New norms for market players from June 1

The finance ministry now proposes to bring in a new set of guidelines from June 1 that will allow income tax officers to minutely examine the classification for income from the stock market by specifying new assessment criteria.

At present, market participants sometimes classify their stock market gains as trading or investment income, depending on their convenience.

For example, market players can show their stock market income as trading income and offset it against their other business income to avoid paying the capital gains tax and reduce their tax on business income.

According to the Income Tax Act, while losses of one business can be offset against other income, capital gains cannot be used to offset business losses.

With the new norms, the tax department has attempted to plug this loophole by asking that the assesses give detailed information on the nature and scale of their activities to establish whether the income has been correctly classified as trading or investment income.

The Central Board of Direct Taxes has put out 15 new criteria to establish the nature of income and put them in public domain and has sought comments by May 25. Once approved, these draft criteria will help an assessment officer to determine whether the income declared by a market participant is to be taxed as an investment or as business income.

The criteria include whether the securities are listed or unlisted, the holding period for the securities, the time devoted to the activity and the total number of stocks dealt in. Assessing officers will be advised to treat no single criterion as "decisive" and to consider the total effect of all criteria to determine the nature of activity.

"These guidelines have been prompted by the large number of litigation where assesses have challenged tax officers' assessment of their income as business related or capital gains," a finance ministry official said, adding that countries like the US and the UK have these norms in place.

The board had last issued instructions in 1989 laying down certain tests to distinguish between shares held as stock-in-trade and shares held as investment. It now proposes to supplement these instructions further.

"These tests are applicable to all "" individuals and companies to determine whether the earnings from investment in securities are to be treated as short-term capital gain, long-term capital gain or as business income," Kumar added.

Some of the other criteria proposed by the CBDT include whether the purchase and sale of securities were allied to an assesses usual trade or business, incidental to it or whether it was an occasional independent activity.

Another criterion is whether the purchase is made solely with the intention of resale at a profit, for long-term appreciation or for earning dividends and interest.

Other criteria include whether the scale of activity is substantial, whether transactions are entered into continuously and regularly during an assessment year, whether purchases are made out of own funds or borrowings, the ratio of sales to purchases and holding, and the characterisation of securities in the books of account and in balance sheet as stock-in-trade or investments.