2023 (2) TMI 1361 - HC - Income Tax

Long term capital gains exempt u/s 10(38) - dematerialised share scripts and the date of acquisition of shares - Date of acquisition of dematerialized shares for capital gains calculation - primary issue under the Income-tax Act in the case of securities whether held in physical form or in the dematerialized form remains the determination of cost of acquisition and the period of holding. HELD THAT - Only problem when securities are held in dematerialized form is that the distinct trail linking every share to a certificate and its unique distinctive number linking it with its subsequent sale is not available. Section 45(2A) stipulates that in the case of securities held in dematerialized form, for determining date of transfer and period of holding , the FIFO method would be applicable. FIFO method is generally used to determine the value of any item moving out of a stock account and those remaining in stock at any point of time. When applied to an account holding dematerialized stock, it implies that, out of the existing holdings, the item that first entered into the account is deemed to be the first to be sold out. Once a sale is linked with an earlier purchase, for determination of their date of transfer and period of holdings . Board s Circular No.704 would be applicable. That is to say that the relevant contract notes as explained in Circular No.704 will have to be referred to, for ascertaining the cost of the security sold and the date of transfer. On a reading of the above circular it is seen that there is nothing to indicate that the circular excludes the cases of securities sold in physical form. In fact the circular deals with securities held in physical form as well as those in demoralised form. The circular has also clarified the position as to the applicability of the earlier circular No. 704 dated 28.4.1995. Thus we are of the view that the conclusion arrived at by Tribunal holding that Board Circular No. 704 dated 28.4.1995 is not applicable to dematerialised share scripts and the date of acquisition of shares would be the date only when dematerialised shares are entered in the D-mat account with depository is incorrect conclusion arrived at by the learned Tribunal. Decided in favour of assessee.

Summary

Issues:
Interpretation of Circular No.704 and No.768 for determining capital gains exemption under section 10(38) of the Income Tax Act, 1961.
Applicability of Circular No.768 to dematerialized share scripts.
Date of acquisition of dematerialized shares for capital gains calculation.

Analysis:
The judgment involves an appeal under Section 260A of the Income Tax Act against the order of the Income Tax Appellate Tribunal for the assessment year 2005-06. The substantial questions of law in this case revolve around the interpretation of Circular No.704 dated April 28, 1995, and Circular No.768 dated June 24, 1998, issued by the Central Board of Direct Taxes. The primary issue is whether the capital gains from the sale of shares purchased by the appellant are exempt under section 10(38) of the Income Tax Act, and if the Tribunal's findings reversing the Commissioner of Income Tax (Appeals) order are arbitrary. Another issue is the determination of the date of acquisition of dematerialized shares for capital gains calculation.

The Circular No.704 dated April 28, 1995, provides clarity on the date of transfer and holding period for capital gains purposes when transacting in securities. It states that the date of the broker's note should be considered as the date of transfer for sale transactions of securities, provided there is delivery of shares and transfer deeds. Similarly, for the purchase of securities, the holding period starts from the date of the broker's note. The Circular aims to establish a clear procedure for determining the relevant dates in securities transactions, whether through stock exchanges or directly between parties.

The subsequent Circular No.768 dated June 24, 1998, addresses the determination of the date of transfer and holding period for securities held in dematerialized form under Section 45(2A) of the Act. It clarifies that the FIFO method is applicable for dematerialized securities, where the first-in-first-out principle is used to determine the value of items sold. However, when a sale is linked to an earlier purchase, Circular No.704 is applicable for determining the cost of the security sold and the date of transfer.

The Court observed that Circular No.768 does not exclude securities sold in physical form and applies to both physical and dematerialized securities. The Circular also reaffirms the applicability of Circular No.704 for determining the cost and date of transfer of securities. Therefore, the Tribunal's conclusion that Circular No.704 is not applicable to dematerialized shares and that the date of acquisition is when shares are entered into the D-mat account is deemed incorrect.

Consequently, the Court allowed the appeal filed by the assessee, answering the substantial questions of law in favor of the assessee.