Budget 2016 – suggestion about trading profit or short term capital gains. -a minimum holding period to treat any assets as a ‘short-term capital asset’, if held for shorter duration- income should be treated as income from business income or income from other sources depending on nature of activities of assessee

[CA DEV KUMAR KOTHARI]

Summary:

There is no minimum holding period prescribed for a capital asset to be treated as short term capital asset. Though there is prescription of such period for treatment as long term capital asset. This leads to litigation on issue of short-term capital gain/ loss or business gain or loss.

Different  rate of tax , different tax implications permissibility of set off of losses during the previous year, carry forward and set off in future etc.  in relation to dealings in shares and securities and other  assets  have always led to litigation. It is desirable that the law should be clear and specific on such vital issues.  A minimum period of holding can be prescribed for different asset to be regarded as short term capital assets to avoid controversies and litigation.

Meaning of ‘capital asset’ may be amended to exclude any asset   which has not been held for at least prescribed number of days. Different number of days may be prescribed for different type of assets for example:

    Shares and securities – 30 days.

    Gold, silver, precious stones or units representing such assets - 60 days.

    Landed properties - 180 days.

In section 28 a new clause may be inserted to provide that profit on sale of any assets which is not a capital asset due to lower holding period, shall be deemed as business income irrespective of fact whether the asset is treated as stock-in-trade or not in the books of account, if any, maintained by the assessee.

Justice Easwar Committee has made some suggestions, however,  with great regard to the recommendations of the Committee, author feel that implementation of those suggestions will lead to more complications and litigation. Rather a simple criterion for minimum holding period for treatment as capital asset will go a long way in simplification as well as rationalization.

Liquid capital assets having vide price fluctuations in short to long term:

This article is basically written in connection with treatment of certain liquid  assets as trading assets or capital asset (investment account). Some suggestions have also been placed to make the legal provisions clear and unambiguous. Various circulars and many judgments   say about various criteria, and nothing is said in conclusive terms- this has resulted in use of discretion of assessee and the AO in different manner hence litigation.

This lead to state of great confusion , uncertainty and dilemma for assessee. The compliance is also not possible in view of large number of assessments being made as per return.

Different circumstances:

The revenue wants to increase revenue collection and tax payer wants to reduce tax liability. Therefore, in same and similar circumstances the revenue and taxpayer will try to choose best possible tax treatment in relation to activity of buying and selling securities – shares, units, debentures, bonds, and similar new instruments.

Reasons for difference of approach:

A tax payer may contend to treat activity as business activity and resultant income as business income to gain tax advantage in the following illustrative situations:

1. Before amendment about this aspect, an FII not having a Permanent Establishment (PE) in India may like to treat income from buying, holding and selling assets as business activity to gain tax advantage of lower tax in his home country. For example see Fidelity Northstar Fund , In re  2007 (1) TMI 545 - AUTHORITY FOR ADVANCE RULINGS and several cases referred to therein and judgments rendered later on.

Note: definition of capital asset ( S. 2 (14) has been amended with effect from 01.0415 so as to deem that any securities held by a Foreign Institutional Investor (FII)  will be considered ‘capital assets’ even if the FII is trader or has held securities as stock-in-trade.

2. An individual who want to take advantage of benefit on investment covered under section 80C as well as tax rebate u/s 88E for security transaction tax (STT) paid on security transactions and not to pay any income tax may prefer to treat activity as business activity instead of investment activity. The AO want to treat it as investment.
3. An assessee who wants to set off past business losses and also to take advantage of tax rebate for STT paid on security transactions may prefer to treat the profit as business profit instead of short term capital gains.
4. An assessee who also want to take advantage of loss arising due to lower valuation of assets at year end may prefer to treat the activity as business activity so as to reduce taxable income due to fall in valuation of assets which can be considered as stock-in-trade with option to value at a price lower than cost.
5. To get benefit of loss suffered in buying and selling securities and other capital assets and set off the same against other incomes.

  In the following illustrative situations assessee may prefer to treat the activity as investment activity:

1. When assessee has other income to avail full benefits available for tax rebate, past losses etc. and has to pay tax which will be lower if income is considered as short term capital gains instead of business income.
2. The non-existence of situations discussed in earlier para will lead to advantage in case income is considered as short-term capital gain instead of business income.
3. When the assessee do not want to get his accounts audited under section 44AB of the income tax act for any reason ( say lapse of period for filing return) and to obtain and  furnish Tax audit report.

In above situations the revenue’s stand will be opposite:

In above situations the stand of the revenue will be opposite with a view to collect higher tax by way of higher rate, denial of set off or c/f etc.  . As a result if assessee want to claim activity as business the revenue may try to bring it under capital gain and vice versa.

Shares held as a tool of trade or intangible assets must be differently treated:

Shares held as a tool of trade (business or profession or vocation)   or as intangible assets must be differently treated. For such investors securities can be considered as block of asset, in which any addition be added and sale proceed be deducted and capital gains can be considered on line of depreciable block of assets.

For other securities in the context of determining character of share as a trading share or a share held as investment the following type of shares are found:

Shares of unlisted companies:

These shares are held by people in management and their associates and are not traded on stock exchange.  Therefore, in most of the cases such shares are held as investment.  In case of private limited companies there is restriction on transfer of shares and therefore, those shares must generally be regarded as investment.  In case of public limited companies whose shares are not listed the general treatment should be of investment and not as stock-in-trade.

However, some people like share trader, share broker, underwriters etc. in some circumstances or due to likely event of change in management or forthcoming  public issue etc. may acquire shares with a view to trade in the same within a short duration and the holder may choose to treat such shares though unquoted as stock-in-trade.

Shares listed on stock exchange – Shares listed on stock exchange are considered to be liquid and easily transferable.  However, that also may not be true in practice always. We find that even in case of listed shares the following categories can be found.

a) Regularly traded shares– In this category also we find some share which have enough fluctuation in price and there is lot of volume of trading and there are other types of shares which have very low volume of shares.  Some examples of shares based on volume in trading can be found in any days news papers. On website of Stock Exchanges we can find proportion of shares  trades, which are delivered and those settled with out delivery.

b) Casually or rarely traded shares: We find some shares which are traded  very casually and the volume is also low, a person who purchases such shares generally will have to hold the shares as investment at least for short duration.

c) Shares listed on regional stock exchanges only – We find some shares, which are listed on regional stock exchanges only and have very low liquidity.

Liquidity a factor to be considered:

Liquidity of shares is also an important factor to determine the character as stock or investment.  Share which are not frequently traded or which have very low volume at stock exchange can best be considered as investment.

Even in very highly liquid shares on stock exchanges, some type of holders like promoters and directors may hold shares for control of the company, and therefore those shares will always be capital assets and cannot be regarded as stock-in-trade.

Highly liquid shares:

shares which have high liquidity, causes a difficulty to determine  character of stock or investment. This is so because within a short duration an investor may find desired appreciation and wish to realize his appreciation in investment. Similarly if for some reasons price has fallen considerably, the investor may transfer the investment so as to realize remainder of his capital and reduce further capital erosion.

Dividend yield:

 Investments by way of debentures and bonds or deposits yield safe, secured but low returns. Therefore, in case of investment in shares appreciation of even 5-7 % in a short duration can be considered as a good return on investment and not necessarily result of trading in share. It can be said that practically most of share trader or investor purchases shares for gain by way of appreciation and not necessarily for dividend. This can be justified because overall yield by way of dividend is hardly around 1%.

Short term capital asset:

Any minimum period of holding is not prescribed for treatment of asset as a capital asset. Therefore, holding of any period qualify an asset to be regarded as a short-term capital asset. In fact recently Tribunal has decided a case in which it is considered that property was purchased and sold on the same day when promoter directly gave possession to the ultimate buyer in view of agreement for transfer of booking of property during construction stage. See Mrs. Mangala Dilip Sable V JCIT 2006 (3) TMI 290 - ITAT PUNE-B.

In relation to shares and other listed securities units of mutual funds etc. a holding  period of twelve months makes them long term capital asset as against thirty six months for other assets. Thus, in law itself it has been considered that shares are a means of investment for short duration in comparison to other assets. Considering the holding period for long term asset it can be considered that under law any period of holding is enough to treat the capital asset as a short term capital asset. Shares may be held in physical form with blank transfer deeds, or duly registered in physical form or in own depository account or in account of depository of the share broker or the financier. If shares are purchased and held for any moment, they can be considered as short term capital assets, if they are not treated as stock-in-trade by the owner.

Economic situations may change very fast:

In current times situation may change very fast. For a recent example we can take case of shares of sugar companies. They appreciated in price very fast and on average by four times within a period of about fifteen months and then within a period of about four five month declined and prices of many sugar companies shares has come down to about one fourth of  peak price achieved during last fifteen months. This is due to fall in price of sugar and Crude oil resulting into lower price of ethanol – to be produced by sugar mills in large scale in near future.

Investment - an adventure in nature to commerce:

The term ‘business’ included not only trading activity but also any adventure in nature of trade, commerce or industry. Investment activity is not a trading activity but is definitely an adventure in nature of commerce. Therefore, investment activity is also a business within the inclusive definition of ‘business’ given in section 2 (13) of the income-tax Act, 1961.

 In the present days due to several investment opportunities available and fast changes therein it can be said that investment activity itself is in nature of adventure in nature of  commerce. In case of shares in a single day one can get appreciation or loose significantly because the price fluctuation may be very high on a particular day.

It is difficult to ascertain the intention when a share is bought and sold within a short duration because suppose within two to three days we can get appreciation of 5 to 10 % we may be tempted to transfer the share and realize appreciation though at the time of purchase there may have been intention to hold the shares for longer duration. Similarly if price starts falling one may sell to reduce further losses without waiting for a trend reversal.

Various tests are not universally applicable or full proof:

The Courts have held several tests to examine whether a person is share-trader or an investor. Tests as laid down in the circular issued by the Board being instruction No.1827 dated 31.08.1989  now stands out-dated because of change in circumstances.  Because of open economy, influence of share market world over and also global commodity markets world over, the circumstances have totally changed.  Share market is based on news relating to companies as well as commodities – raw materials used by companies and finished goods produced.  Furthermore, online speculation activity in commodities have also increased.  All these factors have changed the situation very significantly.  Therefore, application of a list of tests will be very much cumbersome, confusing and arbitrary situation and it will involve lot of litigation.  The persons whose returns are accepted and the persons whose returns are selected for scrutiny will be put altogether on different basis of criteria and it will deny justice.

For example merely because one borrow money and invests in shares and securities cannot be regarded as trader. He may have perception that he will get return by way of appreciation in share price within two years which will be more than interest payable for two years. Whether interest will be allowed or not that is a different question, but merely use of borrowed funds cannot be conclusive to determine nature of activity.

In fact the circular itself , interalia, states as follows:

       “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.”

Thus, mere issuance of a list of several factors would not make things clear.

Summary assessment procedures will not be effective:

Most of the return of income are now accepted by the revenue. Therefore, the returns which are accepted by the revenue will not be examined as per guidelines. Whereas in similar circumstances, other return which is examined under scrutiny procedure will be applied different tests by the A.O.

It is likely that the A.O. will apply double standards – in some cases where benefit of set off of business loss is claimed the A.O. will try to bring transactions under short-term capital loss category, and cases where lower tax liability is claimed the A.O. will try to bring the same in business category to demand higher tax. However nothing would be perfectly correct because the application of several tests as laid down by the board would be subject to personal preferences and prejudices.   

  In case there is so much requirement to examine controversy about treatment as stock or investment, a large portion of returns may require compulsory scrutiny. In many cases the A.O. may form an opinion about escapement of tax and issue notice for reassessment.  Because wherever, there is some transactions in assets the A.O. may like to examine them in a manner opposite to one taken by the assessee.

Suggestion – In view of the above discussion the following suggestions are put forth for consideration of the Hon’ble Finance Minister.

1. Shares of private limited companies, unquoted companies, co-operative societies etc. must always be regarded as investment and not as stock-in-trade.
2. A period of 15- 30 days holding in case of shares and securities may be prescribed as minimum  holding period for its treatment as capital asset.
3. Sale of any capital assets with less than prescribed period  may be regarded as a trading activity and income or loss arising from such sale may be regarded as income from business or profession.

Definition of capital asset  –

 Even case of assets other than shares we find that units of mutual funds, bonds and debentures, paintings, gold and silver coins etc. may be transferred after a short duration of holding. Sometimes, even landed properties may be sold within a short duration.  For most of assets, the period of holding is 36 months to make them long term capital asset.  However, there is no period prescribed for treating the same as a short term capital asset and in those cases also the same problem of determining the character as trading stock or as investment arises and different views are possible. Lot of litigation have already taken place on such matters and things are not yet clear. To overcome this situation it is requested that any asset held for less than prescribed period may not be considered a capital asset.

To summarize:

Meaning of ‘capital asset’ may be amended to exclude any asset   which has not been held for at least prescribed number of days. Different number of days may prescribed for different type of assets for example:

    Shares and securities – 30 days.

    Gold, silver, precious stones or units representing such assets - 60 days.

    Landed properties - 180 days.

In section 28 a new clause may be inserted to provide that profit on sale of any assets which is not a capital asset due to lower holding period, shall be deemed as business income irrespective of fact whether the asset is treated as stock-in-trade or not in the books of account, if any, maintained by the assessee.

Intra-day trading (may be in nature of hedging in relation to capital assets) can  be considered as business in all cases.

Any asset held for more than minimum prescribed holding period shall be treated as capital asset, even if it is treated as stock-in-trade in books of account by assessee.