Do you trade or invest? It makes a lot of difference
June, 22nd 2007
The distinction between equity holdings of an investor to be classified as either stock in trade or as an investment can have major implications on the tax paid on the transaction. The Central Board of Direct Taxes has come out with a circular that will guide both investors and tax officers in making the right classification. ET lists out the impact of this move on equity markets.
What is the importance of classification of equity holdings into different heads?
There is great importance attached to the way in which a certain equity holding is considered because this determines the taxation on the particular share. If the share is considered as a stock in trade for a person, then the gain and loss will be calculated as a business gain or loss.
If there is a gain, then the tax rate applicable will be the one that is relevant for the entity and this can go up to 34% for a company. On the other hand if the share is considered as a capital asset then the gains or losses here will be considered as capital gains.
There is a beneficial tax rate applicable for capital gains and this can even be zero for long-term capital gains where the transaction takes place on a recognised stock exchange and securities transaction tax is paid.
What is the importance of the new circular?
The issue of classification of gains from stock transactions into either business income or capital gains has a long history. A lot of judgements have been given on the matter and there was even a draft circular to deal with the issue. This issue affects a lot of investors and hence any change or clarification in this area assumes importance.
Both the investor and the tax authorities can use the guideline given in the new circular in order to arrive at the correct position. It is important to know that an investor in this case will refer to all kinds of investors, be they individuals carrying on activities under their own name to even foreign institutional investors.
What is the most notable thing mentioned in the circular?
One of the most important points that has been mentioned in the circular is that the investor has the option to classify shares into different categories. This means that the investor can have some shares that are in the nature of long-term investments and are hence classified as capital assets.
At the same time they can also have some holdings that are in the nature of trading assets, where the idea is to earn quick capital gains by moving in and out of the company.
This is a change because now a person can have investments falling into both categories, while earlier there was a good chance that if there were some trading assets with the investor then all the holdings would be classified as trading assets and then taxed accordingly.
How will this impact the equity markets?
According to a preliminary analysis of tax experts, this circular will not solve the existing problem faced by various investors because each case would still have to be considered according to the facts present.
Thus the overall question of giving a certain position to a class of investors based on the circular will not be possible. At the same time this is not expected to have a material impact on all those foreign institutional investors who are registered in tax-friendly places like Mauritius.
The direct impact of the move on the equity markets is not expected to be very high because there is nothing new in the circular and the ambiguity regarding the taxation is yet to be resolved.