TAXATION OF SHARES AND SECURITIES Nihar Jambusaria nihar.jambusaria@ril.com jnihar@rediffmail.com
CONTENTS Provisions to Prevent Possible Tax Avoidance Treatment of Share Transactions Capital Gains Business Income including Speculation Income
MEASURES TO CHECK TAX AVOIDANCE/EVASION Dividend stripping S. 94(7) Where (a) any person buys or acquires any securities or unit within a period of three months prior to the record date; (b) such person sells or transfers such securities within a period of three months after such date; or such unit within a period of nine months after such date;
MEASURES TO CHECK TAX AVOIDANCE/EVASION (Contd) (c) the dividend income on such securities or unit received or receivable by such person is exempt, then, the loss, if any, arising to him on account of such purchase and sale of securities or unit, to the extent such loss does not exceed the amount of dividend or income received or receivable on such securities or unit, shall be ignored for the purposes of computing his income chargeable to tax. S. 94(7) cannot be applied from retrospective effect. Wallfort Shares & Stock Brokers Pvt. Ltd. v. ITO & Ors. 96 ITD 1 (Mum.) (TM).
MEASURES TO CHECK TAX AVOIDANCE/EVASION (Contd) Bonus / right stripping S. 94(8) Where (a) any person buys or acquires any units within a period of three months prior to the record date; (b) such person is allotted additional units without any payment on the basis of holding of such units on such date;
MEASURES TO CHECK TAX AVOIDANCE/EVASION (Contd) c) such person sells or transfers all or any of the units referred to in clause (a) within a period of nine months after such date, while continuing to hold all or any of the additional units referred to in clause (b), then, the loss, if any, arising to him on account of such purchase and sale of all or any of such units shall be ignored for the purposes of computing his income chargeable to tax and notwithstanding anything contained in any other provision of this Act, the amount of loss so ignored shall be deemed to be the cost of purchase or acquisition of such additional units referred to in clause (b) as are held by him on the date of such sale or transfer.
MEASURES TO CHECK TAX AVOIDANCE/EVASION (Contd) Whether dividend stripping is allowable - Whether a premeditated transaction by virtue of which an assessee earns tax free income and squares off profits with losses is permissible if it is within the four corners of law? EVEREADY INDUSTRIES INDIA LTD vs CIT (2011- TIOL-169-HC-KOL-IT)
TREATMENT OF SHARE TRANSACTIONS The following factors would be relevant in determining whether transactions for purchase & sale of shares & securities are in the nature of business or investment? (1) Motive (2) Number of transactions (3) Relation with other activities (4) Source of investment (5) Resources employed (6) Consistency
TREATMENT OF SHARE TRANSACTIONS Issues Where a large number of transactions of purchase and sales of shares and securities of different companies are entered into during P. Y., whether the gain can be declared as short term or long term capital gain or should it be declared under the head income from business or profession. Consider the decisions o Smt. Neerja Birla v. ACIT 66 ITD 148 (Mum.) and o Arjun Kapoor 70 ITD 161 (Del.) o Janak Rangwala vs. ACIT 11 SOT 627 (Mum.) o Circular No.4/2007 dt. 15-6-2007.
TREATMENT OF SHARE TRANSACTIONS Assessee company having reflected its entire shareholding in various shares, including the shares in question, as stock-intrade all along in the past and the Revenue authorities having come to the finding of fact that the shares of the same company were purchased by the assessee by way of trading and not by way of investment, income derived by assessee from sale of such shares is to be treated as business income and not as capital gains. ANKITA DEPOSITS & ADVANCES (P) LTD. vs. CIT [(2010) 235 CTR (HP) 273]
TREATMENT OF SHARE TRANSACTIONS Where the assessee has shown investment in shares under the head Investment in the balance sheet for many years and the same is accepted by the AO in the past, there is no justification for treating the activity of the assessee of purchase and sale of shares as business merely on the reason of the volume of the transactions, particularly when no money has been borrowed for making investment in shares. BHARAT KUNVERJI KENIA vs. Addl. CIT [(2010) 130 TTJ 86] Assessee having shown the shares as investment in the books and there being no material on record to show that the same were converted into stock-in-trade, receipts from sale thereof are assessable as capital gains and not business income CIT vs. ESS JAY ENTERPRISES (P) LTD. [(2008) 173 TAXMAN 1 (Del)]
TREATMENT OF SHARE TRANSACTIONS Tribunal having entered a pure finding of fact that the assessee is engaged in two different types of transactions namely, investment in shares and dealing in shares for the purposes of business and held that the delivery based transactions are to be treated as investment transactions and that there ought to be uniformity in treatment and consistency in various years when the facts and circumstances are identical, no substantial question of law arises. CIT vs. GOPAL PUROHIT [(2010) 228 CTR (Bom) 582]
TREATMENT OF SHARE TRANSACTIONS Assessee transacting numerous transactions in large quantity of shares, profit from which was shown as short-term capital gain. Assessee was investor in shares having portfolio built-up over a period of 50 years. Shares and other securities have been shown under the head "Investment" in balance sheet consistently. Revenue having accepted the profit arising from the sale of shares as capital gain in previous assessment years, there is no need to give different treatment this year KUNVARJI NANJI KENIA vs. Addl. CIT [(2010) 131 TTJ (Mum)87]
TREATMENT OF SHARE TRANSACTIONS Where in the earlier year it had been held that the income from impugned shares are assessable as business income having regard to the shares held and nature of the business conducted by the assessee, in the absence of any material to despair the same, profit from sale of shares in the current year is assessable as business income and not as capital gains. MATHESON BOSANQUET ENTERPRISES LTD. vs. DCIT [(2009) 316 ITR 375 (Mad)] Where the assessee is doing both types of activity i.e. trading in shares and investment in shares and the stock transferred during the year is demonstrated by the assessee to be from the investment account, the profit was rightly offered by the assessee as short-term capital gain; AO was not justified in assessing the same as business income. PARESH D. SHAH vs. JCIT [(2010) 2 ITR (Trib) 311]
TREATMENT OF SHARE TRANSACTIONS Assessee s business being investment in shares and interest on capital borrowed for purposes of said investment having been claimed and allowed as deduction under s. 36(1)(iii), assessee cannot, at the same time, be allowed to return said profits as capital gains by taking benefit of indexation and the said profits have to be assessed as business income. PENINSULAR INVESTMENTS LTD. vs. DCIT [(2009) 120 TTJ (Hyd) 96] Where there was a long gap between the date of acquisition of shares and their sale and the shares having been shown as investment in wealth-tax returns right from the asst. yr. 1957-58, profits from sale of shares were chargeable as capital gains and not business income CIT vs. REWASHANKER A. KOTHARI [(2006) 283 ITR 338 (Guj)]
TREATMENT OF SHARE TRANSACTIONS Where on the basis of facts it was found that the investment is out of own fund and not borrowed; that the investment is not rotated frequently; that the total number of transactions are very few; that all the shares purchased are not sold and rather held for quite number of days, held that the transactions are to be treated as giving rise to the capital gain CIT vs. ROHIT ANAND [(2010) 327 ITR 445 (Del. HC)]
TREATMENT OF SHARE TRANSACTIONS The intention of the assessee is relevant to determine whether he is carrying on the business in shares or investments. Where it was found that the assessee has been holding shares for a long time and has been utilising the surplus funds only for the investments. Both CIT(A) and Tribunal have concurrently found that assessee was dealing as also investing in shares while maintaining separate books of account and receipts from sale of shares in question was assessable under the head capital gains. No substantial question of law arose CIT vs. S. RAMAAMIRTHAM [(2008) 306 ITR 239]
TREATMENT OF SHARE TRANSACTIONS In the matter of deciding whether the income of assessee derived from portfolio management investments is to be charged under business income or capital gains, where lower authorities had taken into consideration only the volume of transactions and not the other relevant factors, the issue was remanded to AO for fresh adjudication. SAR INVESTMENT (P) LTD. vs. DCIT [(2010) 40 SOT 566 (Ahd)] Assessee dealing in shares both as business as well as investment and, inter alia, keeping separate accounts in respect of the two portfolios, profits from sale of shares in investment portfolio after holding them for two to four years were taxable as capital gains and not as business income. SARNATH INFRASTRUCTURE (P) LTD. vs. ACIT [(2009) 120 TTJ (Lucknow) 216]
TREATMENT OF SHARE TRANSACTIONS Where the assessee has maintained separate account of trading in shares and investment in shares and such investment is made from surplus funds which is accepted by the Department as investment in earlier years the profit on sale of such shares is taxable as long term capital gain and not as business income. SURESH KUMAR SEKSARIA vs. ACIT [(2010) 1 ITR (Trib) 783 (Mum)] Assessee company having been incorporated to engage in the business of investment in shares and securities, shares purchased could not be a business asset in the hands of assessee, hence the assessee rightly offered the same under the head "Capital gains". CIT vs. TRISHUL INVESTMENTS LTD. [(2008) 305 ITR 434]
TREATMENT OF SHARE TRANSACTIONS Whether the assessee whose substantial income from capital gain comprises long term capital gain and who has shown substantial dividend income, can be said to be a trader of shares and doing share trading business MANAGEMENT STRUCTURE & SYSTEMS PVT LTD vs. ITO [2010- TIOL-254-ITAT-MUM] Where the Assessee held certain shares as investment and also as stock in trade and claims deduction for trading loss. On disallowance by AO Tribunal remands. AO goes by entry treatment in books and again treats it as capital loss. Tribunal holds that the nomenclature of the entry will not decide the actual character of the transactions. Since the frequency of trading in shares is very high, it is clearly stock in trade. No substantial question of law involved CIT vs. SMC CREDIT LIMITED [2010-TIOL-50-HC-DEL]
TREATMENT OF SHARE TRANSACTIONS Considering the facts that most of the shares were purchased and sold immediately and there are no shares which are acquired prior to 1-01-2004 and held after 31-01-2005, the intention of the assessee is to gain profits by dealing in short term profit only; further, considering the borrowing of funds, small amount of dividend when compared to the gain in shares and also the fact that assessee group companies are involved in share trading, the conclusion of the revenue authorities that the income from sale of shares declared by the assessee as short term capital gain is income from business was sustainable. Sadhana Nabera Vs. ACIT [41 DTR (Mum)(Trib.) 393]
TREATMENT OF SHARE TRANSACTIONS In respect of gain in shares held for more than 365 days when in the past the department has accepted sale of shares of holdings of more than a year as investment, the gain should be assessed as long term capital gain in the year under appeal; however, in respect of shares with the frequent transactions where shares are held for more than a month, they should be treated as investments and for those held for less than a month as profit from business. Sugamchand C Shah Vs. ACIT [36 DTR (Ahd)(Trib.) 345]
TREATMENT OF SHARE TRANSACTIONS Though the assessee had purchased/sold other shares and units of mutual funds, this solitary transaction had been disputed by the AO mainly because the assessee had purchased the shares in question from borrowed funds obtained on high rate of interest, which also forms the basis for the conclusion arrived at by the AO that the transaction in question is an "adventure in the nature of trade or business" rather than a normal investment. Held that: merely because the shares had been purchased from borrowed funds obtained on high rate of interest would not change the nature of the transaction from investment to one in the nature of an "adventure in the nature of trade particularly when the assessee is mainly engaged in jewellry business. CIT Versus NIRAJ AMIDHAR SURTI [(Appeal No. 836 of 2009), Guj HC]
TREATMENT OF SHARE TRANSACTIONS If share transactions are treated as business, the following expenses are allowable as deduction- (1) Interest on borrowed capital (2) Brokerage, service tax, stamp duty (3) Penalties, bad delivery charges, auction charges (4) Demat account charges (5) Portfolio Management & advisory fees
CAPITAL GAINS Conversion of capital assets into stock in trade Issues Any care is required to be taken before converting shares / securities into stock in trade? Whether an assessee can hold some shares and securities as stock in trade and some shares and securities as investment. o Century Builder 5694/Mum./2000/dt. 30.07.02 o Arjun Kapoor 70ITD161(Del) o Circular No. 4/2007 dt. 15-6-2007
CERTAIN JUDGEMENTS 1. Shares obtained in family settlement Family settlement is analogous to partition of H.U.F. Therefore, S. 49(1)(i) shall apply for determining the cost of acquisition of shares under family settlement. Shanti Chandran 241 ITR 371 (Mad.)
CERTAIN JUDGEMENTS (contd.) 2. Opening stock of a new firm constituted by some partners of dissolved firm should be valued at market price. V. S. Chandraprakasa Nadar & Co. v. CIT 244 ITR 298 (Mad.) 3. Bad investments written off would not give rise to capital loss. R.C. Mudliar 240 ITR 552 (Mad.)
CERTAIN JUDGEMENTS (contd.) 4. Where business loss arises due to valuation of closing stock at cost or market price whichever is less and there was no purchase and sale of shares during the P.Y., Explanation to S. 73 does not apply. Nirvan Holding Pvt. Ltd. BCA-399 JULY 2003, SMC, MUM Sun Dist. & Mining Co. 68 Taxman 223. Mumbai High Court held in Prasad Agents Pvt. Ltd. V. ITO [2009 TIOL-164-HC-MUM] that share valuation loss is covered by Explanation to S.73.
CERTAIN JUDGEMENTS (contd.) 5. Where shares / securities are acquired by any mode u/s. 49(1), indexation shall be allowed from the P. Y. of acquisition of the previous owner. o o o Pushpa Sophat v. ITO 81 ITD 1 (Chd.) Meera Khera February 2004 BCA Journal. Contrary- Kishor Kanoongo Mum. Trib. o DCIT v. Manjula J. Shah dt.16 th October, 2009.
CERTAIN JUDGEMENTS (contd.) 6. Indexation is allowable on L.T.C.G. on transfer of MEP 91 and MEP 92 refer S. 45(6). K. B. Shah 77 TTJ 30 (Mum.) 7. Transfer of investments is not hit by Explanation to S. 73. Mysore Rolling Mills Pvt. Ltd. 195 ITR 405 (Kar.)
SPECULATION BUSINESS A transaction which is not periodically or ultimately settled by delivery or transfer of the contracted goods is a speculative transaction as defined by S. 43(5) of the Income-tax Act. No exception is made in that section for shares and stocks in fact, s. 43(5) specifically includes stocks and shares, and hence the provisions of S. 43(5) equally apply to dealing in shares and stocks. Under 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 shares is immaterial for determining a speculative transaction. What is material is whether delivery or transfer has actually taken place or not.
SPECULATION BUSINESS (Contd) Explanation 2 to s.28 reads as under : Where speculative transactions carried on by an assessee are of such a nature as to constitute a business, the business (hereinafter referred to as speculation business ) shall be deemed to be distinct and separate from any other business.
SPECULATION BUSINESS (Contd) S. 43(5) provides for certain exceptions. The following transactions concerning shares and stocks are not construed as speculative transactions 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 holdings of stocks and shares through price fluctuations (commonly referred to as hedging transactions). 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.
SPECULATION BUSINESS (Contd) Whether rule 8D applies even to a period when it was not framed - Whether proviso inserted in clause (d) of Sec 43(5) is prospective and hence loss attributable to prior period of derivatives is speculative? ELEGANT MARBLES & GRANITE INDUSTRIES LTD vs. DCIT [(2011-TIOL-198-ITAT-MUM)] Whether clause (d) of proviso to section 43(5) is inserted prospectively w.e.f. A.Y. 2006-07.Whether the expenses incurred on speculative transactions cannot be allowed to be set off against the profit / loss of non-speculative business? ITO Vs M/s TCFC FINANCE LIMITED (2011-TIOL-184- ITAT-MUM)
Issues relating to Expln. to S.73- (1) Applicability to shares held as investments- Mysore Rolling Mills Pvt. Ltd. 195ITR 404(kar) Trade Team Pvt. Ltd. 54 ITD 36(Bom) (2) Share broking-whether business of purchase & sale of shares? SRJ Securities Ltd. v ACIT 81 TTJ 484 (Del) DCIT v Frontline Capital Services Ltd. 96 TTJ 201 (Del)
(3) Applicability to securities other than shares Appollo Tyres Ltd. 255 ITR 273 (S.C.) (4) Loss due to stock valuation not regarded as speculation loss Nirvan Holding Pvt. Ltd. 35 BCAJ 399 (Mum) Contrary view-prudential Constn. Co. Pvt. Ltd. 75 ITD 338 (Hyd.) Associated Capital Markets Pvt. Ltd. ITA No11-3-4 & 3057 Mum.2001 dt 31-3-2003 Now resolved by Mum. H.C. decision in Prasad Agents- Contrary view upheld.
(5) Whether the Expln. Applies to arbitrage, hedging,etc. excluded from the meaning of speculation u/s. 43(5)? Rohini Capital Services Ltd. v DCIT 92 ITD 317 (Del) (6) Settlement for breach of contract is not a speculative transaction. Bhandari Rajmal Kushalraj v ITO 96 ITR 401 (7) Applicability to units of UTI and loss suffered on account of wrong deals entered on behalf of clients? DCIT vs. M/s CSL SECURITIES (P) LTD [(2011-TIOL- 201-ITAT-DEL)]
(5) Whether loss on sale of shares is speculative loss in view of explanation to section 73 though the transaction is not speculative in nature as per Sec 43(5) because there is actual delivery of shares. M/s RPG INDUSTRIES LIMITED vs. CIT (2011-TIOL-171- HC-KOL-IT)
Conversion of Stock into Capital Asset Whether conversion of shares held as stock in trade into capital asset would attract any tax. What will be the cost of acquisition of such shares cost or market value?
CIRCULAR NO. 4/2007, DATED 15-6-2007 Distinction between shares held as stock-in-trade and shares held as investment - tests for such a distinction The Income Tax Act, 1961 makes a distinction between a capital asset and a trading asset. Capital asset is defined in Section 2(14) of the Act. Long-term capital assets and gains are dealt with under Section 2(29A) and Section 2(29B). Short-term capital assets and gains are dealt with under Section 2(42A) and Section 2(42B). Trading asset is dealt with under Section 28 of the Act.
CIRCULAR NO. 4/2007, DATED 15-6-2007 4. The Central Board of Direct Taxes (CBDT) through Instruction No.1827 dated August 31, 1989 had brought to the notice of the assessing officers that there is a distinction between shares held as investment (capital asset) and shares held as stock-in-trade (trading asset). In the light of a number of judicial decisions pronounced after the issue of the above instructions, it is proposed to update the above instructions for the information of assessees as well as for guidance of the assessing officers. 5. In the case of Commissioner of Income Tax (Central), Calcutta Vs Associated Industrial Development Company (P) Ltd (82 ITR 586), the Supreme Court observed that: 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.
CIRCULAR NO. 4/2007, DATED 15-6-2007 6. In the case of Commissioner of Income Tax, Bombay Vs H. Holck Larsen (160 ITR 67), the Supreme Court observed: The High Court, in our opinion, made a mistake in observing whether transactions of sale and purchase of shares were trading transactions or whether these were in the nature of investment was a question of law. This was a mixed question of law and fact. 7. The principles laid down by the Supreme Court in the above two cases afford adequate guidance to the assessing officers. 8. The Authority for Advance Rulings (AAR) (288 ITR 641), referring to the decisions of the Supreme Court in several cases, has culled out the following principles :-
CIRCULAR NO. 4/2007, DATED 15-6-2007 (i) 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; (ii) the substantial nature of transactions, the manner of maintaining books of accounts, 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; (iii)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.
CIRCULAR NO. 4/2007, DATED 15-6-2007 9. Dealing with the above three principles, the AAR has observed in the case of Fidelity group as under:- We shall revert to the aforementioned principles. The first principle requires us to ascertain whether the purchase of shares by a FII in exercise of the power in the memorandum of association/trust deed was as stock in-trade as the mere existence of the power to purchase and sell shares will not by itself be decisive of the nature of transaction. We have to verify as to how the shares were valued/held in the books of account i.e. whether they were valued as stock-in-trade at the end of the financial year for the purpose of arriving at business income or held as investment in capital assets. The second principle furnishes a guide for determining the nature of transaction by verifying whether there are substantial transactions, their magnitude, etc., maintenance of books of account and finding the ratio between purchases and sales.
CIRCULAR NO. 4/2007, DATED 15-6-2007 It will not be out of place to mention that regulation 18 of the SEBI Regulations enjoins upon every FII to keep and maintain books of account containing true and fair accounts relating to remittance of initial corpus of buying and selling and realizing capital gains on investments and accounts of remittance to India for investment in India and realizing capital gains on investment from such remittances. The third principle suggests that ordinarily purchases and sales of shares with the motive of realizing profit would lead to inference of trade/adventure in the nature of trade; where the object of the investment in shares of companies is to derive income by way of dividends etc., the transactions of purchases and sales of shares would yield capital gains and not business profits.
CIRCULAR NO. 4/2007, DATED 15-6-2007 10. CBDT also wishes to emphasise that it is possible for a tax payer 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. 11. Assessing officers are advised 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. 12. These instructions shall supplement the earlier Instruction no. 1827 dated August 31, 1989.