Section 10(38) Exemption Denied: ITAT Ruling 2026 on Share Transactions

What Happened?

The Income Tax Appellate Tribunal (ITAT) has recently upheld the Assessing Officer's decision to deny Section 10(38) exemption on share transactions in the case of SRK Industries. The tribunal also upheld the addition made under Section 68 of the Income Tax Act 2025 (relating to unexplained investments and income), while remanding certain computation-related issues back to the Assessing Officer for recalculation. This ruling is a significant development for taxpayers and businesses engaged in share trading and investments.

Background & Legal Context

What is Section 10(38)?

Section 10(38) of the Income Tax Act 2025 provides an exemption on capital gains derived from the transfer of certain eligible securities. Under the old Act (1961), this section allowed taxpayers to claim exemption on long-term capital gains from shares held for specified periods. The section was introduced to encourage investment in the securities market and provide relief on genuine share investments.

When Does Section 10(38) Apply?

• The transfer must involve listed or specified securities
• The securities must be held for the specified holding period as defined under the Act
• The transaction must be genuine and not a sham arrangement
• The taxpayer must pay the Securities Transaction Tax (STT) or comply with other prescribed conditions

What is Section 68?

Section 68 of the Income Tax Act deals with unexplained investments. If a taxpayer receives funds or makes investments without credible explanation, the Assessing Officer can add such amounts to the taxpayer's income. In this case, the ITAT confirmed that the share transactions were sham arrangements with no genuine business purpose, making them liable for addition under Section 68.

The ITAT's Finding

The tribunal examined the facts and found that:

• The share transactions lacked genuine commercial substance
• The investments appeared to be structured primarily for tax exemption benefits rather than actual investment purposes
• The circular flow of funds suggested these were sham arrangements designed to create artificial capital gains and claim Section 10(38) exemption
• The taxpayer failed to provide satisfactory evidence of genuine investment intent

What Does This Mean for You?

For Share Investors and Traders

This ruling sends a clear message: the Income Tax Department will closely scrutinize share transactions that appear designed primarily to claim Section 10(38) exemption. If your transactions have the following characteristics, you are now at higher risk of similar disallowance:

• Circular flow of funds (money going out and coming back in a short cycle)
• Transactions with related parties or associated persons
• Lack of genuine business rationale beyond tax planning
• Insufficient documentation of investment purpose
• Transactions not aligned with the taxpayer's normal business or investment profile

Assessment Year (AY) 2025-26 and AY 2026-27 Implications

For assessments being conducted in AY 2025-26 and AY 2026-27, the Assessing Officer will now have stronger precedent to deny Section 10(38) exemption on suspicious share transactions. This means:

• More detailed scrutiny of share purchase and sale agreements
• Demand for bank statements showing movement of funds
• Questioning on investment purpose and timing of sale
• Cross-examination with related transaction records

Double Impact: Loss of Exemption + Addition Under Section 68

Unlike simple disallowance, this case shows that the Department can:

1. Deny the Section 10(38) exemption, taxing the entire gain as capital gains
2. Also add the investment amount itself under Section 68 as unexplained investment

This creates a double taxation scenario where the taxpayer loses both the exemption AND must justify the source of the investment.

For Corporate and HUF Investments

This ruling is particularly important for:

• Private companies making inter-company share transfers
• HUFs engaged in share trading
• Partnership firms distributing share investments to partners
• Trusts and charitable institutions making share trades

What Should You Do Now?

Step 1: Review Your Share Transactions

If you have claimed Section 10(38) exemption in any of your previous returns (especially AY 2024-25 and AY 2025-26), review whether your transactions have similar characteristics to the sham transactions identified in this case. Ask yourself:

• Were the funds you invested in shares already available with you before the transaction?
• Did you hold the shares for a genuine investment period?
• Did you receive the proceeds from sale in a normal manner, or was there circular flow?
• Can you explain the business purpose of the transaction?

Step 2: Document Your Investment Intent

For current and future share transactions, maintain comprehensive documentation:

• Bank statements showing source of funds for purchase
• Email exchanges or notes explaining investment rationale
• Broker statements and contract notes
• Evidence of where proceeds were utilized after sale
• If related party transaction: copy of Board resolution and valuation report

Step 3: File Amended Return if at Risk

If you have pending assessments or if the statute of limitation (4 years) is still open, consider filing a voluntary amended return under Section 139(5) of the Income Tax Act. This can:

• Reduce penalties (though interest will still apply)
• Demonstrate good faith to the Department
• Prevent higher additions under Section 68

Step 4: Seek Professional Guidance

If you have received any notice or assessment order related to Section 10(38) disallowance, consult a tax professional immediately. The computation-related issues that were remanded to the Assessing Officer may provide some relief in the final assessment.

Step 5: Revise Your Tax Planning Strategy

Going forward, ensure that any share investment strategy:

• Is based on genuine investment objectives
• Does not involve circular flow of funds
• Is properly documented with clear intention
• Complies with all STT and other prescribed conditions

Key Takeaways

• Sham transactions get caught: The ITAT confirmed that share transactions lacking genuine commercial substance will not qualify for Section 10(38) exemption, even if technically structured as eligible securities transfers.
• Double addition risk: Loss of exemption is compounded by addition under Section 68, creating significant tax outgo. Taxpayers must now be aware they can face both disallowance and unexplained investment additions.
• Documentation is critical: The ruling underscores the importance of maintaining clear evidence of investment purpose, source of funds, and end-use of proceeds. Lack of documentation will lead to disallowance.
• Related party transactions face higher scrutiny: Share transactions with connected persons or entities are now under the microscope. These require Board approvals, valuations, and clear commercial rationale.
• Amended returns may offer relief: While the ITAT upheld the denial, computation issues were remanded. Additionally, voluntary disclosure through amended returns can still provide some protection against penalties in pending cases.

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