Shares- latest circulars intended to reduce litigation - some suggestions to really reduce litigation on share transactions and other tax litigation in tax matters

[CA DEV KUMAR KOTHARI]

Relevant references and links:

Circular - Income Tax - LETTER F.NO.225/12/2016/ITA.II   DATED 2-5-2016

 Circular no. 6/2016 dated 29th February, 2016,

Provisions  of section 2 of Income-tax Act, 1961 containing various meanings and explanations about capital asset, stock-in-trade,  long-term and short-term capital assets , long-term and short-term capital gains etc.

General discussion:

Disputes about treatment of gains as business income or income from other sources or income from capital gains have all along been area of long-drawn process. In same facts and circumstances, tax authorities have taken different views to deny relief or benefit allowable under law to particular assessee. The rule that where two views are possible, a view in favour of tax payer must be adopted are not followed. The view which benefit revenue are followed to deny benefit to tax payer. This has caused lot of litigations.

Even Circulars and instructions issued by CBDT have not been able to reduce litigation, rather more litigation have been created due to riders, exceptions, and discretions provided to tax authorities.

It is advisable to provide a minimum period of holding for treatment of any asset as capital asset and treatment as ‘short-term capital asset’. If holding period is less than such period, then the asset must not be regarded a capital asset and income or loss should be assessed under head business or other sources as may properly fit in any given case.  

It seems that Government of India, including present Government headed by Shri Narendra Modi is least interested to reduce litigation. Settled legal positions are being changed and unsettled by amendments. Now provisions provide more filed of litigation due to lack of clarity.

Unlisted companies and their shares:

Unlisted companies (private or public) are generally closely held companies and unlisted shares of such companies are held mostly by promoters and their associates.

Majority of unlisted companies are private limited companies. Earlier, under the companies Act, limit on number of shareholders was 50  + any employee or ex-employee shareholder, who continues to be shareholder. Under the Companies act 2013 this limit has been raised to 200 + any employee or ex-employee shareholder who continues to be shareholder. In case of private limited companies, there are restrictions on transfer of shares and invitation of public for subscription on shares.

In case of closely held public limited companies there are no such restrictions. However, still they have shareholders who are a group of people associated with a view to carry business in corporate style.

After maximum number of shareholders have been raised to 200 + employee and ex-employee shareholder, for private companies, there will be lesser need to have limited companies.

Companies as Special Purpose Vehicle (SPV)

Such closely held unlisted  companies are in nature of   ‘Special Purpose Vehicle’ ( SPV) through whom business is carried by promoters in corporate style. Some SPV’s are  initially formed for limited purpose and once that purpose is achieved, either company is wound up or it changes objects for furtherance of other business by the same set of promoters or by new promoters. In some cases a section of shareholders transfer shares to other section of shareholders and company continue.

Shares in such companies are acquired with a long-term perspective and not for short-term perspective and in any case not for the purpose of trading.  The holding of shares are in nature of instrument to control the company.

Transferability:

In case of private companies there is no free transferability of shares therefore there is no free market for such shares. For this reason also shares of private companies are generally on investment account and capital asset.

In case of unlisted public limited companies also shareholders are associated persons. The market for such shares is limited. Marketability of share of unlisted public companies are also restricted because generally people in control have understanding about transfer of shares and shares can be transferred within group of approved people including nominees.

Therefore, shares of such companies (private or public) being held with a long-term perspective and as instrumentality for controlling companies are generally ‘capital asset’.  

Exceptions:

The exceptions can be in respect of shares held by some persons who are not within associates in control of company and have acquired shares of unlisted companies in expectation of shares being listed by way of issue of further shares or by way of IPO by promoters of the same company or some other companies in the group.

Management:

Generally majority shareholders control and manage such companies directly. Only in case of such companies belonging to very large groups, the management is handed over to professional teams. The control still remains with shareholders. 

Listed shares held by people in control of companies:

Even in case of listed shares held by promoters and  directors who control such companies are acquired and held with a long-term perspective and are used as instrumental for control of such companies. Therefore, even listed shares held by people in control of company or acquired with a view to acquire significant holding are for long-term perspective and are therefore investments and ‘capital assets’ and not stock-in-trade.

Shares held above controlling limits:

However, shares acquired in excess of controlling stake by a person or a group of persons can be for short-term or even for trading purposes. For example, suppose a person or a family or a group of associated persons hold more than 50% shares to control the company say 51% or more than 75% to control even special resolution rights.  In such situations shares acquired after acquisition of controlling stake (more than 50% or 75% as may be intended) can be with a view of short-term perspective and objective or even with a view to trade and gain.

Minimum holding period for short-term asset should be provided:

In case of freely marketable assets, particularly listed shares, it is desirable that a minimum holding period (say one month)  be provide for treatment of listed shares and three  months for  any other  asset as a ‘capital asset’.  In fact different minimum period of holding for treatment as short-term capital asset can be provided, for example:

Listed shares - one month (this is 1/12^th of holding period for long-term – 12 months).

Unlisted shares- two months (this is 1/12^th of holding period for long-term- 24 months).

Any other capital asset- three months (this is 1/12^th of holding period for long-term- 36 months). 

A holding period of less than prescribed period must be considered as a holding of asset for trading purposes and gains should be treated as business profit or loss or income from other sources considering nature of assessee, volume etc.

Recent circular about shares:

Recently two circulars have been issued by CBDT about treatment of income as business income or capital gains. The circulars have been issued for simplicity and avoid litigations. However, instructions are  with many riders. This provide scope of more discretion to the Assessing Officer and are therefore, likely to create more litigation. Some conditions stipulated are like that an option once exercised by assessee shall prevail in future also is totally unjustified and rob the freedom of assessee for indefinite period to revert to other option. For this reason such instructions can be held unreasonable restriction and unjust discrimination so invalid.

Recent circulars are reproduced below with highlights added by author for analysis and easy understanding:

Circular - Income Tax

LETTER F.NO.225/12/2016/ITA.II

DATED 2-5-2016

Regarding characterisation of income from transactions in listed shares and securities, Central Board of Direct Taxes ('CBDT') had issued a clarificatory Circular no. 6/2016 dated 29th February, 2016, wherein with a view to reduce litigation and maintain consistency in approach in assessments, it was instructed that income arising from transfer of listed shares and securities, which are held for more than twelve months would be taxed under the head 'Capital Gain' unless the taxpayer itself treats these as its stock- in-trade and transfer thereof as its business income. It was further stated that in other situations, the issue was to be decided on the basis of existing Circulars issued by the CBDT on this subject.

2. Similarly, for determining the tax-treatment of income arising from transfer of unlisted shares for which no formal market exists for trading, a need has been felt to have a consistent view in assessments pertaining to such income. It has, accordingly, been decided that the income arising from transfer of unlisted shares would be considered under the head 'Capital Gain', irrespective of period of holding, with a view to avoid disputes/litigation and to maintain uniform approach.

3. It is, however, clarified that the above would not be necessarily applied in the situations where:

i.    the genuineness of transactions in unlisted shares itself is questionable; or

ii.   the transfer of unlisted shares is related to an issue pertaining to lifting of corporate veil; or

iii.  the transfer of unlisted shares is made along with the control and management of underlying business and the Assessing Officer would take appropriate view in such situations.

4. The above may be brought to the notice of all for necessary compliance.

Circular - Income Tax

Circular No.6/2016

Government of India

Ministry of Finance

Department of Revenue

Central Board of Direct Taxes

North Block, New Delhi, the 29^th of February, 2016

Sub: Issue of taxability of surplus on sale of shares and securities - Capital Gains or Business Income - Instructions in order to reduce litigation – reg.

Sub-section (14) of Section 2 of the Income-tax Act, 1961 ('Act') defines the term "capital asset" to include property of any kind held by an assessee, whether or not connected with his business or profession, but does not include any stock-in-trade or personal assets subject to certain exceptions. As regards shares and other securities, the same can be held either as capital assets or stock-in-trade/ trading assets or both. Determination of the character of a particular investment in shares or other securities, whether the same is in the nature of a capital asset or stock-in-trade, is essentially a fact-specific determination and has led to a lot of uncertainty and litigation in the past.

2. Over the years, the courts have laid down different parameters to distinguish the shares held as investments from the shares held as stock-in-trade. The Central Board of Direct Taxes ('CBDT) has also, through Instruction No. 1827, dated August 31, 1989 and Circular No.4 of 2007 dated June 15, 2007, summarized the said principles for guidance of the field formations .

3. Disputes, however, continue to exist on the application of these principles to the facts of an individual case since the taxpayers find it difficult to prove the intention in acquiring such shares/securities. In this background, while recognizing that no universal principal in absolute terms can be laid down to decide the character of income from sale of shares and securities (i.e. Whether the same is in the nature of capital gain or business income), CBDT realizing that major part of shares/securities transactions takes place in respect of the listed ones and with a view to reduce litigation and uncertainty in the matter, in partial modification to the aforesaid Circulars, further instructs that the Assessing Officers in holding whether the surplus generated from sale of listed shares or other securities would be treated as Capital Gain or Business Income, shall take into account the following-

a) Where the assessee itself, irrespective of the period of holding the listed shares and securities, opts to treat them as stock-in-trade, the income arising from transfer of such shares/securities would be treated as its business income,

b) In respect of listed shares and securities held for a period of more than 12 months immediately preceding the date of its transfer, if the assessee desires to treat the income arising from the transfer thereof as Capital Gain, the same shall not be put to dispute by the Assessing Officer. However, this stand, once taken by the assessee in a particular Assessment Year, shall remain applicable in subsequent Assessment Years also and the taxpayers shall not be allowed to adopt a different/contrary stand in this regard in subsequent years;

c) In all other cases, the nature of transaction (i.e. whether the same is in the nature of capital gain or business income) shall continue to be decided keeping in view the aforesaid Circulars issued by the CBDT.

4. It is, however, clarified that the above shall not apply in respect of such transactions in shares/securities where the genuineness of the transaction itself is questionable, such as bogus claims of Long Term Capital Gain / Short Term Capital Loss or any other sham transactions.

5. It is reiterated that the above principles have been formulated with the sale objective of reducing litigation and maintaining consistency in approach on the issue of treatment of income derived from transfer of shares and securities. All the relevant provisions of the Act shall continue to apply on the transactions involving transfer of shares and securities

[F. No. 225/12/2016-ITA-II]

(Rohit Garg)

Deputy Secretary Government of India

From the circulars we notice that:

Any minimum period of holding has not been provides. In fact such prescription of minimum holding period must preferably be by amendment of the provisions of Income-tax Act.

There are many riders to instructions whereby the AO get discretion to go against treatment adopted by the assessee.

In fact’, in disputed cases what has happened in past are illustrated below:

a. Where assessee claimed business income or loss, AO treated it as capital gains.

b. Where assessee claimed capital gains AO treated it as business income.

c. In scrutiny cases, generally intentions of the AO has always been to try denial of a claims made by the assessee, just to deny benefits available under law to assessee. For example, if an assessee has claimed profit on transfer ofshares as business income so as to set off past losses, the AO has treated the profit as capital gains.

d.  We find that even at level of legislation, amendment has been made to treat securities held by a foreign institutional investor (FII),as capital asset, and also to exclude such securities from definition of stock in trade. This is simply with a view to treat such gains as taxable because in absence of Permanent Establishment, FII’s could not be taxed when income was claimed to be business income.

We have noticed that generally the Government of India (GOI)  has adopted policy to make amendments in tax laws just to deny benefits allowed under law, if such benefit involved litigation and courts held in favour of tax payers. The amendments are introduced with a view to express legislative intention. This really is a loose expression used to make amendment. When a provision has remained in statutory books for years and have been interpreted then how suddenly GOI wakeup, and express legislative intention. Particularly in case of very old provisions such expression of legislative intention by amendment is not at all justified and must come to an end.

How to avoid litigation:

Litigation can be reduced:

a. by prescribing provisions clearly with lesser discretion to tax authorities.

b. By carefully reconsidering provisions and if necessary amendment must be made on real time basis and not at any time indefinitely. Any amendment should not be retrospective.

c. Change in policy that merely taking a tax benefit by assessee should not be viewed suspiciously and as tax avoidance.

d. The provisions intended for benefit of taxpayers must be interpreted liberally.

e. Accountability of tax authorities to consider law, facts and explanation of taxpayer reasonably and honestly and not just to deny benefit to tax payers. The present attitude of tax authorities is find ways and means to disallow benefit, wherever there is some scope to deny the benefit, even though unreasonably.

f. There should be no litigation by tax authorities where over a period of 3-5 years there is no revenue impact. Therefore, there should not be litigation when matters like rate of depreciation, valuation of stock-in-trade, provisions for allowable bad debts, amortization of expenses are involved.

g. Provisions which have effect of disallowing certain sums in one year and allowing in next year or any subsequent year should be deleted. Particularly when such payments are also governed and checked by other provision of the Income-tax Act or other law. For example

i. Provisions of TDS/ TCS must be applied and enforced for recovery of TDS/ TCS by ITO (TDS) instead of by theITO (AO) . In this regard, a report by ITO (AO) can be sent to the ITO (TDS) about non compliance of TDS/ TCS provisions instead of disallowing expenses in one year and allowing in subsequent years.

ii. Section 43B must be deleted.A sum disallowed in one year is allowed in subsequent years. A track has to be maintained about sums paid and allowed in one year- advance actually paid, will not be allowable if it is debited in subsequent year. a sum not paid and disallowed in one year and will be allowable in year of payment. Instead of keeping Section 43B which creates lot of litigation, concerned authorities must be careful in enforcing relevant laws like PF, Labor laws, other authorities collecting any tax, duty, cess , fees etc. and also concerned parties like banks and financial institution,employees and their unions,Railways in enforcing timely payment. A disallowance u/s 43B of any such provision of the Income-tax act is not a solution to keep check on practice of delayed payments.

h. Provisions of following binding precedence/ precedence in favour of tax payer and provision to make rectification todevelopment / or revision in law on pronouncement of subsequent judgments must be introduced. For example, decision of CIT(A) in favour of assessee must be followed. In case, on appeal be revenue, the decision of CIT(A) goes against assessee then the relief allowed must be disallowed by rectification.

i. Last but not least – the attitude of tax authorities must be to express reasonable regard and respect for tax payers and not to treat and presume them as tax avoider. The prejudice and bias in mind of tax authorities that tax payer has avoided tax is wrong. It must be changed.