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Business
Income Or Capital Gains - What's The Difference? New
Draft Instructions By The Indian Tax Department Attempts To Clarify
The
Central Board of Direct Taxes ("CBDT") proposes to issue
supplementary Instructions to Instructions no.1827 dated 31.08.1989,
which are guidelines to an Assessing Officer ("AO"), in
determining whether a person is a trader in stocks
or an investor in stocks. The CBDT has invited comments
of all stakeholders by May 25 before issuing the instructions.
The
distinction as to whether the income arising from sale of shares
would be capital gains or business income would determine the
taxability of the investor. If it is capital gains, then the long
term capital gains is exempt under the Income Tax Act, 1961("ITA")
provided the applicable Securities Transactions Tax ("STT")
is paid by the buyer and the seller. The short term capital gains
tax on listed securities on which applicable STT is paid is 10%,
(increased by the applicable surcharge and education cess). However,
if the income is treated as business income, then, the same would
be subject to tax at the rate of 41.82% in the hands of a foreign
investor or at the rate of 33.66% in the hands of a resident investor.
It
is stated that the draft instructions are supplementary to the
instruction no. 1827 issued by the CBDT on August 31, 1989, to
provide further guidelines in determining whether a person is
a trader in stocks or an investor. The draft instructions enumerate
15 criteria, with an advice to the tax officer that the total
effect of all these criteria should be considered to determine
the nature of activity and hence the nature of the income. These
criteria are as follows:
-
Whether the purchase and sale of securities was allied to his
usual trade or business / was incidental to it or was an occasional
independent activity.
- Whether
the purchase is made solely with the intention of resale at
a profit or for long term appreciation and/or for earning dividends
and interest.
- Whether
scale of activity is substantial.
- Whether
transactions were entered into continuously and regularly during
the assessment year.
- Whether
purchases are made out of own funds or borrowings.
- The stated
objects in the Memorandum and Articles of Association in the
case of a corporate assessee.
- Typical
holding period for securities bought and sold.
- Ratio
of sales to purchases and holding.
- The time
devoted to the activity and the extent to which it is the means
of livelihood.
- The characterization
of securities in the books of account and in balance sheet as
stock in trade or investments.
- Whether
the securities purchased or sold are listed or unlisted.
- Whether
investment is in sister/related concerns or independent companies.
- Whether
transaction is by promoters of the company.
- Total
number of stocks dealt in.
- Whether
money has been paid or received or whether these are only book
entries.
Over
the years, the Indian courts have discussed general principles
while determining the character of income in such situations.
This list attempts to compile all those principles. However, it
is not clear how does a criteria such as whether the transaction
is by promoters of the company would really affect the determination.
Further, it would be useful to prescribe weightage to each of
the criteria and to clarify how many minimum criteria need to
be satisfied for making the determination. This would make the
determination more objective and transparent rather than leave
it to the discretion of the tax officer, thereby rendering it
open to litigation. That would defeat the very purpose of the
instructions that they seek to achieve.
Though
the intention is to provide clarity especially with respect to
determining the taxability of foreign investors, such as Foreign
Institutional Investors, Private Equity Funds and other Offshore
Funds, the draft instructions would create more onerous tax burden
on domestic small investors, especially pensioners, housewives,
retired persons, who engage in such investment activity as a means
of enhancing their meager income. So far such investors would
have only been subject to 10% tax on short term capital gains.
Now, if they were regarded as traders, they would be taxed at
the rate of 33.66%.
As
regards foreign investors, those coming from treaty countries
would be taxed on business income only if they have a permanent
establishment ("PE") in India and the income is attributable to
the PE. In case the income is capital gains, to the extent that
it is exempt under the ITA, the foreign investors will also not
be taxed in India. Those investors who are residents of jurisdictions
such as Mauritius, Singapore or Cyprus and eligible to the beneficial
treaty provisions, they would not be taxed even on the short term
capital gains in India, if the income were to be considered capital
gains and they do not have a PE in India. Only the foreign investors
who are not protected by a tax treaty could have tax implications
in India if their income is regarded as business income since
they could be considered to have a business connection in India
under the ITA and the income would then be taxed at the rate of
41.82% as opposed to 10% in case of the short term capital gains.
Rulings given in cases such as Fidelity Investment Trust, TCW-ICICI
and Morgan Stanley have examined this issue in detail and have
ruled that the income would be business income based on the factual
position of each applicant. The present instructions appear to
indicate that such income would be treated as business income
and not capital gains, which means that the litigious forums for
such foreign investors who do not have a PE in India, would be
passé.
The
CBDT has invited comments from public before finalizing the above
instructions. This indeed is very commendable and indicates the
importance that the CBDT gives to the consultative process and
to the concerns of the stakeholders .
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