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How to tax your stock portfolio- inventory or investment?

Over the years, courts have laid down different parameters to resolve the dispute and following the judgments of various courts, the CBDT has also issued circulars from time to time.

March 10, 2016 / 03:48 PM IST

Kamal PoddarTax authorities have now allowed investors the choice to either treat their equity stocks as stock-in-trade or as investments to clearly differentiate between business income generated from trading in shares or income from capital gains, as per the recent notification issued by Central Board of Direct Taxes.The change has compelled the investor to take stand in his/her return of income to offer profit/loss in any one head of income, without the option to change it in subsequent years. However, if investor is incurring losses on sale of securities on regular basis and earning profit in other businesses, he/she can set off the said loss on sale of listed security against other business income.Alternatively, for investors who would like to have a mix of both stock-in-trade and investments will have to maintain separate demat accounts and also provide different treatment in the books of accounts. Usually such option is availed by investor whose main business is 'sale/purchase of securities' and surplus income is invested without a trading motive.According to the CBDT circular dated February 16, “the stand taken (by investors) shall continue to all the subsequent assessment years.” In other words, investors once executing the choice in terms of treating their equity shares as stock in trade – for trading purpose or as income from capital gains will not be allowed to deviate from their commitment for tax purposes.As per the circular, “where the tax payer itself opt to treat them as stock-in-trade, irrespective of the period of holding the shares, the income arising from such shares would be treated as business income.In respect of shares held for a period of more than 12 months, assesse can treat them as income from capital gains.So far, prior to the CBDT notification, the reason for far ranging disputes have primarily risen due to absence of specific guidelines in the Income Tax Act relating to classification of an investment as a capital asset or as stock in trade, leaving a lot to the discretion of the assessing officer to interpret. This apart, the wide difference in tax rate between the modes of treatment with long term capital gain at zero, short term at 15% and business income at 30% has been the bone of contention for several disputes.Over the years, courts have laid down different parameters to resolve the dispute and following the judgments of various courts, the CBDT has also issued circulars from time to time. These include frequency of transactions of purchase and sale, if found substantial were considered as business income. If the holding period of security was for shorter period, it was considered as business income. Business income was also determined based on the impact given in books of accounts if the same was shown as Stock in trade and not as investment while motive of earning with the intention of earnings trading profit was considered as business income in the past.Let us look at some examples in this context. Mr.A is in the business of retail trading of medicines and has incurred a loss of Rs.5,00,000 in his business activity. He also trades in shares at an average of 1-2 transaction a month with a holding period of 3-5 month and earns a profit of Rs 300,000. In such cases, Mr A is now well within his right to set off the loss against other business income. Prior to recent CBDT notification, tax authorities could have levied 15% tax as income from capital gain, which will not be possible any more.However, in other scenario, where Mr A is earning profit in business as well as security trading and paying taxes @30% slab rate, he may opt to offer trading in security as income from capital gain and pay tax @15% but tax authority may defer. The CBDT circular has given the option to offer transaction as income from capital gain only if it is held for more than 12 months.To conclude, investors can take necessary precautions to reduce the likely disputes by not indulging in flip-flops. Author is Managing Director of Choice Group