Shares Income: Should it be classified as Business Income or Capital Gains?
[Query 1] I remember reading in one of your earlier columns that income from shares can be categorized either as business income or capital gains. Which of these options is more profitable? Can tax liability be reduced with proper classification? I have three demat accounts under different family members’ names and would like to use them effectively to minimize tax. Could you please provide some guidance on this? [ravi*******23@gmail.com]
Opinion:
Proper classification of income is important while filing the income tax return. Though CBDT & judiciary has laid down guidelines for determining whether income should be classified as business income or capital gains, there are situations when particular income may meet the criteria of two heads of income. In such cases, strategic planning and proper classification can make a significant difference in the tax liability. Let’s explore this with respect to share transactions.
The correct classification with respect to income from delivery based share transactions as “Income from Business” or “Income from Capital Gain” would depends on several factors, including:
- Volume & Nature of transactions
- Intention & Logic behind investments.
- Holding period of shares
- Investment of own funds or a borrowed fund.
- Other business activities of the Taxpayers, etc.
Generally, if trading in shares is the primary activity of the taxpayer or if there are frequent and numerous transactions aimed at earning quick profits, the income is more likely to be categorized as business income. However, if the taxpayer is holding shares for a longer period as an investment, it may fall under capital gains. Despites specific guidelines by CBDT, there is still room for interpretation, planning, and tax optimization. Here’s a breakdown of the key differences and how tax implications vary under both classifications:
1. TAX RATE:
a] If Capital Gain (Transaction done through stock exchange):
(i) Long Term Capital Gain (LTCG) would be exempt up to ₹1.25 Lakh and amount above ₹ 1.25 Lakh shall be taxable @ 12.50% under section 112A of the Income Tax Act-1961;
(b) Short Term Capital Gain (STCG) would be taxable @ 20% under section 111A.
b] If 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 12.50% to 20% whereas the tax rate would vary from 5% to 30% if the income is considered as Business Income.
2. DEDUCTION TOWARDS EXPENSES:
a) Business Income: If income from shares is classified as business income, one can claim deductions for various expenses like salaries, depreciation, telephone bills, interest, etc.
b) Capital Gains: The only deductions allowed are those directly related to the transfer of shares, such as brokerage, fees, etc.
3. REQUIREMENTS OF AUDIT:
a) Capital Gains:No audit is required, regardless of the transaction, turnover or volume.
b) Business Income: A tax audit is mandatory if in the case of Individual/HUF/ Firm if (i) The turnover exceeds ₹10 crore, or (ii) The turnover is not exceeding ₹ 3 crore, but the income declared is less than 6% of the turnover. For persons other than mentioned above, tax audit would be mandatory if turnover exceeds ₹ 10 Cr.
4. IF LOSS IN SHARES TRANSACTIONS:
a)Capital Gains:
– Long-Term Capital Loss (LTCL) can only be offset against LTCG.
– Short-Term Capital Loss (STCL) can be adjusted against both LTCG and STCG, but not against other income heads.
To simplify, if a taxpayer has business income, say ₹ 30 lakh, and incurs a capital loss of ₹ 50 lakh, the business profit would still be taxable even though there’s an overall net loss. Losses from capital gains cannot offset business profits.
b) Business Income:
If the share transactions are treated as business income, losses can be adjusted against other business incomes. In the same scenario, the ₹ 50 lakh loss can offset the ₹ 30 lakh profit, reducing the taxable amount to ₹ 20 lakh.
5. VALUATION OF THE CLOSING STOCK:
a) Business Income: If shares are classified as business income, taxpayers can value the closing stock at the lower of cost or market price. This provides an opportunity to account for un-booked losses if the market value falls.
b) Capital Gains: For capital gains, there’s no flexibility in valuing shares—closing stock has to be valued at cost.
6. DEDUCTION UNDER CHAPTER VI-A (i.e., Section 80C, 80G, 80D etc):
a) Capital Gains: Deductions under Section 80C (LIC, PPF, NSC), Section 80G (donations), and Section 80D (mediclaim), etc are not allowed against capital gains income.
b) Business Income: These deductions are allowed if the taxpayer in case the taxpayers opts for the Old Tax Regime (OTR).
7. BENEFIT OF EXEMPTION FROM LTCG UP TO ₹1.25 LAKH:
a) Capital Gains: LTCG from shares enjoys a blanket exemption of ₹1.25 lakh, with tax applicable at 12.50% on amounts above this threshold.
b) Business Income: No such exemption applies.
So, Which is Better?
The choice of classification between business income and capital gains depends on several factors, including the nature and frequency of the share transactions, overall income, and future financial plans. Careful planning and considering both current and future years’ income and investments are keys to optimizing the tax outcomes. There’s no one-size-fits-all answer. Above analysis may guide the taxpayers in making informed decisions regarding the classification of the share transactions for optimal tax planning.
[Views expressed are the personal view of the author. Readers are advised to seek professional advice before taking any decisions. Readers may forward their feedback & queries at nareshjakhotia@gmail.com. Other articles & response to queries are available at www.theTAXtalk.com]
