Shares Transactions & the Dilemma of Business Income vs. Capital Gain

Two persons with the same income can have different tax liability. The proper classification & categorization of income plays a vital role in determining the tax liability of the person. Though there are pre-determined set rules for classifying the income under one head or other head of income, there are chances when particular income may simultaneously be fulfilling the criteria of two heads of income. Making proper planning and classification in such a scenario may b e crucial in such a scenario.

One such instance is with regard to the transactions in shares. Income from delivery based share transactions which may either be “Income from Business” or “Income from Capital Gain”. The correct classification depends upon various parameters & criteria. The following factors are highly relevant for the correct classification of such incomes:

1. Volume & Nature of transactions

2. Intention & Logic behind investments.

3. Holding period of shares

4. Investment of own funds or a borrowed fund.

5. Other business activities of the Taxpayers, etc.

Income from Share transactions would be categorized as business income if there are numerous & frequent transactions or if it is the main activity of the taxpayer or if trading is done with a view to earn instant profit, etc. Even though the Courts & CBDT have laid down the principles to differentiate between Business income & Capital Gain income, still there is a room for planning & classification. One may find it interesting to know how the tax implications vary for such income if it is classified as “Business Income” vis a vis “Capital Gain Income”. The same is discussed as under:

1. TAX RATE:
   a] If transaction is treated as Capital Gain:
    If the share transaction is considered under the head “Capital Gain” & if the sale transaction is done through stock exchange then

   (i) Long Term Capital Gain (LTCG) would be exempt up to Rs. 1 Lakh and amount above Rs. 1 Lakh shall be taxable @ 10% U/s 112A;

   (b) Short Term Capital Gain (STCG) would be taxable @ 15%.

   b] If the transaction is treated as Business Income:
   If treated as business income then the entire income would be taxable like other regular income of the taxpayer and tax liability would be in accordance with the applicable tax slab of the taxpayers.

   
   On a standalone basis, one may see that the tax rate for capital gain income would be in the range of 10% to 15% whereas the tax rate would vary from 5% to 30% if the income is considered as Business Income.

2. DEDUCTION TOWARDS EXPENSES:
   If the income from share transactions is treated as Business Income then one can claim deduction towards expenses like salary, depreciation, telephone expenses, interest, etc.  However, if such income is offered for taxation as capital gain income then no such deduction shall be available. Only deduction in case of capital gain expenses would be expenses incurred in connection with the transfer (like brokerage).

3. REQUIREMENTS OF AUDIT:
   Irrespective of the amount of sale/turnover, audit would not be compulsory if the income from share transactions is considered as “Capital Gain”. However, if the share transactions are considered as business then tax audit would be mandatory for

   (i) individual/HUF/Firm if (a) the turnover exceeds Rs. 10 Crore or (b) if the turnover is not exceeding Rs. 2 Crore & income offered for taxation is less than 6% of turnover.

   (ii) Other than persons covered by (i) above, if the turnover exceeds Rs. 10 Crore.

4. IF LOSS IN SHARES TRANSACTIONS:
   Tax impact varies significantly if there is a loss in the share transactions. If the income from share transactions is considered under the head “Capital Gain” and if there is a loss then taxpayers may note that

   a) Long term Capital Loss (LTCL) is allowed to be adjusted against LTCG only. Such LTCL cannot be adjusted against STCG or Other heads of income of the taxpayers.

   b) Short Term Capital Loss (STCL) is allowed to be adjusted against STCG or LTCG. Such STCL is not allowed to be adjusted against other heads of incomes of the taxpayers.

   In short, if a taxpayer has incurred loss in shares transactions of say Rs. 50 Lakh & have profit in the business of say Rs. 30 Lakh then such taxpayer would be required to pay the tax on business income of Rs. 30 Lakh even though during the year, there is a net loss of Rs. 20 Lakh to the taxpayers. Seamless adjustment of loss against profit is not possible in case of loss under the head “Capital Gain”.

   If the income from share transactions are considered under the head “Business Income” then the loss from such transactions can very well be adjusted against all other business incomes of the taxpayers as well against other LTCG / STCG. In short, if a taxpayer has incurred loss in shares transactions of say Rs. 50 Lakh (which is considered under the head Business Income) & have profit in the other business of say Rs. 30 Lakh then such taxpayers would be required to pay the tax on income of Rs. 20 Lakh only as business income from one business can be adjusted against business income of another business.

5. VALUATION OF THE CLOSING STOCK:
   If the share transactions is considered as Business Income then the taxpayers have a choice to decide the mode of valuing the closing stock i.e., taxpayers may choose to value the closing stock at cost or market  price whichever is lower. In short, the loss due to fall in the value of the shares may be available if the income is considered under the head “Business Income”.

   No such benefit of lower valuation is admissible in case the share transaction if it is treated as “capital gain” income. In such a case, closing stock of shares has to be taken at the cost value only.

6. DEDUCTION UNDER CHAPTER VI-A (i.e., Section 80C, 80G, 80D etc):
   Deduction under section 80C (LIC, PPF, NSC etc), U/s 80G (Donation), Under Section 80D (Mediclaim) is not admissible against income which is chargeable to tax under the head “Income from Capital Gain” whereas there is no such restriction against business income. In short, if the income from shares transactions is considered as “Business Income”, deduction under Chapter VI-A would also be admissible.

7. BENEFIT OF EXEMPTION FROM LTCG UP TO Rs. 1 LAKH:
   If the income from shares transaction is taxable as “Income from Capital Gain” then the taxpayer is eligible for blanket exemption of Rs. 1 Lakh. Tax @ 10% is payable on an amount exceeding Rs. 1 Lakh. There is no such blanket exemption if the income from share transactions is offered for taxation under the head “Business Income”.

The question arises, which heads of income is better if the taxpayers share transactions suitably fulfills the criteria of both the heads of income?

One size doesn’t fit all. The reply cannot be given in isolation. The answer would also depend upon not only on the basis of current year income but also on the basis of its subsequent year’s vision. The tax implications vary from person to person and there is enough scope of tax planning while doing transactions in the share market. Above discussion may guide the taxpayer for tax optimization.

 
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