The issue whether the gains arising from sale/dealing of shares are taxable under the head "Capital Gains" or under "Business Income" has been increasingly engaging the attention of the assessees, the tax department and, consequently, of the judiciary. The litigation on the issue has tended to only multiply. The question has attained greater relevance in the cases where an assessees (immaterial of whether it is an individual, firm, company or any other entity) have engaged in a series of frequent transactions and the turnover is high. The question also assumes relevance in cases where an assessee bifurcates his gains (on some rational, systematic and consistent basis by applying criteria such as the period of holding, or the actual/constructive delivery of shares, etc.) into Capital Gains or Business income, i.e., where he maintains a dual portfolio comprising of a trading portfolio and an investment portfolio and, consequently, has income both under the head "Capital Gains" as well as under "Business Income".
Income tax department has issued three circulars on the above issue which has been reproduced hereunder for your reference,
CIRCULAR NO. 6/2016, DATED 29/06/2016
Sub: Issue of taxability of surplus on sale of shares and securities - Capital Gains or Business Income - Instructions in order to reduce litigation - reg.-
Sub-section (14) of Section 2 of the Income-tax Act, 1961 ('Act') defines the term "capital asset" to include property of any kind held by an assessee, whether or not connected with his business or profession, but does not include any stock-in-trade or personal assets subject to certain exceptions. As regards shares and other securities, the same can be held either as capital assets or stock-in-trade/ trading assets or both. Determination of the character of a particular investment in shares or other securities, whether the same is in the nature of a capital asset or stock-in-trade, is essentially a fact-specific determination and has led to a lot ot uncertainty and litigation in the past.
2. Over the years, the courts have laid down different parameters to distinguish the shares held as investments from the shares held as stock-in-trade. The Central Board of Direct Taxes ('CBDT) has also, through Instruction No. 1827, dated August 31, 1989 and Circular No.4 of 2007 dated June 15, 2007, summarized the said principles for guidance of the field formations .
3. Disputes, however, continue to exist on the application of these principles to the facts of an individual case since the taxpayers find it difficult to prove the intention in acquiring such shares/securities. In this background, while recognizing that no universal principal in absolute terms ca.n be laid down to decide the character of income from sale of shares and securities (Le. whether the same is in the nature of capital gain or business income), CBDT realizing that major part of shares/securities transactions takes place in respect of the listed ones and with a view to reduce litigation and uncertainty in the matter, in partial modification to the aforesaid Circulars, further instructs that the Assessing Officers in holding whether the surplus generated from sale of listed shares or other securities would be treated as Capital Gain or Business Income, shall take into account the following
a) Where the assessee itself, irrespective of the period of holding the listed shares and securities, opts to treat them as stock-in-trade, the income arising from transfer of such shares/securities would be treated as its business income,
b) In respect of listed shares and securities held for a period of more than 12 months immediately preceding the date of its transfer, if the assessee desires to treat the income arising from the transfer thereof as Capital Gain, the same shall not be put to dispute by the Assessing Officer. However, this stand, once taken by the assessee in a particular Assessment Year, shall remain applicable in subsequent Assessment Years also and the taxpayers shall not be allowed to adopt a different/contrary stand in this regard in subsequent years;
c) In all other cases, the nature of transaction (i.e. whether the same is in the nature of capital gain or business income) shall continue to be decided keeping in view the aforesaid Circulars issued by the CBDT.
4. It is, however, clarified that the above shall not apply in respect of such transactions in shares/securities where the genuineness of the transaction itself is questionable, such as bogus claims of Long Term Capital Gain / Short Term Capital Loss or any other sham transactions.
5. It is reiterated that the above principles have been formulated with the sale objective of reducing litigation and maintaining consistency in approach on the issue of treatment of income derived from transfer of shares and securities. All the relevant provisions of the Act shall continue to apply on the transactions involving transfer of shares and securities .
Distinction between shares held as stock-in-trade and shares held as investment - tests for such a distinction
CIRCULAR NO. 4/2007, DATED 15-6-2007
The Income Tax Act, 1961 makes a distinction between a "capital asset" and a "trading asset".
2. Capital asset is defined in Section 2(14) of the Act. Long-term capital assets and gains are dealt with under Section 2(29A) and Section 2(29B). Short-term capital assets and gains are dealt with under Section 2(42A) and Section 2(42B).
3. Trading asset is dealt with under Section 28 of the Act.
4. The Central Board of Direct Taxes (CBDT) through Instruction No.1827 dated August 31, 1989 had brought to the notice of the assessing officers that there is a distinction between shares held as investment (capital asset) and shares held as stock-in-trade (trading asset). In the light of a number of judicial decisions pronounced after the issue of the above instructions, it is proposed to update the above instructions for the information of assessees as well as for guidance of the assessing officers.
5. In the case of Commissioner of Income Tax (Central), Calcutta Vs Associated Industrial Development Company (P) Ltd (82 ITR 586), the Supreme Court observed that:
"Whether a particular holding of shares is by way of investment or forms part of the stock-in-trade is a matter which is within the knowledge of the assessee who holds the shares and it should, in normal circumstances, be in a position to produce evidence from its records as to whether it has maintained any distinction between those shares which are its stock-in-trade and those which are held by way of investment."
6. In the case of Commissioner of Income Tax, Bombay Vs H. Holck Larsen (160 ITR 67), the Supreme Court observed :
"The High Court, in our opinion, made a mistake in observing whether transactions of sale and purchase of shares were trading transactions or whether these were in the nature of investment was a question of law. This was a mixed question of law and fact."
7. The principles laid down by the Supreme Court in the above two cases afford adequate guidance to the assessing officers.
8. The Authority for Advance Rulings (AAR) (288 ITR 641), referring to the decisions of the Supreme Court in several cases, has culled out the following principles :-
- "(i) Where a company purchases and sells shares, it must be shown that they were held as stock-in-trade and that existence of the power to purchase and sell shares in the memorandum of association is not decisive of the nature of transaction;
- (ii) the substantial nature of transactions, the manner of maintaining books of accounts, the magnitude of purchases and sales and the ratio between purchases and sales and the holding would furnish a good guide to determine the nature of transactions;
- (iii) ordinarily the purchase and sale of shares with the motive of earning a profit, would result in the transaction being in the nature of trade/adventure in the nature of trade; but where the object of the investment in shares of a company is to derive income by way of dividend etc. then the profits accruing by change in such investment (by sale of shares) will yield capital gain and not revenue receipt".
9. Dealing with the above three principles, the AAR has observed in the case of Fidelity group as under:-
"We shall revert to the aforementioned principles. The first principle requires us to ascertain whether the purchase of shares by a FII in exercise of the power in the memorandum of association/trust deed was as stockin-trade as the mere existence of the power to purchase and sell shares will not by itself be decisive of the nature of transaction. We have to verify as to how the shares were valued/held in the books of account i.e. whether they were valued as stock-in-trade at the end of the financial year for the purpose of arriving at business income or held as investment in capital assets. The second principle furnishes a guide for determining the nature of transaction by verifying whether there are substantial transactions, their magnitude, etc., maintenance of books of account and finding the ratio between purchases and sales. It will not be out of place to mention that regulation 18 of the SEBI Regulations enjoins upon every FII to keep and maintain books of account containing true and fair accounts relating to remittance of initial corpus of buying and selling and realizing capital gains on investments and accounts of remittance to India for investment in India and realizing capital gains on investment from such remittances. The third principle suggests that ordinarily purchases and sales of shares with the motive of realizing profit would lead to inference of trade/adventure in the nature of trade; where the object of the investment in shares of companies is to derive income by way of dividends etc., the transactions of purchases and sales of shares would yield capital gains and not business profits."
10. CBDT also wishes to emphasise that it is possible for a tax payer to have two portfolios, i.e., an investment portfolio comprising of securities which are to be treated as capital assets and a trading portfolio comprising of stock-in-trade which are to be treated as trading assets. Where an assessee has two portfolios, the assessee may have income under both heads i.e., capital gains as well as business income.
11. Assessing officers are advised that the above principles should guide them in determining whether, in a given case, the shares are held by the assessee as investment (and therefore giving rise to capital gains) or as stock-in-trade (and therefore giving rise to business profits). The assessing officers are further advised that no single principle would be decisive and the total effect of all the principles should be considered to determine whether, in a given case, the shares are held by the assessee as investment or stock-in-trade.
12. These instructions shall supplement the earlier Instruction no. 1827 dated August 31, 1989.
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Instruction No. 1827 dated 31.08.1989 - Tests for distinction between shares held as stock-in-trade and shares held as investment Tests for distinction between shares held as stock-in-trade and shares held as investment
1. The question whether a particular assessee is a trader in shares or the shares are held as capital assets sometimes gives rise to disputes and litigation. Over the years the courts have laid down the various tests or factors to be taken into account in determining this question.
2. Certain general principles in this regard were laid down by the Supreme Court in the case of G. Venkata Swami Naidu & Co. v. CIT  35 ITR 594. In this case the Supreme Court was dealing with a question whether the excess sum realised on the sale of certain plots was assessable as income from an adventure in the nature of business. The Supreme Court held that in deciding the character of such transaction, several factors were relevant.
For instance :—
- i. Whether the purchaser was a trader and the purchase of the commodity and its resale were allied to his usual trade or business or were incidental to it.
- ii. The nature and quantity of the commodity purchased and resold - if the commodity purchased is in very large quantity, it could tend to eliminate the possibility of investment for personal use, possession or enjoyment.
- iii. The repetition of the transaction.
3. The Supreme Court observed that the presence of all these factors may be held in the court to draw an inference that a transaction is in the nature of trade but it is not a matter of merely counting the number of facts and circumstances pro and con what is important to consider is their distinctive character. In each case, it is the total effect of all relevant factors and circumstances that determines the character of the transaction.
4. The Supreme Court in this case also discussed the test of intention. It held that in cases where the purchase has been made solely and exclusively with the intention of resale at a profit and the purchaser has no intention of holding the property for himself or otherwise enjoying it or using it, the presence of such intention is a relevant factor and unless it is off-set by the presence of other factors, it would raise a strong presumption that a transaction is an adventure in the nature of trade.
5. In the case of H. Mohammad & Co. v. CIT  107 ITR 637 the Gujarat High Court observed that a stock-in-trade is something in which a trader or a business man deals, whereas his capital asset is something with which he deals. According to the High Court one of the indicators for deciding as to what is stock-in-trade is whether a particular assessee is buying or selling the goods or commodity or whether he has merely invested his money with a view to earning further income or with a view to carrying on his other business. It was further held by the High Court that the distinction between stock-in-trade and investment is that of selling outright in the course of the business activity and deriving income from exploitation of one’s own assets.
6. These general principles hold good in respect of shares also. However certain specific issues relevant for determining this question with reference to shares have also been decided by the courts. In the case of Sardar Indra Singh & Sons Ltd. v. CIT  24 ITR 415, the Supreme Court was dealing with the case of a company which was incorporated with the object, inter alia of carrying on the business of bankers, financiers, managing agents and secretaries and was also empowered to invest and deal with the monies of the company not immediately required for its business upon such securities and in such manner as might from time to time be determined. It was held by the Supreme Court in this case that to constitute business income, it was not necessary that surplus should have resulted from such a course of dealing in securities as by itself would amount to the carrying on of business or if the realisation of securities is a normal step in carrying on the assessee’s business. The Supreme Court observed that the principle applicable in all such cases was well settled and the question always was whether the sales which produced the surplus were so connected with the carrying on of the assessees business that it could fairly be said that the surplus was the profit and gains of such business. On the facts of this case it was held that the surplus resulting from sale of shares and securities constituted business income.
7. The aforesaid principles laid down by the Supreme Court was followed by Andhra Pradesh High Court in the case of SBH v. CIT  151 ITR 703. The main business of the SBH was to accept deposits and to advance loans and the money constituted its stock-in-trade. The banking company has to carry on its business in accordance with the provisions of the Banking Regulation Act, 1949. Section 24 of the said Act requires every banking company to maintain in India either in cash or in the shape of gold or in the shape of unencumbered approved securities, 20% of its total time and demand liabilities at any given point of time. It was held by the High Court that what section 24 of the said Act did was to insist on the observance of a normal prudent banking business practice. If the banking company chooses to invest the money in unencumbered approved securities it is only one mode of keeping a portion of its deposits in ready cash or readily convertible into cash securities. Any income arising from the sale of such securities is, therefore closely connected with the banking business and is business income, it was concluded by the High Court.
8. In the case of Karam Chand Thapar & Brothers (P.) Ltd. v. CIT  83 ITR 899 it was held by the Supreme Court that the circumstance that the assessee had shown certain shares as investment in its books as well as its balance sheet was by itself not a conclusive circumstances, though it was a relevant circumstance.
9. The decisions in CIT v. Associated Industrial Development Co.  82 ITR 586 (SC) and A.N. Ramaswami Chettiar v. CIT  48 ITR 771 (Mad.) may also be referred to for guidance.
10. Although the tests laid down by the courts may help determine the issue in particular cases the decision will ultimately turn on the facts of each case.
Instruction : No. 1827, dated 31-8-1989.
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