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How does income tax on share trading profits work in India? Should trading gains be classified as Business income or Capital gains? How are gains on unlisted shares taxed?
In this article on income from trading, Sandeep Koonaparaju helps us understand the nuances that go into classifying income from trading either as business income or capital gains. Sandeep is a practising Chartered Accountant based out of Bangalore.
Some tax-related questions cannot be answered with a straightforward ‘Yes/No’.
We will deal with one such question in this article: whether income from trading in shares should be classified as business income or capital gains?
However, before answering this, we need to understand why classification is so important after all and how it impacts your taxes.
We are well aware that business income and capital gains are taxed (with exceptions, where applicable). So let’s understand a few basic differences between these two in short, without getting into the details:
– Tax rates – Business income is generally taxed at slab rate (for individuals) or the standard rate (30%, 25% etc.) depending on the legal form of the taxpayer. On the other hand, capital gains are taxed at special rates (except for non-equity short-term gains), which are lower than the standard rates apply.
– Audit and compliances – An audit is required only when a taxpayer has a business or profession. Certain other compliances, such as maintaining books of accounts etc., are applicable only when a business or profession exists. There are no such compliances for capital gains; you may retain the documents to back up the numbers in your ITR (as support in case of scrutiny etc.)
Having understood a few basic differences, now let’s get familiar with the options available to a taxpayer in classifying trading income.
The question related to the classification of trading income as business or capital gains is pretty old. You might find it surprising that there are supreme court judgements on this issue, dating as far back as 1953.
The income tax department has also issued many circulars and internal memos at regular intervals clarifying its position and providing guidance to tax officials. Two such instructions most relevant to our discussion are a circular issued on 29th February 2016 (for listed shares and securities) and a letter dated 2nd May 2016 (deals with unlisted shares).
Listed shares and securities:
The circular states that:
Understanding these clauses better:
If the shares are treated in books of account as inventory, then the income from the sale of such shares will be considered business income. The period of holding is irrelevant. A taxpayer can also opt to offer the income from shares held for more than 12 months as capital gains, and such an option has to be followed consistently.
A combined reading of both the conditions also indicates that if the taxpayer chooses to offer income from the sale of shares held for more than 12 months as capital gains, he must follow it consistently irrespective of how he classifies (as inventory or investment) them in books in subsequent years.
Also, as is evident from point C above, the circular attempts to reduce litigation and uncertainty but not eliminate it, in other words, the classification of income from listed shares and securities held for less than 12 months is still open for dispute (discussed later in the article).
The income tax department has issued a letter to tax officers dated 2nd May 2016 instructing them to deal with gains from the sale of unlisted shares during assessments. As per the letter, income arising from the transfer of unlisted shares should be considered capital gains irrespective of the holding period.
The letter further states that tax officers can use their discretion in the following situations (ignoring the general rule):
Unless a sale falls into the above three categories, income from unlisted shares is taxed under Capital Gains. If you wonder under what circumstances the genuineness of a transaction will be considered ‘questionable’, my guess is as good as yours.
As mentioned at the beginning of the article, the question on the classification of trading income does not have a straight answer. Though the circulars and letters issued by the department helps reduce the ambiguity, unanswered questions remain.
If a person sells listed shares/securities with a holding period of fewer than 12 months and wants to consider the gain as ‘capital gain’ for tax purposes, the tax officer can dispute that. As discussed earlier in the article, we need to rely on the principles evolved over a period of time-based on various old circulars issued by the department and court judgments. An office memorandum dated 13th December 2005, issued by CBDT, listed out the circumstances to be considered by tax officers while determining whether a person is a trader or an investor. A few of those (not copying the entire list here) are:
The list provided above gives you an idea of the various factors that can influence the case in favour or against the taxpayer. Having said that, the department understands and accepts that a taxpayer can have two portfolios, one for investments (securities are treated as capital assets) and one for trading (securities are treated as stock in trade). So, taxpayers with two different portfolios may have income from business and also capital gains.
To conclude, there is no decisive answer, and each case has to be dealt with based on its merits. Small traders are generally not troubled by tax officers concerning the classification of trading income.
Here is an extract from one of the circulars issued by the department which sums it up:
“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.”
If you’re a Capitalmind Premium member, you can continue the conversation and ask more specific questions on the #taxation channel in Slack. You can reach Sandeep by email sandeep.vvc98 [at] gmail.com