Circular No. 6 of 2016: Issue of taxability of surplus on sale of shares and securities. The CBDT has accepted that inspite of its circular no. 4 of 2007 dated 15th June 2007 and instruction no. 1827 dated 31st August 1989 on the matter of characterization of income from sale of shares and securities, there remains difficulty in application of the principles emanating from the above circulars in individual cases thereby leading to litigation.
The CBDT, with a view to provide certainty, clarity and reduce litigation with respect to the above matter, provides that the Circular No 6 of 2016 would alter its earlier circulars with regards to the points provided therein.
Before observing the changes made by CBDT, it would be beneficial to have glance at the developments which led to issue of this circular.
The aspect of providing clarity on taxation on gains arising from sale of shares and securities was covered in the report submitted by The Income Tax Simplification Committee set up under the chairmanship of Justice R.V. Easwar (retd.). With the presence of binding CBDT circulars and several judicial precedents in this regard, the controversy had refused to settle. The committee had recommended amending the provisions of the Act, to bring clarity and certainty, towards taxation of gains on sale of shares and securities. The committee had recommended that amendment should be made under the Act to resolve the controversy of characterization of such receipts.
It was suggested by the committee in their report that the provisions under the Act should be amended, in order to bring clarity on surplus arising on sale of shares and securities. It was suggested by the Committee that the provisions of section 2(14) of the Act should be amended by introduction of new clause which would provide that shares and securities held by an assessee for more than 12 months would constitute capital assets. These would exclude such shares and securities which have been declared as stock in trade or trading asset by the assessee in its return of income.
The committee report explained that the above would not have meant that shares and securities held for a period of 12 months or less, would have automatically been considered as not being capital assets. They would have still constituted as capital assets as per clause (a) of section 2(14). It was recommended by the committee that cases wherein the shares and securities are held for a period of 12 months or less than 12 months, but the surplus arising from the same is upto rupees five lakhs, the same would be treated as, at the option of the assessee, Capital gains and the assessing officer in such cases would not characterize the surplus as business income.
Thus, on summarizing the recommendations of the committee, it can be said that the committee advocated that:
- (i). If the shares and securities are held for more than 12 months and are not declared as Stock in trade, it would be characterized as Capital Gains.
- (ii). If the shares and securities are held for a period of 12 months or less and the surplus do not exceed rupees five lakhs, the gains would be characterized as Capital Gains at the option of teh assessee.
- In other cases, the characterization would be governed by the CBDT circulars and judicial precedents.
It was very unfortunate that the recommendations of the committee did not find place in the amendments provided by Finance Act, 2016.
The CBDT, issued a circular on 29th February 2016 which dealt with bringing the much needed clarity with respect to taxation of gains from sale of shares and securities. The Circular no 6 dated 29th February 2016 provided the following:
- Where an assessee himself prefers to treat his listed shares and securities as stock in trade, the income arising on transfer of the same would be income from business and profession. This would be irrespective of the period of holding of such securities.
- If for listed shares and securities the period of holding is more than 12 months and the assessee desires to treat the income arising on transfer of the same as capital gains, the same shall have to accepted by the assessing officer. However the stand once taken by the assessee would have to be followed consistently by him and he would not be allowed to take a contrary stand in subsequent assessment years.
- For cases other than those covered above, the issue would be decided based on the principles established by the earlier CBDT circulars.
The CBDT clarified that since the above measure is taken to reduce litigation and providing clarity on the issue, the provisions of the Income tax Act shall continue to apply and that the guidelines provided in this circular shall not apply to such transactions where the genuineness of the transaction is itself questionable.
Thus, the above circular has an overriding effect to the earlier CBDT circulars issued in this regard, however to a limited extent.
One aspect which needs to be considered is that, the above clarity is provided vide a circular vis-a-vis by an amendment in the Act. Although, the circulars are binding on the assessing officers and they are bound to abide the same, the force of a circular is less compared to the force of a statute provided through an enactment. This is for the simple reason that, CBDT has powers to withdraw the circular. This would not require any parliamentary approval, as required in case of amendment under the Act. However, considering the approach of the government to curtail litigation, the implications of this aspect is only academic.
An important point is that an assessee would have a choice not to follow the CBDT circular. This is because, the CBDT circulars are binding on the Assessing Officer and not on the assessee as against the statute, which is binding on all. Thus if the assessee feels that the CBDT circular has adversarial consequences, the assessee may well choose to not follow the circular.
There is a possibility of circumventing the circular. The circular provides that once assessee chooses to consider the income arising on sale of shares and securities as capital gains, if the same is held for more than 12 months, the assessing officer would have to accept the same. However, the circular further provides that this stand would be followed consistently and assessee would not be allowed to take a different stand. Now, supposing an assessee takes benefit of the circular and characterizes the gains as capital gains. After doing so, if the assessee feels that it would be more beneficial to consider the gains as business income, then the assessee is barred from doing so, as provided by the circular. However, as explained above, the assessee has an option to follow the CBDT circular. it is not a compulsion to follow the CBDT circular. Thus, in the subsequent years, assessee can take a stand that he does not want follow the CBDT circular. In such cases, he would be governed by the Act, judicial pronouncements and probably earlier CBDT circulars.
Assuming further that the assessee now again feels that it would be better if he would characterize the gains as capital gains, he might be able to take shelter of the circular. There is no surety in this regard as the circular talks of not changing the stand. Considering that the circular talks of change of stand in context of the circular itself, it is possible to take the benefit of the circular. This is because the earlier stand of the assessee in context to the circular was to characterize the gains as capital gains, and interestingly, even now the stand seems to characterize the gains as capital gains.
However, if the change of stand is considered with respect to the assessment year, the assessee might have violated that condition as there is a change of stand to consider the receipts as capital gains. Ideally speaking this would be a perfect case of exaggerating beneficial step taken towards reduction of litigation. It is pretty clear from the first reading itself that the change of stand with respect to characterization of gains is in the context of assessment year. This whole exercise would first have to pass the test of being genuine in nature as required by the circular. The genuineness would be seriously doubted if the test of Human probability, as explained by the Apex Court in the case of Sumati Dayal v. CIT (1995) 214 ITR 801, is applied. The whole of the above exercise might rarely have any practical implication and is suitable only for theoretical analysis. The applicability of the idea of changing of stand and not following circular is solitary in nature and can be applied only once as agsinst the hypothetical example given above of changing the stand repeatedly.
The ultimate choice in this regard is with the assessee. Several aspects like lower rate of taxation for capital vis-a-vis allowability of expenses incase of business income, would have to be analysed to take a call as to whether, the surplus is to be characterized as business income or capital gains. Further it can be seen that the clarity provided by the circular is with regards to listed shares and securities only and not for unlisted shares and securities.
This step of CBDT is a step in a right direction and would certainly help in reducing litigation.
Click Here to Download Official Circular No. 6 of 2016: Issue of taxability of surplus on sale of shares and securities
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