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CIRCULAR NO. 4/2007
June 15, 2007
Distinction between shares held as stock-in-trade and
shares held as investment - tests for such a distinction
The Income Tax Act, 1961 makes a distinction between a capital asset
and a trading asset.
2. Capital asset is defined in Section 2(14) of the Act. Long-term
capital assets and gains are dealt with under Section 2(29A) and Section
2(29B). Short-term capital assets and gains are dealt with under Section
2(42A) and Section 2(42B).
3. Trading asset is dealt with under Section 28 of the Act.
4. The Central Board of Direct Taxes (CBDT) through Instruction No.1827
dated August 31, 1989 had brought to the notice of the assessing officers
that there is a distinction between shares held as investment (capital
asset) and shares held as stock-in-trade (trading asset). In the light of
a number of judicial decisions pronounced after the issue of the above
instructions, it is proposed to update the above instructions for the
information of assessees as well as for guidance of the assessing
officers.
5. In the case of Commissioner of Income Tax (Central), Calcutta Vs
Associated Industrial Development Company (P) Ltd (82 ITR 586), the
Supreme Court observed that:
Whether a particular holding of shares is by way of investment or
forms part of the stock-in-trade is a matter which is within the
knowledge of the assessee who holds the shares and it should, in normal
circumstances, be in a position to produce evidence from its records as
to whether it has maintained any distinction between those shares which
are its stock-in-trade and those which are held by way of investment.
6. In the case of Commissioner of Income Tax, Bombay Vs H. Holck Larsen
(160 ITR 67), the Supreme Court observed :
The High Court, in our opinion, made a mistake in observing whether
transactions of sale and purchase of shares were trading transactions or
whether these were in the nature of investment was a question of law.
This was a mixed question of law and fact.
7. The principles laid down by the Supreme Court in the above two cases
afford adequate guidance to the assessing officers.
8. The Authority for Advance Rulings (AAR) (288 ITR 641), referring to
the decisions of the Supreme Court in several cases, has culled out the
following principles :-
(i) Where a company purchases and sells shares, it must be shown that
they were held as stock-in-trade and that existence of the power to
purchase and sell shares in the memorandum of association is not
decisive of the nature of transaction;
(ii) the substantial nature of transactions, the manner of
maintaining books of accounts, the magnitude of purchases and sales and
the ratio between purchases and sales and the holding would furnish a
good guide to determine the nature of transactions;
(iii) ordinarily the purchase and sale of shares with the motive of
earning a profit, would result in the transaction being in the nature of
trade/adventure in the nature of trade; but where the object of the
investment in shares of a company is to derive income by way of dividend
etc. then the profits accruing by change in such investment (by sale of
shares) will yield capital gain and not revenue receipt.
9. Dealing with the above three principles, the AAR has observed in the
case of Fidelity group as under:-
We shall revert to the aforementioned principles. The first principle
requires us to ascertain whether the purchase of shares by a FII in
exercise of the power in the memorandum of association/trust deed was as
stock-in-trade as the mere existence of the power to purchase and sell
shares will not by itself be decisive of the nature of transaction. We
have to verify as to how the shares were valued/held in the books of
account i.e. whether they were valued as stock-in-trade at the end of
the financial year for the purpose of arriving at business income or
held as investment in capital assets. The second principle furnishes a
guide for determining the nature of transaction by verifying whether
there are substantial transactions, their magnitude, etc., maintenance
of books of account and finding the ratio between purchases and sales.
It will not be out of place to mention that regulation 18 of the SEBI
Regulations enjoins upon every FII to keep and maintain books of account
containing true and fair accounts relating to remittance of initial
corpus of buying and selling and realizing capital gains on investments
and accounts of remittance to India for investment in India and
realizing capital gains on investment from such remittances. The third
principle suggests that ordinarily purchases and sales of shares with
the motive of realizing profit would lead to inference of
trade/adventure in the nature of trade; where the object of the
investment in shares of companies is to derive income by way of
dividends etc., the transactions of purchases and sales of shares would
yield capital gains and not business profits.
10. CBDT also wishes to emphasise that it is possible for a tax payer
to have two portfolios, i.e., an investment portfolio comprising of
securities which are to be treated as capital assets and a trading
portfolio comprising of stock-in-trade which are to be treated as trading
assets. Where an assessee has two portfolios, the assessee may have income
under both heads i.e., capital gains as well as business income.
11. Assessing officers are advised that the above principles should
guide them in determining whether, in a given case, the shares are held by
the assessee as investment (and therefore giving rise to capital gains) or
as stock-in-trade (and therefore giving rise to business profits). The
assessing officers are further advised that no single principle would be
decisive and the total effect of all the principles should be considered
to determine whether, in a given case, the shares are held by the assessee
as investment or stock-in-trade.
12. These instructions shall supplement the earlier Instruction no.
1827 dated August 31, 1989.
(F.No.149/287/2005-TPL)
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