The Mumbai Bench of the ITAT in a recent decision, Management Structure & Systems v. ITO, has elaborately discussed the law on when income from sale of shares is to be treated as business income and when it is to be treated as capital gains. The assessee was a private company engaged in “management consultancy, investment advisory and equity reserve research services”. It filed returns showing certain income from sale of shares as capital gains. The Assessing Officer on the other hand categorised the income as business income, as he concluded that the assessee’s activity in trading of shares was a business activity and the shares were not held as a capital asset but as stock-in-trade. It was not disputed that the assessee was not registered as a broker or sub-broker with any stock exchange – in the view of the AO, this was immaterial, while in the view of the assessee, this non-registration was urged to be conclusive of the fact that that the shares were not traded by the assessee as a business activity.
Allowing the assessee’s appeal, the Tribunal held that whether the activity of buying and selling of the shares is in the nature of trade or investment is a mixed question of law and fact; and importance has to be given to how the assessee’s books treat the shares. Following the decisions of the Supreme Court in Associated Industrial Development Co., 82 ITR 586, and H. Holck Larzsen, 160 ITR 67, as well as CBDT Circular No. 4/2007, the Tribunal approved a set of principles which could be applied in this regard. The same principles have also been reached by a co-ordinate Bench of the Tribunal in Gopal Purohit, 122 TTJ (Bom).
Accordingly, the position of law is that in determining whether the income arising from sale of shares is to be treated as business income or as capital gains, the following factors are relevant:
(1) What is the intention of the assessee at the time of purchase of the shares? The answer to this can be found out from the treatment given to the purchase in the assessee’s books of account.
(2) Has the assessee borrowed money to purchase the shares, and paid interest thereon? As per the Tribunal, money is generally borrowed to purchase goods for the purposes of trade and not for investing in an asset for retaining.
(3) What is the frequency of the purchases and disposals? As per the Tribunal, “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).”
(4) Is the purchase and sale made for realizing profit, or for retention and appreciation in its value? The former is indicative of the purchases being part of trade; and the latter is indicative of the purchases being an investment. Furthermore, it would be relevant to ask whether the intention behind the purchase was to enjoy dividend, or merely to earn profit on sale of shares. Importantly, a commercial motive is an essential ingredient of trade in this context.
(5) The Tribunal also considered that if the items in question were valued at cost, it would indicate that they were investments. Where they were valued at cost or market value or net realizable value, whichever is less, it will indicate that items were treated as stock-in-trade.(6) Finally, it would be relevant to consider how the assessee is authorized in its Memorandum / Articles.