If you buy shares of a company listed on a recognised stock exchange and sell such an investment after a year, any gains derived from them are not subject to income tax, provided STT on such a sale has been paid. The same rule applies to units of an equity-oriented mutual fund.

This is because the sale of such an investment after a year qualifies as a long-term capital gain, which is exempt under Section 10(38) of the Income-Tax Act, 1961.

But what if after a year, the sale of such a listed share or equity-oriented mutual fund over the stock exchange (and subject to STT) results in a long-term capital loss? Can such a loss on specified listed securities be claimed by the taxpayer for setoff against any other long-term capital gain, say, a gain made from the transfer of land?

The long-settled position under the tax regime is that since the income from sale of listed shares (STT paid) on the stock exchange does not form part of the total income, the losses from such a transaction should also not form part of the total income and, thus, disallowed for setoff against any income.

However, the issue was recently discussed by the Mumbai Bench of the Income Tax Appellate Tribunal (ITAT), which decided the matter in favour of the taxpayer. It held that such a long-term capital loss on the sale of listed securities  — which, otherwise, is tax-exempt, had such sale resulted in gains — is available for setoff against the long-term capital gains on sale of land. While arriving at this decision, the Mumbai ITAT has provided us with a different perspective of a long-settled interpretation of law.

The argument by the assessee before the ITAT was that since the purpose of not including exempt income as defined under Section 10(38) of the I-T Act is to provide a benefit to the assessee making such an investment, it should only include a positive income and losses shall not fall under the purview of the section.

On the other hand, the tax authorities relied on judicial precedents in which it was held that income includes loss and, therefore, loss from an exempt source shall not be taken into consideration while computing the income of the assessee. This was rejected by the ITAT by creating a distinction between a ‘source of income’ and a ‘stream of that source’.

Section 10(38) of the I-T Act provides exemption of income only from transfer of equity shares and equity oriented funds only upon fulfillment of certain conditions, such as being long term in nature, transaction having been conducted on a recognised stock exchange in India, payment of STT,  and so on.

If any of these conditions are not fulfilled, the exemption would not be available. Thus, the income contemplated under Section 10(38) is only a part of the source of capital gain on shares and only a limited portion of the source is treated as exempt, and not the entire capital gain on the sale of shares.

While it is likely that the ITAT order would be challenged at higher forums, till that time, the taxpayer can rely on this ruling.

The writer is partner with Nangia Co. With inputs from Akshay Lakra

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