Income from shares: Capital Gain or Profits and Gains of Business or Profession?

Overview: Statutory Classification Framework

Rise in Share Trading

India has witnessed a very high rise in demat accounts from April 2020. People have started showing more interest in share market these days. While people have started earning from share market, they are unaware of showing such income in the returns filled by them. They are also unclear about under which head of income shares income should go.

Conventionally, people in India have been scared to invest in the securities market. There has been a common fear among people. We have always heard from our elders not to invest in stock market as it was thought to be a gamble. But recent trends show that there has been a change in the mentality of people. According to data from Securities and Exchange Board of India (SEBI), the number of demat accounts opened during April 2020 and January 2021, were around 10.7 million. This has been a record-breaking rise.

During the lockdown imposed due to the COVID-19 pandemic, many people saw an opportunity to acquire new skills. The stock market was open during lockdown and the option of online trading made it easy to enter the stock market. As a result, many people started trading in shares. Many youngsters became interested in trading in the stock market. But they do not have enough knowledge to show this in their income tax returns. Many people do not show profit or loss from these transactions in their returns due to lack of awareness.

Also, there have been doubts in classification of such transaction under different heads of income. The most common dispute in this regard is to classify as capital gain or business income. Also, there are doubts in classification as speculative and non-speculative business.

This article attempts to resolve some of these doubts.

Types of transactions in shares

There are different types of transactions that can be done in the stock market. These are,

1. Delivery based: Buying securities in cash and holding them for long-term. This can be called investing.
2. Delivery based: Buying securities in cash and selling them after price rise in short-term.
3. Intraday trading: Generally, these transactions are not settled by actual delivery. They are settled by price difference.
4. Trading in derivatives: They are commonly called future and options. They may or may not involve actual delivery.

Let us discuss about these types in detail.

1. Long-term delivery based

When you purchase a share, you acquire a right in the company. Share represents a part of the capital of a company. Therefore, shares are an asset for the investor. The value of shares depend on the performance of the company. A share listed on the stock exchange is classified as a long-term capital asset if it is held for a period of more than 12 months. For unlisted shares, the period of holding is 24 months. It is considered as investing in a company. Therefore, it is considered as capital gains.

Long-term capital gain on sell of shares is taxable @10% if capital gain is more than Rs. 1,00,000. Benefit of concessional rate of 10% is allowed only if STT has been paid at time of purchase and transfer of shares. Long-term capital gains on sale of listed equity share up to Rs. 1,00,000 are exempt. If assessee is a share trader and wants to treat it as business income, then it would be treated as business income.

2. Short-term delivery based

A listed share is classified as short-term capital asset if it is held for a period of less than 12 months. Short-term capital gains are taxable @15%. If transactions are few, they can be classified as short-term capital gain. If transactions occur frequently, then it must be reported as business income. Also, intention of assessee should be considered. If assessee has held asset for investment, then it should be classified as capital gain. On the other hand, if assessee has intention to do trading in shares, it should be treated as business income. It has been a debatable issue for a long time. Many times, this issue has also reached the doors of courts.

Hon’ble A.P. High Court in case of PVS Raju, has held that the question whether the shares were held as an investment to give rise to capital gain on its sale or as a trading asset to give rise to business income is not a pure question of law but essentially one of fact. In case of Vaibhav J Shah (HUF), Tax Appeals 77 of 2010, Hon’ble Gujrat High Court held that where number of transactions of sale and purchase of shares takes place, the most important test is volume, frequency, continuity and regularity of transactions.

CBDT vide circular no. 4/2007 dated 15-06-2007, laid down the tests for distinction between shares held as stock-in-trade and as investments. This circular also accepts that it is possible for an assessee to have both investment and trading portfolio. Therefore, we have to see whether transactions amount to business or not will depend on the facts and circumstances of each case. It is a matter of judgement as there are no specific rules to classify as short-term capital gain and business income.

3. Intraday trading

Intraday trading means purchasing and selling shares on same trading day. It is also known as day trading. Transactions are squared off at the end of the day even if the desired price is not achieved. Delivery of shares does not take place in intraday trading. Intraday trading is considered as speculative business income. It is so because investing for one day cannot be investment in company. It is only for enjoying the benefits of price fluctuations. Assessee has the option to go for presumptive taxation scheme u/s 44AD if turnover is less than 2 crores. If assessee opts for presumptive taxation, income @6% must be declared mandatorily. Loss cannot be claimed u/s 44AD.

Provisions of audit are applicable in accordance with section 44AB. As it is a business income, all the provisions related to PGBP (Profits and Gains from Business or Profession) are applicable to intraday trading. Turnover of trading is absolute turnover. It is the sum of profits and loss from intraday trading in absolute terms. For example, if a trader has profit of Rs. 2,00,000 and loss of Rs. 50,000 from trading, then his turnover would be 2,50,000 (2,00,000+50,000).

One should note that a single transaction does not amount to business. We must separate speculative business and not speculative transactions. In case there are very few intraday transactions of intraday say 10-15, then they may not amount to speculative business. To decide whether it is in the nature of business or not would require professional judgement. It would differ from case to case depending on facts and circumstances of a particular case.

4. Trading in derivatives

Derivative means a financial asset which derives its value from underlying asset or group of assets acting as benchmark. In the stock market, derivatives derive its value generally from shares, commodities, currencies, market index etc. It is commonly known as futures and options (F&O). Now-a-days, trading in F&O can be easily done through stock market. We can also trade using our laptops or mobiles through our demat account. Due to ease in trading, trading in derivatives has increased in India. Many people who trade in derivatives do not know its taxation aspects.

Trading in derivatives is considered a business activity. As per provisions of section 43(5) (d) and (e), income from derivatives is not considered as a speculative business in following cases:

• Trading in derivatives of shares and market index if done through recognised stock exchange.
• Trading in commodity derivatives if done through recognised stock exchange on which CTT has been paid.

Unlike shares, intraday trading in derivatives is not considered as speculative business. Assessee has the option to go for presumptive taxation scheme u/s 44AD if turnover is less than 2 crores. If assessee opts for presumptive taxation, income @6% must be declared mandatorily. Loss cannot be claimed u/s 44AD.

Turnover from trading in derivatives is calculated by adding the following:

• Absolute profits or price difference
• Absolute losses or price difference
• Premium from option writing
• In case of reverse trades, difference thereon

IPO/FPO

IPO means Initial Public Offer. FPO means Further Public Offer. IPO means first time issue of shares by the company. FPO is offer of more shares by a company already listed on the stock exchange. IPO and FPO transactions are like normal transactions of shares and period of holding is calculated by methods as discussed in delivery-based transactions.

The main issue that some people face is what will be the purchase date of IPO/FPO. As in case of an IPO/FPO, payment date, date of allotment and date of listing are different. At the time of payment, there is no certainty that shares would be allotted or not, therefore payment date cannot be considered as purchase date. Date of purchase would be the date on which shares are allotted to the shareholder as that is the date when purchase transaction would be completed.

Dividend

Dividend is the share of profit distributed by the company to the shareholders. Earlier dividend was tax free in the hands of shareholders. Companies had to pay Dividend Distribution Tax for distribution of dividends. From April 1, 2020, dividend is taxable in the hands of taxpayers. Dividend Distribution Tax has been abolished. Dividend is now taxable in hands of shareholders at normal rate of tax. Companies need to deduct TDS @10% on dividends. TDS is not required to be deducted in case total income from dividend of a taxpayer is not more than Rs. 5,000 during a financial year.

Also, Section 115BBDA which provides for taxation of dividend above 10 lakhs @10% has been abolished in Finance Act, 2020. Dividend is now taxable in the hands of shareholders at the normal rate of tax.

Conclusion

Reporting of income from shares is very important. People need to be aware of the need to disclose income in their returns. Also, choosing the right head of income is very crucial. We need to examine the facts of the case carefully before determining the head of income. One of the things that people forget is tax is now payable on dividend income.