Business Income or Capital Gains? Tax Treatment of Share Trading

Declaring Profit on Sale and Purchase of Shares as Business Income under the Income Tax Act, 1961

Introduction

The Indian stock market has witnessed exponential growth, attracting both investors and traders. This growing participation has brought tax implications into sharper focus, particularly in classifying income from sale and purchase of shares. Under the Income Tax Act, 1961, such profits can be classified either as capital gains or business income, depending on the nature and frequency of the transactions. When the transactions are carried out with an intention to trade or make profits in a systematic, organized, and repetitive manner, the profits are generally taxed as business income. This essay explores the criteria, legal framework, and implications of declaring such profits as business income under the Income Tax Act, 1961.

Legal Framework under the Income Tax Act, 1961

The Income Tax Act, 1961, does not explicitly define when profits from sale and purchase of shares should be treated as business income. However, several judicial precedents, circulars by the Central Board of Direct Taxes (CBDT), and general principles of taxation guide the classification.

According to Section 28 of the Act, profits and gains from any business or profession are chargeable to income tax under the head “Profits and Gains of Business or Profession”. If a taxpayer is actively engaged in trading of shares as a business activity, the profits or losses arising therefrom are to be declared as business income.

CBDT Circulars and Judicial Guidelines

To remove ambiguity, the CBDT issued Circular No. 6/2016 dated 29th February 2016, which provides broad guidelines for determining the nature of share transactions:

1. Listed Shares Held for More Than 12 Months: If the taxpayer opts to treat the gains as
capital gains and this is consistently followed, the Department shall not question it.

2. Listed Shares Held for Less Than 12 Months: The taxpayer has the option to treat the income either as capital gains or as business income, provided the choice is consistently followed in subsequent years.

3. Unlisted Shares: As per CBDT Circular No. 6/2016, income from transfer of unlisted shares will be treated as capital gains, unless held as stock-in-trade.

However, if the frequency, volume, and nature of transactions indicate a business-like approach, then such income is to be treated as business income, irrespective of the holding period.

Key Criteria for Classification as Business Income

Several factors are considered by assessing officers and courts to determine whether the income should be taxed as business income. These include:

1. Volume and Frequency of Transactions: High volume and frequent trading activity may suggest a business motive.

2. Intention of the Taxpayer: If the shares are purchased with an intention to resell at profit, as opposed to investment for earning dividends or long-term appreciation, this leans towards business income.

3. Treatment in the Books of Accounts: If shares are recorded as stock-in-trade rather than investment, it indicates a trading business.

4. Use of Borrowed Funds: If loans are used to fund share purchases, this may indicate a business intention.

5. Infrastructure and Organization: If there is a systematic set-up, like having a dedicated office, employees, or frequent dealing in derivatives or futures, the activity is likely to be classified as a business.

Tax Implications of Business Income Classification

When profits are declared as business income:

1. Tax Rate: The income is taxed at the applicable slab rate for individuals or the applicable rate for companies or firms. This can be significantly different from the concessional rates applicable to capital gains.

2. Deductions Allowed: Unlike capital gains, expenses related to business, such as brokerage, internet charges, subscription to financial journals, interest on borrowed funds, office expenses, etc., are deductible.

3. Loss Set-Off and Carry Forward: Business losses can be set off against any income (except salary income) and carried forward for 8 years. However, speculation business losses (e.g., from intra-day trading) can be set off only against speculation income and carried forward for 4 years.

4. Advance Tax Applicability: Business income is subject to advance tax provisions. Failure to pay timely installments can lead to interest under sections 234B and 234C.

5. Books of Accounts and Audit: If the turnover exceeds specified limits (as per Section 44AB), a tax audit is mandatory. Section 44AD presumptive taxation is not applicable to share trading business.

Special Consideration: Speculative vs Non-Speculative Business

Under Section 43(5), speculative transactions are those where contracts are settled otherwise than by actual delivery. Intra-day trading is a typical example and profits from such trading are classified as speculative business income. On the other hand, delivery-based trading or derivatives trading (which are excluded from speculative definition by notification) are considered non-speculative business income.

Conclusion

The classification of income from the sale and purchase of shares as business income requires careful analysis of facts and circumstances. Taxpayers engaged in frequent trading, speculative transactions, or treating shares as stock-in-trade should declare profits as business income under the Income Tax Act, 1961. While this allows for the deduction of related expenses and carry forward of losses, it also brings responsibilities such as maintaining books of account, audit, and advance tax compliance. A clear and consistent approach aligned with CBDT guidelines and judicial precedents ensures proper tax compliance and minimizes the risk of disputes with tax authorities.

1. Sample ITR Disclosure for Business Income from Share Trading

This can be used in the “Profit and Gains from Business or Profession” section of the ITR-3 or ITR-4 form.

Nature of Business:

• Code: 09001
• Description: Trading in shares (own account)

Business Name: Your Name / Proprietorship Name
Business Address: [Your Address]

Part A – P&L (Profit and Loss Account Disclosure in ITR)

Particulars Amount (INR)
Turnover/Gross Receipts from share trading 12,00,000

Schedule BP (Computation of Income from Business or Profession)

Particulars Amount (INR)

Net profit or loss from P&L (above) 1,28,000

Add: Disallowable expenses (if any) –

Particulars Amount (INR)

Less: Allowable depreciation –

Business Income chargeable to tax 1,28,000

Note: You may be required to fill Balance Sheet and Profit & Loss details in ITR if turnover exceeds ₹10 lakh (for presumptive ITR-4) or ₹50 lakh/₹1 crore (for audit).

2. Format of Trading Profit & Loss (P&L) Statement

You can use this format in Excel or accounting software for your records and submission (if audited).

Trading Profit & Loss Account

Maintain detailed ledgers and contract notes to support each transaction.

3. Comparison Table: Capital Gains vs. Business Income Treatment for Shares