Technically, if there is a long-term capital gain in listed equities, there is no debate. However, in the case of short-term capital gains, that is if the listed stocks are sold in less than 12 months, the issue becomes more contentious, notes Priya Nair.
You have just filed your income tax returns.
You have ensured all the profits you have made from your equity investments have been accounted for and paid the 15 per cent short-term capital gains tax for all investments held for less than one year.
Still, how come the income tax department has sent a notice asking you to pay tax on your 'business income'.
You have no other income other than your salary, but the tax assessing officer has decided to charge your income from stock market transactions as business and tax you accordingly.
This issue is subjective and, therefore, sees maximum litigation, says Rakesh Nangia of Nangia and Company, Chartered Accountants.
“The income from stock market transactions has to be seen by the number of cumulative trades conducted and the intention -- whether the objective is to do business or not. This cannot be known by reading the investor’s mind. But it can be seen from or is reflected in the way trades are transacted.”
For instance, an investor might buy shares worth Rs 1 lakh and sell it in, say, eight months if he has made 25 per cent returns, though the intention was investment. Does this become business income?
According to Praveen Nigam, managing director of Amplus Consulting, investors could buy stocks with the intention of either trading or investment.
But even if the stocks are held as investments, since stock markets are risky, if the investor sees an opportunity, he will sell the share irrespective of the period of holding. “It is a very thin line and each case is different.
The intention in either of the cases is to get good returns and not necessarily to earn dividends,” says Nigam.
In the case of listed equities, there is no long-term capital gains tax if held for more than 12 months.
Only securities transaction tax is deducted.
If it is sold before 12 months, the investor has to pay short-term capital gains tax, which is 15 per cent.
Technically, if there is a long-term capital gain in listed equities, there is no debate.
However, in the case of short-term capital gains, that is if the listed stocks are sold in less than 12 months, the issue becomes more contentious.
Then, the basic question is whether the profits made are short-term capital gains or income from business and profession.
If it is classified as business gains, then the investor has to pay tax at 33 per cent tax.
But investors can claim all exemption on expenditure incurred on conducting the business, such as salary, office administration expenses, conveyance, etc.
“Ideally, investors should take a call on trading based on the opportunity, rather than with an aim to avoid tax,” says Nangia.
Since each case is treated differently, in case you get a notice from the I-T department, you must argue your case in totality and represent all aspects. Consider the volume of transaction, frequency of trades, number of shares in each transaction, and so on.
One way of proving the intention is to show there is a cautious, deliberate attempt to earn dividend from holding the stock for the long term.
However, some companies are known to offer high dividend.
There are investors who buy such stocks just before companies announce a dividend. Will this, then, be considered a business income?
Nangia says, “One stray transaction of buying and taking dividend and selling may not have much of an impact. But buying huge amounts can be seen as intention of earning of profit.”
Nigam cites the case of a salaried person who sold some portion of his equity portfolio within two months of buying and some within six months, while a major portion of the shares he held for longer than one year.
The assessing officer was ready to accept that the portion was held for more than one year was long-term capital gains but insisted the shares held for a shorter term should be deemed as business income.
However, the tribunal held that just because the shares were held as investments or just because it was sold in less than a year, it could not be treated as business income.
Finally, it was allowed as capital gains.
Nigam says the Central Board of Direct Taxes (CBDT) has a broad directive on classification.
CBDT says if you hold shares, you must bifurcate your portfolio into 'stock in trade' and ‘investment’.
The shares in the ‘stock in trade’ portfolio are meant for trading and the shares in the ‘investment’ portfolio are meant for investment. So, you will be liable to pay business income if you sell shares in the ‘stock in trade’ portfolio, Nigam explains.
According to Nangia, classification of shares in the book of accounts is not conclusive evidence and is not decisive.
“In every case, the court may have a different opinion because the conduct of business is personal,” he says.
THINGS YOU SHOULD KNOW
- Thin line between capital gains and business income
- Nil tax on long-term capital gains; short term capital gains -15%
- Business income taxed at 33% but can claim exemption on expenses
- Difficult to prove if investor's intention was to 'earn profit' or 'invest'
- Look at each case with regard to frequency, volume of transaction and number of shares per transaction
- Separating your portfolio into 'stock in trade' and 'investment' will help but is not conclusive