TAXATION OF SHARES AND SECURITIES
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TAXATION OF SHARES AND SECURITIES CA. Nihar Jambusaria. Dividend & Interest Income Provisions to Prevent Possible Tax Avoidance Capital Gains Business Income including Speculation Income Issues Related to Stock Brokers. DIVIDEND AND INTEREST INCOME. Dividend exempt u/s. 10(34) :

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TAXATION OF SHARES AND SECURITIES CA. Nihar Jambusaria

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Taxation of shares and securities ca nihar jambusaria

TAXATION OF SHARES AND SECURITIES CA. Nihar Jambusaria


Taxation of shares and securities ca nihar jambusaria

  • Dividend & Interest Income

  • Provisions to Prevent Possible Tax Avoidance

  • Capital Gains

  • Business Income including Speculation Income

  • Issues Related to Stock Brokers


Dividend and interest income

DIVIDEND AND INTEREST INCOME

  • Dividend exempt u/s. 10(34) :

  • Income from units exempt u/s. 10(35)


Measures to check tax avoidance evasion

MEASURES TO CHECK TAX AVOIDANCE/EVASION

  • Dividend stripping S. 94(7)

    Where –

  • any person buys or acquires any securities or unit within a period of three months prior to the record date;

    (b) such person sells or transfers –

    • such securities within a period of three months after such date; or

    • such unit within a period of nine months after such date;

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

      then, the loss, if any, arising to him on account of such purchase and sale of securities or unit, to the extent such loss does not exceed the amount of dividend or income received or receivable on such securities or unit, shall be ignored for the purposes of computing his income chargeable 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).


Measures to check tax avoidance evasion contd

MEASURES TO CHECK TAX AVOIDANCE/EVASION (Contd)

  • 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 any payment on the basis of holding of such units on such date;

    (c )such person sells or transfers all or any of the units referred to in clause (a) within a period of nine months after such date, while continuing to hold all or any of the additional units referred to in clause (b),

    then, the loss, if any, arising to him on account of such purchase and sale of all or any of such units shall be ignored for the purposes of computing his income chargeable to tax and notwithstanding anything contained in any other provision of this Act, the amount of loss so ignored shall be deemed to be the cost of purchase or acquisition of such additional units referred to in clause (b) as are held by him on the date of such sale or transfer.


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. 2009-10.

    (b) On any other security transferred after 30.09.2004 - Taxable at normal rate.

  • Long Term Capital Gain :

    (a) On eligible equity shares purchased on or after 01.03.03 and before 01.03.04 exempt u/s. 10(36).

    (b) On equity shares or units of an equity oriented fund arising after 30.09.04 on which S.T.T. is paid – exempt u/s. 10(38).

CAPITAL GAINS


Business income

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 on which S.T.T. is paid – taxable at normal rate and S.T.T. paid is allowable as deduction U/S.36(1)(xv) in computing income under this head.

  • Issues –

  • Where a large number of transactions of purchase and sales of shares and securities of different companies are entered into during P. Y., whether the gain can be declared as short term or long term capital gain or should it be declared under the head income from business or profession.

    Consider the decisions –

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

  • Arjun Kapoor 70 ITD 161 (Del.)

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

  • Circular No.4/2007 dt. 15-6-2007

  • The following factors would be relevant in determining whether transactions for purchase & sale of shares & securities are in the nature of business or investment?


Business income cont

BUSINESS INCOME (cont.)

(1) Motive

(2) Number of transactions

(3) Relation with other activities

(4) Source of investment

(5) Resources employed

  • If share transactions are treated as business, the following 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

  • Trading in Derivatives :

  • An eligible transaction in respect of trading in derivatives shall not be deemed to be a speculative transaction w.e.f. 01.04.06 by virtue of addition of clause (d) to S. 43(5).


Capital gains1

CAPITAL GAINS

  • Conversion of capital assets into stock in trade –

  • Issues –

  • Any care is required to be taken before converting shares / securities into stock in trade ?

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

  • Century Builder – 5694/Mum./2000/dt. 30.07.02

  • Arjun Kapoor 70ITD161(Del)

  • Circular No. 4/2007 dt. 15-6-2007

    Tax Treatment of Deep Discount Bonds:

    Consider circular No. 2 of 2002 dated 15.02.2002


Certain judgements

CERTAIN JUDGEMENTS

  • 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.)

    2. Opening stock of a new firm constituted by some partners of dissolved firm should be valued at market price.

    V. S. Chandraprakasa Nadar & Co. v. CIT 244 ITR 298 (Mad.)

    3.Bad investments written off would not give rise to capital loss.

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


Certain judgements contd

CERTAIN JUDGEMENTS (contd.)

  • Where business loss arises due to valuation of closing stock at cost or market price whichever is less and there was no purchase and sale of shares during the 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 valuation loss is covered by Explanation to S.73.

    5.Where shares / securities are acquired by any mode u/s. 49(1), indexation shall be allowed from the P. Y. of aquisition of the previous owner.

  • Pushpa Sophat v. ITO 81 ITD 1 (Chd.)

  • Meera Khera February 2004 BCA Journal.

  • Contrary- Kishor Kanoongo Mum. Trib.

    6.Indexation is allowable on L.T.C.G. on transfer of MEP’91 and MEP’92 – refer S. 45(6).

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

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

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


Speculation business

SPECULATION BUSINESS

A 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 hence the provisions of S. 43(5) equally apply to dealing in shares and stocks. Under the normal understanding, a speculative 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.

Explanation 2 to s.28 reads as under :

‘Where speculative transactions carried on by an assessee are of such a nature as to constitute a business, the business (hereinafter referred to as “speculation business”) shall be deemed to be distinct and separate from any other business’.

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

  • a contract in respect of stocks and shares entered by a dealer or investor to guard against loss in his holdings of stocks and shares through price fluctuations (commonly referred to as hedging transactions).


Speculation business contd

SPECULATION BUSINESS (Contd.)

  • a contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member.

  • An eligible transaction of dealing in derivatives, with effect from A.Y. 2006-07.

  • 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 of shares?

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

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


Speculation business contd1

SPECULATION BUSINESS (Contd.)

(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.

    (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


Issues relating to share brokers

ISSUES RELATING TO SHARE BROKERS

  • Determination of Turnover

  • Allocation of expenses to speculaive & other transactions when the assessee is a company.

  • Depreciation on BSE Card post issue of shares by BSE.

  • Allocation of expenses to Dividend Income-S.14A.

  • 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 – cost or market value?


Disallowance of expenses u s 14a

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)

    (b)After introduction of S. 14A-

    Rule 8D-

    Direct Expenditure plus

    • Interest AxB plus

      C

    • ½% of average investment

  • ITO v. Daga Capital Management Pvt. Ltd. 26 SOT 603(Mum) (Spec. Bench)

  • ACIT v. Indexport Ltd.- Mum. Trib.


  • Disallowance of expenses u s 14a cont

    Disallowance of Expenses u/s. 14A (Cont.)

    (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.

      (2)Civil Contractor

    • Income from civil construction taxable u/s. 44AD

    • Dividend Income Rs. 12,00,000

    • Disallowance u/R.- 8D.

      (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.

      (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.


    Circular no 4 2007 dated 15 6 2007

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

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

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

    • Capital asset is defined in Section 2(14) of the Act. Long-term capital assets and gains are dealt with under Section 2(29A) and Section 2(29B). Short-term capital assets and gains are dealt with under Section 2(42A) and Section 2(42B).

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

      4.The Central Board of Direct Taxes (CBDT) through Instruction No.1827 dated August 31, 1989 had brought to the notice of the assessing officers that there is a distinction between shares held as investment (capital asset) and shares held as stock-in-trade (trading asset). In the light of a number of judicial decisions pronounced after the issue of the above instructions, it is proposed to update the above instructions for the information of assessees as well as for guidance of the assessing officers.

      5.In the case of Commissioner of Income Tax (Central), Calcutta Vs Associated Industrial Development Company (P) Ltd (82 ITR 586), the Supreme Court observed that:


    Taxation of shares and securities ca nihar jambusaria

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

    • 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 the knowledge of the assessee who holds the shares and it should, in normal circumstances, be in a position to produce evidence from its records as to whether it has maintained any distinction between those shares which are its stock-in-trade and those which are held by way of investment.

      6.In the case of Commissioner of Income Tax, Bombay Vs H. Holck Larsen (160 ITR 67), the Supreme Court observed:

    • The High Court, in our opinion, made a mistake in observing whether transactions of sale and purchase of shares were trading transactions or whether these were in the nature of investment was a question of law. This was a mixed question of law and fact.

      7.The principles laid down by the Supreme Court in the above two cases afford adequate guidance to the assessing officers.

      8.The Authority for Advance Rulings (AAR) (288 ITR 641), referring to the decisions of the Supreme Court in several cases, has culled out the following principles :-

    • 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;

    • 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;


    Taxation of shares and securities ca nihar jambusaria

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

    • 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.

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

    • We shall revert to the aforementioned principles. The first principle requires us to ascertain whether the purchase of shares by a FII in exercise of the power in the memorandum of association/trust deed was as stock in-trade as the mere existence of the power to purchase and sell shares will not by itself be decisive of the nature of transaction. We have to verify as to how the shares were valued/held in 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 at business income or held as investment in capital assets.

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

    • It will not be out of place to mention that regulation 18 of the SEBI Regulations enjoins upon every FII to keep and maintain books of account containing true and fair accounts relating to remittance of initial corpus of buying and selling and realizing capital gains on investments and accounts of remittance to India for investment in India and realizing capital gains on investment from such remittances.


    Taxation of shares and securities ca nihar jambusaria

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

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

      10.CBDT also wishes to emphasise that it is possible for a tax payer to have two portfolios, i.e., an investment portfolio comprising of securities which are to be treated as capital assets and a trading portfolio comprising of stock-in-trade which are to be treated as trading assets. Where an assessee has two portfolios, the assessee may have income under both heads i.e., capital gains as well as business income.

      11.Assessing officers are advised that the above principles should guide them in determining whether, in a given case, the shares are held by the assessee as investment (and therefore giving rise to capital gains) or as stock-in-trade (and therefore giving rise to business profits). 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.

      12.These instructions shall supplement the earlier Instruction no. 1827 dated August 31, 1989.


    Taxation of shares and securities ca nihar jambusaria

    Nihar Jambusaria

    Executive Director

    Direct Line: +91 22 66729709

    Mobile: +91 98202 37681

    [email protected]

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