CS Deepak Pratap Singh
The income arising from Sale of Shares/Debentures or other securities and real estate business will be determined and taxed on the basis, whether they are Capital Asset or Business Asset. It is important to determine, whether the income is generated from Capital Assets or from Business Assets and be determined as Capital Gain or Income from business.
It is important to determine the nature of income because the rate of tax will be different in case of Capital Gain or Business Income.
There is no parameter prescribed under the Income Tax Act, 1961 to characterised on the basis of which, a transaction can be classified as business transaction or as transaction of investment.
If a transaction emerges on sale/purchase of an asset kept as an investment, then it is in the nature of Capital Asset and income arises from the same will be taxed as Capital Gain or otherwise it is a Business Income.
Section 2(13) of the Income Tax Act, 1961 defines “Business” to “include any trade, commerce or manufacture or any adventure or concern in the nature of trade, commerce or manufacture.”
Section 2(14) of the Income Tax Act, 1961 defines “Capital Asset” as “Property of any kind held by the assesses, whether or not connected with other his business or profession, but specifically excludes “Stock in trade” and other kind of specified assets.
Note: Any kind of property except except those falling in the excluded category is a Capital Asset.
Let us consider some Judicial Decisions in this respect;
CIT vs. Ahmedbhai Umarbhai & Co. (1950)18ITR 472(SC) the Supreme Court has defined business to mean every continued activity of person, which yields profits and which is in the nature of trade, commerce or manufacture.
Barendra Prasad Roy Vs. CIT(1981)129ITR 295(SC) the Supreme Court held that business income mean as activity carried on continuously and systematically by a person by the application of his labour and skill with a view to earning an income.
Thus the main ingredients of a Business are;
- It should be an occupation or profession which occupies the time, attention and labour of a person,
- The object is primarily of making profit.
CIT Vs. Associated Industrial Development Co. (P) Limited (1971) 82 ITR 586/1972 CTR(SC) 239(SC) , the Supreme Court held that “ Whether a particular holding is by way of investment or forms part of the Stock in trade is a matter which is within the knowledge of the assesses, who hold the shares and it should , in normal circumstances, be in a position to produce evidence from its record 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.”
Fidelity North star Fund, In re(2007) 288 ITR 641, Authority for Advance Rulings (AAR) held that “ 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 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.”
Premji Bhimji vs. CIT (1971)81ITR 179(Cal.); it has been held that “In deciding whether a venture is in nature of trade no rigid formula can be applied. The total impression must be gathered from all the relevant facts and circumstances. In a transaction of purchase and re-sale, whether the purchase is made solely and exclusively with the intention to re-sell at a profit and the purchaser has no intention of holding the property for himself or otherwise using it, the presence of such an intention is a relevant fact and unless offset raises a strong presumption that the adventure is in the nature of trade.”
Bhogilal H. Patel Vs. CIT (1969) 74 ITR 692( Bom.) it has been held that “ a person is undertaking a trade or business , or entering into an adventure in the nature of trade, it is essential that the particular transactions under scrutiny should have been entered into with the intention of earning a profit on the other hand if a person invests money in land intending to hold it, enjoys its income for some time, and then sells it at a profit, it would be a case of capital accretion and not profit derived from an adventure in the nature of trade. So intention of the person at the time of entering into transaction will be important to decide whether it is a transaction in the nature of trade or an investment.
Khan Bahadur Ahmed Alladin & Sons. Vs. CIT (1968) 68 ITR 573(SC) it was held that the answer to the question does not depend upon merely counting the number of facts and circumstances and pro and con or upon one particular fact such as original intention of the assessee or upon the application of any abstract rule, principal or formula but must depend upon the total impression and effect of all the relevant facts and circumstances established in a particular case.
Supreme Court of India in case of G. Venkataswami Naidu & Co. vs. CIT (1959) 35 ITR 594(SC) enumerate some tests to decide nature of transaction as;
- Was the purchase a trade and were the purchase of the commodity and its resale allied to his usual trade or business or incidental to it?
- What is the nature of the commodity purchased and resold and in what quantity was it purchased and resold?
- Did the purchaser, by any act subsequent to the purchase, improve the quality of the commodity purchased and thereby make it more readily resalable?
- What were the incidents associated with the purchase and resale?
- Were they similar to the operations usually associated with the trade or business?
- Are the transactions of purchase and sales repeated?
- In regard to the purchase of the commodity and its subsequent possession by the purchaser, does the element of pride of possession come into the picture?
- Whether the finance required for the purchase of the commodity has been found from the surplus funds with the assesses or whether they represent borrowed money?
The above points considered by the Supreme Court are not a conclusive to determine the nature of business or trade. All relevant points should be considered for deciding nature of transaction.
Gujarat High Court in case of CIT Vs. Rewashanker A. Kothari (2006) 283 ITR 338 held that in order to determine ,whether profit arising from sale is business income, following tests can be applied;
- The first test is whether the initial acquisition of the subject matter of transaction was with the intention of dealing in the item or with the view to finding an investment;
- The second test is why and how for what purpose the sale was effected subsequently;
- The third test is as to how the assessee dealt with the subject matter of transition during the time the asset was with the assessee & whether the assessee treated the asset as stock in trade or has been shown in the books of account as investment;
- The fourth test is how the assessee himself has returned the income from such activities and how the department has dealt with the same in the course of preceding and succeeding assessment;
- The fifth test ( normally applied in the case of firm or company) is in what manner the deed of Partnership or MOA as the case may be authorised the transaction;
- The final and most important test is as to the volume, frequency, continuity and regularity of transaction of purchase and sale of goods concerned.
SUMMARY OF TESTS TO DETERMINE THE TRANSACTION AS BUSINESS INCOME OR CAPITAL GAIN:
While going through above judicial proceedings and considering other factors , it is essential to determine the nature of transaction by judging the intention of parties at the time of purchase or sale of assets;
The intention of person can be gathered from a number of factors;
(A) Intention behind investment; if the investment is made as an organised activity , such as by establishment of office, deployment of staff to undertake various activities , etc., and with the intention to earn profit by sale or purchase of asset , the activity will be in nature of business.
(B) Frequency and volume of transactions; more the frequency of transactions, more will be presumption that it is business transaction. If transactions are entered into regularly and continuously, then it is more likely to be treated as a business activity. The period of asset held by person, will also be considered to determined nature of transaction. If a person not regularly enters into transaction or he holds assets for a longer period and sale thereafter than the nature of transaction will raise Capital Gain.
(C) Normal Business of the assessee; if purchase and sale of asset is allied to the assessee’s usual trade or business or are incidental to it, it will be treated as business transaction. On the other hand if a purchase and sale is an independent activity than business of the assessee, then it in nature of investment.
(D) Intention behind sale of asset; if asset is sold in the normal course of business of the assessee or it is a routine matter for assessee then it is a business transaction. On the other hand if asset is sold to generate a fund to meet some liability then it will be treated as an investment transaction.
(E) Mode of acquisition of asset; if an asset has been acquired by way of partition of HUF, gift or under a will and subsequent sale of asset will result Capital Gain.
(F) Accounting treatment in books of accounts; if an asset is shown as an Investment in the books of accounts of the assessee, and then its sale will raise Capital Gain.
(G) Other Factors; there are some other factors, which will affect the nature of transaction such as ratio of sales or purchase and holding, the time devoted to the activity, the extent to which it is the means of livelihood and stated in the MOA in case of a Company , which have to be considered while d determining the nature of transaction.
Thus most important factor for characterisation of transaction as trading or investment is the intention behind it. Other factors are ancillary but there has to be a scrutiny of either all or most of all the factors and the combined effect of all of them have to be considered to characterise the transaction as business or investment. The facts of each case have also to be taken into consideration.