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Taxation of Transactions of Shares/Securities By: CA. Rasesh Shah
Introduction • Taxation of Capital Market Transactions has always remained hot topic for discussion and subject of debate. • The high returns available from the stock market have lured the investors from many other areas and they make investment at regular intervals and they often switch from one script to another on account of increased volatility of market. • The main controversy centers round whether the transaction of sale in capital market is chargeable as business income or capital gain. • Firstly, various provisions of capital gain tax of transactions of capital market are explained
Legal Provisions-I • Capital market plays an important role in the economy of the country. Accordingly, FM took various measures from time to boost capital market • Section 112 was amended by Finance Act, 1999 for taxing long-term capital gain on the sale of listed shares. It gives assessee an option to calculate tax on such income either at 10% or 20% with indexation benefit. • In order to give further fillip to capital market, new section 10(36) is incorporated in the Finance Act 2003 to exempt long term capital gain from sale of long-term capital asset being an eligible equity share in a company purchased on or after 01 -03 -2003 and before 01 -03 -2004.
Legal Provisions-II • However, to boost capita market, new Section 10(38) was inserted by the Finance (No. 2) Act of 2005 providing that income arising from the transfer of a long-term capital asset being equity shares as also units of equityoriented mutual funds would be exempted from the purview of long-term capital gains. • The basic condition for availing of above exemption is that such transaction should be chargeable to securities transaction tax; otherwise section 122 would be applicable. • In case of short term capital gain, the rate of tax is 10% if transaction is subject to STT as per section 111 A. However, if the income other than short term capital gain is below taxable limit, the short term capital gain shall be reduced by other income which falls short of taxable limit.
Legal Provisions-III • As per section 45(2), when any capital asset is converted into stock in trade, the capital gain is payable in the year in which such converted stock in trade is sold and for the purpose of section 48, the fair market value on the date of conversion shall be deemed to be the full value of the consideration. • As per section 45(3), when units under Equity Linked Saving Scheme are redeemed, the difference between amount received and invested shall be deemed to be capital gain.
Business or Capital Gain Various Parameters: • The intention at the time of purchase • The length of period of holding • The frequency of transactions • Owned fund v. Borrowed fund • Time devoted • The infrastructure and set up employed • The volume of transaction • Alternative occupation • The ratio of purchase and sales • Circumstances responsible for sale • Post utilisation of proceeds • Treatment in books of account • MOA/AOA • No. of scripts
Circulars and Case Laws • • • Instruction No. 1827 dated 31/8/89 Draft Circular dated 16/5/2007 Cir. No. 4/2007 dated 16/6/2007 Deepaben A. Shah 99 ITD 218 (Ahd) Fidelity Northstar Star 288 ITR 641 (AAR) Revashankar Kothari 283 ITR 338 (Guj) Smt. Neerja Birla v. Asst CIT 66 ITD 148 (Mum) Janak S. Rangwalla v. Asst CIT (11 SOT 627) General Ele. Pension Trust (280 ITR 425) (AAR) Ramanarain Sons Ltd v. CIT(41 ITR 534) (SC)
Burden of Proof • It is well settled that the onus lies with the person who makes the claim. • In the case if CIT v. Associated Industrial Development Co. (P) Ltd. 82 ITR 586 (SC), the supreme court observed that: “Whether a particular holding of shares is by way of investment or forms part of 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. ”
Intention of Purchase • Intention of reselling at profit as contrast to intention of holding the property for himself or otherwise enjoying or using it. [G. Venkata Swami Naidu & Co. v. CIT (35 ITR 594). • Intention at the time of purchase shall be conceived considering other factors. • If shares are purchased to reap dividend and other corporate benefits, it is case of acquisition of capital asset. (CIT v. N. S. S. Investment Ltd)(277 ITR 149)(Mad) • When the rights shares were purchased in order to retain value of the shares, it was treated as case of capital asset. (CIT v. H. Hock Larsen) (160 ITR 67) (SC). • Shares of a company purchased for acquiring the managing agency was treated as acquisition of capital asset. (Ramnarain Sons (P) Ltd. v. CIT (41 ITR 534). • Buying of shares of sister concern was made to help it to modernise its plant was treated as capital asset (Mysore Rolling Mills (P) Ltd. v. CIT (195 ITR 404) (Kar)
Owned Fund v. Borrowed Fund • If the intention of assessee is to acquire control by buying shares, the fact that assessee borrowed money to purchase these shares is is not relevant (Ramanarain Sons Pvt. Ltd cited supra). • Purchase of large area with borrowed fund was held to be case of acquisition of trading assset (Khan Bahadur Ahmed Allaudin & Sons v. CIT (68 ITR 57) (SC). In context of share buying with borrowed money, it was held to be case of acquisition of trading asset in case of Smt. Neerja Birla v. Asst. CIT (66 ITD 148) (Mum),
Utilisation of Sale Proceeds • Where sale proceeds are invested in fixed deposits or any other securities on long term basis, it is case of capital gain if other factors are positive. • Where sale proceeds of shares were utilised for the purpose of repaying overdraft and purchase of house, it was held to be case of income from capital gain. (H. Holck Larsen cited supra).
Magnitude of Transactions • The nature and quantity of the commodity as well as repetition of transactions tend to eliminate the possibility of investment for personal use, possession or enjoyment (G. Venkata Swami Naidu & Co. cited supra) • Although the assessee was holding large magnitude of shares as the shares were shown as investment and as in past the incoe from capital gain was accepted, it was held to be case of capital gain and business income. (Jamak S. Rangwall v. Asst. CIT) (11 SOT 627) (Mumbai). • Having regard to the large volume, frequency, continuity and regularity of transactions of purchase and sale of shares, it was inferred that assessee must have entered transactions with profit motive and so the claim of assessee for capital gain was rejected (Dy CIT v. Smt. Deepaben A. Shah) (99 ITD 219).
Objects Clause • Where the company was incorporated with the object, inter alia of carrying on the business of bankers, financiers, managing agents etc. and was also empowered to invest funds which was not immediately required, it was held to be case of acquisition of trading assets. (Sarder Indra Singh & Sons v. CIT (24 ITR 415) (SC). • So if bank make investment in securities to comply with the provisions of Banking Regulation Act, it was held to be case of stock in trade following above Supreme Court judgment. (SBH v. CIT) (151 ITR 703) (AP).
Entry in Books of Accounts • In the case of Karam Chand Thapar & Bros Pvt. Ltd. v. CIT (83 ITR 899), it was held by the Supreme Court that circumstances that the assessee had shown certain shares as investment in its books as well as its balance sheet was by itself not a conclusive circumstances, though it was relevant circumstance.
Comparative Analysis Basis Business Income Capital Gains Taxability u/s 28 Types Speculative or Non-speculative STCG or LTCG Deduction allowed All expenses incurred for carrying on the share trading business. Only expenses incurred in connection with the transfer. Indexation No Indexation in any case Indexation allowed in case of LTCG Benefit Rebate u/s 88 E. if STT paid Set-off u/s 45 Computation u/s 48 -LTCG exempt u/s 10(36) or 10(38). -STCG chargeable at concessional rate of 10% u/s 111 A. Non-Speculative loss can be -No loss as per S. 14 A set off against any head except -LTCG cannot be set-off against any salary head and has to be carried forward.
Deductions from Business Income • Interest on Borrowings • Brokerage, Service Tax, stamp duty, SEBI fee charged by Brokers • Penalties, Bad Delivery charges, Auction Charges etc. • Demat Account Charges • Loss of shares & securities and non payment by brokers • Portfolio Management & Advisory Fees
Deduction u/s 14 A • Interest expenditure on borrowing made for the purpose of acquisition of shares and units of equity oriented funds is generally not allowable in view of provisions of section 14 A. • Mumbai Bench of Tribunal in case of Mafatlal Holding Ltd v. Add. CIT (85 TTJ 821) held that such interest allowable in spite of section 14 A; while Ahmedabad Bench in case of Harish K. Bhatt (91 ITD 872) held otherwise. • However, the interest so disallowed be allowed to the cost of acquisition of shares or units. For this proposition, reliance may be placed on decisions of courts namely CIT v. Mithilesh Kumari (92 ITR 9) (Del), CIT v. Maithreyi pai (152 ITR 247) (Kar) and Asst. CIT v. K. S. Gupta (119 ITR 372) (AP).
Section 88 E Where total income of assessee includes any income chargeable under head “Profits and Gains of Business or Profession” , arising from taxable securities transaction Minimum of the following two amounts is allowed as Rebate u/s 88 E Security transaction tax paid by the assessee. Average rate of income-tax * business income from such taxable securities transactions. Note: The rebate u/s 88 E shall be allowed even though the income from taxable securities transaction is of speculative nature.
Conversion of Stock-in-trade into Capital Asset The conversion of stock-in-trade into capital assets requires some deliberation. Two question arises in this respect. q. Value to be recorded in the books of the business and for purpose of computing capital gain in case of future sale or transfer q. The point of time from which indexation should be applied, whether on the date of conversion or the date of purchase as stock in trade
Conversion of Stock-in-trade into Capital Asset q. Stock in trade is valued at lower of cost or net realisable value (NRV). If it is valued at cost this may not pose any difficulty on conversion of stock in trade into investment. If stock is valued at market price which is lower than cost, question may arise with respect to the value at which conversion should be recorded. q. On the basis of the principles laid down in case of Sir Kikabhai Premchand v. CIT (24 ITR 256) (SC) & CIT v. Dhanuka & Sons (124 ITR 24) (Cal), even if the stock in trade is valued at lower of cost, it has to be valued at cost at for the purpose of capital asset and accordingly assessee would be entitled to higher deduction of cost of acquisition.
Conversion of Stock-in-trade into Capital Asset Indexation: As the benefit of indexation is available only to capital asset and not to stock-in-trade, one view is that the indexation of cost would be available from the date of conversion of stock into investment. However, § In the definition of “indexed cost of acquisition” in explanation (iii) to Sec. 48, the reference is to the first year in which the asset was held by the assessee. § It is therefore possible to interpret that the indexation of cost is to be taken from the date of first acquisition even though it was acquired as stock-in-trade. § The same thing is confirmed by the decision of Pune Tribunal in the case of Kalyani Exports & Investment Pvt.
Speculative transaction Transaction which is not periodically or ultimately settled by delivery or transfer of the contracted goods is a ‘speculative transaction’ as defined by Sec. 43(5) of the Income-tax Act. No exception is made in that section for shares and stocks in fact, Sec. 43(5) specifically includes stocks and shares, and hence the provision of S. 43(5) equally apply to dealing in shares and stocks. Under the normal understanding, a speculative transaction is one where there is no intention to take or give delivery. However, under the income-tax law, the intention of the purchaser or seller to take or give delivery of the shares is immaterial for determining a speculative. What is material is whether delivery or transfer has
Exceptions S. 43(5) provides for certain exceptions The following transaction concerning share and stocks are not construed as speculative transaction by virtue of the proviso to S. 43(5) A contract in respect of stocks and shares entered by a dealer or investor to guard against loss in his holding of stocks and shares through price fluctuations (commonly referred to as hedging transaction). A contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member. An eligible transaction of dealing in derivatives, with effect from A. Y. 2006 -07.
Explanation to Sec. 73 It deems all losses of shares trading business of a “Company” as speculative business in nature. The Explanation does not apply to a company whose Gross total income consists mainly of income other than ‘ Profits and Gains of Business’. It does not apply to companies whose principal business is banking or granting of loans and advances.
Issues on Explanation The Explanation applies only where assessee is found to be engaged in the business of dealing in shares. In absence of such a finding, it is not possible to convert a loss under the head “capital gain” to a speculative business loss. The view is supported by many decisions of Tribunals and High Courts. The Explanation applies to dealing in shares of more than one company [Ref: Laxmi Feeds & Export Ltd (62 ITD 3151)] The loss due to stock valuation is also covered Exceptional cases of section 43(5) are also covered. The Explanation to S. 73 restricts its scope to a company which deals in shares. It does not take into its fold the cases of other securities. [Ref: Apollo Tyres Ltd. 255 ITR 273 (SC)] The ICAI has in the Guidance Note on Tax Audit opined that