Assessee Wins Appeal: Circular No.704 Applies to Dematerialized Securities for Capital Gains Exemption Under Section 10(38)

The HC allowed the appeal filed by the assessee, ruling in favor of the assessee on the substantial questions of law. The Court determined that Circular No.704 applies to both physical and dematerialized securities, contrary to the Tribunal's findings. It concluded that the date of acquisition for dematerialized shares should follow the guidelines set in Circular No.704, rather than when shares are entered into the D-mat account. The judgment reversed the Tribunal's decision, thereby granting capital gains exemption under section 10(38) of the Income Tax Act, 1961, for the assessee.

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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.

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