Brief note before assessing authority / appellate authority to treat capital gains on sale of shares and units, held as investment as capital gain.

[C.A. DEV KUMAR KOTHARI]

1. The assessee is not a share trader having any share shop, membership of Stock Exchange, registration with SEBI or other association of share traders etc. In commercial world no body consider the assessee as a share trader. Therefore, in natural way all acquisition of shares, securities, and units will be capital assets of assessee. Under section 45(2) assessee has option to treat or convert capital asset into stock-in-trade, but the A.O. has no such option. The treatment in books of account of assessee as investment or as stock of any item is conclusive. Thus, assesses activities can be considered as adventure in nature of commerce and not an adventure in nature of trade. When there is adventure in nature of commerce by investments in shares, securities, units of mutual fund, plant and machinery, or house property, income is to be computed under respective applicable heads like recurring income as 'income from other sources' or 'income from house property', as the case may be and in case of transfer of capital asset under the head 'capital gains'. Even in case of business in nature of trade, manufacture etc. any gain on sale of  any capital asset of such business is considered under the head 'capital gains'  and not as business income.

2. As per Section 2(14) shares and units of  mutual funds held as investment  are  property of any kind and are capital assets of assessee. These are not in nature of "any stock-in-trade, consumable stores, or raw material held for the purposes of business or profession of assessee", therefore, the learned A.O. cannot treat them as an item excluded from scope of 'capital asset'.

3. The changes in legislative intentions on introduction of security transaction tax and corresponding changes in treatment and taxation of income on sale of shares and units of mutual funds need to be considered in purpose seeking manner. After these changes, the old rulings on these aspects are not much relevant. In view of changes in government policy on taxation, the public and taxpayers have right to change their policies to suit financial and other decisions in changed circumstances so as to reduce tax liability. 

4. Security Transaction Tax (STT) and corresponding benefits of Income-tax are for simplification of tax regime on security transactions. Please see Memorandum Explaining provisions of the Finance (No. 2) Bill, 2004 relevant portions are at 268 ITR (196- 197) (St.) under the heading "Levy of Transaction tax and exemption / concession on capital gain arising from securities entered in a recognized stock exchange". On page 197 it is stated as follows in para 2:

    "With a view to simplify the tax regime on securities transactions, it is proposed to levy a tax at the rate of 0.15 per cent. On the value of all the transactions of purchase of securities that take place in a recognized stock exchange in India. This tax shall be collected by the stock exchange from the purchaser of such securities and paid to the exchequer. The provision relating to the proposed tax are contained in Chapter VII of the Finance (No.2) Bill, 2004, and shall take effect from the date this Chapter comes into force.

Further, it is proposed to insert clause (38) in section 10 of the Income-tax Act, so as to provide exemption from long-term capital gain arising out of securities sold on the stock-exchange. It is also proposed to insert a new section 111A and amend section 115AD of the Income-tax Act,1961, so as to provide that short-term capital gains arising from sale of such securities to an investor including FIIs shall be charged at the rate of ten per cent.

These amendment will take effect from 1st April,2005 and will, accordingly, apply to assessment year 2005-06 and subsequent years." {Chapter VI, and clauses 5, 24, 25}.

It may be recalled that Security Transaction Tax came into force w.e.f. 01.10.2004. Therefore the first assessment year affected by these provisions is assessment year 2005-06 for which the Previous year was ended  on 31.03.2005. Therefore, in the first year the assessee had to reframe their policies to hold shares as stock-in-trade or as investment.  

5. The purpose of levy of STT and corresponding concessions under I.T. Act, may be considered harmoniously and purpose seeking manner. When STT is paid considering of concessions under section 111A, 112 and 88E may be considered in a liberal manner. The assessee may be considered to have options to adopt benefit of taxes under head capital gains or against business under  Section 88E as may be found tax advantageous to him. 

6. It can be considered in a manner that the law grant option to assessee to treat shares and units of mutual fund as stock-in-trade or as capital assets.

7. The options and privileges granted under law may not be considered in a manner so as to burden tax payer with more taxes and litigation.

8. Unfortunately the revenue is taking both views in similar facts and circumstances. Where it is beneficial for revenue to consider profit as capital gains (as in case of FII's having not Permanent Establishment), the officers are treating the gains as capital gains as against business income claimed by FII. In case of others generally short-terms capital gains are treated as business income by revenue to maximize tax demands. Where assessee want to treat the gain as business income to avail benefit of set off of business loss, revenue is trying to brand the same as short-term capital gains.

9. By adoption of such practices by the revenue whole purpose of introduction of new scheme of taxation of transactions in securities is being defeated and lot of litigation is taking place.

10. In view of purpose of introduction of STT, the matter should be decided taking a purpose seeking view of simplification and there should be presumption that shares and units acquired are 'capital asset' and they can e treated as stock-in-trade only when the assessee has treated them as such or converted capital asset into stock-in-trade.

11.  Any minimum period of holding has not been prescribed for a short term capital asset.

12.  Volume and frequency depend on the amount of capital invested and also price fluctuations in particular shares. The investors have a right to use their capital assets to gain by doing hedging transactions or transactions in nature of intra-day deals to gain some benefit as recurring income to commercially exploit capital assets. Gains derived by way of intraday trades or hedging transactions or  by securities lending are  considered as business income, as these are derived on commercial exploitation of capital assets and not on transfer of capital assets.

13.  The assessee has held shares and units as investment, as capital assets and  therefore gains are capital gains which are computed as per section 45 read with section 48. The assessee has not claimed loss due to fall in value of capital assets or  investments.

14. The benefit under section 10(38) and 111A in case of capital gains or benefit of tax rebate under section 88 E should be considered as options or  privileges granted to assessee by the legislature. Where transactions have suffered STT, the treatment given by assessee to transactions as share trading activity or investment activity should be considered as final.