.
(4)   Assessee convinced the Genuiness of the Loss with the help of bank account statement, through which transaction took place.
  From the above facts, it can be observed that by transfer of shares amongst the related parties at fair value at a particular given point in time, assessee has managed to have a genuine Long-Term Capital Loss which can be set off against its income2.

2.2.1 Few Important observations from case law

(1)   Assessee had no intention to transfer the shares to a third party.
(2)   AO has termed these transactions as colourable devices of Tax avoidance in his Assessment Order.
(3)   The Tribunal has after considering the above facts (Transfer at fair Market Value, Genuineness of Transaction) termed the transaction as Tax planning, rather Tax avoidance.

2.2.2 Mischief

  There are certain stocks which are expected to perform well over a long Horizon. These stocks are capable of giving return of 100% over a period of 5 Years. These are well established Stocks and Investors generally hold these stocks with a motive of Value Creation.
  In the above case it can be clearly observed that there was a clear intention of holding stock within the family and not parting with it.
  There could be various reasons for going for off the Market transaction.
(I)   Non-Liquidity of Stocks
(II)   Block Deal option not available to Assessee.
  Selling the Shares
(i)   At FMV
(ii)   Yet Loss
(iii)   To related Party
(iv)   Off the market
  Seems to avail of benefits of Provisions of Income Tax Law.
  The above transaction would ensure that the first Seller sells a share at Loss, whereas Buyer may after period of 1 Year (after being eligible to be characterized as Long-Term) sell the Share at a profit and get the same exempted under the provisions of Sec 10(38) of Act.

2.2.3 Illustration

(1)   A purchases a share in GIL Ltd. at RS. 100 on 01-10-2008.
(2)   A Sells the share to B at Rs. 70 (FMV) on 01-02-2011. During the Year A has Long Term Capital Gain on account of sale of Another Capital Asset amounting to Rs. 50. Assuming that the above sets of income are the only incomes during the year, A would pay tax on 20 Rs. (i.e., 50 Rs. -30 Rs.).
(3)   B after a year, i.e., on 31.03.2014, sells the share at Rs. 200 on Stock Exchange (STT Applicable).

During the year 2013-14, B makes a Long-Term capital Gain under Sec 10(38) of the Act and pays Nil Tax, since Income is exempt.

The amendment to the Bill envisages to remedy the above mischief. Whether the above transaction would be Mischief is a matter of fact and would depend upon the intentions of the party.

Market Concepts of Block Deal

2.3 Other than normal trading on the Stock Exchange, there are concepts like Block Deal which an Investor can opt for. STT is payable on Block Deal. Hence, if other conditions as mentioned under Sec 10(38) are fulfilled, transfer of shares via Block Deal are eligible for exemption under Sec 10(38).

Block Deal 3

2.3.1 It is a single transaction, of a minimum quantity of five lakh shares or a minimum value of Rs 5 crore, between two parties which are mostly institutional players. The transaction happens through a separate trading window.

2.3.2 Salient features of the Block Deal

  Of a minimum quantity of five lakh shares or a minimum value of Rs 5 crore.
  Participants are mostly institutional Players or HNI's.
  Separate window is open for only 35 minutes.
  The Securities and Exchange Board of India (Sebi) rules state that block deal orders should be placed for a price not exceeding +1% to -1% of the previous day's closing or the current market price.

Under the Block Deal Concept two Parties can agree upon a price subject to SEBI rules and execute a transaction wherein all conditions under section 10(38) are fulfilled.

2.4 Proposed Amendment u/Sec 10(38)

The Finance Bill 2017 proposes to amend sec.10 (38) to provide that a transfer of share otherwise exempt under Sec 10(38) would not be exempt if the acquisition of such share was executed without payment of STT.

The amendment has been brought about to remedy the mischief of transfer of shares at a loss, while the Share is trading at a lower Price.

2.4.1 Likely implications of the Amendment and expectations The Amendment is Retrospective in nature.

The Assessees who have purchased the transaction off the market would now not be eligible to avail of the exemption under Sec 10(38).

The NDA Government had promised that it shall not introduce any retrospective amendment. The above amendment is a contradiction to above promise.

The amendment would further lower/reduce the liquidity of Stock The shareholders who held illiquid stock could get rid of their stocks by selling the same off the market, but the new amendment would further reduce the liquidity of such stock, since the amendment would create an uncertainty as to whether the stock could have any future investor/Buyer.

The amendment is subject to acquisitions notified by the Government There are certain genuine transactions wherein STT is attracted, for example:

(i)   Venture Capital Firms and Private Equity Investors investing in Unlisted companies
(ii)   Issue of ESOPS by Unlisted companies

It should be appreciated that the above kind of funding supports 'Make in India Campaign' and has been major source of funding for New Business/Startups.

It is expected that the Government would notify the above genuine transaction.

The amendment is a contradiction to Promise of Ease of Doing Business

Acquisitions at Fair Market Value should also be Notified Considering the fact that transactions at fair market value are genuine in nature, the same should form part of Notified Transactions.


2. chapter VI of Income Tax Act 1961 i.e. Aggregation of Income and set off or carry forward of Loss

3. Source: -

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