I-T - Whether profit from sale of shares intended as investment in books and treated as short-term capital gains, can be construed as business income on basis of frequency and magnitude of transactions - ruled in favour of Revenue by ITAT
MUMBAI, DEC 15, 2011: THE issues before the Tribunal are - Whether profit from sale of shares intended as an investment in the books of the assessee and supported by the resolution of its board of directors, and treated as short term capital gains, can be treated as business income on the basis of frequency and magnitude of the transactions and whether assessee's intention at the time of making the share purchase and the treatment given by the assessee to these transactions in its books of account, would overrule the facts of frequency and volume of the transaction to determine the nature of the transaction as investment or trade. And the answer partly goes in favour of Revenue.
Facts of the case
The assessee is a Private Limited Company engaged in the business of dealing in shares and securities. The Assessee was doing trading, speculation, investment and also had transactions from the derivative market. The assessee had switched from trading to the investment based business following a resolution passed by its Board of Directors in March 2005, stating that all transactions related to delivery based shares were to be carried out only on investment account. Accordingly, during the year, the assessee had not made any fresh purchases of shares in respect of trading. Through a software used by the assessee, all the trading transactions were automatically bifurcated on a day to day basis, as an investment or a speculative activity depending on when the contract for share purchase was squared up, whether on the same day without taking delivery or in a few days after taking delivery. Thus the assessee had a scrip wise analysis for every listed company share on a day to day basis.
During the year, the assessee had made an application for the initial public offers by M/s Shoppers Stop and YES Bank for which it had utilized the financial facilities from L&T Ltd and Kotak Mahindra Investment Ltd and paid interest on such borrowings. The shares acquired through these IPOs were sold as short term investment and the interest paid was reduced from the working of such gain. The assessee also maintained a running ledger with the share broker through whom such investments were arranged, which reflected the loans from and advances made to various associates and group concerns. This ledger showed huge loans taken and repaid for the activity of investment without any interest having been paid. The accounts were generally squared up at the end of the year and thus showed nil balance.
In its return of income, the assessee had shown its sale and purchase transactions and reported a net profit. After reducing miscellaneous expenses and the interest paid on two IPOs, the assessee had shown short term capital gains which were adjusted against the brought forward unabsorbed depreciation loss short term capital loss for earlier assessment years which resulted in short term capital gain on which the assessee had applied the tax rate of 10 per cent. The assessee had also shown long term capital gain which was claimed as exempt under section 10(38).
According to the assessee, the assessee was an investor. This was because the intention at the time of making an investment had to be seen, to determine whether the assessee was an investor or a trader. There was no trading transaction during the year and the trading profit had arisen only out of sale made from the opening stock of earlier year. Also, at the end of the year, the assessee company had sufficient funds and investment in shares had been made out of own funds.
While the AO accepted the long term capital gains and the short term capital losses posted by the assessee, he rejected the assessee's explanation of being an investor and objected to the short term capital gains on which the assessee had applied the lower tax rate of 10 per cent.
The AO noted that only in a few cases the assessee had squared up the contract of purchase and sale after more than one month. The AO thus held that the frequency and the amount of borrowing showed that the assessee's intention was business in the trading of shares and securities on a day to day basis. The scrip wise list showing stock in trade during the year, had shares of various listed companies which were also there in the huge list shown as investment. Even the purchases in the same scrip on the same day were divided into speculation and investment. Thus, the assessee had smartly but intentionally switched over its trading business to the investment business to have undue advantage of lower tax rate provided for short term capital gain. The assessee had utilised borrowed money for these huge investments made during the year. The assessee's IPO application for a huge amount had incurred a huge interest cost, which could not be treated as a short term investment by any prudent businessman and clearly showed the assessee's intention of doing business was a camouflage of showing the same as investment activity. Its accounts were also squared up at the end of the year to avoid the reflection in the balance sheet as borrowed loans. This view was also supported by the fact that the assessee was also trading in the derivative market with a huge volume on almost day to day basis. Thus the AO treated the short term capital gain as business income on which the higher tax rate of 30 per cent was applicable.
In appeal, the CIT(A) treated the short term capital gain on shares allotted in the IPO as business income but otherwise reversed the AO's order. The CIT(A) held that, there were no outstanding loans against the assessee; the net worth of the assessee company was substantial enough to cover the entire investment in shares, which proved that the assessee had made the entire investment out of its own funds without any borrowing. Also, considering the resolution passed by the assessee company's board of directors, the intention of the assessee at the time of purchase was accepted as that of investment. The CIT(A) held that it was immaterial whether the assessee held the shares for 90 days or 380 days and it could not alter the nature of transaction. Thus, the CIT(A) held that the short term capital gain earned on shares could not be taxed as business income. The CIT(A) then directed the AO to tax the income from short term capital gains at the lower rate of 10 per cent under section 111A.
In appeal before the Tribunal, the Revenue side submitted that the activity of frequent buying and selling of shares over a short span of period had to be treated as business being adventure in nature of trade. This was the first year where the volume and frequency were more and the holding period was less. Also, the frequency and amount of borrowings for investment in shares and the magnitude of the transaction justified the income as "business income" as against "short term capital gain" treated by the assessee. Thus, the profit from purchase and sale of shares had to be considered as business income and not capital gain as claimed by the assessee. The assessee's intention was to pay less tax that is at the rate of 10 per cent as against 30 per cent.
The assessee did not appeal against treating the short term capital gain on IPO shares as business income. The assessee submitted that in the earlier assessment years, the AO had accepted the short term capital gain and the long term capital gain without making any disallowance. Also, no borrowed funds had been utilized as its own funds and free reserves were higher than the value of investments. Also, as per CBDT circular, the assessee could have two portfolios of securities, one for investments and the other for stock in trade and the valuation of shares in the books of account had an important bearing in the matter.
Having heard the parties, the Tribunal held that,
++ the Board had accepted that an assessee could have two portfolios simultaneously – one, an investment portfolio comprising of securities which were to be treated as capital asset and two, a trading portfolio comprising of stock in trade which were to be treated as trading asset and the assessee could have income under both heads that is, capital gains and business income;
++ the AAR had culled out various principles from the decision of the Apex Court, following which the CBDT had issued guidelines for AOs to determine whether the shares held by the assessee were investment or stock-in-trade. Accordingly, it was possible for an assessee to be both an investor as well as dealer in shares. Following various legal precedents, whether a transaction of sale and purchase of shares was a trading or investment transaction was a mixed question of law and fact. Purchase with intention to resell could constitute capital gain or business profit depending on circumstances like quantity of purchase and nature of activity. A company that purchased and sold shares had to show that they were held as stock-in-trade and the existence of its power to purchase and sell shares in the memorandum of association was not decisive of the nature of transaction. The Board had also advised that no single principle was decisive and the total effect of all the principles had to be considered;
++ in this case, the shares were held for a few days or in few cases for a few weeks or months. Purchase of shares during the year and selling them frequently in a short period indicated that the assessee had purchased the shares with a motive to earn profit in a short period. Therefore, the frequency and volume of the transactions gave an impression that the assessee did not intend to acquire the shares with an investment motive. In the case of investment, the earning of dividend and the appreciation of the shares was the primary consideration. Only a trader looked for short term gains from purchase and sale of shares. Therefore, the treatment given by the assessee to these transactions in the books of account, could not be the only determinative factor about the nature of the transactions. The fact that the shares were disclosed as investment in the balance sheet had to be reckoned with but when other factors or circumstances threw some doubt on the motive of the assessee in acquiring the shares, as in this case, then the entries in the books of account or balance sheet would not override them and be taken as decisive of the intention of the assessee.
++ although in the preceding two years, the short term capital gain had been accepted by the Revenue in scrutiny/summary assessment, the assessee's argument that the same had to be followed this year too was without force as it was the settled proposition of law that principles of res judicata did not apply to income tax proceedings and every assessment was independent and separate;
++ in the preceding assessment year, the assessee traded in shares and the resolution to treat delivery based shares as investment was passed only towards the end of the financial year. The entire exercise was done by the assessee with a motive to reduce the tax liability which was 10 per cent for short term capital gains and 30 per cent for business income. Therefore notwithstanding the fact that the shares were shown as investment in the balance sheet of March 2005, which were earlier a part of stock in trade, sale of the same, could not be considered as sale of investment and consequently the profit had to be treated as business income. Also, it was the computer which decided whether the share was delivery based or non-delivery based and whether it was for trading or investment. Therefore the Board's resolution had lost its significance;
++ the assessee's argument that no borrowed funds had been utilized for making the investment was also without force as the AO had given a categorical finding that the assessee had used borrowed money from group concerns and associates and only towards the end of the year, the same was squared up so as to give an impression that no borrowed funds had been utilized for the purpose of investment in shares;
++ the assessee could have two portfolios; one for investment and one for trading. Mere volume of transaction did not mean that the assessee was a trader and the intention with which the purchase was made had to be seen. However, in this case, the intention of the assessee appeared to be whimsical. Purchases in the same scrip on the same day had been divided into speculation and investment whereby the intention of the assessee was just to reduce the tax liability by treating a part of the profit as short term capital gain. Therefore, the profit on account of purchase and sale of shares by the assessee had to be treated as income from business. The order of the CIT(A) was therefore set aside and the AO's order was restored. The grounds raised by the Revenue were accordingly allowed.
MUMBAI, DEC 15, 2011: THE issues before the Tribunal are - Whether profit from sale of shares intended as an investment in the books of the assessee and supported by the resolution of its board of directors, and treated as short term capital gains, can be treated as business income on the basis of frequency and magnitude of the transactions and whether assessee's intention at the time of making the share purchase and the treatment given by the assessee to these transactions in its books of account, would overrule the facts of frequency and volume of the transaction to determine the nature of the transaction as investment or trade. And the answer partly goes in favour of Revenue.
Facts of the case
The assessee is a Private Limited Company engaged in the business of dealing in shares and securities. The Assessee was doing trading, speculation, investment and also had transactions from the derivative market. The assessee had switched from trading to the investment based business following a resolution passed by its Board of Directors in March 2005, stating that all transactions related to delivery based shares were to be carried out only on investment account. Accordingly, during the year, the assessee had not made any fresh purchases of shares in respect of trading. Through a software used by the assessee, all the trading transactions were automatically bifurcated on a day to day basis, as an investment or a speculative activity depending on when the contract for share purchase was squared up, whether on the same day without taking delivery or in a few days after taking delivery. Thus the assessee had a scrip wise analysis for every listed company share on a day to day basis.
During the year, the assessee had made an application for the initial public offers by M/s Shoppers Stop and YES Bank for which it had utilized the financial facilities from L&T Ltd and Kotak Mahindra Investment Ltd and paid interest on such borrowings. The shares acquired through these IPOs were sold as short term investment and the interest paid was reduced from the working of such gain. The assessee also maintained a running ledger with the share broker through whom such investments were arranged, which reflected the loans from and advances made to various associates and group concerns. This ledger showed huge loans taken and repaid for the activity of investment without any interest having been paid. The accounts were generally squared up at the end of the year and thus showed nil balance.
In its return of income, the assessee had shown its sale and purchase transactions and reported a net profit. After reducing miscellaneous expenses and the interest paid on two IPOs, the assessee had shown short term capital gains which were adjusted against the brought forward unabsorbed depreciation loss short term capital loss for earlier assessment years which resulted in short term capital gain on which the assessee had applied the tax rate of 10 per cent. The assessee had also shown long term capital gain which was claimed as exempt under section 10(38).
According to the assessee, the assessee was an investor. This was because the intention at the time of making an investment had to be seen, to determine whether the assessee was an investor or a trader. There was no trading transaction during the year and the trading profit had arisen only out of sale made from the opening stock of earlier year. Also, at the end of the year, the assessee company had sufficient funds and investment in shares had been made out of own funds.
While the AO accepted the long term capital gains and the short term capital losses posted by the assessee, he rejected the assessee's explanation of being an investor and objected to the short term capital gains on which the assessee had applied the lower tax rate of 10 per cent.
The AO noted that only in a few cases the assessee had squared up the contract of purchase and sale after more than one month. The AO thus held that the frequency and the amount of borrowing showed that the assessee's intention was business in the trading of shares and securities on a day to day basis. The scrip wise list showing stock in trade during the year, had shares of various listed companies which were also there in the huge list shown as investment. Even the purchases in the same scrip on the same day were divided into speculation and investment. Thus, the assessee had smartly but intentionally switched over its trading business to the investment business to have undue advantage of lower tax rate provided for short term capital gain. The assessee had utilised borrowed money for these huge investments made during the year. The assessee's IPO application for a huge amount had incurred a huge interest cost, which could not be treated as a short term investment by any prudent businessman and clearly showed the assessee's intention of doing business was a camouflage of showing the same as investment activity. Its accounts were also squared up at the end of the year to avoid the reflection in the balance sheet as borrowed loans. This view was also supported by the fact that the assessee was also trading in the derivative market with a huge volume on almost day to day basis. Thus the AO treated the short term capital gain as business income on which the higher tax rate of 30 per cent was applicable.
In appeal, the CIT(A) treated the short term capital gain on shares allotted in the IPO as business income but otherwise reversed the AO's order. The CIT(A) held that, there were no outstanding loans against the assessee; the net worth of the assessee company was substantial enough to cover the entire investment in shares, which proved that the assessee had made the entire investment out of its own funds without any borrowing. Also, considering the resolution passed by the assessee company's board of directors, the intention of the assessee at the time of purchase was accepted as that of investment. The CIT(A) held that it was immaterial whether the assessee held the shares for 90 days or 380 days and it could not alter the nature of transaction. Thus, the CIT(A) held that the short term capital gain earned on shares could not be taxed as business income. The CIT(A) then directed the AO to tax the income from short term capital gains at the lower rate of 10 per cent under section 111A.
In appeal before the Tribunal, the Revenue side submitted that the activity of frequent buying and selling of shares over a short span of period had to be treated as business being adventure in nature of trade. This was the first year where the volume and frequency were more and the holding period was less. Also, the frequency and amount of borrowings for investment in shares and the magnitude of the transaction justified the income as "business income" as against "short term capital gain" treated by the assessee. Thus, the profit from purchase and sale of shares had to be considered as business income and not capital gain as claimed by the assessee. The assessee's intention was to pay less tax that is at the rate of 10 per cent as against 30 per cent.
The assessee did not appeal against treating the short term capital gain on IPO shares as business income. The assessee submitted that in the earlier assessment years, the AO had accepted the short term capital gain and the long term capital gain without making any disallowance. Also, no borrowed funds had been utilized as its own funds and free reserves were higher than the value of investments. Also, as per CBDT circular, the assessee could have two portfolios of securities, one for investments and the other for stock in trade and the valuation of shares in the books of account had an important bearing in the matter.
Having heard the parties, the Tribunal held that,
++ the Board had accepted that an assessee could have two portfolios simultaneously – one, an investment portfolio comprising of securities which were to be treated as capital asset and two, a trading portfolio comprising of stock in trade which were to be treated as trading asset and the assessee could have income under both heads that is, capital gains and business income;
++ the AAR had culled out various principles from the decision of the Apex Court, following which the CBDT had issued guidelines for AOs to determine whether the shares held by the assessee were investment or stock-in-trade. Accordingly, it was possible for an assessee to be both an investor as well as dealer in shares. Following various legal precedents, whether a transaction of sale and purchase of shares was a trading or investment transaction was a mixed question of law and fact. Purchase with intention to resell could constitute capital gain or business profit depending on circumstances like quantity of purchase and nature of activity. A company that purchased and sold shares had to show that they were held as stock-in-trade and the existence of its power to purchase and sell shares in the memorandum of association was not decisive of the nature of transaction. The Board had also advised that no single principle was decisive and the total effect of all the principles had to be considered;
++ in this case, the shares were held for a few days or in few cases for a few weeks or months. Purchase of shares during the year and selling them frequently in a short period indicated that the assessee had purchased the shares with a motive to earn profit in a short period. Therefore, the frequency and volume of the transactions gave an impression that the assessee did not intend to acquire the shares with an investment motive. In the case of investment, the earning of dividend and the appreciation of the shares was the primary consideration. Only a trader looked for short term gains from purchase and sale of shares. Therefore, the treatment given by the assessee to these transactions in the books of account, could not be the only determinative factor about the nature of the transactions. The fact that the shares were disclosed as investment in the balance sheet had to be reckoned with but when other factors or circumstances threw some doubt on the motive of the assessee in acquiring the shares, as in this case, then the entries in the books of account or balance sheet would not override them and be taken as decisive of the intention of the assessee.
++ although in the preceding two years, the short term capital gain had been accepted by the Revenue in scrutiny/summary assessment, the assessee's argument that the same had to be followed this year too was without force as it was the settled proposition of law that principles of res judicata did not apply to income tax proceedings and every assessment was independent and separate;
++ in the preceding assessment year, the assessee traded in shares and the resolution to treat delivery based shares as investment was passed only towards the end of the financial year. The entire exercise was done by the assessee with a motive to reduce the tax liability which was 10 per cent for short term capital gains and 30 per cent for business income. Therefore notwithstanding the fact that the shares were shown as investment in the balance sheet of March 2005, which were earlier a part of stock in trade, sale of the same, could not be considered as sale of investment and consequently the profit had to be treated as business income. Also, it was the computer which decided whether the share was delivery based or non-delivery based and whether it was for trading or investment. Therefore the Board's resolution had lost its significance;
++ the assessee's argument that no borrowed funds had been utilized for making the investment was also without force as the AO had given a categorical finding that the assessee had used borrowed money from group concerns and associates and only towards the end of the year, the same was squared up so as to give an impression that no borrowed funds had been utilized for the purpose of investment in shares;
++ the assessee could have two portfolios; one for investment and one for trading. Mere volume of transaction did not mean that the assessee was a trader and the intention with which the purchase was made had to be seen. However, in this case, the intention of the assessee appeared to be whimsical. Purchases in the same scrip on the same day had been divided into speculation and investment whereby the intention of the assessee was just to reduce the tax liability by treating a part of the profit as short term capital gain. Therefore, the profit on account of purchase and sale of shares by the assessee had to be treated as income from business. The order of the CIT(A) was therefore set aside and the AO's order was restored. The grounds raised by the Revenue were accordingly allowed.
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