Categorisation of gain on sale of investment after conversion from stock in trade. The categorisation of income from sale of share as capital gains or business income has been a bone of contention since a long time and there are a plethora of decisions on the said issue. Each of the cases has been decided on peculiar facts of the case and although the Government has issued circulars in this regard from time to time, the matter is still not free from doubt.
One has to study the guidelines issued by the Government along with the ratio of the various decisions before arriving at any conclusion as to whether the income constitutes capital gain or business income. Recently, the Mumbai Bench of the Income Tax Appellate Tribunal ITAT in the case of ACIT vs. Superior Financial Consultancy Services ITA No. The ITAT had to decide whether the gain so arising was in the nature of capital gain or business income.
The ITAT had to also decide whether it was permissible to have two separate portfolios viz one comprising of capital assets and other of stock in trade. This tax alert discusses this interesting decision. This judgment clearly brings out the fact that there are no provisions that restrict the conversion of stock-in-trade into investments and hence, such conversion holds good in law. In our view, this is a welcome relief for tax payers and although the principle was laid down by the Supreme Court long back, due to passage of many years, the Revenue took the view that such conversion is not possible.
The Capital Asset Pricing Model (CAPM)
This ITAT decision reaffirms this principle. The Tribunal has further gone into the intention behind the transaction and has held that based on the facts of the case, there is no motivation for any tax evasion. This should bring relief to those tax payers who genuinely convert their portfolio of stock in trade into investments based on the market conditions.
Of course, one has to follow the accounting treatment consistently to prove that it is bonafide. This SKP Tax Alert contains general information existing at the time of its preparation only. It is intended as a news update and is not intended to be comprehensive nor to provide specific accounting, business, financial, investment, legal, tax or other professional advice or opinion or services.
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Tax planning by conversion of stock in trade into capital asset
Offices also at Delhi, Pune, Hyderabad and Chennai. Volume 6, Issue 4 27 th April, Facts of the case: In the previous year relevant to assessment year , the tax payer was engaged in the business of borrowing and lending of funds. Prior to 31st March, the tax payer carried on the business of trading as well as speculation in shares. These shares were reflected as stock-in-trade in the Balance sheet for the year ended 31st March, However, from 1st April, the tax payer discontinued delivery based trading of shares and converted the stock of shares into investments which was also duly reflected as Investments in the balance sheet as on 31st March, along with a suitable clarificatory note in the notes to accounts.
Aggrieved by the order of the CIT A , the Revenue appealed to the ITAT. The following issues were raised before the ITAT by the Revenue: Whether the conversion of stock-in-trade into investments is legally permissible?
SKP Tax Alert - Volume 6 Issue 4 - Categorisation of gain on sale of investment after conversion from stock in trade
If yes, whether the conversion is motivated by tax avoidance? Whether a tax payer can be an investor and a speculator at the same time? Contentions of the Revenue: With regard to the first issue, the Revenue contended as under. The stock-in-trade cannot be converted into investments till the time such stock remains in the business carried on by a tax payer. However, there is no explicit provision in the ITA to capture the reverse scenario.
Accordingly, the Revenue argued that the conversion of stock in trade into capital asset cannot be recognised and is only a colourable device to avoid tax. With regard to the second issue, the Revenue placed reliance on the decision of the Bombay High Court in the case Twin Star Holdings Ltd. Anand Kedia ITR 6 Bom. The Revenue did not raise any specific contention in support of the third question.
Contentions of the Tax Payer: The market conditions compelled it to discontinue its share trading business. This shift in business activity from share trading to financing business necessitated conversion of stock-in-trade into investment.
These shares were consistently shown as investments since the conversion. Suitable clarificatory notes were also provided in the accounts.
As regards the second issue, the tribunal upheld the order of the CIT A and concluded that the tax payer cannot be said to have entered into a sham transaction since the conversion is transparent from the audited accounts and the notes to accounts. Further, the Tribunal distinguished the judgement of Bombay High Court Supra on the ground that the facts of the said decision were quite different.
Further, if the Revenue accepts such shares held as investments then the gains accruing therefrom shall be considered as capital gains. About this Tax Alert This SKP Tax Alert contains general information existing at the time of its preparation only. For queries e-mail info skpgroup.