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Tax circular on shares does not provide any objective guidelines
July, 03rd 2007

The Central Board of Direct Taxes (CBDT) recently released a circular containing a set of guiding principles to make a distinction between shares held as stock-in-trade and those held as investment. But the circular appears to fall short of its objective, said Mr Hiresh Wadhwani, Tax Partner of Ernst & Young and Leader for its Financial Services Tax practice in India.

Speaking to Business Line on the why such a circular has been drafted and where it falls short, he said: Conflicting rulings given by the Authority for Advance Ruling (AAR) on the income characterisation in the hands of FIIs, and the growing debate on this issue, are likely to have prompted the CBDT to release such a circular and attempt to clarify the same.

Capital asset

According to him, determining whether a particular investment is a capital asset (and taxed under the head capital gains) or stock-in-trade (and taxed under the head business profits) has always been a vexed issue.

There have been several judicial precedents on this subject in the past, though no judicial precedent gives clear guidance on the subject.

He added that the judicial decisions have substantially relied on the facts of the particular case being considered and the distinction between the two types of transactions would be largely driven by the facts and circumstances of each case.

FIIs realise gains or losses on investments made in the ordinary course of business, as a result of which the issue of whether the gain or loss should be assessed as business income or as capital gains continues to remain a bone of contention.

While the characterisation of FII income from purchase and sale of Indian securities has never been entirely free from doubt, in practice most FIIs have been filing their returns in India on the basis that their holdings are capital assets.

And the revenue authorities have also, for the most part, accepted this position, he said.

The latest circular supplements an earlier internal instruction issued by the CBDT in 1989 and provides guidance in determining the characterisation of the gains on securities transactions on the basis of valuation of the securities, magnitude of purchases and sales and the ratio between purchases and sales and the holding period and motive of acquisition.

Mr Wadhwani said that the circular does not provide any objective guidelines to the assessing officers but is merely a summary of the principles laid down in several cases dealing with characterisation of income, including the ruling issued by the AAR in the case of Fidelity Northstar Fund vs DIT.


In the absence of specific guidelines, it is possible that different assessing officers may draw different conclusions from similar fact patterns, he added.

The circular does not seek to provide the necessary clarity as regards the characterisation of gains from securities transactions, which is long overdue.

Mr Gurpreet Sidana, Head (Internet Trading), Religare Securities, said that from the perspective of the retail investor, there has always been a certain level of ambiguity on the issue of treatment of the income generated from stock investments.

Most taxpayers try to exploit this ambiguity and prefer to treat all investments as capital assets. Not surprisingly, the assessing officer would like to assess all income involving the slightest of trading as trading income charge it under business income.

He added that there is no ambiguity with regard to transactions in future and options and intra-day transactions in the capital market segment, as these are trading transactions in nature.

It is only in the case of delivery transactions resulting in shares being purchased by investor where doubts have lingered on nature and treatment of assets for different investors.

The latest circular has also clarified that it is possible for a taxpayer to have two portfolios - capital assets and trading assets.

D. Murali
C. Ramesh

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