Classification of Stock Market Income

The fear of the IT Department only can be removed by acquiring knowledge of all the basic rules and regulations. Income tax rates in India have radically reduced where there is no requirement to pay tax has on net total income up to Rs. 2,50,000. Income Tax Department is becoming more sophisticated in terms of penalties and notices issued because of misreporting of income, under reporting of income and non-filing of income tax return. In addition to that now a days Income Tax Department has access to your all bank accounts and also counter check on all Stock Market transaction done by you through PAN linked with your bank account and your DEMAT account. In future Income Tax Department will send your Income and Expense Statement, similar to how NSDL and CDSL are sending your holding of all your DEMAT accounts. From A.Y.-2019-20 Income Tax Department have started facility of prefilled Income Tax Return, as of now they are providing information which is available in your 26AS, but in future this facility may show you all your Stock Market transactions. Classification of Stock Market Income is very cumbersome for income tax computation. Taxation of Mutual Funds and Shares are very easy, but it is very difficult to understand taxation of trading in intraday stocks, futures and options.

While calculating income for the purpose of Income Tax you need to classify your income in to the following heads:
    1)  Long Term Capital Gain (LTCG)
    2)  Short Term Capital Gain (STCG)
    3)  Speculative Business Income
    4)  Non Speculative Business Income

Until now it was an issue, whether your income is Capital Gain Income or it is Business Income. Both Assessee and Assessing Officer (AO) were categorizing income on their own benefit. And in result litigation was arose. To eliminate this litigation Central Board of Direct Taxes (CBDT) has issued Circular No.-6/2016 dated 29th February, 2016. Two Important points mentioned in this circular are as under:

  • 1)  Where assesse himself, irrespective of the period of holding the listed shares and securities, opts to treat them as stock in trade, the income arising from transfer of such shares or securities would be treated as its business income.
  • 2)  In respect of listed shares and securities, which are held for a period of more than 12 months immediately preceding the date of its transfer, if the assessee wants to treat the income arising from the transfer thereof as Capital Gain, the same shall not be put to dispute by the Assessing Officer. However, this stand, once taken by the assessee in a particular Assessment Year, shall remain applicable in subsequent Assessment Years also and the taxpayers shall not be allowed to adopt a contrary stand in this regard in subsequent Assessment Years.

This circular has allowed an alternative to the assessee, about his intent to classify income. Now, assessee has an option whether to classify his income as Capital Gain Income or Business Income. Defiantly, assessee would classify his income which will be more beneficial in terms of tax benefits. Let’s take an overview of classification of income.

1) Long Term Capital Gain (LTCG):-
Classification of Assets into Long Term or Short term depends on period of holding of asset. Here we are giving you a chart to understand whether the asset if Long Term Capital Asset or Short Term Capital Asset.

Tax Rate on Long Term Capital Gain on Securities:-
Earlier tax on LTCG on securities was exempt if Securities Transaction Tax (STT) was paid. But with effect from Assessment Year-2019-20 CBDT had withdrawn such exemption. However under Section-112A of the Income Tax Act, 1961 concessional tax rate for LTCG of Equity Shares, Equity Oriented Units of Mutual Fund or Units of Business Trust in excess of Rs. 1,00,000 is provided @10% if the following conditions are satisfied:
    (A)  Securities Transaction Tax (STT) is paid on acquisition and transfer of Equity Shares and
    (B)  STT is paid on transfer of Equity Oriented Units of Mutual Fund or Units of Business Trust
In case transaction is undertaken on a Recognised Stock Exchange Located in International Financial Service Centre (IFSC) even STT is not paid, benefit of concessional rate of tax @10% will be available.

If you are not eligible to pay tax at concessional rate of 10%, then tax on LTCG shall be chargeable @20% under Section-112.

Proviso to Section-112 allows paying tax for LTCG on Listed Securities (other than Units) and Zero Coupon Bond (ZCB) at least of the following:
    (i)  10% without indexation or
    (ii)  20% with indexation

2)  Short Term Capital Gain (STCG):-
Tax Rate on Short Term Capital Gain on Securities:-
Generally STCG income is taxed at normal tax rate however as per Section-111A of Income Tax Act-1961 concessional tax rate on STCG of Equity Shares, Equity Oriented Units of Mutual Fund or Units of Business Trust is provided @15% if STT is paid on transfer.
In case transaction is undertaken on a Recognised Stock Exchange Located in International Financial Service Centre (IFSC) even STT is not paid, then also benefit of concessional rate of tax @15% will be available.

  • 3)  Speculative Business Income:-
    Business Income earned from Speculative transaction is considered as Speculative Business Income. Section-43(5) of the Income Tax Act, 1961 defines Speculative Transaction as follows:

“speculative transaction” means a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrips:

Provided that for the purposes of this clause
(a)   a contract in respect of raw materials or merchandise entered into by a person in the course of his manufacturing or merchanting business to guard against loss through future price fluctuations in respect of his contracts for actual delivery of goods manufactured by him or merchandise sold by him; or

(b)   a contract in respect of stocks and shares entered into by a dealer or investor therein to guard against loss in his holdings of stocks and shares through price fluctuations; or

(c)   a contract entered into by a member of a forward market or a stock exchange in the course of any transaction in the nature of jobbing or arbitrage to guard against loss which may arise in the ordinary course of his business as such member; or

(d)   an eligible transaction in respect of trading in derivatives referred to in Section-2(ac) of the Securities Contracts (Regulation) Act, 1956 carried out in a recognised stock exchange; or

(e)   an eligible transaction in respect of trading in commodity derivatives carried out in a recognised stock exchange, which is chargeable to Commodities Transaction Tax (CTT) under Chapter-VII of the Finance Act, 2013,

shall not be deemed to be a speculative transaction.

Provided further that for the purposes of clause (e) of the first proviso, in respect of trading in agricultural commodity derivatives, the requirement of chargeability of Commodity Transaction Tax under Chapter-VII of the Finance Act, 2013 shall not apply.

As per Section-2(ac) of the Securities Contracts (Regulation) Act, 1956 “derivative” includes
    (a)  a security derived from a debt instrument, share, loan, whether secured or unsecured, risk instrument or contract for differences or any other form of security;
    (b)  a contract which derives its value from the prices, or index of prices, of underlying securities.

Important point is that trading in equity intraday and trading in currency [purchase and sale of currency (not derivative)] unless it is used for hedging your risk, is considered as speculative transaction.

  • 4)  Non-Speculative Business Income:-
    Income which is not derived from speculative transaction is Non-Speculative Business Income. From the reading of the Section-43(5) it is clear that trading in derivatives (Future & Options) whether it is Equity derivative, currency derivative or commodity derivative, is not a speculative business. However trading in equity intraday and trading in currency is a speculative business.

Benefits and drawback of considering profit as Business Income are as follows:

Benefits Drawbacks
1) Claim of Expenses:-
All the expenses like brokerage, STT, trading charges, stationery expense, Salary, telephone, internet, newspaper expense, depreciation, statutory taxes can be claimed as business expense.

2) Set off of Losses:-
Business loss can be set-off against any head of income other than salary.

3) Carry Forward of Non-speculative Business Losses:-
Losses of the business head can be carried forward for 8 years if return of income is filed in time and can be set off against business income.

4) Carry Forward of Speculative Business Losses:-
Speculative losses can be carried forward for 4 years if return of income is filed in time and can be set off against speculative profit.

1) Slab Rate:-
Business income is taxable at slab rate. If your income is high then you must have to pay higher tax as compared to fixed tax rate on LTCG and STCG.2) Audit Cost:-
You must have to maintain your accounts properly. And if your turnover goes above Rs. 5 CR then you have to get your accounts audited from Chartered Accountants.

 

Here you may be benefited if you show your income as capital gain instead of business income. It totally depends on case to case basis. If you are investing in equity delivery based investment and holding it. And you are not buying and selling stocks frequently then you are advised to show your investment as capital asset.

On the other side if you are buying and selling stocks frequently then it is advisable to show your income as business income and file Form ITR-3. However Circular-6/2016 dated 29th February, 2016 has clarified that you can be a trader or investor or both. However before deciding anything, you are advised to consult your Chartered Accountant.

We will discuss practical issues relating to Stock Market transaction in our next article.

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