BUSINESS INCOME OR CAPITAL GAINS

Dear Virag,

There is no clarification in this regard in Income tax Act, its all depend on the intention of the assessee how he wants to traet the same in his books of accounts.

However circular has been issued by CBDT in this regard specifying that the assessee can have two portfolio one is Investment in shares and second one is of Business Stock. Enclosed herewith circular and Questionnaire given by ITAT in various case laws, which will help you. Please take action at this time and have proper documentation in this regard to avoid any difficulty at the time of assessment proceedings.

A. Principles laid down by CBDT in circular 04/2007 dated 15.06.2007

“(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”.

A. Details as per decision given by ITAT (Mum) in the case of Management Structure & Systems Pvt. Ltd. (ITA No. 6966/Mum/2007 – AY: 2004-05)

What is the intention of the assessee at the time of purchase of the shares (or any other item) ? This can be found out from the treatment it gives to such purchase in its books of account. Whether it is treated as stock-in-trade or investment ? Whether shown in opening/closing stock or shown separately as investment or non-trading asset ?

Whether assessee has borrowed money to purchase and paid interest thereon ? Normally, money is borrowed to purchase goods for the purposes of trade and not for investing in an asset for retaining.

What is the frequency of such purchases and disposal in that particular item ? If purchase and sale are frequent, or there are substantial transactions in that item, it would indicate trade. Habitual dealing in that particular item is indicative of intention of trade. Similarly, ratio between the purchases and sales and the holdings may show whether the assessee is trading or investing (high transactions and low holdings indicate trade whereas low transactions and high holdings indicate investment).

Whether purchase and sale is for realizing profit or purchases are made for retention and appreciation in its value ? Former will indicate intention of trade and later, an investment. In the case of shares whether intention was to enjoy dividend and not merely earn profit on sale and purchase of shares ? A commercial motive is an essential ingredient of trade.

How the value of items has been taken in the balance sheet ? If the item in question are valued at cost, it would indicate that they are investments or where they are valued at cost or market value or net realizable value (whichever is less), it will indicate that items in question are treated as stock-in-trade.

How the company (assessee) is authorized in memorandum of association/articles of association ? Whether for trade or for investment? If authorized only for trade, then whether there are separate resolutions of the board of directors to carry out investments in that commodity ? And vice versa”.

These principles of law have to be applied to the following facts (or answer to the below 8 question):

Treatment given in the Books of Accounts by the assessee, whether treated entire Investment in shares as an “investment” and not as “stock-in-trade”