Tax Alert: Taxability of Profit on Sale of Shares
11 January 2019
Profits arising from sale of equity shares could be taxable as capital gains or as business income, depending upon the various facts and circumstances i.e. intention of the taxpayer to invest in shares, frequency and volume of purchase and sale transactions undertaken by the taxpayer, treatment in books of accounts, etc. Classification of gain arising on sale of shares has been litigated at judicial forums in the past. The Hon’ble Bombay High Court recently dealt with the issue as to whether gains arising from sale of shares by a private trust would be taxable as capital gain or business income. The Hon’ble High Court, after considering various aspects, held that such income is taxable as capital gains and not as business income. We, at BDO, have summarized latest Bombay High Court ruling on this and provided our comments on the impact of this decision.
Facts of the Case
- Shri Vineet Nayyar and his wife, Mrs. Reva Nayyar (‘Settlors’) created the Vernan Private Trust (‘Trust’ or ‘taxpayer’) on March 24, 2010 for utilization of the Trust corpus and the income generated therefrom, for the benefit and maintenance of the beneficiaries of the Trust and the ensuring an effective intergenerational transfer of wealth.
- One of the settlors gifted six lakh equity shares of Tech Mahindra Ltd. to the Trust on March 26, 2010. Out of these, 96 percent of the shares were received by him as ESOP and 4 percent of the shares were purchased by him.
- Trust sold these shares on March 30, 2010 i.e. within seven days of formation of the trust.
- While filing income tax return, taxpayer claimed the profit on sale of shares as capital gain being exempt under Section 10(38) of the Income-tax Act (the ‘Act’) considering that the sale of the said shares was undertaken on a recognised stock exchange.
- The tax officer observed that sale of shares was undertaken in seven days after acquisition, which is too short a period for treating the activity as an investment and accordingly, considered the gain as business income.
- On further appeal, the first appellate authority allowed the appeal of the taxpayer and considered the profit to be in the nature of capital gain.
Ruling of the Tribunal and High Court
On further appeal, the Income-tax Appellate Tribunal, Mumbai (‘Tribunal’) ruled in favour of the taxpayer. In its ruling, the Tribunal noted as under:
- The very object of the Trust was the utilization of the trust corpus and the income generated therefrom in investment, so as to ensure the benefit of the beneficiaries.
- The Trust is specifically prohibited from undertaking any business activity.
- Appointment of portfolio manager by taxpayer is in line with the intent and objective of the creation of the trust.
- The shares acquired by the settlor by way of ESOP and direct purchase, were held by him for more than 2 years before settling the same into Trust. Hence, it was not the intention of Settlor to resell the shares immediately and make a quick profit.
- The shares were treated as an investment and not as stock-in-trade in the balance sheet.
- All shares were sold at once to diversify the portfolio and use the proceeds to make secure investments.
- Tax officer did not question that the Trust is a shame or bogus Trust. The validity of the corpus of the Trust had also never been doubted.
In view of the above, the Tribunal observed that the sale of shares was in line with the stated intention of the Trust and the Trust cannot be considered as carrying out any business activity, giving rise to business income. Accordingly, the Tribunal considered the profit arising on sale of shares as capital gain and accordingly, exempt under the Act.
The above ruling of the Tribunal was upheld by the Bombay High court.
- Classification of profit arising on sale of shares has been litigated at judicial forums in past. To reduce litigation with respect to listed shares and securities, the CBDT has issued a Circular in June 20071 and February 20162 that provided guidelines for classification of shares and securities as business assets or capital assets. The CBDT has provided factors such as treatment by taxpayer, holding period, nature of income arising from transfer, etc. to be considered for classification of profit as business income or capital gain.
- The ruling also highlights the importance of clear articulation of objectives while executing trust documents, since they bring out the intention of parties involved. The ruling not only examines the treatment of the shares itself, but also the utilisation of the sale proceeds, to conclusively adjudicate on the intention behind the sale. The ruling also reinforces the perspective that the taxability of profit from sale of shares is an aspect essentially driven by facts, circumstances, intentions and conduct of taxpayers.
1Circular No. 04/2007 dated June 15, 2007
2Circular No. 06/2016 dated February 29, 2016