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:
- 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
- Existence of the power to purchase and sell
shares in the MoA is not decisive of the
nature of transaction
- 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;
- 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:
- 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.
- 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.
- What is the frequency of purchases and
disposal of a particular item? Frequent or
habitual trading in a particular scrip indicates
business purpose
- 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.
- 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.
- 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. |