The debate as to whether income from sale of shares constitutes business income or capital gains rages on. Two contrasting decisions by the Income Tax Appellate Tribunal leaves more questions to be answered

A constant bone of contention between taxpayers and tax authorities is regarding the classification of income from sale of shares. On the one hand, tax authorities seek to treat such income as 'business income' while on the other hand, taxpayers demand that it be classified under 'capital gains'. The Mumbai Bench of the Income Tax Appellate Tribunal recently gave two contrasting decisions on this issue-one treating the gain as capital gains and the other treating it as business income. It seems this debate will continue to rage on.

In the first case, the taxpayer contended that the shares were held for the purpose of earning dividend income and that he was not trading in equity shares. Around 83% of the total gain was in the nature of long-term capital gain. The period of holding indicated that the shares were held for the long term. Also, it was found that there was no opening and closing stock of shares. The shares purchased were shown as investments in the books of accounts and all transactions were delivery-based.

The tax authority's contentions were that the taxpayer was regularly buying and selling shares and had professional knowledge of the capital market. The period of holding of shares and entries in the books of account are not solely determinative to contend that the shares are held as investments. Simply because delivery of the shares is taken or substantial amount of dividend is received, the transactions would not constitute investments. Where the taxpayer has abnormal short-term capital gains as compared to the long-term capital gains, the transactions in shares cannot be considered as investments.

In the second case, the taxpayer only had short-term gains, where the dividend income was substantially lower. Majority of the transactions were delivery-based. The taxpayer contended that even though the dividend income was lower than the capital gains, it should be considered as a determinative factor since dividend is received only when the concerned company declares the same. In this case too, there was no opening and closing stock of shares and the shares purchased were shown as investments in the books of accounts.

The tribunal, considering both the cases, concluded that there is no fixed formula to determine whether the activity of the taxpayer is to be regarded as business activity or investment activity. No single factor is determinative to conclude whether the purchase of shares is an investment activity or business activity. All the relevant factors should be considered in totality to determine the nature of activities. It further decided that:

" Where the taxpayer never claimed that he was trading in shares, there is no opening or closing stock of shares and the taxpayer has treated the transactions as investments in the books of account, the purchases of shares can be considered as investments.

" Where majority of the gain is a long-term gain, the activity is not a business activity but an investment activity.

A CBDT (Central Board of Direct Taxes) circular has also laid down that the purchase and sale of shares with the motive of earning a profit would result in the transaction being in the nature of trade or adventure in the nature of trade, but where the object of the investment in shares of a company is to derive income by way of dividend etc. then the profits accruing by change in such investment will yield capital gain and not revenue receipt. The circular as well as the tribunal acknowledged the fact that it is possible for a taxpayer to have two separate portfolios-one for business purposes and one for investment purposes.

After taking into account the facts in each case in totality, the tribunal held that the activity in the first case is an investment activity whereas the activity in the second is a business activity. The above cases indicate that there is a very fine line between transactions in the nature of business and investments. Since no single factor is determinative of tax treatment, the tax authorities could still argue that the taxpayer is holding shares for business purpose even when they are shown as investments.

A few of these issues should be resolved once the new Direct Tax Code is implemented.