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Opinion

Investor or Trader? The tax department doesn’t really want to tell you.

The Income Tax department has released a circular which supposedly deals with the “distinction between shares held as investment versus for trading”.

This is to distinguish whether profits from sales of such transactions are treated as capital gains (short term: 10% tax, long term: 0% tax) or as business income (34% tax).

Now you would expect that by such a circular, the I.T. department would have clarified what the conditions are for treating share sales as investments or for trading.

That would be a dream, it seems, because all the tax department has clarified is NOTHING! They have simply stated some court rulings and have maintained that the distinction between the two is entirely subjective and in the complete discretion of tax assessing officers. This is criminally wrong; we should be putting clear cut guidelines on what is trading and what is investment!

So what have they really said? That:

  • You can have two separate accounts – one for “trading” and one for “investment”.
  • How do you distinguish the two? The I.T. department’s answer: We are not going to tell you.
  • They (not you, but the IT dept) can choose any criteria to decide what is what; for instance, if you do “substantial” transactions it may be a trading account. But what is “substantial”? They won’t tell you.
  • If you hold stocks for dividend they might think of it as investment. But with yields of 2-3% are they expecting us to invest for dividend?
  • The circular says that “the magnitude of purchases and sales and the ratio between purchases and sales and the holding” can determine the difference. Yet, they give you no indicative ratios or magnitudes and offer you no relevant data about how this was done in the past.

I am convinced that the department has muddied the waters some more. It’s ridiculous that we are going back to a discretionary system instead of simply designating such profits as one or the other based on objective, understandable criteria.

What would I be more happy with? Something that says: If you hold a share for less than three months, this is trading income. If you borrow money on “margin” with a stock broker, this is trading income. If you turn over more than 400% of your capital, this is trading income. (Meaning that if you have 10 lakhs invested, and your buy and sell transactions add up to more than 40 lakhs, you are a trader) And a humble request is to keep it simple.

Will the tax department lose a lot of revenue? Not really – with clarity, more people will invest (or trade) and therefore the net revenue they recover will be higher. Add to that the fact that clarity means lesser number of expensive arbitration and court rulings, computer identifiable trade vs. investor situations and less scope for corruption. Even if it means some people will suffer (will be called “traders” versus “investors”) it’s a way for all of us to rest easy because we know how much tax we have to pay!

Currently, even FIIs are confused:

According to Punit Shah, leader-financial services of PwC, “The uncertainty over the FII tax regime could grow. Our experience is that many FIIs are filing returns as capital gains, paying a 10% tax. The circular has reproduced certain principles laid down by judicial pronouncements which seem to hint FIIs are earning business income rather than capital gains.”

Questions that still remain unanswered:

  • What happens to futures/options transactions? They are obviously not long term but there is a specific section in the income tax act allowing such gains to be treated as capital gains.
  • What happens to PMS customers, whose transactions can be huge in number? While I would say such people are bound to be treated as “traders”; but it would be far easier for them if they knew now rather than one year later.
  • Traders need to maintain full books of accounts as their income is business income; and doing this retrospectively is a waste of effort. It’s better to classify someone as a trader right up so they can maintain correct paperwork through the year.
  • Real estate, which is not in ambit of the circular, is almost exclusively held [in India] for capital appreciation rather than [rental] income; given that is a criteria for stocks now, will all real estate transactions get quagmired in tax later?

I hope that further circulars will be more informative.

  • Anonymous says:

    >hello Deepak,

    Thanks for bringing this IT dept circular to our notice. This is indeed criminal, if they do not clearly specify how to distinguish between ‘stock-in-trade’ and investment. For a relatively new investor like me, are there any forums through which we can bring this up with the IT dept?

    Also, is this applicable from 2007-08, or also for tax calculations for the 2006-07 year?

    thanks in advance,
    adolf

  • Deepak Shenoy says:

    >Adolf: The tax department on its web site (http://www.incometaxindia.gov.in) has ways to contact them and perhaps they will listen to us when we all talk about it.

    This is applicable going forward I think – but I’m not sure. It could be applicable for all assessments, which means it’s for 2006-07 as well! Again, not really clear there.

  • Suresh Kaimal says:

    >Hi Deepak
    Went through few of your blog pages. Indeed a good blog. My best wishes to you..

    Just wanted to add in this comment that IT dept has confirmed there will be no change in the tax liability for PMS and we will have to pay stcg of 10% only at least for this financial year. But yes the confusion still remains till a new circular is isued.
    Warm Regards
    Suresh Kaimal
    http://kaimalsway.blogspot.com

  • Paddu says:

    >* What happens to futures/options transactions? They are obviously not long term but there is a specific section in the income tax act allowing such gains to be treated as capital gains.

    This guy feels f&o is business activity. BTW I have a few unanswered questions in his blog here and here . It would be very helpful if you could share your thoughts on these.