FROM BUSINESS WORLD OF 10 JUNE 2006
Revenue by any
means
Following the
stock market crash, the finance minister has been most forthcoming. He talked
freely to the media, and he had two clear and simple messages – that it was
wrong to blame the circular of the Central Board of Direct Taxes (CBDT) for the
meltdown, and that the Indian growth story was continuing and robust. According
to him, the circular did not mention foreign institutional investors, let alone
suggest that they should be taxed. In any case, the circular was a tentative
one, and only invited discussion. He also urged investors to stay invested in
shares.
On the growth
story, Mr Chidambaram is right. In the past year, signs of rising inflation
have led to hardening of interest rates in the main international financial
markets, which has been followed up in India. The balance of payments has been
worsening rapidly. Capital inflows were adequate to finance the deficit – until
the stock market crash which was due to a sudden outflow of FII funds. The
exchange reserves are more than enough to prevent such outflows from having an
impact on the exchange rate or real flows. But both outflows and changes in
reserves affect money supply, liquidity and interest rates and confront Reserve
Bank with delicate choices in monetary and exchange rate policy. The
uncertainty regarding these monetary variables is the only cloud on
macroeconomic horizon. For economic activity to turn down, real events are not
necessary; perception of increased uncertainty and risk is enough to slow down
the economy. It is this uncertainty that the finance minister tried to combat
with his reassuring remarks on the state of the economy.
The CBDT circular is another matter. It is called draft instructions.
But issued on 16 May, it called for
comments within nine days; after that CBDT could end its tentativeness and make
the instructions binding any minute. Hence the market was not unjustified in
taking them seriously. It refers to CBDT’s instruction No 1827 of 1989 which
lay down criteria to be used to distinguish between shares held as stock-in-trade
and as investment. That instruction basically underlined three criteria laid
down by Supreme Court in 1959 – whether the buyer was a trader in shares,
whether he bought and sold them repeatedly, and whether he had bought or sold a
large quantity. It went on to cite some High Court judgments to confound the
issue; but otherwise it was clear enough.
The new draft instructions, on the other hand, are designed to
confound the confusion. They aim to add new criteria such as whether a purchase
was made with an intention to make a profit or for capital appreciation and
earning dividends or interest, whether the buyer borrowed to make the purchase
or not, whether transactions were made continuously and regularly or
occasionally, how long securities were held, ratio of purchases to sales, time
spent over investments, whether they were a means of livelihood or not. The
mindset working behind these criteria is alarming; the draughtswoman seems to
believe that an investor must not profit from his investment, must not borrow
to make investments, must not trade too often, must keep his investments unsold
for a long time, must buy more than he sells, must not pore too long over
financial pages, and must not make a living out of investments. The criteria
laid down by Supreme Court were simple and clear; the new instructions are
designed to overturn them and enable income tax officers to treat investors as
share traders and vice versa.
Thus it is not surprising that the market took fright. But that is
not the only reason why the draft instructions should make the finance minister
pause. First, they were not necessary. The circular of 1989 was clear enough,
and the draft instructions added nothing to it. Second, if the finance ministry
genuinely wants to invite discussion on what it proposes, it should go out to
get a public response instead of just going through the motions. The public
does not spend all its time reading CBDT circulars; and nine days is far too
short a period to expect any substantial response. The finance ministry should
study and emulate the way the regulators do it – they issue discussion papers,
put them on the web for weeks, and hold meetings all across the country to
evoke response.
And finally, the circular is well in line with the CBDT tradition of
soaking the taxpayer by fair means or foul. If Mr Chidambaram made his
departments more mindful of justice and fairness and less obsessed with revenue,
he would be remembered longer and more fondly by the people of this country.
DRAFT CIRCULAR Sub : “Circumstances to be considered by the
Assessing officers in determining whether a person is a trader in stocks or an
investor in stocks:
The Central Board of Direct Taxes in its instruction no.1827 dated 31-08-1989 had laid down certain tests to distinguish between shares held as stock-in-trade and shares held as investment. CBDT proposes to issue supplementary instructions in this regard to provide further guidelines for determining whether a person is a trader is stocks or an investor in stocks. Before issuing the instructions, CBDT would like to invite comments of all stakeholders.
Comments on the draft instructions may be sent by email or post by 25th May, 2006 to Ms Monica Bhatia, Director (TPL-I), Room No.147D, North Block, New Delhi (e mail : dirtpl1@nic.in).
DRAFT INSTRUCTIONS
Instruction No.
Dated………….
Sub : Distinction between shares held as stock-in-trade and shares held as investment - Tests For –
The Central Board of Direct Taxes in its instruction no.1827 dated 31-08-1989 had laid down certain tests to distinguish between shares held as stock-in-trade and shares held as investment. The following supplementary instructions in this regard will provide further guidelines for determining whether a person is a trader in stocks or an investor in stocks:
i. Whether the purchase and sale of securities was allied to his usual trade or business / was incidental to it or was an occasional independent activity.
ii. Whether the purchase is made solely with the intention of resale at a profit or for long term appreciation and/or for earning dividends and interest.
iii. Whether scale of activity is substantial.
iv. Whether transactions were entered into continuously and regularly during the assessment year.
v. Whether purchases are made out of own funds or borrowings
vi. The stated objects in the Memorandum and Articles of Association in the case of a corporate assessee
vii. Typical holding period for securities bought and sold
viii. Ratio of sales to purchases and holding
ix. The time devoted to the activity and the extent to which it is the means of livelihood.
x. The characterization of securities in the books of account and in balance sheet as stock in trade or investments.
xi. Whether the securities purchased or sold are listed or unlisted.
xii. Whether investment is in sister/related concerns or independent companies.
xiii. Whether transaction is by promoters of the company.
xiv. Total number of stocks dealt in.
xv. Whether money has been paid or received or whether these are only book entries.
The Assessing Officers are also advised that no single criterion listed above is decisive and total effect of all these criteria should be considered to determine the nature of activity.
(F.No.149/287/2005-TPL from Central Board of Direct Taxes)
(Vandana Ramachandran)
Under Secretary (TPL-I)
16th May, 2006
Instruction No. 1827 dated 31.08.1989
Subject : Distinction between shares held as stock-in-trade and shares held as investment - Tests For –
The question whether a particular assessee is a trader in shares or the shares are held as capital assets sometimes gives rise to disputes and litigation. Over the years the courts have laid down the various tests or factors to be taken into account in determining this question.
2. Certain general principles in this regard were laid down by the Supreme Court in the case of G.Venkata Swami Naidu & co. Vs. CIT (1959) 35 ITR 594. In this case the Supreme Court was dealing with a question whether the excess sum realised on the sale of certain plots was assessable as income from an adventure in the nature of business. The Supreme Court held that in deciding the character of such transaction, several factors were relevant. For instance:-
i. Whether the purchaser was a trader and the purchase of the commodity and its resale were allied to his usual trade or business or were incidental to it.
ii. The nature and quantity of the commodity purchased and resold - if the commodity purchased is in very large quantity, it could tend to eliminate the possibility of investment for personal use, possession or enjoyment.
iii. The repetition of the transaction.
3. The Supreme court observed that the presence of all these factors may be held in the court to draw an inference that a transaction is in the nature of trade' but it is not a matter of merely counting the number of facts and circumstances pro and con what is important to consider is their distinctive character. In each case, it is the total effect of all relevant factors and circumstances that determines the character of the transaction.
4. The Supreme Court in this case also discussed the test of intention. It held that in cases where the purchase has been made solely and exclusively with the intention of resale at a profit and the purchaser has no intention of holding the property for himself or otherwise enjoying it or using it, the presence of such intention is a relevant factor and unless it is off-set by the presence of other factors, it would raise a strong presumption that a transaction is an adventure in the nature of trade.
5. In the case of H. Mohammad & Co. Vs. CIT (1977) 107 ITR 637 the Gujarat High Court observed that a stock-in-trade is something in which a trader or a business man deals, whereas his capital asset is something with which he deals. According to the High Court one of the indicators for deciding as to what is stock-in-trade is whether a particular assessee is buying or selling the goods or commodity or whether he has merely invested his money with a view to earning further income or with a view to carrying on his other business. It was further held by the High court that the distinction between stock-in-trade and investment is that of selling outright in the course of the business activity and deriving income from exploitation of one's own assets.
6. These general principles hold good in respect of shares also. However certain specific issues relevant for determining this question with reference to shares have also been decided by the courts. In the case of Sarder Indra Singh & sons Ltd. Vs. CIT (1953) 24 ITR 415, the Supreme Court was dealing with the case of a company which was incorporated with the object, inter alia of carrying on the business of bankers, financiers, managing agents and secretaries and was also empowered to invest and deal with the monies of the company not immediately required for its business upon such securities and in such manner as might from time to time be determined. It was held by the Supreme Court in this case that to constitute business income, it was not necessary that surplus should have resulted from such a course of dealing in securities as by itself would amount to the carrying on of business or if the realisation of securities is a normal step in carrying on the assessee's business. The Supreme Court observed that the principle applicable in all such cases was well settled and the question always was whether the sales which produced the surplus were so connected with the carrying on of the assessees business that it could fairly be said that the surplus was the profit and gains of such business. On the facts of this case it was held that the surplus resulting from sale of shares and securities constituted business income.
7. The aforesaid principles laid down by the Supreme Court was followed by Andhra Pradesh High court in the case of SBH. Vs.CIT (1988) 151 ITR 703. The main business of the SBH was to accept deposits and to advance loans and the money constituted its stock-in-trade. The banking company has to carry on its business in accordance with the provisions of the banking regulation act, 1949. Sec.24 of the said act requires every banking company to maintain in India either in cash or in the shape of gold or in the shape of unincumbered approved securities, 20% of its total time and demand liabilities at any given point of time. It was held by the High Court that what section 24 of the said Act did was to insist on the observance of a normal prudent banking business practice. If the banking company chooses to invest the money in unincumbered approved securities it is only one mode of keeping a portion of its deposits in ready cash or readily-convertible-into-cash securities. Any income arising from the sale of such securities is, therefore closely connected with the banking business and is business income, it was concluded by the High court.
8. In the case of Karam Chand Thapar and brothers (P) Ltd Vs. CIT (1971) 83 ITR 899 it was held by the Supreme Court that the circumstance that the assessee had shown certain shares as investment in its books as well as its balance sheet was by itself not a conclusive circumstances, though it was a relevant circumstance.
9. The decisions in the CIT Vs. Associated Industrial Development co. (1971) 82 ITR 586 (SC) and A.N. Ramaswami Chettiar Vs. CIT (1963) 48 ITR 771 (Madras) may also be referred to for guidance.
10. Although the tests laid down by the courts may help determine the issue in particular cases the decision will ultimately turn on the facts of each case.
11. These instructions may please be brought to the notice of the Assessing officers in your region.
[F.No 181/1/89 - IT(AI) dated 31/08/1989 from Central Board of Direct Taxes]
The Central Board of Direct Taxes in its instruction no.1827 dated 31-08-1989 had laid down certain tests to distinguish between shares held as stock-in-trade and shares held as investment. CBDT proposes to issue supplementary instructions in this regard to provide further guidelines for determining whether a person is a trader is stocks or an investor in stocks. Before issuing the instructions, CBDT would like to invite comments of all stakeholders.
Comments on the draft instructions may be sent by email or post by 25th May, 2006 to Ms Monica Bhatia, Director (TPL-I), Room No.147D, North Block, New Delhi (e mail : dirtpl1@nic.in).
DRAFT INSTRUCTIONS
Instruction No.
Dated………….
Sub : Distinction between shares held as stock-in-trade and shares held as investment - Tests For –
The Central Board of Direct Taxes in its instruction no.1827 dated 31-08-1989 had laid down certain tests to distinguish between shares held as stock-in-trade and shares held as investment. The following supplementary instructions in this regard will provide further guidelines for determining whether a person is a trader in stocks or an investor in stocks:
i. Whether the purchase and sale of securities was allied to his usual trade or business / was incidental to it or was an occasional independent activity.
ii. Whether the purchase is made solely with the intention of resale at a profit or for long term appreciation and/or for earning dividends and interest.
iii. Whether scale of activity is substantial.
iv. Whether transactions were entered into continuously and regularly during the assessment year.
v. Whether purchases are made out of own funds or borrowings
vi. The stated objects in the Memorandum and Articles of Association in the case of a corporate assessee
vii. Typical holding period for securities bought and sold
viii. Ratio of sales to purchases and holding
ix. The time devoted to the activity and the extent to which it is the means of livelihood.
x. The characterization of securities in the books of account and in balance sheet as stock in trade or investments.
xi. Whether the securities purchased or sold are listed or unlisted.
xii. Whether investment is in sister/related concerns or independent companies.
xiii. Whether transaction is by promoters of the company.
xiv. Total number of stocks dealt in.
xv. Whether money has been paid or received or whether these are only book entries.
The Assessing Officers are also advised that no single criterion listed above is decisive and total effect of all these criteria should be considered to determine the nature of activity.
(F.No.149/287/2005-TPL from Central Board of Direct Taxes)
(Vandana Ramachandran)
Under Secretary (TPL-I)
16th May, 2006
Instruction No. 1827 dated 31.08.1989
Subject : Distinction between shares held as stock-in-trade and shares held as investment - Tests For –
The question whether a particular assessee is a trader in shares or the shares are held as capital assets sometimes gives rise to disputes and litigation. Over the years the courts have laid down the various tests or factors to be taken into account in determining this question.
2. Certain general principles in this regard were laid down by the Supreme Court in the case of G.Venkata Swami Naidu & co. Vs. CIT (1959) 35 ITR 594. In this case the Supreme Court was dealing with a question whether the excess sum realised on the sale of certain plots was assessable as income from an adventure in the nature of business. The Supreme Court held that in deciding the character of such transaction, several factors were relevant. For instance:-
i. Whether the purchaser was a trader and the purchase of the commodity and its resale were allied to his usual trade or business or were incidental to it.
ii. The nature and quantity of the commodity purchased and resold - if the commodity purchased is in very large quantity, it could tend to eliminate the possibility of investment for personal use, possession or enjoyment.
iii. The repetition of the transaction.
3. The Supreme court observed that the presence of all these factors may be held in the court to draw an inference that a transaction is in the nature of trade' but it is not a matter of merely counting the number of facts and circumstances pro and con what is important to consider is their distinctive character. In each case, it is the total effect of all relevant factors and circumstances that determines the character of the transaction.
4. The Supreme Court in this case also discussed the test of intention. It held that in cases where the purchase has been made solely and exclusively with the intention of resale at a profit and the purchaser has no intention of holding the property for himself or otherwise enjoying it or using it, the presence of such intention is a relevant factor and unless it is off-set by the presence of other factors, it would raise a strong presumption that a transaction is an adventure in the nature of trade.
5. In the case of H. Mohammad & Co. Vs. CIT (1977) 107 ITR 637 the Gujarat High Court observed that a stock-in-trade is something in which a trader or a business man deals, whereas his capital asset is something with which he deals. According to the High Court one of the indicators for deciding as to what is stock-in-trade is whether a particular assessee is buying or selling the goods or commodity or whether he has merely invested his money with a view to earning further income or with a view to carrying on his other business. It was further held by the High court that the distinction between stock-in-trade and investment is that of selling outright in the course of the business activity and deriving income from exploitation of one's own assets.
6. These general principles hold good in respect of shares also. However certain specific issues relevant for determining this question with reference to shares have also been decided by the courts. In the case of Sarder Indra Singh & sons Ltd. Vs. CIT (1953) 24 ITR 415, the Supreme Court was dealing with the case of a company which was incorporated with the object, inter alia of carrying on the business of bankers, financiers, managing agents and secretaries and was also empowered to invest and deal with the monies of the company not immediately required for its business upon such securities and in such manner as might from time to time be determined. It was held by the Supreme Court in this case that to constitute business income, it was not necessary that surplus should have resulted from such a course of dealing in securities as by itself would amount to the carrying on of business or if the realisation of securities is a normal step in carrying on the assessee's business. The Supreme Court observed that the principle applicable in all such cases was well settled and the question always was whether the sales which produced the surplus were so connected with the carrying on of the assessees business that it could fairly be said that the surplus was the profit and gains of such business. On the facts of this case it was held that the surplus resulting from sale of shares and securities constituted business income.
7. The aforesaid principles laid down by the Supreme Court was followed by Andhra Pradesh High court in the case of SBH. Vs.CIT (1988) 151 ITR 703. The main business of the SBH was to accept deposits and to advance loans and the money constituted its stock-in-trade. The banking company has to carry on its business in accordance with the provisions of the banking regulation act, 1949. Sec.24 of the said act requires every banking company to maintain in India either in cash or in the shape of gold or in the shape of unincumbered approved securities, 20% of its total time and demand liabilities at any given point of time. It was held by the High Court that what section 24 of the said Act did was to insist on the observance of a normal prudent banking business practice. If the banking company chooses to invest the money in unincumbered approved securities it is only one mode of keeping a portion of its deposits in ready cash or readily-convertible-into-cash securities. Any income arising from the sale of such securities is, therefore closely connected with the banking business and is business income, it was concluded by the High court.
8. In the case of Karam Chand Thapar and brothers (P) Ltd Vs. CIT (1971) 83 ITR 899 it was held by the Supreme Court that the circumstance that the assessee had shown certain shares as investment in its books as well as its balance sheet was by itself not a conclusive circumstances, though it was a relevant circumstance.
9. The decisions in the CIT Vs. Associated Industrial Development co. (1971) 82 ITR 586 (SC) and A.N. Ramaswami Chettiar Vs. CIT (1963) 48 ITR 771 (Madras) may also be referred to for guidance.
10. Although the tests laid down by the courts may help determine the issue in particular cases the decision will ultimately turn on the facts of each case.
11. These instructions may please be brought to the notice of the Assessing officers in your region.
[F.No 181/1/89 - IT(AI) dated 31/08/1989 from Central Board of Direct Taxes]
