Be consistent in the tax treatment you ask for

A recent CBDT circular will go a long way towards reducing litigation in the matter of how gains from sale of securities are to be treated

On February 29, 2016, the Central Board of Direct Taxes (CBDT) issued a circular (no. 6 of 2016) on how income from sale of securities is to be treated. Hereafter, if the assessee wants the income to be treated as business income, the assessing officer (AO) must accept it as such, irrespective of holding period. When securities are sold through the stock exchanges after being held for more than 12 months and the assessee wants the gains to be treated as capital gains, the AO should again not dispute this. The circular also says that once an assessee has chosen a certain mode of tax treatment, he can’t change it in subsequent years.   

       

First, let us understand why so many disputes arise on the subject of treatment of gains from sale of securities as capital gains versus business income. There are two key reasons. 

One, the Income Tax Act does not contain specific guidelines on how to classify an investment—as capital asset or as stock-in-trade. A lot is left to case-by-case interpretation. 

Two, there is a wide difference in tax rate between the two modes of treatment, which provides incentive for litigation. If income is classified as long-term capital gain, the applicable tax rate is zero. On short-term capital gain (for securities held for less than a year) the rate is 15% (plus cess and surcharge). 

On the other hand, if the AO can prove that the gain is business income, he can impose a tax rate of 30% (plus surcharge and cess). 

The latest circular is expected to bring down the number of litigations. “This is a serious statement from the government towards its commitment to reduce litigation,” said Suresh Surana, founder, RSM Astute Consulting Group. 

However, there is still scope for AOs to dispute the treatment of short-term gains. High-frequency traders, day traders and others who churn their portfolios a lot may still find themselves embroiled in disputes. 

Investors can take a few precautions to reduce the possibility of disputes. 

One way is to invest in equities for the long term (more than a year), which we always recommend to our readers. 

Second, as Rajesh H Gandhi, partner, Deloitte Haskins & Sells suggests, “There should be no disparity between how an income is treated in your books and the tax treatment you ask for it.” In other words, don’t indulge in opportunistic flip-flops, asking for the income to be treated as capital gain when you make gains (so you pay zero tax) and as business income when you make losses (so you can offset the loss against business gains, or carry them forward). 

Three, if you have invested your own funds, have documentary proof to back up your claim. 

Finally, if you have multiple streams of income and income from sale of securities is only one of them, it will be easier for you to get your claim accepted that the income be classified as capital gain.     

The clause that once you have chosen a particular mode you can’t switch to another in subsequent years is significant. In the future, if the government imposes a tax on long-term capital gains, you will remain stuck with this mode of treatment. 
 

On the other hand, if you choose to have your gains treated as capital gains and you incur losses, you will not be able to set them off against business income. Do consult a tax expert before making this choice once and for all.