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Background
In a recent judgement in the case of Management Structure & Systems Pvt. Ltd. 1(“the assessee”), the Mumbai bench of the Income-tax Appellate Tribunal (“the Tribunal”) has held that the profits from the sale of securities held as investments by the assessee should be assessed as capital gains. The Tribunal also reiterated the legal position and tests laid down in earlier judgments to treat the income from securities held as investment, as capital gains.
Facts
• The assessee was engaged in management consultancy, investment advisory and equity reserve research services and was also dealing in investments. During the year under consideration,
1 Management Structure & Systems Pvt. Ltd. v. ITO [2010-TIOL-254-ITAT-MUM]
the assessee offered profits amounting to INR 10.32 million earned from sale of shares as taxable under the head ‘capital gains’.
• While passing the assessment order, the assessing officer (“AO”) held that the assessee was regularly dealing in the shares throughout the year and hence, was a dealer in shares. Accordingly, the AO held that the income from the shares held by the assessee should be assessed as business income.
• On appeal, the Commissioner of Income-tax (Appeals) confirmed the assessment order passed by the AO.
• Being aggrieved, the assessee filed an appeal before the Tribunal.
Guiding principles to determine whether income from securities is “business income” or “capital gains”
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28 May, 2010
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Issue
Whether gain arising from the sale of shares held as investments by the assessee would be considered as ‘business income’ or as ‘capital gains’.
Assessee’s contentions
• The assessee had invested in shares and held such shares as an investment and not as stock-in-trade. Further, the assessee had used its own surplus funds for investing in shares and had not borrowed any money.
• Each transaction was delivery based wherein an amount was paid for the purchase of shares and consideration was received for sale of shares.
Furthermore, a substantial amount of capital gains was made on the transfer of shares as a result of holding shares for more than twelve months.
• The assessee received dividends on the investment made in shares.
• The transactions were not undertaken in the futures and options segment to indicate that the assessee was trading in shares.
• The quantum of shares purchased and sold were not substantial to indicate that the company was engaged in any business of trading or dealing in shares.
• The investment in shares was treated in the books of account as an “investment”
and not as “stock-in-trade”.
• The assessee was not registered as a share broker nor registered with any stock exchange.
• CBDT Circular No. 4/2007 dated 15 June, 2007 was relied upon which accepted that it was possible for a tax payer to have two portfolios.
Revenue’s contentions
• Though the main object of the assessee was management consultancy and the incidental object was to make investment, the main activity of the assessee was trading in shares. In respect of the main object, the contribution to the gross income was very small.
• The assessee regularly bought and sold the securities / shares, which showed that profit motive was the main object for purchasing the shares.
• Merely showing the securities purchased as an investment and invoking the method of accounting by showing it as an investment, was a mere camouflage of the assessee’s real interest in trading in shares.
• Merely holding securities for long periods could not be decisive in concluding that the assessee was not trading in securities.
Tribunal ruling
The Tribunal held that though there was no fixed formula to determine whether the activity of purchasing and selling shares should be treated as a trading activity or as an investment activity, certain guiding principles had been laid down by CBDT in Circular No.
4/2007 dated 15 June, 2007 as well as by the judiciary in the cases of Gopal Purohit2, and Fidelity Northstar Funds & Others3.
The guidelines relied upon by the Tribunal are reproduced below:
• Intention of the assessee at the time of purchasing the shares has to be identified.
This can be found out from the treatment it gives to such purchase in its books of account. If the securities in question are valued at cost, it would indicate that they are investments, however where they are valued at cost or market value or net realisable
2 Gopal Purohit v. JCIT [2009] 122 TTJ 87 (Bom)
3 Fidelity Northstar Fund & Others, In re [2007] 288 ITR 641 (AAR)
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value (whichever is less), it will indicate that the items in question are treated as stock-in-trade.
• Whether the assessee has borrowed money to purchase the shares and paid interest thereon has to be seen. Normally, money is borrowed to purchase goods for the purposes of trade and not for investing in an asset for retaining.
• Frequency of purchases and disposal of the securities has to be looked at. If purchase and sale are frequent, or if there are substantial transactions in that item, it would indicate trade. Similarly, ratio between the purchases and sales and the holdings may show whether the assessee is trading or investing. High transactions and low holdings indicate trade whereas low transactions and high holding indicate investment.
• If the purchase and sale is for realising profit it will indicate the intention of trade and if purchase and sale are made for retention and appreciation in its value, it will indicate an investment.
• Authorisation in memorandum of association / articles of association has to be considered. Where the assessee is authorised only for trade and separate board resolutions are passed to carry out investment in the commodity it would indicate the intention of the assessee is to treat it as investment.
The intention of the assessee cannot be read from his mind but it reflects in his conduct and the way he treats the transactions. Further, the assessee had received substantial dividend and that was also disclosed. Considering the totality of the facts, the Tribunal held that the sale and purchase of shares should not be treated as trading in shares nor as an adventure in the nature of the trade, but was assessable as ‘capital gains’.
The Tribunal also held that though the rule of res judicata was not applicable to the income tax proceedings, it was nevertheless a well settled principle that if there was no
change in the facts, then a consistent approach should be taken by the revenue authorities while deciding the tax liability of the assessee.
Conclusion
The decision provides guidance to determine the taxability of gain / profit arising from the sale of securities.
The judgement above refers to a plethora of decisions, including the decisions of Associated Industrial Development Co. (P.) Ltd.4, H Holck Larsen5, Gopal Purohit (above) and CBDT’s Circular No. 4/2007 dated 15 June, 2007 which lay down the guiding principles for determining the taxability of sale of securities.
It is possible for an assessee to be an investor as well as a dealer in shares and whether the sale and purchase of shares is a trading or an investment transaction is a mixed question of law and fact.
4 CIT v. Associated Industrial Development Co. (P) Ltd. [1971] 82 ITR 586 (SC)
5 CIT v. H. Holck Larsen [1986] 160 ITR 67 (SC)
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