POLICY MODIFICATIONS FOR MAXIMIZATION OF PROFIT AFTER TAX (PAT) ON CHANGES IN FISCAL POLICIES OF GOVERNMENT SHOULD NOT BE DOUBTED AS COLORABLE DEVICE TO AVOID TAX. – a study in context of capital gain or business income when security transaction tax is paid.

[C.A. DEV KUMAR KOTHARI]

Fiscal policies of governments:

The Central, State and local Governments changes their fiscal policies including tax  and incentive policies from time to time. The changes in policies are made to achieve certain socio-economical purpose. For example some of such  purposes  of such policy decisions can be as follows;

a.   To promote investment in any industry or geographical area.

b.  To promote savings of individuals and others.

c.   To impose restrictions on some activities  or make them costlier.

d.  To reduce certain type of expenses.

e.     To promote welfare of people of particular type or particular area.

f.    To reduce certain type of activities in particular area.

g.   To simplify tax  assessment and collection  system.

Effect of changes in policies:

Depending on changes in   governments' fiscal policies the tax payers are also required to effect some changes in their business modules, business policies, investment policies etc. The tax payer can make such changes just to avail benefit of changed fiscal policies of governments. Such changes are quite natural and are consequential to change in government policies.

When a change is effected in view of change in government policy, it should be considered in right earnest in right perspective. When a change in fiscal policy contemplate lower rate of tax with higher effectiveness in collection of tax, then it should be considered in a liberal manner so as to achieve the purposes of the change in fiscal policies. In case a tax payer makes some changes in his business modules, investment policies, operational manner etc. to avail benefit of new fiscal policy, then his changes should not be considered as a change to reduce tax burden. This is because tax system in our society is a live system that goes on changing on regular basis. Therefore, any changes in pursuance of changes in government policies should be viewed as a natural consequence. 

Fiscal changes on introduction of Security Transaction Tax (STT):

STT was introduced vide the Finance (No.2) Act, 2004. Relevant provisions are contained in Chapter VII of the said Act and STT Rules,2004.  By way of STT, a tax on different type of Taxable transaction carried through recognized stock Exchange or through Mutual Funds is imposed. The tax is on transactions therefore, it is levied irrespective of any profit earned or loss suffered. This is a simple and easy way of collection of tax because number of tax payer / assesses for the purpose of STT are small, collection is almost in computerized manner and chances of avoidance is very low. 

With a levy of STT, relaxation in income tax is allowed. These relaxations are applicable only when STT has been paid and not otherwise. Therefore, STT is in a way in lieu of income tax. The Government has found an easy way of tax collection by way of STT. Therefore, it can be said that STT is a convenient levy introduced to garner more revenue easily and even when there is no income . STT and corresponding benefits are introduced with specific purpose and scheme in mind, therefore these provisions should be construed in a purpose seeking and liberal manner.

Policy changes by taxpayer:

Lower rate of tax/exemption is allowed when STT is paid.  Change on behalf of government  may necessitate  change in policy of tax payers also. A tax payer is free to adopt such policies, which results into lower taxes. In view of levy of STT, if a person changes policy to hold shares as investment instead of stock-in-trade or vice versa, as it may suit to him, then such change in policy or accounting system should not be viewed with suspicion or doubt. Different sets of provisions and tax implications relating to tax,  set off and carry forward of loss  etc. will  prompt taxpayer  to treat shares as stock or investment in different circumstances. Therefore, such decisions or change in policy should be willingly accepted by the revenue authorities as bonafide commercial decision because aim of any investor or trader is not to avoid tax but to maximize his PAT while working within four corners  of law.

Who is share trader:

A share broker as such is not a share trader. He acts on instructions of his client and purchase and sell securities on behalf of client. A share broker is not called a share trader.

Now -a-days we hardly  can find  a share trader. The people transact there transactions through stock brokers. Many large brokers have provided facility of placing orders directly by the client on line. The transactions is routed through the website of the stock broker to the stock exchange. The bid or offer is placed  on online trading system of the stock exchange, when a matching offer comes the transaction is placed. The clients can also place orders by phone calls or personal visit to broker. The broker while providing services act as an agent and not as a principal. The broker charges his services charges called as brokerage.  

Share brokers advertise themselves as share broker being members of one or more stock exchanges. They do not advertise themselves as a trader in shares.

In commercial world a share broker is not known as a share trader.

Therefore, a share broker is not a share trader.

Purchase on own account by share broker is his investment:

A share broker can purchase and hold shares and units on his own account. These  shares or units will be his capital assets because share or unit is a property which falls in the meaning of 'capital asset'. Therefore they will be his 'capital asset'. Therefore, if the share broker sells his shares or units held as  'capital asset', he will earn capital gains and not business profit.

Share traders of odd lots, physical share etc:

We find a class of share trader who specializes in trading of certain type of shares. For example, a share trader who deals in physical shares, odd lot of shares, suspended shares etc. These type of traders are known as share trader. They operate a share shop or trading office where one can contact them to purchase and sell shares of such type.  These people also send emails, letters and place advertisements for buying and selling such shares.  Therefore, these types of people can be called a trader of such type of shares. Therefore, in their case the shares which they deal in as share traders can be considered as stock-in-trade in a natural way.

However, when a person purchases odd or small lot of shares to hold several shares with small investment, to get company information and some benefits associated with concerned group, or shares then such shares will be on investment account and not stock-in-trade, because the buyer is not purchasing them in capacity as share trader.

Stock-in-trade is either a natural fact or a man made fact:

A person who is a trader or dealer, in a commercial manner of any  article or thing is called a trader or  dealer of that commodity , article or thing. For example a grains trader, a sugar trader, a paper trader, a machine trader or a car trader etc. Such persons are known for such business and people go t them to purchase or sell such article or thing. For example, no one will go to a sugar trader to purchase paper or to  a paper dealer to purchase sugar. If a person trade in more than one commodity he is accordingly recognized. For example a trader who deal in sugar and grains both will be known as trader of sugar and grains. A person who deals in several thing of a particular branch is recognized as a trader of such things for example a 'general provision store', or ' grocery shop' , 'stationery shop', medicine shop etc. Therefore, such shops or trading offices or places are known as trader of such things or group of things in which they deal and people go to them knowing that they are trader in such things. Stock held by such traders of such things is his stock-in-trade as a natural fact.

Consumable items required for business purpose or personal  use are kept for use and consumption. Therefore, such things are purchased for use and not for trading. For example spare parts of a machine in a factory are not stock-in-trade but are part of inventory for use and are considered as stock and not capital assets. A motor car for business use is a capital asset but its spare parts may  not considered as capital asset, unless they form part of car and are sold with car.

  An article or thing or property which is not a trading item or a consumable  in business of  any person or as a consumable for personal need is a capital asset. The owner has option to convert or treat such things as stock-in-trade. Therefore, unless the owner has treated them as stock-in-trade or converted into stock-in-trade, such items will be his capital asset.   

Accordingly, it can be said that any property is a capital asset, unless it is a stock-in-trade of owner or a consumable item.

Stock-in-trade can also assume character of 'capital asset':

In some circumstances stock-in-trade can also assume character of 'capital asset'. For example, a car dealer may take few cars from his stock for purpose of his personal use or use in business  by employees or for running them on hire. In such cases cars earlier held as stock-in-trade, and now put to business or personal use assumes character of capital asset.

Similarly shares purchased as stock-in-trade can be considered as capital asset by treating them as investment in books of account.

Business assets are capital assets:

All business assets are also capital asset, unless they are considered as stock-in-trade in natural way in capacity of trader of such asset or by way of conversion of capital asset to stock-in-trade.

Capital asset vis a vis stock-in-trade:

The term stock-in-trade is not defined in the Income-tax Act. Therefore, this expression shall have to be understood in its general meaning as understood in trade or commerce in which a person is engaged. According to the same we have to ascertain the nature of trade, industry or business in which any person is engaged and the items required in such business  for the purpose of business of supplying goods whether manufactured by him or not.   

In the exception clause (i) in section 2 (14) as reproduced above we find that the expression stock-in-trade is used, therefore the stock must have linking with the trade and other items excluded in the same context are   consumable stores or raw materials held for the purposes of  business or profession.

Therefore we can say and analyze  that  the following items are excluded from the meaning of capital assets in the context  of this article:

Description	Examples and remarks
Stock-in-trade	These items are held as a trader in item for example a sugar dealer or a book dealer,  held sugar, or books  respectively  as stock-in-trade. The people knows that he deals in sugar or books and approaches him to purchase sugar or books as the case may be.
Consumables stores  required for business or profession,	In a factory lubricants, cleaning material, oils and fuels are used as consumables. In an office stationary items are used as consumables. A doctor uses items like syringes, testing material etc. as consumables in his profession. Coal will be raw material in a power generating organization whereas coal will be consumable in case of other manufacturer.
Raw material required for business or profession	Raw material required to manufacture goods or rendering services  falls in this category. For example steel sheets in a machinery manufacturing facility, or coal in power generating organization or raw films in a doctors chamber who also take X-ray.

Common features:

The items like stock-in-trade, consumables and raw material have a common feature- they are related with a  trade or industry which supply certain products or items  which may be  manufactured by him or not. Or these items may be held to render certain services.   Thus, the holding of such items is for specific purpose of  supplying some things or rendering some services as business or profession. In view of the expressions used in the exclusion clause, it is necessary that the items to be excluded from the definition of capital asset should have connection with the business in nature or trade, or industry or the profession carried by the assessee. If there is no connection with the trade or industry or commerce in which assessee is engaged, then similar items held by assessee cannot be considered as stock-in-trade.

The  assessee has option to treat an item as stock-in-trade or not:

It can be said that except the items like raw material, consumables, and items used for supplying to others (that is trading items) other items of assets are generally capital asset. It is at option of the assessee to treat them as stock-in-trade or as capital asset. We find the  provision in section 45 (2) which indicates existence of such an option to the assessee. The said provision reads as follows:

                "(2) Notwithstanding anything contained in sub-section (1), the profits or gains arising from the transfer by way of conversion by the owner of a capital asset into, or its treatment by him as stock-in-trade of a business carried on by him shall be chargeable to income-tax as his income of the previous year in which such stock-in-trade is sold or otherwise transferred by him and, for the purposes of section 48, the fair market value of the asset on the date of such conversion or treatment shall be deemed to be the full value of the consideration received or accruing as a result of the transfer of the capital asset."

Thus, it can be said that  except in case of items which are normally held as  stock-in-trade, consumables, or raw material in the business or profession  of the  assessee ,all other assets are  to be regarded as property of nay kind and capital assets of the assessee.

 However, the assessee has option to treat any property as stock-in-trade  from the time of acquisition or to  convert  a   'capital assets' in to    stock-in-trade by proper book entries. Unless such items are considered in books of account originally or on conversion or treatment as stock-in-trade, all such items of properties shall be 'capital asset' as known in commercial world.

It can also be said that the option is only with the assessee  to treat any capital asset or any property as stock-in-trade and the  Assessing Officer has no option to treat an item as stock-in-trade which is held and  disclosed as capital asset by the assessee.  The A.O. also cannot force the assessee to treat or convert a capital asset as stock-in-trade.

Capacity of trader vis a vis stock-in-trade:

A person is known as trader of item or items in which he usually  deals or act as a supplier/ distributor/ dealer/ whole seller/ retailer   etc. The items held by such businessman in the course of such business shall be considered as his stock-in-trade. The trader cannot, usually  treat such items as his capital assets. However, in exceptional circumstances like closure of business or particular asset assuming character of 'capital asset', such items may be converted to investment. For example,  a car dealer may use some cars out of his stock-in-trade for business use or personal use or in business of running such cars on hire. In such events the car shall assume character of 'capital asset' and may also become a part of block of asset for depreciation claim.

   A professional person, a salaried person, a trader in other goods say motor cars or petroleum products or cloth merchant  or , a retired person who was employed earlier or engaged in some other business earlier, cannot be called as a share trader, merely because his investment portfolio is large and due to large portfolio, naturally frequency of transactions and volume  is increased. - newly added, after sending the article.

Non-trade items are generally capital asset:

In view of above discussions it can be said that  an items held a as a trader of particular item is  his stock-in-trade and  non-trade items are generally capital assets in case of any person who does not trade in such items or who does not require them as raw material or consumables. Investment in any article or thing is therefore holding of such things as capital assets and cannot be assumed as stock-in-trade. Thus gold, silver, jewellery,  land and buildings, shares , securities, units,  bonds other saving instruments etc. are to be considered as 'capital assets', unless they have been converted or treated as stock-in-trade by the assessee. The A.O. has no right to treat a capital asset into stock-in-trade.

Gain on sale of a non trade item is capital gain:

Therefore, it can be said that any gain on sale of an item of asset that is not 'stock-in-trade' of the assessee will result into income or loss under the head' capital gains' and it cannot be considered as business income.

Not a share trader- gain will be capital gains:

A company or an individual who does not have a share shop or who is not known as a share trader holds shares as his investment. Volume or frequency will make no difference s far head of income is concerned. In case share is held as investment , the gains will be under the head 'capital gains'.

A person who has purchased shares on stock-exchange and sells shares on stock exchange cannot be called as share trader.

Changes in pursuance of STT:

In view of levy of STT and corresponding changes in tax rates and rules, the assesses had an option to change their policies so as to suit them best and that minimizes tax burden. With exemption of LTCG and lower rate of tax in case of STCG, it is quite natural that it may be more advantageous to hold shares as capital asset. Therefore, even if stock-in-trade is converted into 'capital asset', it should not be viewed as tax avoidance. Because on change in law, one has to change his methods.

A FII who has no permanent establishment,  or  an assessee who had brought forward business losses,  

may find it more advantageous to hold shares as stock-in-trade so that business income is not taxable or it is reduced on set off of losses.

Volume and frequency should not be a criterion:

Volume will depend on various factors like:

a.     Capital invested,

b.     Price fluctuations- its range and frequency.

A person who has invested say Rs. one crore, wil naturally and  definitely  will have higher volume and higher frequency of activity of buying and selling shares. With larger amount invested, one will need an organization to carry out various related activities.

Scrip  in which range of fluctuation is low, will have lower frequency of deals then those having high range of fluctuations. Therefore, even when there is high volume and frequency, the transfer of capital asset will result into capital gain.

High volume and high frequency is not without payment of tax:

High the volume and frequency of buying and selling, there will be higher amount of STT paid. Therefore, these should not be criterion to consider the capital gain as business income.

Two view- then view favorable to assessee should be adopted:

Where two views are possible, the view that reduces tax burden of assessee should be adopted.

Conclusion:

If shares are held as investment and they are sold, the gain will be capital gain irrespective of volume and frequency of activity of buying and selling of shares.If the assessee has treated shares or converted them  into stock-in-trade, then only they can be considered as stock-in-trade, and income can be computed under the head 'business'.