In the direction to curb the black money and fabricated transactions, the Finance Act, 2017 has amended the provisions of section 10(38) of the Income-tax Act, 1961(‘the Act’) effective AY 2018-19.

Prior to this amendment dated 5 June 2017, the exemption under section 10(38) of the Act was available if the three conditions are satisfied as under:

(a) It should be a transfer of long term capital asset, being an equity share in a company;

(b) sale of such equity share should be on or after October 1,2004; and

(c) the said transaction is chargeable to Securities Transaction tax.

The government has evidenced that the above exemption was misused by declaring the unaccounted income in the equity shares thereby claiming exemption under section 10(38) of the Act by entering into (sham) transactions by declaring the black money as equity shares and routing the same through banking channels as sales and paying the STT at the time of sales (after October 1, 2004) which entitles the exemption on such long term capital gains.

To counterfeit the practice of availing exemptions on the ground of being bogus/sham transaction and not denying the benefit available to the genuine investors, the CBDT had invited comments to its draft notification on April 3,2017 on the negative list on the specified transactions where the long term capital gain benefit would be affected.

After considering the comments on the draft notification, the recent notification introduced few changes in the provisions, to be eligible for the benefit of provisions of section 10(38). However, the exception to the above would be for the:

1. Issuance of shares which are approved by Supreme Court, NCLT, SEBI or RBI;

2. Issuance of shares to a non-resident in accordance with FDI regulations;

3. Issuance of shares to Venture Capital fund or qualified institutional buyer.

The exemption would be available on long term capital gains only if Securities Transaction Tax (STT) has been paid on acquisition of equity shares on or after October 1, 2004. Further, it specifically denies the benefit of section 10(38) in the following cases:

1. Acquisition of preferential shares of existing equity shares of the company whose equity shares are not frequently traded on recognised stock exchange of India;

2. Acquisition of equity shares of the company which are not traded on a recognised stock exchange of India at the time of acquisition;

3. Acquisition of equity shares of the company during the delisting and re-listing of the shares in a recognised stock exchange of India.

It is very useful at this juncture, to refer to a few recent interpretations by courts, starting from the decision of Hon’ble Karnataka High Court, in the case of Bhoruka Engineering Services –Vs– CIT wherein, the Hon’ble court had a chance to examine provisions of S.10(38). Paragraph 23 of the said judgment analyses the scope of S.10(38) and according to the Court, three conditions are required to be satisfied, which are (i) It should be a transfer of long term capital asset, being a equity share in a company; (ii) Sale of such equity share should on or after chapter 7 of the Finance Act 2/2007 came into force. It is with effect from 29.08.2004. (iii) the said transaction is chargeable to Securities Transaction tax under the chapter. Once a transaction is found to satisfy these conditions, then, the Court has ruled that, the authorities could not deny benefit of S.10(38) of the Act. Bombay High court also had occasion to get into this aspect, of interpretation of S.10(38), in the case of CIT –Vs– Mukesh Ratilal Marolia. Though the Hon’ble court has upheld the findings of ITAT, Mumbai, it is rather pertinent to refer to observations of ITAT. At paragraph 10.3, it is observed that “..purchase and sale of shares outside the floor of Stock Exchange is not an unlawful activity. Off-market transactions are not illegal……10.4  when the transactions were off-market transactions, there is no relevance in seeking details of share transactions from Stock Exchanges. Such efforts would be futile…..”.