Section 10 (38) of Income Tax Act 1961 was one of the main sections for investors in India, more so if you were investing in the equity markets. It allowed you to claim an exemption on long-term capital gains or LTCG from the sale of equity shares and equity-oriented mutual funds, provided certain conditions were met. This exemption made equity investments especially attractive and helped the growth of the stock market, making it wider in terms of participation. The Finance Act, 2018 introduced significant amendments in how LTCG is taxed. Here is all you need to know about section 10 38 while investing in the market.

Section 10 38 of Income Tax Act 1961, deals with long-term capital gains arising from the transfer of equity shares and equity-oriented mutual funds. If you sold these investments after holding them for more than 12 months, and the transaction took place on a recognised stock exchange and is subject to Securities Transaction Tax, your gains were exempt from tax. It was brought in for making equity investments more tax-efficient and lucrative for investors. Prior to the amendments in the Finance Act, 2018, this section granted absolute exemption from tax liability on such gains, impacting your investment decisions to a great extent.

Section 10 38 had prescribed some conditions for you to avail the exemption on long-term capital gains. This included maintaining equity shares or equity-based mutual funds for over 12 months and making certain that the sale was on a recognised stock trade, subject to STT. The following paragraphs on the key provisions of sec 10 38 are discussed below:

Applicability

Section 10 38 applied if you were rearning long-term capital gains from selling equity shares or equity-oriented mutual funds listed on the recognised stock exchanges in India, provided you were subject to the STT norms. This exemption was likely to result in a substantial reduction in the tax liability of an individual, a company, or a mutual fund house on long-term gains from investments. Moreover, the sec 10 38 was key if you were a retail investor, as it provided a tax shield that enhanced your returns.

Equity shares

If the equity shares were held for more than 12 months prior to sale, the sale of shares would be considered an exempt under Section 10 38. This was provided the shares were listed on a recognised stock exchange in India and the sale was subject to STT. It encouraged you to adopt a long-term investment strategy, rewarding you for your patience with tax-free gains. Besides, you could take advantage of the growth potential of the Indian stock market without worrying about tax implications on your returns.

Holding period

The holding period was a critical aspect of Section 10 38. To claim the exemption, the equity shares or equity-oriented mutual funds had to be held for more than 12 months. This distinguished long-term capital gains from short-term gains, which were taxed differently. The holding period was targeted to be a method of prompting people for long-term thinking in investments, aligning with the government's goal of promoting stability and growth in the financial markets.

Listed securities

Section 10 38 applied particularly to listed securities, which also meant that your shares or mutual funds had to be traded on a recognised stock exchange in India. This provision was purposely in place to ensure that the tax exemption was available to only the transactions that were highly traded, well-regulated, and transparently agreed to by the general public. By focusing on listed securities, the government aimed to channel your investments into formal, regulated markets, enhancing market integrity and investor confidence.

Securities transaction tax (STT)

Securities Transaction Tax or STT was a key feature of Section 10 38. For you to benefit from the exemption on long-term capital gains, the transaction needed to be subject to STT, a tax levied on the purchase and sale of securities on the stock exchanges. This requirement was introduced to ensure that only genuine market transactions received the tax benefit, encouraging transparency in market dealings. By linking the exemption to STT, the government aimed to align your tax benefits with regulated and monitored market activities, ensuring that the incentives were available only for legitimate, on-market transactions.

Exclusion

Section 10 38 was not all-inclusive, applicable to all types of securities or to transactions. If your gains arose from the sale of unlisted shares or off-market transactions, you would be ineligible to the exemption as that does not attract STT. Besides, the exemption did not cover gains from debt-oriented mutual funds, bonds, or debentures. The idea behind the exemption under Section 10 38 was to reserve such gains only for transactions that were transparent, regulated, and conducted within the formal financial market.

The Finance Act 2018 brought about a pivotal change in how long-term capital gains from equity shares and equity-oriented mutual funds are taxed under Section 10 38. Prior to the amendment, such gains were wholly exempt from tax, while equities were considered one of the most attractive investment instruments. From April 1 2018, gains above Rs. 1 lakh were taxed at a flat rate of 10%, without indexation benefits. This, in fact, was a measure toward bringing equity investments at par with other asset classes like real estate and fixed deposits, which were already facing taxation. The Rs. 1 lakh threshold could have been a probable exemption to protect small investors from the impact of this new tax and allow them to continue taking advantage of the exemption. Above all, it marked a change in the government's policy toward widening the tax base.

Section 10 38 of Income Tax Act sparked considerable debate due to its perceived bias towards equity investments. Many argued that it was unfair to equity investors because it exempted their long-term capital gains from taxation, while other asset classes, such as fixed deposits and real estate, were being increasingly brought under heavier taxation. This disparity led to fears that the taxation system was skewed in favour of market-based investments, thus leading to a divergence of investment decisions. Additionally, there were worries about tax evasion, as some investors might manipulate STT to create artificial gains and claim exemptions. The partial rollback of these benefits in the Finance Act 2018 was widely seen as an attempt to address these issues and find balance in the need for tax incentives with a fair and equitable tax regime.

The 2018 amendments to Section 10 38 of Income Tax Act had a great impact on taxpayers, more so if you previously benefited from the full exemption on long-term capital gains. With the introduction of a 10% tax on LTCG exceeding Rs. 1 lakh, many likely had to rethink their investment strategies. If your gains were substantial, this new tax could have increased your overall tax liability, making it essential to reassess your portfolio and explore more tax-efficient investment options. On the other hand, if your gains fell below the Rs. 1 lakh threshold, the impact was minimal, allowing you to continue enjoying the benefits of the exemption. This change was to emphasise the importance of proactive tax planning and ensure that your investments remain aligned to your financial goals and tax obligation.

The amendments to Section 10 38 were complex giving rise to the need of, seeking professional advice on taxation. In this regard, tax consultants and financial advisors provide valuable insights into how the changes would affect your portfolio and suggest strategies to minimise your tax liabilities. They could also guide you on optimising your investments to ensure compliance with the new tax regulations. If you have a substantial portfolio, professional advice is essential to help you navigate the intricate tax landscape and align it with your financial goals.

Compliance with the provisions of Section 10 38 and the subsequent amendments was key to avoid penalties and legal issues. Proper documentation and adherence to the rules regarding STT and holding periods were essential. Now, with the introduction of exemption threshold of Rs. 1 lakh and a new tax rate, you have to be careful while reporting your gains in your tax returns. Moreover, fines or loss of the exemption could result from non-compliance. Thus, knowledge of the updated regulations was quite critical in ensuring financial discipline and avoiding legal ramifications.

The withdrawal of the full exemption under Section 10 38 had implications for the Indian economy, particularly the stock market. The tax on long-term capital gains was seen as a move towards creating a more balanced and equitable tax system. However, it also raised concerns about a potential slowdown in market participation, as the tax could deter long-term investors like you. The impact on market sentiment was mixed, with some viewing the tax as a necessary step towards broadening the tax base, while others feared it might reduce the attractiveness of equity investments. The long-term economic impact of the tax remains debatable.

Section 10 38 of Income Tax Act 1961, has been instrumental in shaping investment behaviour in India, especially in equity markets. However, the amendments introduced by the Finance Act 2018, brought a significant shift, balancing revenue generation with investor protection. Staying informed and compliant with the latest income tax regulations will help you make strategic and informed financial decisions, ensuring your investments remain tax-efficient and aligned with your financial goals. To explore other investment opportunities, consider investing in mutual funds through Bajaj Finserv. Their platform allows you to compare mutual funds and access a wide array of Mutual Fund Schemes. You can also use their Mutual Fund Calculator to plan effectively and stay updated on Income Tax Slabs.