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22 July 2011
TAX

In respect of shares held as investments, even gains on shares held

for 30 days or less to be treated as short term capital gains and not
business profits
Recently, the Mumbai Bench of the Income-tax Appellate Tribunal (the
Tribunal) in the case of Hitesh Satishchandra Doshi 1 (the taxpayer) held,
based on the facts of that case, that where shares are held as
investments, even gains from shares held for 30 days or less were to be
considered as short term capital gains and not business profits.
The Tribunal held that holding period of the securities could not be the
sole criterion for determining whether the shares in question were held
as capital asset or trading asset.
The Tribunal also held that even though the Bombay Stock Exchange
(BSE) and National Stock Exchange (NSE) were notified as Recognised
Stock Exchanges with effect from 25 January 2006, any derivative
transaction carried out on these exchanges from and after 1 April 2005
will not be speculative in nature [in view of amendment to Section 43(5)
of the Income-tax Act, 1961 (the Act)].
I Gains on shares held for less than 30 days are treated as short term
capital gains
Facts of the case

The taxpayer, an individual, was engaged in the business of share

trading and investments. The taxpayer had also received income
from interest and dividend income.

The taxpayer made gains from sale of shares during the relevant
year and showed gains from sale of one set of shares under the head

Hitesh Satishchandra Doshi v. JCIT (ITA No. 6497/Mum/2009, 6603/Mum/2009 &

CO No. 239/Mum/2009 in ITA 3231/Mum/2009)

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business income and the gains from sale of another set of shares
under the head capital gains (long term as well as short term).
Assessing Officers order

The Assessing Officer (AO) treated the capital gains as business

income in view of the volume, regularity and turnover of
transactions in shares. In this regard, the AO relied on the Central
Board of Direct Taxes (CBDT) instruction 2 , which laid down
certain tests to determine whether the shares could be considered
held as stock in trade or investments.

In this regard, the AO found that the ratio of purchases to opening

balances and that of sales to closing stock was indicative of the
taxpayer being trader in shares.

The AO held that the taxpayer is engaged in only one activity, that
is, activity of earning profit through dealing in shares, within a short
period or a long period. On that basis, the AO taxed the gains
offered as capital gains (long term as well as short term) as the
taxpayers business income.

Commissioner of Income-tax (Appeals) Order

The Commissioner of Income-tax (Appeals) [CIT(A)] asked the

taxpayer to bifurcate his statement of short term capital gains into
two parts, shares sold within 30 days and after 30 days of their
purchase.

The CIT(A) accepted the gains classified as long term capital gains,
as such. He also accepted the short term gains from sale of shares
held for more than 30 days as such. However, he treated the short
term gains/loss on shares held for less than 30 days as business
income/loss.

Issue before the Tribunal

The taxpayer raised the question whether the surplus/loss earned

from shares held for less than 30 days could be treated as business
income/loss?

Taxpayers contentions

The statute itself recognises a capital asset held for not more than 36
months/ 12 months as a short term asset, depending upon the nature
of asset.

The nature of the transaction capital gain or trading gain - is to be

determined as per the intention of the taxpayer on the date of
acquisition of the asset and not on the basis of subsequent events
which lead to the sale of the asset.

Instruction no. 1827 dated 31 August 1989

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The taxpayer had started investment in shares at least two to three

years prior to the years under consideration. These shares were
shown as investments in the books of accounts and had always been
recorded at their cost and never at market value.

The taxpayer was making these investments out of his own funds
and not borrowed funds.

Majority of the investments made were in the top 10 scrips. In spite

of manifold increase in their market value, the taxpayer continued to
hold these scrips rather than sell them off for profits. Further, there
was a steady increase in the investment portfolio of the taxpayer. All
of these factors demonstrated the taxpayers intention to make and
hold these investments. The investments were booked under a
variety of scrips to avoid risk of over exposure of funds to fewer
scrips.

It is clear from CBDT circular 3 that it is possible for a taxpayer to

simultaneously have two portfolios, that is, an investment portfolio
and a trading portfolio.

The taxpayer had been consistently showing income/ loss from sale
of shares held as investment as capital gains/ loss. The revenue had
always accepted such treatment except for the years under
consideration. Given this position, it was not open for either the
taxpayer or the tax department to start treating such shares as stock
in trade, unless the taxpayer were specifically to convert such shares
held as capital asset into stock in trade.

Tax departments contentions

The tax department contended that the large quantum and frequency
of the transactions and the short period of holding of shares
established that the taxpayer was engaged in the profit earning
activity through dealing in shares in an organized way.

In certain instances the shares were sold on the next day of purchase
and were claimed as short term capital gains.

The taxpayer had used borrowed funds for the purpose of purchase
and sale of shares.

Tribunals ruling

The statute has laid down the 12 month/ 36 month criteria for
determining whether an asset could considered as long term or short
term. The 30 days holding period criterion as was considered by the
CIT(A), does not find place either in the statute or in any circulars/
instructions as well as any judicial pronouncements.

Circular no. 4 of 2007 dated 15 March 2007

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Holding period is only one of several criteria for determining the

nature of the asset whether trading or investment. Some of the
other important criteria as per the principles laid down by the
various courts 4, which have also been considered by the CBDT in its
circular no. 4/ 2007 dated 15 June 2007, are: intention of the
taxpayer at the time of purchase, whether money has been borrowed
for making purchase of shares, the frequency of purchase and sale in
the particular item, whether the intention is to realise profits or to
retain and gain from appreciation in value. No single criterion can
be the determinative factor all the relevant factors are to be taken
into account in this regard.

Therefore, it was not proper for the CIT(A) to judge the transaction
solely based on the holding period of the shares.

The taxpayer was having own funds to the extent of 95 percent of

the investment in shares. This made it clear that investments were
not funded out of borrowed funds.

The transactions in shares had taken place through electronic system

of the stock exchange wherein a single order placed is split into
numerous small transactions. This factor had led to an unrealistic
picture of the number of transactions/ frequency.

It is an accepted practice for an investor to reshuffle the investment

portfolio by selling some scrips and buying others to mitigate the
scope of loss of capital or income such activity is not to be
considered as trading activity.

That the taxpayers investment portfolio largely comprised the top

10 scrips, the value of which increased substantially over the years,
showed that the taxpayer was an investor in shares, which was a
relevant fact also considered by the Tribunal in its own case of
Mahendra C. Shah5.

The taxpayer had, over the years, been consistently maintaining two
separate portfolios - one for investment and another for trading.
This was the case even prior to change in the scheme of the law with
the introduction of securities transaction tax (STT) effective 1
October 2004 6. The taxpayer had been consistently valuing his
investments at cost and never based on market value.

The Tribunal has made specific references to the Apex Courts decisions in:

CIT v. Associated Industrial Development Co Pvt Ltd. 82 ITR 586 (SC)

CIT v. Holck Larsen 160 ITR 67 (SC)
5

Shri Mahendra C Shah v. ACIT (ITA No. 6289/Mum/2008 dated 18 May 2011)
Prior to introduction of STT, the long term capital gains from sale of shares on a
recognized stock exchange in the case of an individual were taxable at a minimum base
rate of 10 percent. Post introduction of STT, such gains have been exempted from
income-tax.
Prior to introduction of STT, the short term capital gains from sale of shares on a
recognized stock exchange in the case of an individual were taxable at a maximum rate
6

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All along, the tax department had accepted this consistent treatment
followed by the taxpayer.

Given that the capital gains offered in earlier years and

investments shown in the balance sheet in earlier years were
accepted as such by the tax department, and there being no change
in facts, applying the principle of consistency, the tax department
could not change the treatment given to the same transactions in the
years in question. In this regard, the Tribunal applied the principle
laid down in the case of Gopal Purohit by the Tribunal 7, which has
also been confirmed by the Bombay High Court 8.

Our comments
This is yet another case where the Tribunal has followed the well settled
principle that a number of factors have to be taken into consideration in
their totality for determining the nature of transactions in securities
whether investment or trading. These factors include, among others, the
intention of the taxpayer at the time of purchase of shares, own funds or
borrowed funds used for purchase of shares, frequency of purchases and
sales, basis of classification and valuation in books of account as well as
the holding period of the securities.
The Tribunal has also observed that the 30 day holding period criterion,
as was considered by the CIT(A), was not in accordance with the law,
which provides a 12 month/ 36 month holding period criterion.
In its ruling, the Tribunal has noted that while the taxpayers investment
portfolio increased substantially in value over the years, the portfolio
continued to comprise more or less the same scrips. This factor also
appears to have led the Tribunal to consider that the shares were in the
nature of investments.
II Derivative transactions carried out on BSE and NSE are not
speculative from 1 April 2005
Facts of the case

The taxpayer undertook transactions in derivatives during the

financial year 2005-06 (1 April 2005- 31 March 2006). He claimed
business loss on account of such transactions. This loss was claimed
in terms of section 43(5)(d) of the Act .

Section 43(5)(d) of the Act was introduced with effect from

financial year 2005-06 to allow business losses from derivative

of 30 percent. Post introduction of STT, such gains became taxable at a base rate of 10
percent now increased to 15 percent.
7
Gopal Purohit v. JCIT [2009] 29 SOT 117 (MUM)
8
CIT v. Gopal Purohit [2010] 228 CTR 582 (BOM)

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transactions carried out on recognized stock exchanges being

characterized as not speculative in nature 9.
Assessing Officers order

The law requires the recognized stock exchange (on which

transactions in derivatives are carried out) to be notified for the
purpose of section 43(5)(d) of the Act.

The relevant notification no. 2/ 2006 (the notification) was issued on

25 January 2006 in terms of which the BSE and the NSE were
notified as recognised stock exchange for this purpose.

On that basis, the AO characterized the taxpayers losses in

derivatives in respect of transactions prior to 25 January 2006 as
losses from speculative business He allowed losses from the
derivative transactions from 25 January 2006 onwards nonspeculative business loss.

Commissioner of Income-tax (Appeals) order

The CIT(A) confirmed the views of the AO that losses from

derivative transactions prior to 25 January 2006 were speculative in
nature.

Issue before the Tribunal

Whether business loss from derivative transactions prior to 25

January 2006 be considered as speculative in nature?

Tribunals ruling

The Tribunal relying on its own decisions 10 ruled on the effective

date of the notification. The Tribunal observed that even though the
notification was issued on 25 January 2006, it will apply from the
effective date of amendment to Section 43(5) of the Act i.e. from 1
April 2005. 11

Section 43(5) (d), introduced with effect from financial year 2005-06 provides that a
transaction in respect of trading in derivatives carried out in a recognized stock
exchange is a not speculative transaction. Under the rules relating to set off of losses,
business losses from speculative transactions are a separate basket and cannot be set off
from profits from non-speculative business.
10
The Tribunal has made specific references to the Mumbai Tribunals decisions in:
Prem Associates Advertising & Marketing (ITA No. 6547/Mum/2009 dated 17
September 2010)
Nipra Financial Services Pvt. Ltd. (ITA No. 4605/M/2009 dated 30 September
2010)
11
In other words, the Tribunal held that from 1 April 2005 any derivative transaction
carried out on BSE and NSE will not be treated as speculative in nature.

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