All about Taxation for Capital Market

CA Gautam Gupta

With lots of confusion regarding Capital Market likes how to tax income from capital market, how to compute turnover for tax audit u/s 44AB and what are the compliances to be fulfilled for income tax.

Frequent ask question regarding capital market.

Question 1. What are segments of Capital Market?

Answer1. Capital market is to be divided into two parts:

a. Cash Market, which further be divided into two parts:

i. Delivery Based

ii. Intraday (No Delivery)

b. Derivative Market, which further be divided into two parts:

i. Future

ii. Option

Question 2. How to classify, income from capital market, according income tax act?

Answer 2. Classification of income from capital market:

a. Purchase and Sale of shares where deliveries have been effected

i. The Profit/Loss is assessable as Capital Gains if shares are held as Capital Assets, i.e., Investments.

ii. The Profit/Loss is assessable as Business Income if share are held as stock-in-trade.

b. Purchase and sale of shares where delivery have not been affected, i.e., Intraday

The Profit/Loss is assessable as Speculation Income.

c. Purchase and sale of securities Derivatives/Futures & Option

The Profit/Loss is assessable as business Income.

Question 3. In case of `options’ and `futures’, is the gain or loss to be treated as speculation Gain or Loss?

Answer 3. The gain or loss from dealing in `options’ and `futures’ will not be treated as a speculation loss. This will be so because of the provisions of Section 43(5) of the Act.

Under section 43(5) of the Income Tax Act, 1961 an eligible transaction in respect of trading in derivatives referred to in clause (ac) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) carried out in a recognised stock exchange will not be treated as speculative transaction despite not been settled by actual delivery.

1. Eligible transaction in respect of Section 43(5) means any transaction

A. carried out electronically on screen based systems through a stock broker or sub broker or such other intermediary registered under section 12 of the Securities and Exchange Board of India Act, 1992 (15 of 1992) in accordance with the provisions of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) or the Securities and Exchange Board of India Act, 1992 (15 of 1992) or the Depositories Act, 1996 (22 of 1996) and the rules, regulations or bye laws made or directions issued under those Acts or by banks or mutual funds on a recognised stock exchange; and

B. which is supported by a time stamped contract note issued by such stock broker or sub broker or such other intermediary to every client indicating in the contract note the unique client identity number allotted under any Act referred to in sub clause (A) and permanent account number allotted under this Act;

2. recognised stock exchange means a recognised stock exchange as referred to in clause (f) of section 2 of the (A) Securities Contracts (Regulation) Act, 1956 (42 of 1956) and which fulfils such conditions as may be prescribed and notified by the Central Government for this purpose;]

Question 3. How to differentiate Investment Income & Business Income?

Answer 3. An issue may arise whether such transactions of purchase or sale of stocks and shares undertaken by the assessee are in the course of business or as investment. The answer to this issue will depend on the facts and circumstances of each case taking into consideration the nature of the transaction, frequency and volume of transactions etc. For this, attention is invited to the following judgments where this issue has been considered.

a. CIT v. P.K.N. and Co Ltd (1966) 60 ITR 65 (SC)

b. Saroj Kumar Mazumdar v. CIT (1959) 37 ITR 242 (SC)

c. CIT v. Sutlej Cotton Mills Supply Agency (1975) 100 ITR 706 (SC)

d. G. Venkataswamy Naidu v. CIT (1959) 351TR 594 (SC)

Further, CBDT Circular No.4/2007, dated: 15-6-2007 may also be referred to.

In deciding whether shares/units are capital assets or stock in trade, the following should be considered:

a. The treatment which assessee has given in the books of account, i.e., whether shown as investment or as stock in trade.

b. The existence of power to purchase and sell shares in Memorandum of Association is not decisive factor that it is stock in trade.

c. Quantum of Purchase and Sales.

d. Ratio between purchase and sale.

e. Holding Period.

f. If objective is to earn dividend, then it is a capital asset.

g. Method of valuation.

h. It is possible to have one portfolio as investment and other portfolio as stock in trade.

i. Whether such shares have been purchased out of own funds or from loans taken.

Question 4. When Tax Audit u/s 44AB is mandatory?

Answer 4. As per Sec 44AB, Every Person

a. carrying on business shall, if his total sales, turnover or gross receipts, as the case may be, in business exceed or exceeds one crore rupees in any previous year; or

b. carrying on profession shall, if his gross receipts in profession exceed twenty-five lakh rupees in any previous year; or

c. carrying on the business shall, if the profits and gains from the business are deemed to be the profits and gains of such person under section 44AD and he has claimed such income to be lower than the profits and gains so deemed to be the profits and gains of his business and his income exceeds the maximum amount which is not chargeable to income-tax in any previous year

Example: Mr. X has gross turnover of Rs.40,00,000.00 and total expense during the year is Rs.37,00,000.00.

So As per Sec 44AD his net taxable income is Rs.3,20,000.00, i.e., (40,00,000*8%) but as per normal provision his taxable income is Rs.3,00,000.00, i.e, (40,00,000-37,00,000) which is lower than net income of Sec 44AD and exceed amount not chargeable to tax, i.e., 2,50,000.00.

If above mentioned conditions are fulfilled then person is liable to get his accounts of such previous year audited by an accountant before the specified date and furnish by that date the report of such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars as may be prescribed.

Question 5. How to compute turnover of Speculative Business (Intraday Transaction) for Sec. 44AB?

Answer 5. As per Para 5.12 of ICAI guidance note for tax audit, the turnover or gross receipts of speculative transaction may be determined in the following manner:

In Speculative Transaction contract is settled without delivery and squared up by paying out the difference which may be positive or negative. In such transaction the difference amount is ‘turnover’.

Accordingly, the aggregate of both positive and negative differences is to be considered as the turnover of such transactions for determining the liability to audit vides section 44AB.

Example: Mr. X has purchased 1000 shares of Archies Ltd. for Rs.25 per share and 1000 share of Ashok Leyland Ltd. for Rs. 80 per share on 25/10/2015 and sold out same for Rs.27 per share and Rs.75 per share respectively on the same date.

So it is a speculative (Intraday) transaction, in that case we consider difference of sale or purchase for computation of turnover.

Turnover in that case is aggregate of both positive and negative differences.

Turnover is 2,000+5,000=7,000

Question 6. How to deal with losses in Speculation Business (Intraday)?

Answer6. Losses of Speculation Business can be set off against profit of speculation business only.

Example 1: Business Income: Rs.3, 00,000.00

Salary: Rs. 2, 50,000.00

Speculation Losses: Rs.1,00,000.00

Total Income during the year is Rs.5, 50,000.00, i.e., (3,00,000+2,50,000)

Carried forward speculation losses Rs.1, 00,000.00

Example 2. Speculation Income: 5, 00,000.00

Business Income: Rs. 4, 30,000.00

Carried forward losses: Rs.1, 00,000.00

Now, Total Income is Rs.4, 00,000.00(5,00,000-1,00,000) + 4, 30,000.00= 8, 30,000.00

Such Losses can be carried forward for 4 Assessment Years and set off against speculation Income only

Question 7. How to compute turnover in case of Future and options transactions?

Answer 7. As per Para 5.12 of ICAI of guidance note on Tax Audit u/s 44AB,

Derivatives, futures and options: Such transactions are completed without the delivery of shares or securities. These are also squared up by payment of differences. The turnover in such types of transactions is to be determined as follows:

1. The total of favourable and unfavourable differences shall be taken as turnover.

Example: Mr. X has purchased 5 lots of Nifty Index consisting 200 shares per lot of Rs.65,000 per lot on 14/09/2015 with expiry on 26/11/2015 and sold out same on 25/10/2015 for Rs.64,000 per lot.

In that case turnover will include 1,000(65,000-64,000)*5*= (5,000)

2. Premium received on sale of option is also to be included in turnover.

Example: Mr. X has purchased 5 lots of Reliance industries consisting 250 shares per lot of Rs.15 premium per share on 14/09/2015 with expiry on 26/11/2015 and sold out same on 25/10/2015 for Rs.20 premium per share.

In that case turnover will include 5(20-15)*250*5=6,250.00

Turnover in that case is aggregate of both positive and negative differences.

The nature of positive or negative will be ignored while computing turnover.

Question 8. How to compute turnover in case of delivery transaction?

Answer 8. As per Para 5.12 of ICAI of guidance note on Tax Audit u/s 44AB,

Where the transaction for the purchase or sale of any commodity including stocks and shares is delivery based whether intended or by default, the total value of the sales is to be considered as turnover.

But if such transactions are for the purpose of investment and income/loss arising therefrom is to be computed under the head ‘Capital Gains’, then the value of such transaction is not to be included in sales or turnover for deciding the applicability of audit under section 44AB. However, in case such transactions are in the course of business, then the total of such sales are to be included in the sale, turnover or gross receipts as the case may be, of the assessee for determining the applicability of audit under section 44AB.

Question 9. How to deal with losses in Business Income, i.e. (F&O and Delivery)?

Answer 9. Losses under head of Business Income:

1. Can be set off in current year against any income except salary income.

Example:

Capital Gain: Rs.1, 00,000.00

Salary Income: Rs.5, 00,000.00

House Property Income: Rs.1, 30,000.00

Business losses: Rs.3. 00,000.00

Now, Total Income is as follows :-

Balance Losses to be carried forward for 8 Assessment years and set off only against Business Income.

Question 10. How to tax income from capital market?

Answer 10. Tax on income from Capital Market

For Individual/HUF

1. Capital Gain

a. Short term Capital Gain: If STT has been paid on it then it should be taxed at 15% otherwise according to slab rate.

b. Long term Capital Gain: If STT has been paid on it then income from it is fully exempt otherwise it should be taxed at 20%.

2. Business Income, i.e.,(Deliveries and F&O Income): It should be taxed at slab rate.

3. Speculation Income, i.e., (Intraday): It should be taxed at slab rate.

For Others

1. Capital Gain

a. Short term Capital Gain: If STT has been paid on it then it should be taxed at 15% otherwise at 30%.

b. Long term Capital Gain: If STT has been paid on it then income from it is fully exempt otherwise 30%.

2. Business Income, i.e.,(Deliveries and F&O Income): It should be taxed at 30%.

3. Speculation Income, i.e., (Intraday): It should be taxed at 30%.

(Author can be reached at [email protected] / 99-999-354-71 for any queries)