The Hindu Business Line : Fine line between traders and investors

Following the controversy generated by the proposed securities transaction tax, the proposal has now been revamped to distinguish between different categories of intermediaries. While the guidelines help determine the taxability based on whether it is a normal business or a trade transaction, some fine-tuning must be done to the new Section 111A to prevent litigation, says H. P. Ranina.

The revised proposals on the securities transaction tax have gone a long way in addressing brokers' worries.

THE Finance Minister, Mr. P. Chidambaram, is known for his sharp mind and ability to get to the bottom of any issue. The recent controversy generated over the Securities Transaction Tax (STT) and his immediate response to the issue has brought out his fair-minded and objective approach.

Within a fortnight of the Budget proposals being introduced in Parliament, the Finance Minister took pains to revamp the STT proposals. This was done by dividing the intermediaries into two categories. The Press Release of July 21, 2004 stated that:

"(i) For those who are now paying capital gains tax

Delivery-based trade in equity: The rate is being maintained at 0.15 per cent (i.e. 15 basis points). I propose to split the levy of the tax equally between the buyer and the seller.

Unit-holders holding units in equity-oriented mutual funds: I propose to treat "units" as "securities" and extend the benefit of the new capital gains tax regime to such unit-holders. However, just as for any other equities traded on the stock exchange, they would now have to pay STT at 0.15 per cent (i.e. 15 basis points).

(ii) For those who are now paying income-tax on business profits

Day-traders and arbitrageurs: The rate for these categories will be 0.015 per cent (i.e. 15 basis points). They will be allowed to take the credit for STT against business tax on profits.

Derivative traders (futures and options): The rate for these categories will be 0.01 per cent (i.e. 1 basis point). They will be allowed to take the credit for STT against business tax on profits.

Credit for STT against business income-tax will also be allowed in cases where business profits are declared on delivery-based transactions."

The press release further stated that buying and selling bonds, including government bonds, will be completely exempt from STT. Similarly, units of mutual funds other than equity-oriented funds will be exempt from STT. Further, it was clarified that where STT is attracted, long-term capital gains tax will be nil while short-term capital gains tax will be 10 per cent. Where STT is not attracted or exempted, the normal capital gains tax regime will apply.

However, litigation may still arise in future under the tax law in the case of delivery-based trade and equity, where the rate is maintained at 15 basis points, though it is split equally between the buyer and seller.

In the press note, it is mentioned that the STT at the aforesaid rate would continue to apply to "those who are now paying capital gains tax". The press note, therefore, proceeds on the footing that persons who trade in equity by taking delivery are liable to capital gains tax. This assumption is not applicable in every case.

Under the Income-tax Act, 1961, profits in respect of securities would be taxable either under Section 28, under the head "Profits and Gains of Business or Profession" or under Section 45, under the head "Capital Gains".

A person who regularly buys and sells securities would be liable to tax under the head "Business". Though a person may buy securities and sell them after a few days, if such operations are carried on in a continuous and regular manner, they may rise to the level of business, attracting the provisions of Section 28 of the Act.

On the other hand, capital gains arise only in the hands of an investor whose intention is primarily to invest his funds or savings. Of course, he may still sell the securities at an appropriate time to realise his profit but if he holds on to capital assets, the profits would be taxable under Section 45, under the head "Capital Gains".

To make a profit taxable under the head "Capital Gains", a person must hold "capital assets" as defined in section 2(14). This definition includes all movable assets, unless these assets are held as stock-in-trade. Therefore, though a person may take delivery of securities, if they are held as stock-in-trade, the profits would be taxable under the head "Business" and not under the head "Capital Gains".

A delivery-based trade in equity referred to in the July 21 press note postulates that the person is a trader and not an investor, thereby attracting normal rates of tax applicable to business income. The press note refers to "those who are now paying capital gains tax" in respect of delivery-based trade. This stems from a lack of adequate appreciation of the principles of law as applicable to taxation.

In several decisions of British and Indian courts, the circumstances in which a transaction is in the nature of business have been discussed. If a transaction is in the assessee's ordinary line of business, there can be no difficulty in holding that it is in the nature of a trade (Cape Brandy Syndicate v I.R. (12 T.C. 358)).

The Supreme Court held in Kamakshya Narain Singh v C.I.T. (77 I.T.R. 253, 262-63); C.I.T. v Sutlej Cotton Mills Supply Agencies Ltd. (100 I.T.R. 706); Oriental Investment Co. Ltd. v C.I.T. (32 I.T.R. 664) and Visheshwara Singh v C.I.T. (41 I.T.R. 685) that the profit or loss on the sale of shares and securities would be capital in nature if the seller is an ordinary investor realising his holdings, but it would be revenue if he carries on a business in shares and securities or his dealing in them constitutes an adventure in the nature of trade.

Some of the guidelines to be adopted to determine what is in the nature of business and what should be treated as a capital asset have been considered by courts while laying down the proposition that where purchase is made with intention to resell, the profits made would be taxable under Section 28, under the head "Business".

Whether a purchase is made with the intention to resell depends upon the conduct of the assessee and the circumstances of the case, including the nature and quantity of the article purchased and the nature of operations involved.

The Supreme Court laid down in Venkataswami Naidu v C.I.T. (35 I.T.R. 594, 610, 622) that the dominant or even sole intention to resell is a relevant factor and raises a strong presumption, but by itself is not conclusive proof, of an adventure in the nature of trade.

In Ashok Kumar Jalan v C.I.T. (187 I.T.R. 316), it was held that the intention to resell may, in conjunction with the conduct of the assessee and other circumstances, point to the business character of the transaction.

The three guidelines to distinguish between business profits and capital gains are the following:

Trading operations;

Multiplicity of transactions;

Other circumstances.

In view of the aforesaid guidelines, the issue whether a transaction is delivery-based or not is irrelevant. Even where delivery is taken, the person could still be a trader in securities if he falls within the aforesaid guidelines. The issue of taking delivery is only relevant to determine whether the business is speculative or not.

Speculative transaction is defined by Section 43(5) to mean transactions in which a contract for purchase or sale of stock and shares is periodically or ultimately settled otherwise than by the actual delivery of scrips.

Therefore, non-delivery of scrips would be treated as speculation business and delivery-based trade would be treated as a normal business where the person regularly buys and sells securities, the multiplicity of transactions and other circumstances indicating trade or business operations. In this context, it is relevant to point out that Section 2(13), which defines "business", includes adventure in the nature of trade. Therefore, even transactions of purchase and sale, though delivery-based, would result in profits being taxable under the head "Business" and not "Capital Gains".

Hence, the new Section 111-A, which taxes short-term capital gains at the rate of 10 per cent, would not apply in respect of transactions that generate business profits. Such profits will continue to be taxed at the normal rates.

Undoubtedly, litigation will arise because the difference in the rates of tax is so substantial that an assessing officer, given the regularity and multiplicity of transactions, may take the stand that the profits are taxable under the head "Business" and not "Capital Gains". Having regard to judgments of courts, the assessment of business income may be upheld in many cases.

If the intention of the Finance Minister is to bring all delivery-based transactions, which are subject to the STT, within the ambit of the new Section 111-A so as to tax the profits at the concessional rate of 10 per cent, it would be necessary to re-draft Section 111-A.

This provision should expressly cover both short-term capital gains and profits taxable under the head "Profits and Gains of Business or Profession". Such amendment would prevent litigation on the issue of whether delivery-based trading results in business profits or capital gains. If Section 111-A is not re-drafted, a new avenue will open up in the existing paradise of lawyers.

(The author is a tax expert and a Mumbai-based advocate.)

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