Understanding Section 10(38) of the Income Tax Act: Exemption on Long-Term Capital Gains
When it comes to investing in equity shares, mutual funds, or business trusts, the Indian Income Tax Act provides certain tax benefits to incentivize long-term investments. One such benefit is under Section 10(38), which offers an exemption on income arising from the transfer of long-term capital assets. In this blog, we’ll delve into the specifics of Section 10(38), the conditions for availing this exemption, its practical implications, and some additional nuances.
What is Section 10(38)?
Section 10(38) of the Income Tax Act, 1961, exempts income arising from the transfer of long-term capital assets. These assets can include:
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- Equity shares in a company
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- Units of an equity-oriented fund
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- Units of a business trust
Key Conditions for Exemption
To qualify for the exemption under Section 10(38), the following conditions must be met:
Transaction Date:
The sale transaction must be entered into on or after the date Chapter VII of the Finance (No. 2) Act, 2004, comes into force.
Chargeable to Securities Transaction Tax (STT):
The transaction must be chargeable to STT under the relevant chapter of the Finance Act.
Specific Provisos and Exceptions
The section includes several provisos and exceptions that investors should be aware of:
Book Profit and Minimum Alternate Tax (MAT):
The income by way of long-term capital gain of a company shall be considered in computing the book profit and income-tax payable under Section 115JB (Minimum Alternate Tax).
International Financial Services Centre (IFSC):
The requirement of STT does not apply to transactions undertaken on a recognized stock exchange located in an IFSC, where the consideration is paid or payable in foreign currency.
Acquisition after 1st October 2004:
The exemption does not apply to any income arising from the transfer of long-term capital assets (equity shares) if the acquisition transaction, not notified by the Central Government, was entered into on or after 1st October 2004, and the transaction is not chargeable to STT.
Transactions from 1st April 2018:
The exemption does not apply to any income arising from the transfer of long-term capital assets (equity shares, units of equity-oriented funds, or units of business trusts) made on or after 1st April 2018.
Practical Implications of Section 10(38)
For Individual Investors
Section 10(38) historically provided a significant tax exemption for individual investors on the sale of long-term equity investments. However, for transactions made on or after 1st April 2018, this exemption has been curtailed, making long-term capital gains on such transactions taxable.
For Companies
Companies can still benefit from this exemption, but the income must be taken into account while computing book profits for MAT purposes. This ensures that companies do not avoid taxes entirely on large capital gains.
IFSC Transactions
Special provisions are in place for transactions conducted in IFSCs, encouraging international investments through these centers. Transactions on recognized stock exchanges in IFSCs, where the consideration is in foreign currency, are exempt from the STT requirement.
Calculation of Long-Term Capital Gains
Long-term capital gains (LTCG) are calculated as follows:
Cost of Acquisition:
This is the purchase price of the asset.
Cost of Improvement:
Any expenditure incurred for improving the asset.
Indexed Cost of Acquisition:
This is the cost of acquisition adjusted for inflation using the Cost Inflation Index (CII).
Indexed Cost of Improvement:
This is the cost of improvement adjusted for inflation using the CII.
Full Value of Consideration:
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- This is the sale price of the asset.
The formula for calculating LTCG is:
LTCG=Full Value of Consideration−(Indexed Cost of Acquisition+Indexed Cost of Improvement+Expenses on Transfer)\text{LTCG} = \text{Full Value of Consideration} – (\text{Indexed Cost of Acquisition} + \text{Indexed Cost of Improvement} + \text{Expenses on Transfer})LTCG=Full Value of Consideration−(Indexed Cost of Acquisition+Indexed Cost of Improvement+Expenses on Transfer)
Relevant Case Laws
To better understand the application of Section 10(38), let’s look at some notable case laws:
CIT v. Venkatesh Security Ltd. (2008):
This case emphasized the conditions under which the exemption applies and the importance of STT payment for claiming the benefit.
Hindustan Unilever Ltd. v. DCIT (2010):
Discussed the inclusion of exempted income in book profits for MAT calculation under Section 115JB.
DCIT v. HSBC Securities & Capital Markets (India) Pvt. Ltd. (2012):
Focused on transactions conducted through recognized stock exchanges and the applicability of the exemption.
Changes Post 1st April 2018
The Finance Act, 2018 introduced a new Section 112A, which reintroduced the tax on LTCG on equity shares and equity-oriented funds exceeding Rs. 1 lakh at the rate of 10% without the benefit of indexation. This change effectively limited the scope of exemption under Section 10(38).
FAQs on Section 10(38)
Q1: What is the primary benefit of Section 10(38)?
A1: Section 10(38) provides an exemption on income arising from the transfer of long-term capital assets like equity shares, units of equity-oriented funds, and units of business trusts, provided certain conditions are met.
Q2: Are there any exceptions to the exemption provided under Section 10(38)?
A2: Yes, the exemption does not apply to transactions undertaken on or after 1st April 2018, acquisitions made on or after 1st October 2004 that are not chargeable to STT, and transactions on recognized stock exchanges in IFSCs where the consideration is in foreign currency.
Q3: Does the exemption under Section 10(38) apply to all investors?
A3: The exemption applies to individual investors, companies, and transactions conducted through recognized stock exchanges, subject to specific conditions and exceptions mentioned in the section.
Q4: How does Section 10(38) affect companies?
: For companies, the income from long-term capital gains must be considered while computing book profits for MAT purposes under Section 115JB.
Q5: What changes occurred to Section 10(38) after 1st April 2018?
A5: After 1st April 2018, the exemption on income from the transfer of long-term capital assets (equity shares, units of equity-oriented funds, and units of business trusts) was withdrawn, making such gains taxable.
Q6: How is the LTCG calculated under Section 10(38)?
A6: LTCG is calculated by deducting the indexed cost of acquisition, indexed cost of improvement, and expenses on transfer from the full value of consideration (sale price).
Conclusion
Section 10(38) of the Income Tax Act offers a valuable tax exemption for long-term capital gains from equity shares, units of equity-oriented funds, and business trusts. While changes from 1st April 2018 have limited this exemption, it remains a crucial aspect of tax planning for investors. Understanding the conditions and exceptions can help in making informed investment decisions and optimizing tax liabilities.
For more insights and updates on tax exemptions and other financial planning tips, stay tuned to our blog at Smart Tax Saver.
