CA Falguni Padiya
In case of a business of trading in shares assessee may transfer some of his stock in trade into his capital asset by deciding to hold it as an investment or on discontinue of delivery based trading of shares, convert the stock of shares into investments and sell the same at a later stage and pay tax on the profit as capital gain instead of business profit. It is here to be noted that long term capital gain from equity shares sold in stock exchange and on which Security Transaction Tax has been paid, is exempt u/s 10(38) of Income Tax Act. Thus in case of conversion of shares held as stock in trade into capital asset, the benefit of exemption u/s 10(38) will be available if such converted capital asset is sold later and long term capital gain arises from it. There will not be any capital gain at the time of conversion.
Section 45(2) of the Act are absolutely clear and applicable only in case when investment is converted into stock- in – trade and not vice – versa. On the date of conversion of stock-in-trade to capital asset, there shall be no business income. Generally, no one can earn income from oneself. [Kikabhai Premchand (Sir) vs. CIT (1953) 24 ITR 523 (SC)1. Unlike capital gains, there is no such provision under the provisions of “Income under the Business/Profession” creating a deeming fiction and charging the same as Business income.
In this article two decision contradictory to each other are discussed.
The controversy is whether gain arise on sale of shares in case of transfer of shares from stock –in –trade to investment is exempt or not:
Aggrieved by the order of the CIT (A), the Revenue appealed to the ITAT.
Assessee was engaged in trading of shares and had been consistently declaring shares as its stock in trade – On opening date of current year, i.e., on 1-4-2005, it converted stock in trade into investment and immediately thereafter sold most of shares – Since shares had been classified as investment, assessee computed long term capital gain and short-term capital gain and claimed long term capital gain as exempt under section 10(38) – Whether on facts it was clear that assessee converted stock in trade into investment only to avail benefit of exemption and concessional rate of tax and, therefore, revenue authorities were justified in assessing gain arising on sale of shares as business income of assessee by disregarding claim of long-term capital gain and short – term capital gain. – Held, yes [para 5] [in favour of Revenue]
lT : Where assessee converted shares held as stock in trade into investment and sold same immediately thereafter with a view to avail benefit of exemption under section 10(38) and concessional rate of tax, conversion of stock in trade into investment was disregarded and gain on sale of shares was assessed as business income.
Amendment Recommended to Section 2(14) to provide clarity regarding Taxability Of Surplus On Sale Of Shares & Securities – Capital Gains or Business Income
Committee recommends that the Act be amended to specifically provide in a new clause (aa) of section 2(14) that a capital asset shall include shares and securities held by an assessee for a period exceeding 12 months from the date of acquisition (other than those declared as stock-in-trade/trading asset in the return of income furnished under section 139 of the Act) and the profits or gains arising from transfer of the same shall be taxable under the head “capital gains”. Shares and securities which are held for a period not exceeding twelve months will continue to be capital assets as per the existing clause (a) of section 2(14).
The result of the amendments recommended will be that:
(i) surplus arising on transfer of shares and securities held for a period exceeding twelve months will be, in all cases, chargeable as capital gains if they are not held as stock-in-trade.
(ii) surplus arising on transfer of shares and securities held for a period less than twelve months, upto a sum of rupees five lakhs, will be chargeable as capital gains if they are not held as stock-in-trade.
It is further proposed to provide that where the profits or gains arising to an assessee from transfer of shares or securities held by him for a period which is less than twelve months and which have been offered to tax under the head “capital gains”, do not exceed rupees five lakhs during the previous year, the Assessing Officer shall not treat such profits and gains as business income, provided the shares were not held as stock-in-trade.
Cases which are not covered by the above proposed amendment shall continue to be assessed on the basis of existing principles laid down by the courts and summarised by the CBDT.
The recommendations are aimed at reducing, if not altogether eliminating, a substantial chunk of litigation.
The proposed amendment will take effect from 1st April, 2017 and will, accordingly, apply in relation to the assessment year 2017-18 and subsequent years.
This judgment clearly brings out the fact that there are no provisions that restrict the conversion of stock-in-trade into investments and hence, such conversion holds good in law. The character of a transaction cannot be determined solely on the application of any abstract rule, principle or test but must depend upon all the facts and circumstances of the case. The facts that may be considered while determining the same are the magnitude and frequency of buying and selling of shares by the assessee; the period of holding of shares, ratio of sales to purchases and the total holding, etc. Mere classification of shares in the books of accounts of the assessee is not relevant for determining the nature of income for Income-tax purpose.
Thus, if the transaction is genuine and there is supporting circumstantial evidence, such as Board resolution passed in general meeting, Affidavit, suitable clarificatory note given in the Notes to Accounts, there is a strong ground for defending the claim that the same has not been entered into only for the purpose of tax evasion/avoidance. Of course, one has to follow the accounting treatment consistently to prove that it is bonafide.
Author CA Falguni Padiya, ACA, DISA is a Chartered Accountant and associated with Rajesh Lifespaces. Can be reached at firstname.lastname@example.org