Today Share Trading has gained widespread popularity among the common men as a means of making quick money but still many are not aware when to treat the income from share trading as capital gain or business income. The tax liability of an individual would depend on this, as the taxability of capital gains and business income is different.

The provisions of the Income Tax Act, 1961 (The Act) do not provide any clear cut demarcation for treating a particular income from shares as capital gain or as business income and as such the debate is still on rage. However, the recent circular issued by CBDT bearing no. 4/2007 dated 15.06.2007 (The Circular) specifies that an assessee can have two portfolios, i.e., investment portfolio and the other is trading portfolio. This circular is a guiding force in deciding whether a particular income from shares is to be treated as income from capital gains or business income.

The Act 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).  Further, trading asset is dealt with under section 28 of the Act.

As per the circular, whether a particular holding forms part of investment or stock in trade is the matter solely attributable to the assessee who holds the shares and should be able to produce evidence from its records detailing whether it is stock in trade or investment.

Thus, what matters is the intention of the assessee whether he holds for a longer period of time to accumulate profits which constitutes the capital gain or does trading to earn profit (day to day) which constitutes the same to be treated as the business income.

Further, basic character of trader and investor is very different which can be summarized as below:

• A trader trades in shares with sole objective of earning business income that is day to day revenue, which is very different from the nature of investor who generally holds for a longer period of time to earn short term / long term capital gain.
• A trader trades in volume based trading in shares, to earn recurring revenue (day to day), whereas, an investor does restricted purchase and sale. In this regard the circular of CBDT says that 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.
• A trader does hold shares for a very short period of time, that is one or two days, whereas, the holding period of an investor is quite long.
• A typical trader normally does not take delivery of shares and does day to day trading, where purchase and sale is done even on the same day, whereas a typical investor takes delivery of shares, and keeps the same in his demat account till he earns some return on the same.
• A trader shows the remaining shares as at the year-end as closing stock in trade, as a business stock in the balance, whereas an investor shows the investment in shares under the head investments in the balance sheet.
• A trader in shares treats the closing stock as business stock in the books of accounts as per guidance of “Accounting Standard 2” as issued by the institute of Chartered Accountants of India. And thus, values the closing stock of shares at the “net realizable value” or “cost” whichever is lower, as mandate by AS 2. Whereas, an investor shows the investment in shares as investment and accounts at purchase value irrespective of market value and discloses the total investment made in shares as investment in his balance sheet at the purchase cost.
• A trader for whom purchase and sale of shares is business, treats securities transaction tax (STT) as advance tax paid and claims a deduction for the same in calculating total tax liability but for an investor, the STT paid is just a sunk cost.

Thus, the issue is all about the characterization of income and the applicable tax rate in case of a share transaction. Any change or clarification therefore assumes importance. Where an assessee has two portfolios, the assessee may have income under both the heads i.e., Capital Gain as well as Business Income. Further, the circular also adds that no single principle is decisive and the total effects of all principles should be considered to determine whether, in a given case, the shares are held by the assessee as investment or stock-in-trade.

The individual should be very careful in characterization of income from share trading as capital gains or business income, this is more so as the IT department has become very particular on this topic and has made quite a number additions in the recent concluded assessment proceedings.

We at Taxmantra.com have the expertise to guide you in lowering your tax outgo and thus enhancing your total take away.  We at Taxmantra.com provide full year support solving all your tax issues, in addition to filing of your return of income with excellent tax planning.

Please join us now in pursuit of simplifying individual taxation!

Alok Patnia

Founder and Director at Taxmantra.com