Long Term Capital Gain and Loss on Shares

     Taxation of shares in recent times has undergone number of changes. Finance Act 2004 sought to exempt long term capital gain on equity shares and equity oriented funds in the hands of all  types of investors including FIIs, institutional investors and other foreign nationals by introducing section 10(38). However this seemingly simple exemption clause with times has unfolded a number of issues . This article is a humble attempt to deal with a few taxation issues pertaining to income as well loss arising from long term capital assets in the form of  equity shares and equity oriented funds

Section 10(38)

As per Section 10(38) of the Income Tax Act 1961, following income shall not be included in the total income of the assessee

10(38)

any income arising from the transfer of a long-term capital asset, being an equity share in a company or a unit of an equity oriented fund or a unit of a business trust  where—

(a)		the transaction of sale of such equity share or unit is entered into on or after the date on which Chapter VII of the Finance (No. 2) Act, 2004 comes into force; and
(b)		such transaction is chargeable to securities transaction tax under that Chapter

Analysis of Section 10(38) :

1.     Since the exemption is available only in respect of equity shares in a company or units of Equity oriented funds, Long term capital income on other securities like bonds, debentures, derivatives, rights or interest in securities is not exempt under section 10(38).

2.     Securities Transaction tax applies to  :

a)    Sale of Equity Shares or equity oriented funds entered in recognized stock exchange

b)    Sale of unlisted equity shares by any holder of such shares under an offer for sale to the public included in an initial public offer and where such shares are subsequently listed on a recognised stock exchange

c)     Sale of a unit of an equity oriented fund to the Mutual Fund

Hence long term capital gain on buy back of shares, sale of rights in shares, negotiated deals is not exempt because they are not exigible to STT.

Sale of Unlisted Shares

3.      It was held in Udey Punj (Del Trib) ITA 1689/2010 dtd 30-09-2011, that sale of unlisted shares under offer for sale included in IPO does not attract STT, hence exemption u/s 10(38) is not available. However Finance Act 2012, brought these sale transactions also under STT, hence now exemption u/s 10(38) shall also be available on sale of unlisted shares under an offer for sale to public included in IPO for diluting shareholding of existing shareholders.

However for claiming exemption u/s 10(38) unlisted shares are required to be held for 36 months by virtue of amendment brought by Finance Act 2014.

Acquisition need not be through recognized stock exchange

4.      Purchase of shares in physical form and done through off market and then converted into D-Mat form in absence of any evidence to be regarded genuine and sale shall be exempt u/s 10(38) [Smt Arti Mittal (Hyd Trib.) ITA 165/2011]

Shares held as stock in trade and conversion

5.     Sale of Shares held as stock in trade are not exempted under section 10(38) [Smt Alka Aggarwal (Del Trib.) ITA 80/2011].

6.     Securities held by FII where in investment has been made as per SEBI guidelines shall always be treated as capital asset and not as stock in trade by virtue of amendment brought by Finance Act 2014.

7.     Conversion of Stock in trade into Investment and sale of shares after two years of conversion held exempt u/s 10(38) [Express Securities (Del High Court) ITA 406/2013]

8.     Sale of Share immediately after conversion of stock in trade into investment held ingenuine and hence taxable [Indo Sto Sec (Mum Trib) ITA 3472/2010]

9.     The conversion of shares held as investment into stock in trade shall be covered by section 45(2) and difference between fair market value and cost of shares shall be claimed as exempt u/s 10(38) in the year of sale of shares and not in the year of conversion.

10.                       Conversion of stock in trade of shares into investment shall not attract any gain or loss for income tax purposes but for calculation of book profits u/s 115JB, it shall be dealt as per AS-13 which says:

“Where investments are reclassified from current to long-term, transfers are made at the lower of cost and fair value at the date of transfer”

Further long term capital gain arising from equity shares and equity oriented funds shall be included in the calculation of MAT u/s 115JB. Further no indexation shall be done for inclusion of such long term capital gain in the book profits. [Dharam yug Investments Ltd. (Mum Trib) 10-06-2015].

11.                       Onus to prove that shares are held as capital asset is on the assessee [Karan R. Behal (Mum Trib) ITA 7334/2011]

Treatment of Long Term Loss on Sale of Equity Shares

Supreme Court in case of Harprasad & Co. (P) Ltd (1975) 99 ITR118

At the relevant time capital gains from sale and purchase of shares was not taxable and assessee was not obliged to show capital gains in his return. The assessee how ever in the instant case suffered loss which he pleaded to be carried forward and set off against capital gain from other activities in future years.

                        The apex court held that had he incurred capital gain from sale and purchase of shares in future years, he would not have been able to claim the set off of capital loss against capital gain of future years because the assessee as per provisions of  the law at the relevant time was not at all required to reflect capital gain from shares in his return of income.

                        The Supreme Court enunciated the principle that loss is negative profit.

Supreme Court in Karam Chand Prem Chand Ltd 40 ITR 106

The assessee carried on business in British India and also out side British India. Profits of business outside British India could not be taxed in british India. However assessee incurred loss in his business outside british India. The loss was allowed to be set off against the income of the assessee in British India.

                        This judgement stands on entirely different footing from Harprasad & Co(supra) and enunciates that income and loss to be treated differently and loss is not negative income in certain circumstances.

Gujrat High Court in Kishorebhai Bhikhabhai Virani (2014) 367 ITR 261 

Loss arising on sale of equity shares covered under section 10(38) would not be includible in computation of assessee's income and therefore would not be available for set off against capital gain.

It was held relying upon Supreme Court decision in Harprasad & Co (supra) that   ' Term income' under section 10(38) of the Act would also include the loss.

Mumbai Tribunal in Asia Pacific Performance ITA 7106/2010

In this case also the assessee claimed set off of long term capital loss on equity shares . The Assessing Officer rejected the claim of the assessee. The assessee didn’t prefer an appeal against the quantum proceedings. However in appeal against the penalty proceedings , Tribunal upheld the penalty  u/s 271(1)(c )for claiming long term loss on shares covered by section 10(38).

Mumbai Tribunal in Schrader Duncan Ltd. ITA 1010/2009

In the instant case, the issue before Tribunal was regarding set off of long term capital loss arising from conversion of US-64 units into 6.75% tax free bonds. The Tribunal in this case described all the peculiar circumstances resulting in conversion of units into tax free bonds and recorded a finding that not only income but entire source of activity is sought to be kept outside the purview of income tax having regard to beleaguered financial position of UTI units which resulted into incorporation of section 10(33) by Finance Act 2003. Tribunal relying upon SC decision on Harprasad (supra) held that since loss is negative income, hence both income as well as loss from UTI units shall not enter the computation of Income.

Calcutta High Court in Royal Calcutta Turf Club 144 ITR 709

In this decision similar issue arose with regard to the losses on account of breeding horses and pigs which are exempt u/s. 10(27) as to whether such loss can be set off against its income of other source under the head "business". The Hon'ble High Court after considering the relevant provisions of section 10(27) and section 70, held that section 10(27) excludes in expressed terms only any income derived from business of livestock breeding, poultry or dairy farming. It does not exclude the business of livestock breeding, poultry or dairy farming from the operation of the Act. The losses suffered by the assessee in respect of livestock, breeding were held to be admissible for deduction and were allowed to be set off against other business income.

Hon'ble Supreme Court, in the case of CIT v. Karamchand Premchand Ltd. (supra) was relied upon in this case.

Path Breaking Judgment of Mumbai Tribunal in case of Raptokas Brett & Co. Ltd. Rendered on 10-06-2015 ITA 3317/2009

Facts of the case:

The assessee is a pharmaceutical company, engaged in manufacturing and sale of pharmaceuticals, formulations, dietetic specialities and animal husbandry. The assessee in the computation of income had shown Long term capital loss on sale of shares amounting to Rs.57,32,835/- and loss on sale of mutual funds units amounting to Rs.2,61,655/-. The said Long term capital loss has been set off against the Long term capital gains of Rs.94,12,00,000/- arising from sale of land at Chennai. The Assessing Officer held that the losses claimed cannot be allowed since the income from Long term capital gain on sale of shares and mutual funds are exempt u/s. 10(38). That apart, of the Long term capital loss in respect of shares where securities transaction tax has been deducted, would have been exempt from Long term capital gain had there been profits, therefore, Long term capital loss from sale of shares cannot be set off against the Long term capital gain arising out of the sale of land. CIT A also confirmed the action of AO. Now the assessee was before Tribunal.

Held

a) The Tribunal relied upon Royal Calcutta Turf Club (supra) which observed as under:

"under the Income tax Act 1961 there are certain incomes which do not enter into the computation of the total income at all. In computing the total income of a resident assessee, certain incomes are not included under s.10 of the Act. It depends on the particular case; where the Act is made inapplicable to income from a certain source under the scheme of the Act, the profit and loss resulting from such a source will not enter into the computation at all. But there are other sources which, for certain economic reasons, are not included or excluded by the will of the Legislature. In such a case, one must look to the specific exclusion that has been made."

Mumbai Tribunal held that the ratio laid down by the Hon'ble Calcutta High Court is clearly applicable and accordingly we follow the same in the present case.

b) Tribunal further  held that while rendering the decision by Gujrat High Court in case of Kishorebhai Bhikhabhai Virani (2014) 367 ITR 261 the judgement of Calcutta High Court in Royal Calcutta Turf Club (supra) was not considered by Gujrat High Court. Hence the decision of Gujrat High Court can not be applied.

b) Further the Tribunal distinguished the case of Schrader Duncan Ltd.(supra) holding that in this case the peculiar circumstances as discussed in the judgment prevailed behind conversions of units of US-64 into tax free bonds, where by the entire source and not just income is sought to be kept outside the purview of tax net.

c) Further the decision of Supreme Court in the case of  Harprasad  & Co. (supra) was distinguished holding that the ratio and the principle laid down by the Hon'ble Apex Court would not apply here in this case, because the concept of income includes loss will apply only when entire source is exempt or is not liable to tax and not in the case where only one of the income falling within such source is treated as exempt. The Hon'ble Apex Court on the other hand, itself has stated that if loss from the source or head of income is not liable for tax or congenitally exempt from income tax, then it need not be computed or shown in the return and Assessing Officer also need not assess it. This distinction has to be kept in mind.

Conclusion : The Judgement of Mumbai Tribunal has unsettled the law decided by Gujrat High Court by drawing a distinction between exempting the income and exempting the entire source from which income or loss arises. The Tribunal has further stated that the principal that loss is negative income shall apply only when entire source is sought to be kept outside the purview of Income Tax Law. But where only income is exempted, the same treatment can not be met out with loss arising from that activity and therefore loss shall be allowed to be set off.