Long Term Capital Gain On Sale Of Listed Equity Shares – Not always Exempt

At present, Long Term Capital Gain (LTCG) on transfer of equity shares of a company is exempt under section 10(38) of the Income Tax Act, if the sale has been undertaken on or after October 1, 2004 and Security Transaction Tax (STT) is paid at the time of sale. Once these two conditions are satisfied, the LTCG is exempt, irrespective whether it is sham or bogus transaction.

The memorandum explaining the Finance Bill has provided the intent for the amendment to the section to prevent abuse as it has been noticed that the exemption is being misused by certain persons for declaring their unaccounted income as exempt LTCG by entering into sham transactions. More than 200 shell companies were suspended and more than 1,300 entities banned from the market for taking benefit of bogus LTCG. Tax evasion is of more than Rs15,000 crore.

In order to prevent misuse of this exemption by persons dealing in penny stocks, Section 10(38) is amended with effect from assessment year 2018-19. Under the amended provisions, the exemption shall be available only if STT is paid not only at the time of sale, but also at the time of acquisition of shares. Thus, to avail exemption under section 10(38), the assessee has to establish that both at the time of acquisition and at the time of sale he has paid STT.

RELEVANT AMENDED PROVISIONS { SECTION 10(38) }

(i) Income arising from transfer of long term capital assets being the equity shares in a company
(ii) Transaction of sale of such equity shares is entered into on or after October 1, 2004 and such transactionis chargeable to   STT.
(iii) If the shares are acquired on or after October 1, 2004, then at the time of purchase, STT is paid.
(iv) Such exemption will be denied only to such classes of cases as may be notified by the government. Therefore, the cases in which this exemption is not given will be liable to tax under the head Long Term Capital Gain.

NOTIFICATION OF CBDT NO.43/2017 DATED 5/6/2017 

The CBDT initially issued a draft notification which mainly prescribes negative list of transactions on which such exemption would not be available. After considering representations by various stakeholders, the CBDT has issued a final notification which is similar to the draft notification in terms of prescribing negative list of transactions. However, in certain genuine cases, relaxation has been given. 

(i) Acquisition of listed equity shares through a preferential allotment in company whose equity shares are not frequently traded in the stock exchanges. This clause covered only fresh issue of equity shares by listed company under the preferential issuance route. It does not include equity shares issued under public issue, right issue, bonus issue, ESOPs.
(ii) Acquisition of listed equity shares not entered through a recognized stock exchange. This clause mainly covers secondary acquisition of listed shares.
(iii) Acquisition of equity shares of a company during the intervening period between delisting and relisting of a company.

The CBDT has kept some genuinetransactions outside the aforesaid negative list on which capital gain exemption would be available, even if the equity shares were acquired without payment of STT
(i) Shares acquired in the scheme of merger and acquisition duly approved by a court, NCLT, SEBI and RBI.
(ii) Acquisition of shares due to loan restructuring with banks or financial institutions who have accepted equity shares in lieu of loan from the borrower
(iii) Acquisition of shares by employees under Employee Stock Option Scheme (ESOPS)
(iv) Acquisition of shares by nonresidents which is in accordance with FDI guidelines
(v) Acquisition by investment funds being Category-I or Category-II Alternate Investment Fund or a venture capital fund or QIB.
(vi) Acquisition of shares by any mode which is not regarded as transfer under section 47 of the Income Tax Act such as acquisition of shares on amalgamation, demerger, inheritance, gift, slump sale under section 50B, etc.
(vii) Acquisition of shares from the government.
(viii)Acquisition of shares of a company under SEBI’s Take-Over Rules.

The amendment, read with notification, is a welcome step to stop abuse of LTCG exemption. This is a step towards the present government’s war against black money. The amendment mainly targets bogus LTCG. The government has no intention to deny exemption of LTCG in genuine transactions. With this amendment, investors and other persons should not indulge in entering into sham transactions to create a tax-free capital. However, the shares purchased before October 1, 2004, are still eligible for exemption under section 10(38) of the Income Tax Act even if the same is sold today and on which STT is paid.