Following article may help to explain whether buying selling shares on a fairly regular basis comes with the meaning of business or investment
Determining tax liability on share trading
Gautam Nayak
15 Dec 2000
Of late, it is common to find persons who actively trade on the stock markets, with frequent purchases and sales. In such cases, the tax liability depends upon whether the person is carrying on an activity of investing or is carrying on a business of share trading. How does one determine this?
Merely because the person states that he is investing or carrying on a share trading business, or is accounting for it as such, does not determine the nature of the transactions. There are many court cases with decisions on how to determine when an activity is business or merely an investment. The thrust of all these decisions is that no single factor gives you an answer to this question - the overall effect of several factors has to be considered, which will determine the issue. What are these factors that help you decide whether a business is being carried on or not?
From a reading of the court cases, and applying them to transactions in shares, these would be :
The motive for the original purchase as perceived at the time of sale
If at the time of sale, it is seen that the original motive of purchase was to earn a quick profit, this would support the presumption that the transactions represent a business.
The period of holding of the shares
The shorter the period, the greater the presumption that the transactions are in the nature of a business. One indicator of this is the definition of long term capital asset vis--vis shares - any shares held for more than 12 months are regarded as long term capital assets. Generally, shares bought with the intention of holding them for more than 12 months would be an indicator that the transaction was intended as an investment.
The frequency of sale of shares
The more frequent the transactions, the greater the presumption that it amounts to a business.
The circumstances responsible for the sale of shares
If the sale is necessitated by the need for funds for other personal purposes, such as for payment of taxes or family functions, the presumption would be that it is merely a realisation of investments.
The presence of a clearly discernible motive for the purchase of the shares
If the purchase was necessitated not merely by motive of profit, but was undertaken on account of other motives, generally, the transaction would be regarded as investment activity. For instance, where the purchase of shares was with an intention to acquire controlling interest in the company, such purchase of shares would be in the nature of an investment. Similarly, the shares acquired by the promoter of a company are generally in the nature of investments.
The relation of the share transactions to the normal business of the assessee
In the case of a sharebroker or an underwriter, acquisition of shares would generally be regarded as an extension of his sharebroking or underwriting business. On the other hand, shares acquired by a professional such as a chartered accountant, lawyer or doctor would generally be considered to be investments.
The treatment of the shares and profit or loss on their sale in the accounts of the assessee
The treatment of the shares as stock-in-trade by the assessee would be one of the indicators of his intention to treat it as a business.
The source of funds out of which the shares were acquired - borrowed or own Investment out of borrowed funds would generally support the presumption of existence of a business activity. On the other hand, acquisition of shares by liquidation of another investment would support the presumption that the transaction is one of change of investment from one form to another.
In the case of a company, the existence of an objects clause permitting it to trade in shares
Since a company cannot carry on any business unless permitted by the objects clause of its Memorandum of Association, its acquisition of shares would normally not be regarded as a business activity in the absence of an objects clause permitting share trading. Since a partnership firm can carry on any activity mutually agreed upon by its partners, the absence of a clause in the partnership deed to carry on the business of share trading would not make any difference.
The manner of acquisition of the shares
Where the shares were not purchased voluntarily but were inherited or received as a gift, the presumption would generally be that the sale of such shares is a capital gain. Similarly, shares acquired from the primary market for long term holding would generally support the presumption of an investment activity, while acquisition of shares from the secondary market could indicate either investment or business activity.
The infrastructure employed for the share transactions
If the assessee employs people to assist him in his share activities, such as analysts, dealing assistants, or acquires various assets such as computer hardware and software, etc. for this purpose, it indicates an organized activity, supporting the presumption of a business. On the other hand, investing through a discretionary portfolio manager is indicative of an investment activity, since the investor does not have to be involved with the activity of investment on a regular basis, but is merely concerned with the rate of return on his funds employed.
Marketability of the shares
If the shares acquired are not readily marketable, generally the presumption would be that they are held as investments. The very purpose of acquisition of shares held as stock-in-trade is to make a quick profit, and the acquisition of non-marketable shares is not consistent with such a purpose.
