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Understand profits share trading to be classified as Capital Gains or Business Income

07 Sep 2023

The trading activity in the share markets has grown substantially over the last decade and exponentially in the last few years. The stock markets have risen and many individuals have witnessed gains with the dynamic adoption and evolution of technology. Nowadays, trades take place through easy apps from any corner of the globe and investors can take advantage of opportunities in real time as they present themselves. However, rosy and encouraging this picture appears, any income that is earned from shares has to be taxed, and retail investors are liable to pay that tax in a prompt fashion. 

As clear as the fact of paying taxes may be, one of the common areas of dispute between equity traders and the tax authorities has been regarding the treatment of profits and losses from shares. It is still not too clear whether the profits from trading in shares should be classified as capital gains or as business income. Individuals should, in all respects, be clear about this as it affects income tax on shares, especially if income from this source is in a large amount. In fact, there have been umpteen cases where assesses have received a notice from the Assessing Officer (AO) asking them why the income from shares should not be treated as business income instead of capital gains.

Income and Taxation

The FY 2021 was marked by all-time highs as far as the stock markets were concerned. The profit from shares was felt by many, but with these profits comes the liability of tax that all investors and traders must face. Income not only includes the profits or income earned through stocks, but also your salary, business income, rent, etc, that relates to the tax you have to pay. 

Nonetheless, individuals seem to pay less attention to any gains made through stocks and shares which must be considered for taxation of income. The gains, if any, made by individuals in the share markets must be covered in an income tax return which is filed on a yearly basis. In other words, any profits must be declared by individuals while filing returns. To cut a long story short, under the Indian Income Tax Act, 1961, the taxation on any gains from shares is dependent on the holding period of those shares. Therefore, the transactions you make while in the share market determine how you will be taxed in the future. 

The classification of income from shares: capital gains versus business income

When it comes to shares we are aware that LTCG capital gains are tax free while short term capital gains are taxed at the rate of 15%. If you classify your income from shares as capital gains, then these are the rates of tax that you need to pay. In this case, your exposure to stocks will be treated as your investment portfolio. However, in case your treat your income from shares as business income, then the short-term equity holding will be treated as stock-in-trade. When it is classified as business income, then it will be taxed at the normal business income rate of 30%. If you feel this rate of tax is higher, remember that when you classify as business income you can also write off all your incidental expenses against your income from stocks and pay the tax only on the net income.

Clarification from CBDT makes things a lot simpler

While the dispute over capital gains versus business income is still a major bone of contention, the CBTE had issue a circular a circular to this effect in early2016 which largely clarifies this position. There will be 3 broad rules that the CBDT (Central Board of Direct Taxes) laid out for ratifying this classification.

If the taxpayer opts to classify his equity holdings as stock-in-trade, then the income shall be treated as business income. In such cases the AO shall accept the choice of the taxpayer and there shall be no grounds for dispute.

In case of long-term holdings (more than 12 months), the taxpayer is entitled to opt to treat the same as capital gains and the AO shall not dispute the same. However, the taxpayer shall maintain consistency in this classification and once opted will not be changed in future years.

In all the other cases, basic premise for classification of capital gains versus business income will be predicated on the concept of “Significant trading activity”. If the stock portfolio is churned frequently, then the income shall be classified as business income. The dispute, therefore, boils down to the classification of STCG on equities.

What does Significant Trading Activity refer to?

While the definition of Significant Trading Activity (STA) is still open to discretion, the CBDT has indicated some broad rules that will be used for this classification. The decision will boil down to whether the short-term equity holdings are to be classified as Investments or as Stock-in-Trade. Here are some such broad rules that are indicative of the same

The volume of equity trading during a particular period is taken as a proxy for this classification. While there are no hard and fast cut-offs, some online brokers do advise traders to classify as business income if the trading volumes in a particular fiscal year exceed Rs.1 crore.

The ratio of purchases to sale is also a criterion. If the purchases and sales of shares are of similar magnitude it is typical of a trader and must be classified as business income. A proclivity to buy and hold is more a sign of an investor.

The average period can be a good proxy for this classification. Normally if your average holding period is shorter then it is more likely to be business income rather than classified as capital gains.

Activity in the Futures and Options trading is also an indicator of whether the income from shares should b classified as capital gains or business income. A trader being more active in F&O is a sign of a shorter time frame and a greater intent to trade.

Understanding By Example

The Income Tax Department of India clearly states that any trading capital that represents a profit has to be considered as a business income. Capital gains will only be applied if investments are made with the intent of earning an income, such as dividends. This can be best seen from the point of view of an example: 

Let us assume that an individual, X has earned Rs. 100,000 through share trading activity for the short run. This may have been earned through intraday trading or a futures and options contract. The income is taxable as it is based under the head of income from “business” or “profession”, and thereby aligns with the tax slab that is applicable to X. Now, if X had held shares belonging to him for a substantial period, in order to gain returns, then income through capital gains would have been applicable. 

Declaring Your Gains

Whether you have to pay short term tax on shares bought and sold or LTCG, you have to declare your gains while filing your income tax returns. This is easy to do, provided you have clarity on what tax is applicable to you. You can file your tax returns online, although a proficient chartered account can aid you in this too. However, if you follow a few simple steps, the process is simple: 

  • Below the “Capital Gain Schedule”, in the ITR form, you need to fill in the capital gains obtained by you (through the transfer of shares).
  • If you are declaring your income through shares as a business income, then you must use the ITR 3 or ITR 4 to do this. 


Something to Remember

It needs to be clarified that the mere existence of share trading as an activity in your business memorandum of understanding (MOU) is not necessarily a criterion for classification. Remember, as a tax assesses you can maintain two separate portfolios; one as a long-term capital asset and one as a stock-in-trade. Understanding this distinction can go a long way in helping you plan your portfolio better!


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