Taxation of Listed Shares

The taxation of capital gain on the shares transactions has gone through a bunch of changes in the last few years, so it is very critical for a professional as well as for assessee to understand the concept of taxation of capital gain on listed shares.

Transactions in stock market can be Intra Day Transactions or Derivative Transactions or Delivery based transactions.In case of Intra Day it is well settled law that income from such transactions is a PGBP income of the Speculative Business.While in case of Derivative share transactions it is well settled that income from such transactions is a PGBP income of the Non Speculative Business. But how to tax gain arising from Delivery based transactions in listed shares traded on Recognised stock exchange is always a confusing and debatable issue. It is always debatable when to treat share income as capital gain and when to treat it as  a business income. This article will help you to do tax planning in case of Delivery based listed sharetransactions.

As per the provisions of the Income Tax Law profit/loss arising from the sale of the Listed  shares can be taxed under either of two heads of Income namely (i) PGBP or (ii) Capital Gain. Let us now first discuss the tax liability of gain /loss under both the heads.:

Shares
PGBP	Capital Gain
	Long Term	Short Term
Taxable as Normal Income	Taxable as Special Income under Section 112A	Taxable as Special Income under Section 111A
For Individual/HUF -As per Slab	Taxable @10%	Taxable @15%
For Others –   @30%
Note: Expenses Relating to share Business can be claimed against the share income Like total share purchase value, Expenses of telephone rent expenses of office premises, brokerage expenses, STT,interest cost for the funds used in share business,employee salary etc can be claimed.	No Expenses are Allowed except for the Cost of Acquisition as calculated in accordance with Section 49 of Income Tax Act 1961	No Expenses are Allowed except for the Cost of Acquisition as calculated in accordance with Section 49 of Income Tax Act 1961

So, both the options have their own prose and causes. For some of the assessee’s taxing share income as PGBP will be beneficial while for some of the assessee’s taxing share income as capital gain will be beneficial.

Now Let us understand the difference between both the method with the help of an example:

Example 1

Let Mr. Mehta & Co, a partnership firm do the following transactions on stock exchange

Date	Particular	Amount
01/04/2020	Purchase of 10000 shares of Reliance @Rs 1000 each	Rs 100,00,000
31/01/2021	Sale of 5000 Shares of Reliance @Rs 2000 each	Rs 100,00,000

Market Value of Reliance share on 31/03/2021 is Rs 400 and he had paid Rs 10,00,000 as interest during the year. Calculate Tax Liability under both the option.

Solution

> When taxing Income under the head PGBP 

Profit & Loss Account

Date	Particular	Amount	Date	Particular	Amount
01/04/2020	To Purchase (10000 shares @Rs 1000Each)	100,00,000	31/01/2021	By Sale (5000 Shares @RS 2000 Each)	100,00,000
31/03/2021	To Interest Cost on Borrowed Fund	10,00,000	31/03/2021	By Closing Stock (5000 Shares @Rs 400 Each) Using ICDS 2	20,00,000
31/03/2021	To Gross Profit (Bal Figure)	10,00,000
	Total	1,20,00,000		Total	1,20,00,000

Tax liability Calculation

• Total Income =10,00,000 Tax @30% on Rs10,00,000
• Total Tax Liability Rs 3,00,000.

> When taxing Income under the head Capital Gain

Calculation of Capital Gain

• Sale value (5000 Shares @ Rs 2000 Each) =Rs 100,00,000
• Less: Purchase Cost (5000 Shares @1000Each) =Rs 50,00,000
• Short Term Capital Gain= Rs 50,00,000
• Total Income 50,00,000 Tax @15% on Rs 50,00,000=Rs7,50,000

Thus in the above Example treating share income as PGBP is beneficial for assessee.

Example 2

Now Let Mr. Choksi & Co, a partnership firm do the following transactions on stock exchange

Date	Particular	Amount
01/04/2020	Purchase of 10000 shares of Reliance @Rs 1000 each	Rs 100,00,000
31/01/2021	Sale of 5000 Shares of Reliance @Rs 2000 each	Rs 100,00,000

Market Value of Reliance share on 31/03/2021 is Rs 1500 and he had paid Rs 10,00,000 as interest during the year. Calculate Tax Liability under both the option.

Solution

• When taxing Income under the head PGBP 

Profit & Loss Account

Date	Particular	Amount	Date	Particular	Amount
01/04/2020	To Purchase (10000 shares @Rs 1000Each)	100,00,000	31/01/2020	By Sale (5000 Shares @RS 2000 Each)	100,00,000
31/03/2021	To Interest Cost	10,00,000	31/03/2021	By Closing Stock (5000 Shares @Rs 1000 Each) Using ICDS 2	50,00,000
31/03/2021	To Gross Profit (Bal Figure)	40,00,000
	Total	1,50,00,000		Total	1,50,00,000

Tax liability Calculation

• Total Income =40,00,000   Tax @30% on RS 40,00,000
• Total Tax Liability Rs 12,00,000.

> When taxing Income under the head Capital Gain

Calculation of Capital Gain

• Sale value (5000 Shares @ Rs 2000 Each) =Rs 100,00,000
• Less: Purchase Cost (5000 Shares @1000Each) =Rs 50,00,000
• Short Term Capital Gain= RS 50,00,000
• Total Income 5000000 Tax @15% on Rs 50,00,000=Rs7,50,000

Thus in the above Example treating share income as Capital Gain is more beneficial for assessee.

As illustrated above taxation of share income as ‘Business Income’ and ‘capital gain ‘are subject to tax at different rate of tax under the Income Tax Act 1961.The provisions of Income tax Act do not lay down clear criteria for determining the classification of income under these heads but over the period some generic principle were evolved out of judicial precedents and administrative dispensation.

Further CBDT just to make clarity in taxation of shares has issued various circulars and instructions to maintain uniformity and reduce litigation in assessee practice of either treating share income as capital gain/PGBP income.

Firstly, in year 1989, certain test were laid down by the Central Board Direct Taxes (CBDT) to distinguish between shares held as stock in trade and shares held as investment.The CBDT then issued a circular No. 4/2007 dated 15 June 2007.The said circular is issued as supplement toearlier Instruction of 1989, “Instruction No. 1827 dated 31.08.1989”.The following principles should be kept in mind while deciding whether shares are capital assets or stock in trade “CIRCULAR NO. 4/2007, DATED 15-6-2007” :

(i) Whether a particular holding of shares is by way of investment or forms part of the stock-in-trade is a matter which is within the knowledge of the assessee who holds the shares and it should, in normal circumstances, be in a position to produce evidence from its records 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.

(ii) Where a company purchases and sells shares, it must be shown that they were held as stock-in-trade and that existence of the power to purchase and sell shares in the memorandum of association is not decisive of the nature of transaction;

(iii) The substantial nature of transactions, the manner of maintaining books of account, the magnitude of purchases and sales and the ratio between purchases and sales and the holding would furnish a good guide to determine the nature of transactions.

(iv) 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 the 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”.

(v) We have to verify as to how the shares were valued /held in the books of the account i.e., whether they were valued as stock in trade at the end of the financial year for the purpose of arriving at the business income or held as investments in capital assets.

(vi) Where the object of the investment in shares of the companies is to derive income by way of dividends etc. the transactions of purchases and sales of shares would yield capital gains and not the business profits.

(vii) CBDT also wishes to emphasise that it is possible for a taxpayer to have two portfolios, i.e., an investment portfolio comprising of securities which are to be treated as capital assets and a trading portfolio comprising of stock-in-trade which are to be treated as trading assets. Where an assessee has two portfolios, the assessee may have income under both heads, i.e., capital gains as well as business income.

Further the same circular also advised the Assessing officers that the above principles should guide them in determining whether, in a given case, the shares are held by the assessee as investment (and therefore giving rise to capital gains) or as stock-in-trade (and therefore giving rise to business profits). The Assessing Officers are further advised that no single principle would be decisive and the total effect of all the principles should be considered to determine whether, in a given case, the shares are held by the assessee as investment or stock-in-trade.

Furthermore, CBDT to reduce Litigation also clarified the same through “Circular No. 6/2016, Dated 29-02-2016”. The crux of the circular is:

a) Where the assessee itself, irrespective of the period of holding the listed shares and securities, opts to treat them as stock-in-trade, the income arising from transfer of such shares/securities would be treated as its business income,

b) In respect of listed shares and securities held for a period of more than 12 months immediately preceding the date of its transfer, if the assessee desires to treat the income arising from the transfer thereof as Capital Gain, the same shall not be put to dispute by the Assessing Officer. However, this stand, once taken by the assessee in a particular Assessment Year, shall remain applicable in subsequent Assessment Years also and the taxpayers shall not be allowed to adopt a different/contrary stand in this regard in subsequent years.

c) In all other cases, the nature of transaction (i.e. whether the same is in the nature of capital gain or business income) shall continue to be decided keeping in view the aforesaid Circulars issued by the CBDT.

Conclusion: Thus there is not a particular standardised way for taxation of gain on Delivery based listed shares, the situation of taxability varies according to the situations and nature of security held by an assessee. CBDT however from the above circulars /instruction provided a help /understanding of the concept. Now it depends upon the tax payer or the assessee to  reflect its income by giving proper justification of the same. Taxation under both the head may be beneficial for one assessee and harmful for other. So, while exercising the judgement on treating share income as business income or capital gain assessee should follow above mentioned guidance and proper care must be taken for the same as once the option is exercised in one year assessee will need to follow the same to maintain the uniformity.