Question whether a gain is assessable as “capital gains” or under the head “business” has always assumed importance for various reasons. This has acquired all the more significance in recent years because of differential tax rates applicable on capital gains and on business income. This distinction has got several other dimensions which too affect the computation of income in great way, as the question of indexation, relevance of method of accounting, availability of various types of deductions and exemptions and the benefit of set off and carry forward of losses under the respective heads of income all are dependent upon the answer to this vexed question as to whether a profit is merely on change of investment or it is a profit from an adventure in the nature of trade or from business. The distinction between the two types of transactions, it is seen at times, is wafer thin and is not easy to make. That is the reason that when everybody was basking under this self made impression that gain in the dealing of shares on which Securities Transaction Tax (STT) has been paid, would invariably result into capital gains, the CBDT’s detailed draft guidelines for public consumption and comments came as a rude shock to the tax payers and their belief to this extent that the continued upward leaps of the stock market was arrested all of a sudden with record-breaking approx. 800 points down slide in a single day.

According to the cross section of the society, these guidelines, albeit proposed, generated lot of confusion as to the possible tax treatment of the profits arising on the transactions of the listed securities. But I find naiveté in this kind of argument of the tax payers as, according to me, what the Board has circulated as proposed guidelines (kindly see annexure) was nothing but reiteration of its old Instruction of 1989 (kindly see annexure) based on well settled principles of law culled out on the strength of various judicial expositions available on this point so far and nothing else and thus far and no further.

It goes without saying that a person may purchase shares either by way of investment or for business purpose. Gains/loss resulting in first mentioned situation would give rise to the assessability under the head “capital gains” whereas the other mentioned situation would give rise to the resulting income/gains assessable under the head “Business”. Elaborating on this distinction, Hon’ble Supreme Court in the case of Raja Bahadur Visheshwara Singh Vs. CIT 41 ITR 685 at page 691 & 692 held that where what is done is not merely a realization or a change of investment but an act done in what is truly the carrying on a business, the amount so recovered as appreciation will be assessable as business income. There has in fact been a lot of divergence of judicial opinion on this subject and in every case, the discussion has turned on its own peculiar facts and circumstances. The judicial decisions on this point offer, at best, illustrated guides and laid down the general principles to be kept in mind in arriving at a decision whether the transaction pertains to the domain of revenue or capital. It has been very aptly held by Hon’ble Bombay High Court in the case of Bhogi Lal H. Patel Vs. CIT 74 ITR 692 at page 704 that this question needs to be decided on a consideration of all the relevant facts. Hon’ble Allahabad High Court in the case of Deep Chandra & Company Vs. CIT 107 ITR 716 at page 722 have held that the answer to this question does not depend upon merely counting the number of facts and circumstances pro & con. Hon’ble Supreme Court in the case of Khan Bahadur Ahmed Alladeen and Sons Vs. CIT 68 ITR 573 at page 578 have observed that the answer to this question does not depend upon the application of any abstract rule, principle or formula but must depend upon the total impression and effect of all the relevant facts and circumstances established in the particular case. Hon’ble Apex Court in the case of CIT Vs. H.Holck Larsen 160 ITR 67 at page 87 have held that consideration of all relevant facts involves appreciation of all the facts in their proper perspective & if that is not done, it cannot be said that there has been consideration of all relevant factors.

It thus goes to establish that whether a transaction is giving rise to gain assessable under the head “capital gains” or under the head “business” is a mixed question of law and fact. On the facts of a particular case, proper legal principles are to be applied in order to decide the question as was reiterated by the apex court in the case of Juggital Kamalpat Vs. CIT ITR 186.

In the light of the above discussion, it becomes imperative for us to find out the few legal principles so as to equip ourselves to apply them to the facts and find out the true character of the gain/loss.

1. Intention at the time of purchase is the first guide post i.e. whether to sell it subsequently at a profit or is only to make an investment as the presence of commercial motive is a primarily legal requisite and strong indicative attribute of “trade”. Intention to make a profit in the normal course inspires trade and commerce but, certainly it is not a conclusive test as held in the case of Sarojni Rajah Vs. CIT 71 ITR 504, 510 (Mad).
2. Magnitude & frequency and the ratio of sales and purchase and total holdings is an evidence from which the true nature of the assessee’s activities can be deduced as held in the case of Raja Bhadur Vishashwara Singh Vs. CIT 41 ITR 685, 692 (SC). But though habitual dealing is ordinarily indicator of trade or commerce but this test is also not necessarily decisive like the other tests.
3. Treatment of a transaction in the books of accounts as well as in Balance Sheet though is not a conclusive circumstance but certainly, it is a relevant circumstance to draw an inference as to whether shares/subject matter relates to investment portfolio or other wise as held in the case of Karam Chand Thapar & Bros. Ltd. Vs. CIT 82 ITR 899 (SC).
4. Income from shares dealings in the preceding year may raise a presumption of continuity of the business but it has also to be borne in mind that the fact that an assessee was not treated as share dealer inspite of these transactions in earlier years cannot operate as resjudicata to preclude the authorities from holding other wise i.e. transactions this year amounted to business dealings, as was held in the case of New Jehangir Vakil Mills Limited Vs. CIT 49 ITR 137 (SC).
5. The length of the period of ownership is one of the important factors to decide whether a transaction results into capital gain or business profit. The length of the period of ownership is one of the important factors to decide whether a transaction results into capital gain or business profit.
6. If there is an organized effort to obtain profit in contradistinction to when nothing at all is done, the suggestion tends that it was business profit.

Similarly, the Kerala High Court in the case of Michael A. Kallivayalil Vs. CIT (1976) 102 ITR 202 enumerated the following guiding principles while deciding as to whether a transaction of purchase or sale forms an adventure in the nature of trade or an investment :-

1. The commodity purchased plays an important role in deciding whether a person is indulging in an adventure in the nature of trade or is making an investment.
2. Whether the transaction is an isolated one or forms part of a series of transaction showing a tendency to indulge in trade.
3. The fact that the property bought has been sold within a short time does not by itself indicate that the transaction is in the nature of trade.
4. The fact that the property bought has been sold within a short time does not by itself indicate that the transaction is in the nature of trade.
5. If land or a commodity, which normally is not treated as stock in trade, has been purchased, the presumption is that the intention was to make an investment and not to indulge in an adventure in the nature of trade.
6. If the property purchased is capable of yielding income then again the inference will be that an investment was intended to earn income and is not an adventure in the nature of trade.

It may thus be seen that number of factors like nature of the asset, the dominant intention of acquisition, the period of retention, nature of business of the assessee all are required to be taken into account and no single test is enough to hold that whether the transaction in question would give rise to business profit or capital gain. All told, it is rather balancing upon a knife’s edge to pro and con in the facts and circumstances of such cases and then to decide whether it is or it is not an investment or business. Any impression whosoever gathered that listed securities transactions after payment of Securities Transaction Tax (STT) would invariably give rise to income or loss under the head capital gain may thus well be fallacious and be avoided.

But the only satisfying thing is that onus to prove that the transaction when that transaction is not in the ordinary course or line of business of the assessee is on the department, would give rise to gain or loss under the head “business”. It was held by Hon’ble Bombay High Court in the case of CIT Vs. V. A. Trivedi 172 ITR 95 that the onus of establishing that a purchases made with the intention to trade is on the revenue. It was also held by the Hon’ble Allahabad High Court in the case of Deep Chandra & Co. Vs. CIT 107 ITR 716 that burden lies on the revenue to establish that the profit earned in a transaction was revenue realization and not capital gain. Such onus cannot be discharged by revenue merely by rejecting the assessee’s explanation or by proving the existence of some equivocal circumstances alone or by surmises. But at the same time it has to be borne in mind that apparent is real unless proved otherwise by the person alleging it to be so.

Sub : Circumstances to be considered by the Assessing officers in determining whether a person is a trader in stocks or an investor in stocks:

The Central Board of Direct Taxes in its instruction no.1827 dated 31-08-1989 had laid down certain tests to distinguish between shares held as stock-in-trade and shares held as investment. CBDT proposes to issue supplementary instructions in this regard to provide further guidelines for determining whether a person is a trader is stocks or an investor in stocks. Before issuing the instructions, CBDT would like to invite comments of all stakeholders.

Comments on the draft instructions may be sent by email or post by 25th June, 2006 to Ms Monica Bhatia, Director (TPL-I), Room No.147D, North Block, New Delhi (e mail : dirtpl1@nic.in).

The Central Board of Direct Taxes in its instruction no.1827 dated 31-08-1989 had laid down certain tests to distinguish between shares held as stock-in-trade and shares held as investment. The following supplementary instructions in this regard will provide further guidelines for determining whether a person is a trader in stocks or an investor in stocks:

1. Whether the purchase and sale of securities was allied to his usual trade or business / was incidental to it or was an occasional independent activity.
2. Whether the purchase is made solely with the intention of resale at a profit or for long term appreciation and/or for earning dividends and interest.
3. Whether scale of activity is substantial.
4. Whether transactions were entered into continuously and regularly during the assessment year.
5. Whether purchases are made out of own funds or borrowings
6. The stated objects in the Memorandum and Articles of Association in the case of a corporate assessee
7. Typical holding period for securities bought and sold
8. Ratio of sales to purchases and holding
9. The time devoted to the activity and the extent to which it is the means of livelihood.
10. The characterization of securities in the books of account and in balance sheet as stock in trade or investments.
11. Whether the securities purchased or sold are listed or unlisted.
12. Whether investment is in sister/related concerns or independent companies.
13. Whether transaction is by promoters of the company.
14. Total number of stocks dealt in.
15. Whether money has been paid or received or whether these are only book entries.

The Assessing Officers are also advised that no single criterion listed above is decisive and total effect of all these criteria should be considered to determine the nature of activity.

(F.No.149/287/2005-TPL from Central Board of Direct Taxes)

1. The question whether a particular assessee is a trader in shares or the shares are held as capital assets sometimes gives rise to disputes and litigation. Over the years the courts have laid down the various tests or factors to be taken into account in determining this question.
2. Certain general principles in this regard were laid down by the Supreme Court in the case of G.Venkata Swami Naidu & co. Vs. CIT (1959) 35 ITR 594. In this case the Supreme Court was dealing with a question whether the excess sum realised on the sale of certain plots was assessable as income from an adventure in the nature of business. The Supreme Court held that in deciding the character of such transaction, several factors were relevant. For instance:-

1. Whether the purchaser was a trader and the purchase of the commodity and its resale were allied to his usual trade or business or were incidental to it.
2. The nature and quantity of the commodity purchased and resold–-if the commodity purchased is in very large quantity, it could tend to eliminate the possibility of investment for personal use, possession or enjoyment.
3. The repetition of the transaction.

3. The Supreme court observed that the presence of all these factors may be held in the court to draw an inference that a transaction is in the nature of trade’ but it is not a matter of merely counting the number of facts and circumstances pro and con what is important to consider is their distinctive character. In each case, it is the total effect of all relevant factors and circumstances that determines the character of the transaction.
4. The Supreme Court in this case also discussed the test of intention. It held that in cases where the purchase has been made solely and exclusively with the intention of resale at a profit and the purchaser has no intention of holding the property for himself or otherwise enjoying it or using it, the presence of such intention is a relevant factor and unless it is off-set by the presence of other factors, it would raise a strong presumption that a transaction is an adventure in the nature of trade.
5. In the case of H. Mohammad & Co. Vs. CIT (1977) 107 ITR 637 the Gujarat High Court observed that a stock-in-trade is something in which a trader or a business man deals, whereas his capital asset is something with which he deals. According to the High Court one of the indicators for deciding as to what is stock-in-trade is whether a particular assessee is buying or selling the goods or commodity or whether he has merely invested his money with a view to earning further income or with a view to carrying on his other business. It was further held by the High court that the distinction between stock-in-trade and investment is that of selling outright in the course of the business activity and deriving income from exploitation of one’s own assets.
6. These general principles hold good in respect of shares also. However certain specific issues relevant for determining this question with reference to shares have also been decided by the courts. In the case of Sarder Indra Singh & Sons Ltd. Vs. CIT (1953) 24 ITR 415, the Supreme Court was dealing with the case of a company which was incorporated with the object, inter alia of carrying on the business of bankers, financiers, managing agents and secretaries and was also empowered to invest and deal with the monies of the company not immediately required for its business upon such securities and in such manner as might from time to time be determined. It was held by the Supreme Court in this case that to constitute business income, it was not necessary that surplus should have resulted from such a course of dealing in securities as by itself would amount to the carrying on of business or if the realisation of securities is a normal step in carrying on the assessee’s business. The Supreme Court observed that the principle applicable in all such cases was well settled and the question always was whether the sales which produced the surplus were so connected with the carrying on of the assessees business that it could fairly be said that the surplus was the profit and gains of such business. On the facts of this case it was held that the surplus resulting from sale of shares and securities constituted business income.
7. The aforesaid principles laid down by the Supreme Court was followed by Andhra Pradesh High court in the case of SBH. Vs.CIT (1988) 151 ITR 703. The main business of the SBH was to accept deposits and to advance loans and the money constituted its stock-in-trade. The banking company has to carry on its business in accordance with the provisions of the banking regulation act, 1949. Sec. 24 of the said act requires every banking company to maintain in India either in cash or in the shape of gold or in the shape of unincumbered approved securities, 20% of its total time and demand liabilities at any given point of time. It was held by the High Court that what section 24 of the said Act did was to insist on the observance of a normal prudent banking business practice. If the banking company chooses to invest the money in unincumbered approved securities it is only one mode of keeping a portion of its deposits in ready cash or readily-convertible-into-cash securities. Any income arising from the sale of such securities is, therefore closely connected with the banking business and is business income, it was concluded by the High court.
8. In the case of Karam Chand Thapar and brothers (P) Ltd Vs. CIT (1971) 83 ITR 899 it was held by the Supreme Court that the circumstance that the assessee had shown certain shares as investment in its books as well as its balance sheet was by itself not a conclusive circumstances, though it was a relevant circumstance.
9. The decisions in the CIT Vs. Associated Industrial Development co. (1971) 82 ITR 586 (SC) and A.N. Ramaswami Chettiar Vs. CIT (1963) 48 ITR 771 (Madras) may also be referred to for guidance.
10. Although the tests laid down by the courts may help determine the issue in particular cases the decision will ultimately turn on the facts of each case.
11. These instructions may please be brought to the notice of the Assessing officers in your region.

[F.No 181/1/89 - IT(AI) dated 31/08/1989 from Central Board of Direct Taxes]

The author is a member of the Institute. The views expressed herein are his personal views and do no necessarily represent the views of the Regional Council