Capital gain or business income: classification of income from sale of securities

“Whether the ITAT  was right in holding that the gains from sale and purchase of various securities should be treated as long term capital gains or short term capital gains and not business income?”

CIT vs VINAY MITTAL (HC)

The assessee is an individual and an salaried employee for the A.Y 2007-08 he declared total income of Rs.  6,00,62,080/- as LTCG of  Rs. 2,59,52,165/- which was claimed as exempt and this included short term capital gains of  Rs. 5,53,32,591/- from sale and purchase of various securities.

The AO treated the income from the sale of the shares as business income and made additions accordingly. On appeal before CIT(A) and thereafter before ITAT deleted the additions made by the AO.

On appeal before Hon`ble High Court revenue accepted the assessee claim to treat the long term capital gains as exempt, however revenue disputed the treatment of lower rate of tax on the short  term capital gains.

Before Hon`ble High Court Assessee produced a chart giving details of the purchase and sale of the shares transactions which are subject matter of the A.Y 2007-08 that showed that the shares reported in his return as long-term capital assets were held for periods ranging between 1 year and 5 years and further, the shares reported in his return as short-term capital assets were held for periods ranging between 2 months and 11 months.

During the course of hearing ld. counsel for the Revenue relied on the Instruction No. 4/2007 dated 15 June 2007 issued by CDBT which in turn relied on several judicial precedents reported in CIT v. Associated Industrial Development Co. (P) Ltd. [1971] 82 ITR 586 (SC), CIT v. H. Holck Larsen [1986] 160 ITR 67 (SC), Fidelity Northstar Fund and Ors v. Unknown [2007] 288 ITR 641 (AAR) and advanced the following arguments to treat the sale of shares held for less than a year as business income. The Ld. DR also contented that the quantum of profit made from the sale was significantly higher than the dividend earned by the assessee. This indicated that the main purpose of the assessee was to earn profit. Since dealing in shares involves an element of uncertainty, the sale and purchase activities were in the nature of trade.

The Ld. DR also stated that the frequent transactions, the substantial scale of activities and the ratio of sales to purchase indicated that the assessee was in the business of buying and selling shares.

The Hon`ble High Court, observed that the assessee had salary income and also had maintained two separate portfolios i.e. investment portfolio and trading portfolio. The shares which were subject matter of short term capital gains formed part of the investment portfolio of the assessee. Although the number of shares sold was high, the numbers of transactions were few. Further, the period of holding was not insignificant or small, which indicated that the purchase of shares was in the nature of an investment. The ITAT had also previously determined that the assessee had earned substantial dividend income in the past years.

Hon`ble high court didn`t agree with the Revenue arguments that factors such as the risks inherent in the share purchase activity, the quantum of profits or the ratio of purchase to sale would influence the determination of the nature of income was There are inherent risks in any share related activity and also observed that in the year in which a assessee sells his investments, the ratio will always be in favour of sales and the frequency of transactions may therefore be higher. These cannot be concluding factors.

Relying on judgment reported in (2006) 193 TAXATION 581 (GUJ) upheld the ruling of the ITAT  that the gains arising from the sale of shares were in the nature of ‘capital gains’.