Section 10(38) – Tax on Long Term Capital gains from on the transfer of equity oriented funds

As we all know that the exemption provided under section 10(38) is being misused by certain persons for declaring their unaccounted income as exempt long-term capital gains by entering into sham transactions. Many judgements of various court were also pronounced in favour of assessee on account of long term capital gain on penny stocks.

With a view to prevent this abuse, the Government has come up with New Regime of Taxation of Long Term Capital Gains on sale of equity share, unit of equity oriented funds and unit of the business trust u/s 112A of the Income Tax Act, 1961 with effect from 01.04.2018

The Finance Act, 2018 has withdrawn the exemption under section 10(38) of the Income-tax Act, 1961 and has introduced a new section 112A in order to levy long term capital gain tax on the transfer of a long term capital asset being an equity share in a company or a unit of an equity oriented funds or unit of a business trust w.e.f A.Y 2019-20 and onwards.

The main object behind the introduction of new section 112A, as explained by the Government is that the exemption from long-term capital gain tax on transfer of equity share or unit of equity oriented fund or units of business trust has led to significant erosion in the tax base resulting in loss of revenue and due to abusive use of tax arbitrage opportunities created because of the said exemption.

Before Insertion of Section 112A

Before F.Y 2018-2019, long-term capital gain on transfer of equity share, unit of equity oriented fund and unit of business trust was exempt as per the provisions of section 10(38) of the Income Tax Act, 1961.

After Insertion of Section 112A

• With effect from 1st April, 2018 i.e from F.Y 2018-19, provisions of section 10(38) will not be applicable to any income arising from transfer of equity share, unit of a equity oriented fund or units of business trust.
• From 1st April, 2018 i.e from A.Y 2019-20, provisions of section 112A shall be applicable to tax income arising from transfer of a long term capital asset in the nature of an equity share in a company, unit of equity oriented fund and unit of business trust.
• Section 112A shall be applicable only in case where Securities Transaction Tax (STT) has been paid at the time of transfer. Further, in case of equity share in a company sec 112A shall be applicable where STT has been paid both at the time of acquisition and transfer of equity shares.

Rate of Tax u/s 112A

As per the provisions of sub section (2) of section 112A, long-term capital gain tax @10% (plus applicable surcharge and cess) shall be levied on the amount of capital gains exceeding one lakh rupees.

Salient Features of section 112A:

1. As per First proviso to section 48 in case of Non-resident Indian i.e benefit of calculation of capital gain by converting in foreign currency will not be allowed in cases where section 112A is applicable.

2. Second proviso to section 48, i.e. benefit of indexation of cost of acquisition and indexation of cost of improvement shall not be allowed while calculating long term capital gain tax under section 112A in case of resident tax payer.

3. As per sub section (5) and (6) of Section 112A, deductions u/s 80C to 80U and/or rebate u/s 87A shall not be allowed on the amount of capital gain tax chargeable as per the provisions of section 112A.

4. Section 55(2)(ac) states that cost of acquisition for the purpose of calculating Tax payable u/s 112A shall be as under:

Cost of acquisition for the assets acquired before 1st February, 2018, shall be higher of the following :

• • • The actual cost of acquisition of such asset, and
    • The lower of: (i) the fair market value of such assets; and (ii) the full value of consideration received or accruing as a result of the transfer of the capital asset

Extract of Amended Section 10(38):

“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 :

Provided that the income by way of long-term capital gain of a company shall be taken into account in computing the book profit and income-tax payable under section 115JB :

Provided also that nothing contained in sub-clause (b) shall apply to a transaction undertaken on a recognised stock exchange located in any International Financial Services Centre and where the consideration for such transaction is paid or payable in foreign currency:

Provided also that nothing contained in this clause shall apply to any income arising from the transfer of a long-term capital asset, being an equity share in a company, if the transaction of acquisition, other than the acquisition notified by the Central Government in this behalf, of such equity share is entered into on or after the 1st day of October, 2004 and such transaction is not chargeable to securities transaction tax under Chapter VII of the Finance (No. 2) Act, 2004 (23 of 2004):

18[Provided also that nothing contained in this clause shall apply to any income arising from the transfer of 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, made on or after the 1st day of April, 2018.]

Explanation.—For the purposes of this clause,—

(a) “equity oriented fund” means a fund—

(i) where the investible funds are invested by way of equity shares in domestic companies to the extent of more than sixty-five per cent of the total proceeds of such fund; and

(ii) which has been set up under a scheme of a Mutual Fund specified under clause (23D):

Provided that the percentage of equity share holding of the fund shall be computed with reference to the annual average of the monthly averages of the opening and closing figures;

(b) “International Financial Services Centre” shall have the same meaning as assigned to it in clause (q) of section 2 of the Special Economic Zones Act, 2005 (28 of 2005);

(c) “recognised stock exchange” shall have the meaning assigned to it in clause (ii) of the Explanation 1 to sub-section (5) of section 43”

Author is a Chartered Accountant and can be reached at [email protected]

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