Transacting in stocks in the capacity of a trader or an investor or both, the difference is important, since investor tax liability will depend on it. Unfortunately, the Income Tax Act has not defined the terms ‘trader’ or ‘investor’. With the CBDT issuing a circular on this issue, it will help clear the air over the tax status while investing in shares. In this article we plan to discuss what the circular states and tax implications under trading and investing.
If one is an investor, then he has to pay capital gains tax on investor profits earned from shares. Gains on stocks held for more than 12 months are known as Long Term Capital Gains (LTCG) which attract zero tax at present. For Short Term Capital Gains (STCG), i.e. shares held for less than a year, investor is liable to pay Capital Gains Tax at the rate of 10 per cent (plus surcharge and education cess, if applicable).
The Central Board of Direct Taxes (CBDT) has issued a circular recently, stating that the tax assessing officer, based on various parameters, will decide if investor buying and selling of stocks falls under ‘trading’ or ‘investing’ and investor tax liability will differ depending on this status.
If an individual is a trader, then his entire income from sale of shares is liable to be taxed as a normal business income and the individual is required to pay tax at the income tax rates applicable to him.
In any case irrespective of whether individual is a trader or an investor, he is required to pay STT on the sale of shares. The only advantage accruing to a trader is that he is entitled to a rebate under Section 88E of the Act, based on a prescribed formula.
Recently, the Central Board of Direct Taxes (CBDT) issued a circular entailing certain broad parameters /instructions, for the guidance of tax payers and for tax officers, to decide whether the income from shares would be classified as business income or capital gains.
As per the circular, the following factors merit consideration when deciding whether one is a trader or an investor:
* Objective versus Motive – Whether individual transact in order to earn dividend or to earn profit. The former implies investing while the latter involves comparatively more trading activity.
* The intention of the tax payer.
* The manner in which books and records are maintained (whether shown as a stock-in trade [business income] or investment [capital gains]).
* The period of holding of the shares.
* The frequency of transactions.
To find out the ratio between the purchase and sale:
* The percentage of delivery based transactions to non-delivery based transactions.
* The sources from which the investment is made, whether borrowed funds or otherwise.
Individual can be a trader as well as an investor:
The circular also states that it is possible for a tax payer to have two portfolios, i.e., an investment portfolio, which comprises of shares to be treated as capital assets and a trading portfolio comprising of stock-in-trade. In order words, individual can have income under the head ‘capital gains’ as well as business income.
Further, the CBDT also states that if individual purchase and sell shares with the motive of earning a profit, then it will result in the transaction being deemed trading; but if the investment in shares is done with a motive to earn income by way of dividend, then the profits arising from such sale of shares will be capital gains and not business profits.
Assessing officers to have the final say:
The tax assessing officers will have the last word on investor tax status as investor or a trader. They have been instructed that their decision should not be based on one single principle but the impact of all the above principles should determine whether the shares held by an individual are to be classified as an investment or stock-in-trade.
The circular gives guidance on the direct investment in securities by the investors, where the intention of the investor has to be derived from his own activities; however, it has not answered one crucial question – What happens if a particular individual is an investor in certain Portfolio Management Schemes (PMS)? In PMS, the main objective is to earn capital appreciation without any actual physical participation by the investor.
The onus is on individual to establish investor intention correctly, as a trader or an investor. Individual must not forget to provide proper documentary evidence while paying investor taxes, since this will help get rid of the ambiguity.