Section 10(38)
Section 10(38) of the Income Tax Act, 1961 provided a full exemption on long-term capital gains arising from the transfer of listed equity shares and equity-oriented mutual fund units on which Securities Transaction Tax had been paid — an exemption that was withdrawn by the Finance Act 2018 effective April 1, 2018.
Section 10(38) was introduced by the Finance Act 2004, the same legislation that created Securities Transaction Tax. The rationale was simple: since STT was being levied on every exchange transaction, subjecting the same gains to capital gains tax would amount to double taxation of market activity. Accordingly, LTCG on listed equities and equity mutual funds was placed entirely outside the tax net through this section.
For over thirteen years, Section 10(38) shaped investor behaviour profoundly. Long-term equity investing became highly tax-efficient — gains could compound indefinitely without any capital gains liability as long as the holding period exceeded twelve months. This exemption contributed to the strong retail and institutional participation in equity markets during the 2004–2018 period.
The Finance Act 2018 abolished Section 10(38) with effect from April 1, 2018, applicable to assessment year 2019–20 onwards. In its place, Section 112A was inserted, which taxed LTCG on such assets at 10% on gains exceeding ₹1 lakh. A grandfathering clause was simultaneously introduced, deeming the fair market value as of January 31, 2018 to be the cost of acquisition for assets held on that date, thereby protecting pre-2018 gains from tax.
The withdrawal of Section 10(38) was announced in Budget 2018 and drew considerable debate. Critics argued that it would discourage retail equity participation and increase the cost of capital for companies. Proponents countered that the exemption created an anomaly where speculative short-term trading bore a 15% tax while patient long-term capital went untaxed.
Historically, the abuse of Section 10(38) through circular trading and accommodation entries to convert black money into tax-free capital gains was a well-documented concern flagged by SEBI and the Finance Ministry. The eventual withdrawal was partly motivated by the desire to plug this loophole. Post-2018, all LTCG on equity assets is governed entirely by Section 112A, and Section 10(38) has ceased to have any practical application.