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CA Jaikishan Manghani

In India, the income from long term capital gains on transfer of Shares and Mutual Funds on which security transaction tax (STT) has been paid, is exempt from levy of income tax under section 10(38) of the Income Tax Act, 1961 (‘the Act’). This is a well known exemption amongst the tax payers and investors in India.

But what happens if there is a long term capital loss on transfer of Shares and Mutual Funds on which STT has been paid?

Normally this is left and no set off is claimed from other long term capital gains on transfer other capital assets in terms of section 70 of the Act. This is on the simple assumption that if there were long term capital gains on transfer of such STT paid Shares and Mutual Funds, the same would have been exempt from tax under section 10 (38) of the Act.

But recently, in an interesting case of ‘Raptakos Brett & Co. Ltd. Vs. DCIT-6, Mumbai [Appeal No. 3317/Mum/2009 for the AY 2007-08], the Hon’ble Mumbai Tribunal has decided just contrary to above presumption and held that such long term capital loss on transfer of Shares and Mutual Funds on which STT has been paid are eligible to be set off in terms of section 70(3).

Now let us analyse the said case:

Facts in brief:

  • 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.
  • In the first appeal, the learned CIT(A) too confirmed the action of the Assessing Officer on the ground that exempt profit or loss construes separate species of income or loss and such exempt species of income or loss cannot be set off against the taxable species of income or loss. Tax exempt losses cannot be deducted from taxable income and, therefore, the Assessing Officer has rightly disallowed the claim of losses from shares to be set off against the Long term capital gain from sale of land.

Aggrieved by the said decision of the learned CIT (A), the assessee preferred the second appeal before the Hon’ble ‘D’ Bench of ITAT Mumbai.

Arguments on behalf of the Assessee before the Hon’ble Tribunal:

  • That, what is contemplated in section 10(38) is exemption of positive income and losses will not come within the purview of the said section.
  • That, the set off of Long term capital loss has been clearly provided in sections 70 and 71.
  • That, the Legislation has not put any embargo to exclude Long term capital loss from sale of shares to be set off against Long term capital gain arising on account of sale of other capital asset.
  • That, even in the definition of capital asset u/s. 2(14), no exception or exclusion has been provided to equity shares the profit/gain of which are treated as exempt u/s. 10(38).
  • That, Capital gain is chargeable on transfer of a capital asset u/s. 45 and mode of computation has been elaborated in section 48. Certain exceptions have been provided in section 47 to those transactions which are not regarded as transfer. Nothing has been mentioned in sections 45 to 48 that capital gain or loss on sale of shares are to be excluded as section 10(38) exempts the income arising from the transfer of long term capital asset being an equity share or unit.
  • That, the legislature has given exemption to income arising from transfer of Long term capital asset being an equity share in company or unit of equity oriented fund, which is chargeable to STT. Section 10(38) cannot be read into section 70 or71 or sections 45 to 48.
  • That, the above arguments have got support and accordingly reliance was placed upon the decision of Hon’ble Calcutta High Court in the case of Royal Calcutta Turf Club v. CIT (1983) 144 ITR 709 (Cal) and the decision of Hon’ble Supreme court of India in the case of CIT vs. Karamchand Premchand Ltd. (1960) 40 ITR 106 (SC).]

Decision of the Hon’ble Tribunal:

The Hon’ble Tribunal accepted the above arguments placed upon on behalf of the assessee and observed as under:

  • That, the whole genre of income under the head capital gain on transfer of shares is a source, which is taxable under the Act. If the entire source is exempt or is considered as not to be included while computing the total income then in such a case, the profit or loss resulting from such a source do not enter into the computation at all. However, if a part of the source is exempt by virtue of particular “provision” of the Act for providing benefit to the assessee, then in our considered view it cannot be held that the entire source will not enter into computation of total income.
  • In our view, the concept of income including loss will apply only when the entire source is exempt and not in the cases where only one particular stream of income falling within a source is falling within exempt provisions. Section 10(38) provides exemption of income only from transfer of Long term equity shares and equity oriented fund and not only that, there are certain conditions stipulated for exempting such income i.e. payment of security transaction tax and whether the transaction on sale of such equity share or unit is entered into on or after the date on which chapter VII of Finance (No.2) Act 2004 comes into force. If such conditions are not fulfilled then exemption is not given. Thus, the income contemplated in section 10(38) is only a part of the source of capital gain on shares and only a limited portion of source is treated as exempt and not the entire capital gain (on sale of shares). If an equity share is sold within the period of twelve months then it is chargeable to tax and only if it falls within the definition of Long term capital asset and, further fulfils the conditions mentioned in subsection (38) of section 10 then only such portion of income is treated as exempt. There are further instances like debt oriented securities and equity shares where STT is not paid, then, gain or profit from such shares are taxable.

Accordingly, the Hon’ble ITAT finally held that:

Section 10(38) excludes in expressed terms only the income arising from transfer of Long term capital asset being equity share or equity fund which is chargeable to STT and not entire source of income from capital gains arising from transfer of shares. It does not lead to exclusion of computation of capital gain of Long term capital asset or Short term capital asset being shares. Accordingly, Long term capital loss on sale of shares would be allowed to be set off against Long term capital gain on sale of land in accordance with section 70(3).

Conclusion:

The above decision is therefore an important decision and may be useful to many tax payers and investors by getting the benefit of set off long term capital losses on transfer of shares or mutual funds on which STT has been paid from other long term capital gains and reduce their tax burden to a much extent.

The author is a practising CA based at Indore (MP) and can be contacted at jkmanghani@rediffmail.com.

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2 responses to “Long Term Capital Loss from Shares and Mutual Funds: Set off allowable”

  1. SL GUPTA says:

    Please advise whether there is further development in the case.
    Is it applicable to salaried individual resident Indian?
    Does it apply to other jurisdiction, say Delhi?
    Is the decision also applicable in case of LTCL on sale of shares to be set-off against STCG on sale of shares (same source),or say STCG on sale of shares to be set-off against LTCL on sale of shares, where other conditions are met, i.e. deal on NSE/BSE, and STT paid on both legs of purchase/sale. Otherwise please advise how the LTCL on sale of shares can be set-off in case of salaried individual resident Indian.

  2. SL GUPTA says:

    Please advise whether there is any further development in the case.
    Is it applicable to salaried individual resident Indian?
    Is the decision applies to other jurisdictions also, say Delhi?
    Is the decision also applicable to LTCL from sale of shares to be set off against STCG from sale of shares (same kind of source) or say STCG from sale of shares to be set-off against LTCL from sale of shares where other conditions are met i.e. on a recognized exchange, STT paid on all legs of purchase/sale. Otherwise pls advise how LTCL from sale of shares can be set-off in case of salaried individual resident Indian.
    Thanx and regards,

  3. CA. Jai Kishan says:

    Sear SK,

    The benefit of Indexation is available as per the second proviso of section 48 of the Income tax on transfer of long term capital assets. Normally it is available in all such cases except where it is specifically mentioned in the law that the benefit of the same is not available.

    For Example in case of transfer of shares by an NRI as per the conditions mentioned in the first proviso of Section 48 or the cases falling under section 112 (1) (c) (iii), such benefit of Indexation will not be available to an assessee. Secondly, if an assessee opts to pay tax @ 10% on transfer of long term capital asset instead of tax @ 20%, the benefit of Indexation will not be available.

    Regards,

  4. SK says:

    In light of the tribunal order, would the assessee be able to claim indexation benefit while claiming the long term capital loss?

  5. CA KRISHAN KHANDELWAL says:

    this is a tribunal deceision , not binding on all jurisdictions. But, this shall definitly add weightage to the arguments in any case.

  6. CA Jai Kishan says:

    Dear Nishant,

    Until and unless, there is any stay on the impugned order by the higher appellate fora a or the court, this order of the tribunal stands final.

    If the AO denies, it will be a case of contempt of court and violation of principles of natural justice. Therefore, he is bound to abide by this order legally and also judiciously. Needless to say further that Tribunal is higher and superior authority under the law above the AO.

    Despite of the above, the decision of the hon’ble Tribunal is also based upon the judgements of the Supreme Court and High Court.

    Thanks and best regards,

  7. nishant says:

    but this is decided by tribunal. Still this can be challenged and assessee cant rely on judgment of tribunal because A.O can deny the judgment. We have to wait for the judgment of Court in my opinion.

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