Facts of the cases

Tax authorities’ contentions:

• The contribution of income from other businesses to the gross income is very small
• The tax payer was regularly buying and selling shares and has professional knowledge of the capital market
• The period of holding of shares and entries in the books of account are not solely determinative to contend that the shares are held as investments
• Primary characteristics of an investment are the feeling of security and secondary aspect is capital appreciation. Moreover, there should be incremental periodical income accruing on the investment
• Simply because delivery of the shares is taken or substantial amount of dividend is received, the transactions would not become investments
• Deploying surplus funds in the securities which are likely to appreciate shows the tax payer’s business interest
• Some of the shares sold during the year were held for more than 7 years which shows the soundness of the financial position of the tax payer and wise application of noninterest bearing own funds in selected stocks.
• Where shares are pledged with financial institutions to obtain loans, it indicates that the tax payer treats the shares as stock‐in‐trade
• Where the tax payer has abnormal short term capital gains as compared to the long term capital gains, the transactions in shares cannot be considered as investments

Tax payer’s contentions– Case 1:

• Around 83% of the total gain is in the nature of long term gain
• All transactions are delivery based
• The period of holding indicates that the shares are held for long term
• It is a well settled principle that the intention of the tax payer at the time of purchasing the shares is decisive
• There is no opening and closing stock of shares. The shares purchased are shown as investments in the books of account
• The shares are held for the purpose of earning dividend and the tax payer is not trading in equity shares
• The quantum of shares purchased and sold is too little

Tax payer’s contentions – Case 2:

• Majority of the transactions are delivery based
• There is no opening and closing stock of shares. The shares purchased are shown as investments in the books of account
• Even though the dividend income is lower than the capital gains, it should be considered as a determinative factor since dividend is received only when the concerned company declares the same
• Circular No. 4 / 2007 issued by the CBDT has clarified that it is possible for a tax payer to have two portfolios – Investment portfolio and Trading portfolio

Decision of the Tribunal:

• There is no fixed formula to determine whether the activity of the tax payer is to be regarded as business activity or investment activity. No single factor is determinative to conclude whether the purchase of shares is an investment activity or business activity. All the relevant factors should be considered in totality to determine the nature of activities.
• The intention of the tax payer cannot be read from his mind but it reflects in its conduct; the way he treats the transactions.
• Where the tax payer never claimed that he was trading in shares, there is no opening or closing stock of shares and the tax payer has treated the transactions as investments in the books of account, the purchases of shares can be considered as investments
• Where majority of the gain is a long term gain, the activity is not a business activity but an investment activity
• Where all the transactions are completed by delivery of shares and the tax payer is not a broker or sub‐broker for dealing in shares, it indicates that the tax payer is purchasing shares as an investment
• Reliance was placed on the Circular No. 4 /2007 issued by CBDT which lays down that:

1. Whether a particular holding of shares is by way of investment or forms part of the stockin‐ trade is a matter which is within the knowledge of the tax payer
2. Existence of the power to purchase and sell shares in the MoA is not decisive of the nature of transaction
3. The substantial nature of transaction, 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;
4. 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 will yield capital gain and not revenue receipt.

The Circular also insists 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 tax payer as investment or stock‐in‐trade.

• The Tribunal laid down the following questions to determine the issue:

1. What is the intention of the tax payer at the time of purchase of the shares? This can be found out from the treatment it gives to such purchase in its books of account.
2. Whether the tax payer has borrowed money to purchase the shares and has paid interest thereon? If yes, the transactions are business activities and not investments.
3. What is the frequency of purchases and disposal of a particular item? Frequent or habitual trading in a particular scrip indicates business purpose
4. Whether purchases and sales are made for realising profit or purchases are made for retention and appreciation in value? If the intention is to realise profit, the transactions are business activities.
5. How the value of items has been taken in the Balance Sheet? If shares are valued at cost, they can be considered as investments. If they are valued at lower of cost and Net Realisable Value, they are in the nature of stock‐in‐trade.
6. How the tax payer is authorised in the Memorandum of Association / Articles of Association? Whether for trade or for investment? Whether the resolution of the Board of Directors state that the company is making ‘investments’?

Based on the above principles and after taking into account the facts in each case in totality, the Tribunal held that the activity in Case 1 is an investment activity whereas the activity in Case 2 is a business activity

SKP’s comments:

On a perusal of the above cases, the underlying principles to judge whether the transactions in securities is trading or investment in nature are:

• Magnitude of purchase and sale,
• Period of holding,
• Motive behind it.

The CBDT Circular No. 4 / 2007 as well as the Tribunal in the above cases have acknowledged the fact that it is possible for a tax payer to have 2 separate portfolios– one for business purpose and one for investment purpose.

There is a thin line of divide between transactions in the nature of business and investments. As can be seen from the above, the nature of activity is determined on the basis of totality of factors and no single factor is determinative of the tax treatment.
Hence, even where purchase of shares is shown as investments, the tax authorities may still contend that the tax payer is undertaking business activities in shares.

Hence, tax payers should be particularly careful while deploying the temporary surpluses available with them in the capital market. Care should be taken to ensure that any such investment in securities is not undertaken under the guise of reaping benefits by way of capital appreciation. Moreover, trading in the derivatives segment should be avoided unless there is a business purpose (such as risk hedging) attached thereto.

Hence, regarding the transactions of purchase and sale of shares, the tax payers are advised to proceed with care and caution.