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INCOME TAX CIRCULAR NO. 4/2007, DATED 15-6-2007
The Income Tax Act, 1961 makes a distinction
between a capital asset and a trading asset.
2. Capital asset is defined in Section 2(14)
of the Act. Long-term capital assets and gains are dealt with under Section
2(29A) and Section 2(29B). Short-term capital assets and gains are dealt with
under Section 2(42A) and Section 2(42B).
3. Trading asset is dealt with under Section
28 of the Act.
4. The Central Board of Direct Taxes (CBDT)
through Instruction No.1827 dated August 31, 1989 had brought to the notice of
the assessing officers that there is a distinction between shares held as
investment (capital asset) and shares held as stock-in-trade (trading asset).
In the light of a number of judicial decisions pronounced after the issue of
the above instructions, it is proposed to update the above instructions for the
information of assessees as well as for guidance of the assessing officers.
5. In the case of Commissioner of Income
Tax (Central), Calcutta Vs Associated Industrial Development Company (P) Ltd
(82 ITR 586), the Supreme Court observed that:
Whether a particular holding of shares is by
way of investment or forms part of the stock-in-trade is a matter which is
within the knowledge of the assessee who holds the shares and it should, in
normal circumstances, be in a position to produce evidence from its records as
to whether it has maintained any distinction between those shares which are its
stock-in-trade and those which are held by way of investment.
6. In the case of Commissioner of Income
Tax, Bombay Vs H. Holck Larsen (160 ITR 67), the Supreme Court observed :
The High Court, in our opinion, made a
mistake in observing whether transactions of sale and purchase of shares were
trading transactions or whether these were in the nature of investment was a
question of law. This was a mixed question of law and fact.
7. The principles laid down by the Supreme
Court in the above two cases afford adequate guidance to the assessing
officers.
8. The Authority for Advance Rulings (AAR)
(288 ITR 641), referring to the decisions of the Supreme Court in several
cases, has culled out the following principles :-
(i) Where a company purchases and sells
shares, it must be shown that they were held as stock-in-trade and that
existence of the power to purchase and sell shares in the memorandum of
association is not decisive of the nature of transaction;
(ii) the substantial nature of transactions,
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;
(iii) 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 (by sale
of shares) will yield capital gain and not revenue receipt.
9. Dealing with the above three principles,
the AAR has observed in the case of Fidelity group as under:-
We shall revert to the aforementioned
principles. The first principle requires us to ascertain whether the purchase
of shares by a FII in exercise of the power in the memorandum of
association/trust deed was as stockin-trade as the mere existence of the power
to purchase and sell shares will not by itself be decisive of the nature of
transaction. We have to verify as to how the shares were valued/held in the
books of account i.e. whether they were valued as stock-in-trade at the end of
the financial year for the purpose of arriving at business income or held as
investment in capital assets. The second principle furnishes a guide for
determining the nature of transaction by verifying whether there are
substantial transactions, their magnitude, etc., maintenance of books of
account and finding the ratio between purchases and sales. It will not be out
of place to mention that regulation 18 of the SEBI Regulations enjoins upon
every FII to keep and maintain books of account containing true and fair
accounts relating to remittance of initial corpus of buying and selling and
realizing capital gains on investments and accounts of remittance to India for
investment in India and realizing capital gains on investment from such
remittances. The third principle suggests that ordinarily purchases and sales
of shares with the motive of realizing profit would lead to inference of
trade/adventure in the nature of trade; where the object of the investment in
shares of companies is to derive income by way of dividends etc., the
transactions of purchases and sales of shares would yield capital gains and not
business profits.
10. CBDT also wishes to emphasise that it is
possible for a tax payer to have two portfolios, i.e., an investment portfolio
comprising of securities which are to be treated as capital assets and a
trading portfolio comprising of stock-in-trade which are to be treated as
trading assets. Where an assessee has two portfolios, the assessee may have
income under both heads i.e., capital gains as well as business income.
11. Assessing officers are advised that the
above principles should guide them in determining whether, in a given case, the
shares are held by the assessee as investment (and therefore giving rise to
capital gains) or as stock-in-trade (and therefore giving rise to business
profits). The assessing officers are further advised 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
assessee as investment or stock-in-trade.
12. These instructions shall supplement the
earlier Instruction no. 1827 dated August 31, 1989.
(F.No.149/287/2005-TPL)
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