Recent Circular issued by CBDT on treatment of income from share transactions is not clear and conclusive and is likely to add to confusion on the issue.
The memory of stock market fall and various press reports criticising the draft has recently faded and once again Central Board of Direct Taxes (CBDT) has come out with guidelines to distinguish between shares held as stock-in-trade and shares held as investments vide Circular No. 4/2007, dated 15-6-2007 (F. No. 149/287/2005 – TPL). It is a supplement to 18 year old Instruction No.1827, dated 31st August 1989 [F.No 181/1/89 IT (AI)].
Controversy The circular is important as there is a very thin line distinguishing an investor from a trader in stocks with respect to share transactions.
Indian tax laws As per the Income-tax Act, 1961, capital asset [as defined under section 2(14)] could be either short-term [as defined under section 2(42A) and 2(42B)] or long-term [as defined under section 2(29A) and 2(29B)].
The tax liability of long term capital gains in respect of shares, securities and units (holding period more than twelve months) is elaborated in section 112 and such gain if covered by securities transaction tax is exempt (i.e., nil) under section 10(38). The taxability of short-term capital gain as per section 111A is at a flat rate of 10 per cent in addition to surcharge and cess. Shares held as capital asset by the investor will be chargeable under the head Capital gain.
Trading asset (as defined under section 28 of the Income-tax Act, 1961) results in business gain or loss. Stock-in-trade is charged under the head Profits and gains of business or profession taxable at the rate of 30% in addition to education cess, secondary and higher secondary education cess and surcharge in case of a company. In this case, share transactions are taxed at a relative higher rate and tax concessions are also not available.
Thus, the issue is all about the characterisation of income and the applicable tax rate in case of a share transaction. Any change or clarification therefore assumes importance.
Issue is all about the characterisation of income and the applicable tax rate.
Recent circular – The recent twelve points circular is no better than the supplement instruction draft dated about thirteen months ago, i.e., 16th May, 2006 (F.No.149/287/ 2005-TPL) which listed fifteen parameters.
The circular specifies the principles laid down by the Supreme Court in the two independent cases of year 1971, Associated Industrial Development Company (P) Ltd. (82 ITR 586) and year 1986, Holck Larsen (160 ITR 67). It also highlights the stand taken by the Authority for Advance Rulings (AAR) (288 ITR 641) in the recent case of Fidelity Group.
The circular implies that tax assessing officers will henceforth have to look into
1. Whether the shares purchased were held and valued as stock-in-trade?
2. Whether the transactions were substantial or not?
3. Whether the motive was to rake in profits or to earn dividends?
4. When determining the tax liability involved among others.
AAR has said that ordinarily the purchase, sale of shares with a motive of earning profits amounts to business income, while investments made for earning income through dividend would tantamount to income under the head Capital gain.
The circular also adds that an assessee may have two portfolios under the head Capital gains and Business income.
The final decision depends on the facts of each case and the circular provides legal support. It is a mere guide for both the taxpayers and the tax collector. The Board has also advised its officers to take a holistic view on the basis of all the principles to arrive at a conclusion.
An Implication The circular endeavors to characterise income but fails to lay out exact definite conditions and resolve the contentious issue. It is just a summation of important judicial verdict on the matter.
It might be considered as a persuasive guidance, but it is not conclusive. The circular adds that it is a mere guide and no single principle is decisive and the total effect of all principles are to be considered to determine its taxability.
It also mentions that 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: but in case of individuals it is silent.
Individuals and ordinary investors also do not maintain books of account. The terms substantial and magnitude are very board terms and ought to specifically define. The ratio of purchase and sale and holding are vague terms having an enormous prospect of inclusion and exclusion with no exact parameters mentioned.
The terms substantial and magnitude are very board terms and ought to specifically defined.
Tax experts feel that tax officer may misuse the clause, as most of share purchases are made for profit motive and not for earning income from dividend (comparably low yield). As per the circular such an investor would be regarded as a trader earning business income and not an investor realising capital gains.
The intention of the tax department is to clarify ambiguities. The government’s indication that tax treatment will be based on individual specific cases is highly disappointing and shows a lack of foresight. But by leaving the judgment to individual assessing officers to determine the issue has wide ramifications. It is truly unfair and leaves the tax system open to misinterpretation and enhances the possibility of abuse. The scope of frequent visit to the Assessing Officer with authorities having an upper hand cannot be ignored.
There are no clear-cut guidelines or clarity in the circular. Too much power is given to the Assessing Officer, which will possibly lead to more disputes and litigations. It attempt to segregate trade and investments in stocks for calculating tax liability of investors has proved futile.
The only positive point in the circular is that a person can have two portfolio, i.e., an investment portfolio comprising securities that are to be treated as capital assets, and a trading portfolio comprising stock-in-trade that are to be treated as trading assets. The same was not in the earlier draft circular. The idea is to encourage retail participation in equities. An investor will have to classify his portfolio into two categories – One where the intention is to keep for long-term and the Second where the intention is to trade.
The circular has not removed the uncertainty amongst those representing foreign institutional investors (FIIs) either. The intensity of assessments and investigations could also increase. It also raises issues previously settled.
The power to issue circulars is contained in section 119 of the Income-tax Act, 1961. It is issued to remove any unintended hardship to the taxpayers or to resolve a procedural problem. Circulars are binding on the tax officer (revenue authorities) and not on the assessees (taxpayer). In the absence of any specific clarification, it will apply to all taxpayers, i.e., the domestic investors/traders and foreign investors/traders, despite the fact that the Finance Ministry after the draft circular clarified that different provision for taxing foreign tax investors will be specified.
Conclusion – Indian economy is in a growing stage and poised for charting a high growth trajectory. Union Finance Minister, Shri. P. Chidambaram is doing a laudable job in putting focus back on economic reforms, but circulars like this only act as hindrance and add to confusion. The government should aim at coming out with circulars, which are simple, understandable and unambiguous. Investors who risk money in the share market must be aware of the tax liability and do tax planning accordingly. There is hardly anything new in the circular and the air of ambiguity still exists.
The issue of classification of gains from stock transactions into either business income or capital gains has a long history. After eighteen years and one draft circular (asking for suggestions) and numerous judicial pronouncements, the government could not still come up with a unique formulae to solve the debatable issue. It largely caters to the corporate sectors and again ignores the small investors/traders.
Investor’s main aim is gain and the risk element adds to the profit. The taxpayers need clear, well-structured and specific instructions for investing in capital market with no scope of any uncertainty. On a positive note, only time will tell the direction of movement of the air.
One is having Demat account and online share trading account. With his saving of Rs 25 lakhs he is investing in purchase and sell of share online on delivery based share trading .With Rs 25 Lakhs makes total purchased and sell of shares around Rs 100 lakhs in a year and earned income of Rs. 10 lakhs . CBDT circular on treatment to given this as business income or capital gains/ investment income based on certain criteria is confusing .
How he should pay advance tax i.e. should he treat this as short term capital gains or as business income? Is covered under compulsory tax audit. How to calculate limit of Rs 40 lakhs for compulsory tax audit? How and who is to decide the INTENTION whether it it businrss or investment?