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TAXATION OF SHARES AND

SECURITIES

AT WIRCON 23rd January, 2010.

CA. Nihar Jambusaria

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(1) Dividend & Interest Income

(2) Provisions to Prevent Possible TaxAvoidance

(4) Business Income including Speculation

Income

(5) Issues Related to Stock Brokers

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DIVIDEND AND INTEREST INCOME

Dividend exempt u/s. 10(34) :

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MEASURES TO CHECK TAX

AVOIDANCE/EVASION Dividend stripping S. 94(7)

Where

(a) any person buys or acquires any securities or unit

(b) such person sells or transfers

such securities within a period of three monthsafter such date; or

such unit within a period of nine months aftersuch date;

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AVOIDANCE/EVASION (Contd)

(c) the dividend income on such securities or unit received orreceivable by such person is exempt,

then, the loss, if any, arising to him on account of suchpurchase and sale of securities or unit, to the extent such

received or receivable on such securities or unit, shall beignored for the purposes of computing his incomechargeable to tax.

S. 94(7) cannot be applied from retrospective effect.

Wallfort Shares & Stock Brokers Pvt. Ltd. v.

ITO & Ors. 96 ITD 1 (Mum.) (TM).

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Bonus / right stripping S. 94(8)

Where

(a)any person buys or acquires any units within a period



of three months prior to the record date;

(b)such person is allotted additional units without anypayment on the basis of holding of such units on such

date;

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c) such person sells or transfers all or any of the unitsreferred to in clause (a) within a period of nine months

after such date, while continuing to hold all or any ofthe additional units referred to in clause (b),

then, the loss, if any, arising to him on account of such



ignored for the purposes of computing his incomechargeable to tax and notwithstanding anythingcontained in any other provision of this Act, the amountof loss so ignored shall be deemed to be the cost of

purchase or acquisition of such additional units referredto in clause (b) as are held by him on the date of suchsale or transfer.

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CAPITAL GAINS

Short-term Capital Gain :

(a) On listed securities transferred after 30.09.2004 on

which S.T.T. is paid - Taxable at 10%, 15% w.e.f. A. Y.

- .

(b) On any other security transferred after 30.09.2004 -

Taxable at normal rate.

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CAPITAL GAINS (Contd.) Long Term Capital Gain :

(a) On eligible equity shares purchased on or after01.03.03 and before 01.03.04 exempt u/s. 10(36).

arising after 30.09.04 on which S.T.T. is paid exemptu/s. 10(38).

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BUSINESS INCOME

Where equity shares or units in an equity oriented fund

are held as stock in trade and are sold after 1-4-2008 onwhich S.T.T. is paid taxable at normal rate and S.T.T.

paid is allowable as deduction U/S.36(1)(xv) in

com utin income under this head.

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BUSINESS INCOME (contd.) Issues

1. Where a large number of transactions of purchase and sales ofshares and securities of different companies are entered intoduring P. Y., whether the gain can be declared as short term orlong term capital gain or should it be declared under the headincome from business or profession.

Consider the decisions

o Smt. Neerja Birla v. ACIT 66 ITD 148 (Mum.) and

o Arjun Kapoor 70 ITD 161 (Del.)

o Janak Rangwala vs. ACIT 11 SOT 627 (Mum.)

o Circular No.4/2007 dt. 15-6-2007.

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The following factors would be relevant in determining

whether transactions for purchase & sale of shares &

securities are in the nature of business or investment?

1 Motive

(2) Number of transactions

(3) Relation with other activities

(4) Source of investment

(5) Resources employed

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If share transactions are treated as business, thefollowing expenses are allowable as deduction-

(1) Interest on borrowed capital(2) Brokerage, service tax, stamp duty

(3) Penalties, bad delivery charges, auction charges

(4) Demat account charges(5) Portfolio Management & advisory fees

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BUSINESS INCOME (contd.)

Trading in Derivatives :

An eligible transaction in respect of trading in derivatives

shall not be deemed to be a speculative transaction

w.e. . . . y v r ue o a on o c ause o .

43(5).

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CAPITAL GAINS Conversion of capital assets into stock in trade

Issues

Any care is required to be taken before converting

Whether an assessee can hold some shares andsecurities as stock in trade and some shares andsecurities as investment.

o Century Builder 5694/Mum./2000/dt. 30.07.02

o Arjun Kapoor 70ITD161(Del)

o Circular No. 4/2007 dt. 15-6-2007

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CAPITAL GAINS (contd.)

Tax Treatment of Deep Discount Bonds:

Consider circular No. 2 of 2002 dated 15.02.2002

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CERTAIN JUDGEMENTS

1. Shares obtained in family settlement Family

settlement is analogous to partition of H.U.F.Therefore, S. 49(1)(i) shall apply for determining the

cost of acquisition of shares under family settlement.

Shanti Chandran 241 ITR 371 (Mad.)

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CERTAIN JUDGEMENTS (contd.)

2. Bad investments written off would not give rise tocapital loss.

R.C. Mudliar 240 ITR 552 (Mad.)

3. Where business loss arises due to valuation of closingstock at cost or market price whichever is less and

P.Y., Explanation to S. 73 does not apply.

Nirvan Holding Pvt. Ltd. BCA-399 JULY 2003, SMC,MUM Sun Dist. & Mining Co. 68 Taxman 223.

Mumbai High Court held in Prasad Agents Pvt. Ltd. V.ITO [2009 TIOL-164-HC-MUM] that share valuationloss is covered by Explanation to S.73.

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4. Where shares / securities are acquired by any mode u/s.

49(1), indexation shall be allowed from the P. Y. ofacquisition of the previous owner.

o us pa op a v. .

o Meera Khera February 2004 BCA Journal.

o Contrary- Kishor Kanoongo Mum. Trib.

o DCIT v. Manjula J. Shah dt.16th October, 2009.

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5. Indexation is allowable on L.T.C.G. on transfer ofMEP91 and MEP92 refer S. 45(6).

K. B. Shah 77 TTJ 30 (Mum.)

6. Transfer of investments is not hit by Explanation to S.73.

Mysore Rolling Mills Pvt. Ltd. 195 ITR 405 (Kar.)

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SPECULATION BUSINESSA transaction which is not periodically or ultimately settled by

delivery or transfer of the contracted goods is a speculative

transaction as defined by S. 43(5) of the Income-tax Act.No exception is made in that section for shares and stocks

in fact, s. 43(5) specifically includes stocks and shares, and

.

shares and stocks. Under the normal understanding, aspeculative transaction is one where there is no intention to

take or give delivery.

However, under the income-tax law, the intention of the

purchaser or seller to take or give delivery of the shares is

immaterial for determining a speculative transaction. What is

material is whether delivery or transfer has

actually taken place or not.

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Explanation 2 to s.28 reads as under :

Where speculative transactions carried on by an assesseeare of such a nature as to constitute a business, the

business (hereinafter referred to as speculation business)

SPECULATION BUSINESS (Contd)

business.

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S. 43(5) provides for certain exceptions. The followingtransactions concerning share and stocks are not construed asspeculative transactions by virtue of the proviso to S. 43(5) :

a contract in respect of stocks and shares entered by a dealeror investor to guard against loss in his holdings of stocks and

SPECULATION BUSINESS (Contd)

hedging transactions).

a contract entered into by a member of a forward market or astock exchange in the course of any transaction in the nature

of jobbing or arbitrage to guard against loss which may arise inthe ordinary course of his business as such member.

An eligible transaction of dealing in derivatives,

with effect from A.Y. 2006-07.

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Explanation to S.73-Where any part of the business of a

company other than a company

whose gross total income consistsmainly of income chargeable under

the heads Interest on Sec., Inc. from

House Prop., Capital Gains and Inc.from Other Sources or a company

the principal business is banking or

granting of loans and advances

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Consists in the purchase and sale ofshares of other companies, such

company shall for the purposes of

this section, be deemed to becarrying on a speculation business to

consists of the purchase and sale ofshares.

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Issues relating to Expln. to S.73-

(1) Applicability to shares held as investments-

Mysore Rolling Mills Pvt. Ltd. 195ITR 404(kar)

Trade Team Pvt. Ltd. 54 ITD 36(Bom)

(2) Share broking-Whether business of purchase & sale ofshares?

SRJ Securities Ltd. v ACIT 81 TTJ 484 (Del)

DCIT v Frontline Capital Services Ltd. 96 TTJ 201(Del)

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(3) Applicability to securities other than shares

Appollo Tyres Ltd. 255 ITR 273 (S.C.)

(4) Loss due to stock valuation not regarded as speculation loss

Nirvan Holding Pvt. Ltd. 35 BCAJ 399 (Mum)

Contrary view-Prudential Constn. Co. Pvt. Ltd. 75 ITD 338 (Hyd.)

Associated Capital Markets Pvt. Ltd. ITA No11-3-4 & 3057

Mum.2001 dt 31-3-2003 Now resolved by Mum. H.C. decision in Prasad Agents- Contrary

view upheld.

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(5) Whether the Expln. Applies to arbitrage, hedging,etc.

excluded from the meaning of speculation u/s. 43(5)?

Rohini Capital Services Ltd. v DCIT 92 ITD 317 (Del)

(6) Settlement for breach of contract is not a speculative

transaction.

Bhandari Rajmal Kushalraj v ITO 96 ITR 401

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Issues relating to Share Brokers

(1) Determination of Turnover

(2) Allocation of expenses to speculaive & other

transactions when the assessee is a company.

(3) Allocation of expenses to Dividend Income-S.14A.

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Conversion of Stock into Capital Asset

Whether conversion of shares held as stock in trade into

capital asset would attract any tax.

What will be the cost of acquisition of such shares costor market value?

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Disallowance of Expenses u/s. 14A

History

(a) Before the introduction of S. 14A-

CIT v. Indian Bank Ltd. 56 ITR 77 (SC) CIT v. Maharashtra Sugar Mills Ltd. 82 ITR 452 (SC)

Rajasthan Warehousing Corporation v. CIT 242 ITR

450 (SC)

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(b) After introduction of S. 14A-

Rule 8D-

Direct Expenditure plus

Interest AxB lus

C % of average investment

ITO v. Daga Capital Management Pvt. Ltd. 26 SOT

603(Mum) (Spec. Bench)

ACIT v. Indexport Ltd.- Mum. Trib.

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(1) Share & Stock Broker-

Dividend Income: Rs. 12,50,000/-

Expenditure in relation to dividend income: Rs. 15,000/-

A. O. wants to apply Rule 8D.

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(2) Civil Contractor-

Income from civil construction taxable u/s. 44AD

Dividend Income Rs. 12,00,000

Disallowance u/R.- 8D.

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(3) A co acquired investments out of its own funds in 2000-

Cost Rs.5 Crores.

Dividend Income Rs. 25,00,000

Obtained loans in 2002 for other activities.

A. O. wants to disallow interest as per Rule 8D from

other taxable income.

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(4) A trader in shares has a profit of Rs. 15,00,000 from

share trading and Rs. 1,50,000 from dividend.

Allocation of direct and indirect expenses.

Can one contend that no disallowance can be made as

from the same activity assessee has earned taxable

income.

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CIRCULAR NO. 4/2007, DATED 15-6-2007

Distinction between shares held as stock-in-trade and shares heldas investment - tests for such a distinction

The Income Tax Act, 1961 makes a distinction between a capitalasset and a trading asset.

-.

capital assets and gains are dealt with under Section 2(29A) andSection 2(29B). Short-term capital assets and gains are dealt withunder Section 2(42A) and Section 2(42B).

Trading asset is dealt with under Section 28 of the Act.

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4. The Central Board of Direct Taxes (CBDT) through InstructionNo.1827 dated August 31, 1989 had brought to the notice of theassessing officers that there is a distinction between shares held asinvestment (capital asset) and shares held as stock-in-trade

(trading asset). In the light of a number of judicial decisionspronounced after the issue of the above instructions, it is proposedto update the above instructions for the information of assessees aswell as for guidance of the assessing officers.


5. In the case of Commissioner of Income Tax (Central), Calcutta VsAssociated 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 theknowledge of the assessee who holds the shares and it should,in normal circumstances, be in a position to produce evidencefrom its records as to whether it has maintained any distinctionbetween those shares which are its stock-in-trade and thosewhich are held by way of investment.

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(i) Where a company purchases and sells shares, it must be shownthat they were held as stock-in-trade and that existence of thepower 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 maintainingbooks of accounts, the magnitude of purchases and sales and theratio between purchases and sales and the holding would furnish


a goo gu e to eterm ne t e nature o transact ons;

(iii) ordinarily the purchase and sale of shares with the motive of earning a profit, would result in the transaction being in the natureof trade/adventure in the nature of trade; but where the object ofthe investment in shares of a company is to derive income by wayof dividend etc. then the profits accruing by change in suchinvestment (by sale of shares) will yield capital gain and notrevenue receipt.

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9. Dealing with the above three principles, the AAR has observed inthe case of Fidelity group as under:-

We shall revert to the aforementioned principles. The first principlerequires us to ascertain whether the purchase of shares by a FII inexercise of the power in the memorandum of association/trust deedwas as stock in-trade as the mere existence of the power tourchase and sell shares will not b itself be decisive of the nature of


transaction. We have to verify as to how the shares were valued/heldin 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 atbusiness income or held as investment in capital assets.

The second principle furnishes a guide for determining the nature oftransaction by verifying whether there are substantial transactions,their magnitude, etc., maintenance of books of account and findingthe ratio between purchases and sales.

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It will not be out of place to mention that regulation 18 of the SEBIRegulations enjoins upon every FII to keep and maintain books ofaccount containing true and fair accounts relating to remittance ofinitial corpus of buying and selling and realizing capital gains on

investments and accounts of remittance to India for investment inIndia and realizing capital gains on investment from suchremittances.


The third principle suggests that ordinarily purchases and sales ofshares with the motive of realizing profit would lead to inference oftrade/adventure in the nature of trade; where the object of theinvestment in shares of companies is to derive income by way ofdividends etc., the transactions of purchases and sales of shareswould yield capital gains and not business profits.

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10.CBDT also wishes to emphasise that it is possible for a tax payer tohave two portfolios, i.e., an investment portfolio comprising ofsecurities which are to be treated as capital assets and a tradingportfolio comprising of stock-in-trade which are to be treated as trading

assets. Where an assessee has two portfolios, the assessee may haveincome under both heads i.e., capital gains as well as businessincome.


11.Assessing officers are advised that the above principles should guide

them in determining whether, in a given case, the shares are held bythe assessee as investment (and therefore giving rise to capital gains)or as stock-in-trade (and therefore giving rise to business profits). Theassessing officers are further advised that no single principle would bedecisive and the total effect of all the principles should be considered

to determine whether, in a given case, the shares are held by theassessee as investment or stock-in-trade.

12.These instructions shall supplement the earlier Instruction

no. 1827 dated August 31, 1989.

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Nihar Jambusaria

[email protected]

[email protected]

036C7D28d01

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