When does income be taxed as Capital gain or Business income?
When the transaction involves transfer of capital asset then that will constitute capital gain, whereas transaction which is entered into normal course of business shall constitute business income.
Some Practical Issues
Issue – 1
- Where agreement for construction of hostel building, agreement for lease of hostel building and agreement for provision of facilities in hostel building during lease period were part of one composite arrangement for provision of hostel facilities by assessee to lessee, entire income under three agreements was to be assessed as business income. [Kenton Leisure Services (P.) Ltd. v. DCIT 18 taxmann.com 158 (ITA T-Cochin)  ]
Issue -2 – Taxability of waiver of loan taken for acquiring capital asset.
Section 41(1) -Remission or cessation of trading liability
When loan is taken for acquiring capital asset, waiver thereof would not amount to any income eligible to tax; on other hand, if loan is for trading purpose and has been treated as such from very beginning in books of account, waiver thereof may result in income, more so when it is transferred to profit and loss account.
Bombay Gas Co. Ltd. V ACIT  23 taxmann.com 22 (Mum-ITAT)]
Loans/advances were taken by assessee-company from company B in course of its business activity. Company B approached assessee-company to clear its dues as they had immediate business obligation. Old outstanding dues of Rs. 1,20,67,817 was settled for Rs. 85,00,000. Balance amount of Rs. 35,67,817 was waived by company B. Assessee credited this amount into capital reserve account. Advance received by assessee from company B had never been allowed as a deduction in any of previous financial year. It was a case of loan liability and not trading liability.
Waiver of loan liability credited by assessee under capital reserve account in its books of account would be a capital receipt and could not be deemed as remission or cessation of liability and consequently no benefit would have arisen to assessee in terms of section 41(1).
Issue 3 – Investment of land or sale of land after plotting – whether Business Income or Capital Gain.
- A transaction of purchase and sale of land cannot be assumed, without more, to be a venture in the nature of a trade. [CIT vs. Jawahar Development Association 127 ITR 431 (MP)(1 981)]
- The activity of an assessee in dividing the land in to plots and not selling it as a single unit as he purchased, goes to establish that he was carrying on business in real property and it is a business venture. [Raja J. Rameshwar Rao v CIT 42 ITR 179 (SC)(1961)] also see CIT vs Tridevi (V.A.) (1988) 172 ITR 95 (Bom)]
- Mode of payment i.e. payment in installments is not a determinative factor if the income is in the nature of trade or capital gain. [CIT v Radha Bai 272 ITR 264 (Del) (2005)]
- Where assessee constructed shops which were let out and rent has been received for 3 years, thereafter the shops were sold – Income from sale of shop is capital gain. [ACIT v Janak Raj Chauhan 102 TTJ 297 (A sr.)(2006)]
- The assessee, after dividing the land into plots, sold the land situated in a village which was beyond 8 kms, of the municipal limit. Such land was sold pursuant to an agreement to sell executed earlier. It was held that land in question was rural agriculture not eligible to capital gain. [CIT vs Sanjeeda Begum 154 Taxman 346 (All) (2006)]
- When the land was acquired on the basis of a will on the death of her husband & she sold the same in parcels because the huge area could not be sold in one transaction. Such an activity could not amount to trade or business within the meaning of the Act. [CIT v Sushila Devi Jain 259 ITR 671 (P&H) (2003)]
- Selling of own land after plotting it out in order to secure a better price is not in the nature of trade or business, more so when the land was gifted to the assessee. [CIT v Suresh Chand Goyal 209 CTR 410 (MP)(2007) see also Ram Saroop Saini (HUF) v ACIT 15 SOT 470 (Del)(2007)]
- Relinquishment of right in property against consideration shall attract capital gain. [CIT v Smt Laxmidevi Ratani 296 ITR 0363 (MP)]
- Where assessee held shares from seven to eleven months, earned dividend and entered into a few transactions of sale of such shares during relevant year even though he held a huge number of shares, income arising from sale of shares would be taxable as short-term capital gain. [CIT v. Vinay Mittal  22 taxmann.com 151 (Delhi)]
- Where assessee-company’s main business was investment in shares & securities, shares could not be treated as business assets but income from sale of shares was liable to capital gains. [CIT v. Trishul Investments Ltd. (2008) 305 ITR 434 (Mad.)]
Guiding Principles to determine whether sale of shares is taxable as business income or short term capital gains.
Asst. CIT v. Om Prakash Arora  16 taxmann.com 396 (ITAT-Delhi)
Following principles can be applied on the facts of a case to find out whether transaction(s) in question are in the nature of trade or are merely for investment purposes:
- What is the intention of the assessee at the time of purchase of the shares (or any other item). This can be found out from the treatment it gives to such purchase in its books of account. Whether it is treated as stock-in-trade or investment. Whether shown in opening/closing stock or shown separately as investment or non-trading asset.
- Whether assessee has borrowed money to purchase and paid interest thereon. Normally, money is borrowed to purchase goods for the purposes of trade and not for investing in an asset for retaining.
- What is the frequency of such purchases and disposal in that particular item? If purchase and sale are frequent, or there are substantial transactions in that item, it would indicate trade. Habitual dealing in that particular item is indicative of intention of trade. Similarly, ratio between the purchases and sales and the holdings may show whether the assessee is trading or investing (high transactions and low holdings indicate trade whereas low transactions and high holdings indicate investment).
- Whether purchase and sale is for realizing profit or purchases are made for retention and appreciation in its value?
Former will indicate intention of trade and latter, an investment. In the case of shares whether intention was to enjoy dividend and not merely earn profit on sale and purchase of shares. A commercial motive is an essential ingredient of trade.
- How the value of the items has been taken in the balance sheet? If the items in question are valued at cost, it would indicate that they are investments and where they are valued at cost or market value or net realizable value (whichever is less), it will indicate that items in question are treated as stock-in-trade.
- How the company (assessee) is authorized in memorandum of association/articles of association? Whether for trade or for investment? If authorized only for trade, then whether there are separate resolutions of the board of directors to carry out investments in that commodity and vice versa.
- It is for the assessee to adduce evidence to show that his holding is for investment or for trading and what distinction he has kept in the records or otherwise, between two types of holdings. If the assessee is able to discharge the primary onus and could prima facie show that particular item is held as investment (or say, stock-in-trade) then onus would shift to revenue to prove that apparent is not real.
- The mere fact of credit of sale proceeds of shares (or for that matter any other item in question) in a particular account or not so much frequency of sale and purchase will alone will not be sufficient to say that assessee was holding the shares (or the items in question) for investment.
- One has to find out what are the legal requisites for dealing as a trader in the items in question and whether the assessee is complying with them. Whether it is the argument of the assessee that it is violating those legal requirements, if it is claimed that it is dealing as a trader in that item? Whether it had such an intention (to carry on illegal business in that item) since beginning or when purchases were made?
- It is permissible as per CBDTs Circular No. 4 of 2007 of 15-6-2007 that an assessee can have both portfolios, one for trading and other for investment provided it is maintaining separate account for each type, there are distinctive features for both and there is no intermingling of holdings in the two portfolios.
- Not one or two factors out of above alone will be sufficient to come to a definite conclusion but the cumulative effect of several factors has to be seen.
Issue – 5 – Default in payment of call money
When the assessee commits a default in payment of call money and consequently the share application money is forfeited by the company, it would be extinguishment of a right and consequently there will be short term capital loss. [DCIT v BPL Sanyo Finance Ltd (2009) 312 ITR 63 (Kar.)].
(Source – Book on Practical Aspects of Tax Audit, TDS, HUF & Capital Gains written by CA Agarwal Sanjay ‘Voice of CA’ & Team)
Republished with Amendments