During the current foreclosure, a large number of individual investors have become active online in the stock market, buying and selling stocks and, sometimes, derivatives, from the comfort of their own homes. This was reflected in the large number of individual brokerage and demat accounts opened in recent months. Many of these investors make profits at small price increases, typically hold the stocks for a few days or weeks, and change their portfolios significantly. Many of them may have the impression that the short-term capital gains (STCG) they realize will be taxed at a preferential rate of 15%. This may not necessarily be the case, however.
There is only STCG for transactions in stock exchanges or equity oriented mutual funds which benefit from the preferential tax rate of 15%. Gains on derivative transactions are taxed at the normal individual bracket rate, in most cases 30% plus the applicable surcharge and tax.
In addition, to benefit from this preferential tax rate, income must be taxable under “capital gains”. If the shares are considered to be goodwill, the income from the sale of those shares would be business income, which would be taxable at the normal tranche rate. The mere classification by the taxpayer as capital gains does not necessarily mean that they will only be taxed as capital gains.
A few years ago, the question of whether stock transactions constituted a business or an investment activity was the subject of significant litigation, the tax authorities seeking to tax all capital gains (which the shares have been held for more than a year or less) as business income. The controversy subsided considerably after the Central Commission on Direct Taxes (CBDT) clarified that if a taxpayer treated their gains from shares held for more than a year as long-term capital gains (LTCG), it then had to be taxed as LTCG. It was only if these shares were classified by the taxpayer himself as trading shares that the gains made on the sale of those shares held for more than one year could be taxed as business income. Unfortunately, the clarification does not apply to stocks held for one year or less, and litigation continues over how gains in respect of those stocks are taxed – whether as 15% STCG or as business income at the normal slab rate.
Fortunately, besides the CBDT circulars which laid down guiding principles, litigation in recent years has seen a number of high court and tribunal rulings, setting the guiding principles for determining whether income should be classified as capital gains. or business income. In addition to the classification of the shares by the taxpayer as business or investment shares, other factors to consider include the period of ownership of the shares. the frequency of transactions, the volume of transactions in relation to the total portfolio, whether the shares were acquired with borrowed funds, whether the same shares were bought and sold with regularity, the tax treatment of these gains in previous years, the occupation of the taxpayer, the time devoted to this activity, the infrastructure used for this activity, etc. These factors and several others must be taken into account to assess the real intention of the taxpayer, whether it is to make a return on his funds over a longer period (therefore taxable as capital gains), or to make a profit. fast by taking advantage of short-term stock price movements (therefore taxable as business income).
In the case of derivatives, unless transactions in derivatives are very infrequent and occasional or if the trading was carried out with the intention of hedging the physical holding of shares, the profit would normally be taxed as business income. at normal tax rates, because the intention in most cases is to profit from short-term price fluctuations.
Being classified as a business for tax purposes has its own tax compliance implications. If the turnover is less than ??2 crore and profits are less than 6% of turnover, account books must be kept and a tax audit is required, unless the taxpayer declares business income at 6% of turnover under the flat-rate tax regime. In cases not falling under the flat-rate tax regime, accounting books must be kept. In addition, a tax audit is required if the turnover exceeds ??1 crore. If a tax audit is required for one year, the withholding tax provisions apply to the individual taxpayer from the following year.
Each investor should therefore review their stock market transactions and, based on their facts, take a call to find out whether it is a business or not. He must pay his taxes accordingly and file his income tax returns, after complying with the required requirements, on the basis of his perception of his transactions in accordance with the applicable law.
Gautam Nayak is a chartered accountant
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