Gains arising from transfer of listed shares classifiable as long term, is a matter of choice of the Assessee to treat it as capital gains or business profits

Facts of the Case:

• M/s. Century Plyboards (I) Ltd. (Assessee) is in the business of manufacture and sale of plywood and related products, filed its original return of income for A.Y. 2005-06 which was subsequently selected for scrutiny and notice under Section 143(2) and Section 142(1) of the Income Tax Act, 1961 (the Act) was served on the Assessee.
• During the year under consideration, the Assessee had sold shares held by it as investments and offered to tax the entire profits earned on sale of shares as both short-term and long-term capital gains. The Assessee was show-caused to justify as to why the profit of the sale of shares should not be treated as business profits instead of capital gains against which the Assessee filed its response in due course.
• Subsequently, assessing officer (AO) passed the assessment order in which it was held that memorandum and articles of association of the Assessee clearly shows that one of the main objects of the Assessee was to undertake business in shares and securities. Further, the AO also mentioned in its order that transactions are done in a systematic manner for which the Assessee had engaged professional manager to manage its portfolio which clearly show case that the profits earned by the Assessee shall be treated as business profits instead of capital gains.
• Aggrieved by the order, Assessee filed an appeal before CIT(A). The CIT(A) referred to the main objects of the Assessee, the source of funds deployed, the volume and frequency of transactions to affirm the order passed by the AO.
• Aggrieved by which, the Assessee further preferred an appeal before ITAT, wherein ITAT held that the findings of CIT(A) in respect of the long-term capital gains were incorrect and hence allowed the claim of the Assessee whereas transaction with respect to short-term capital gains ITAT held that it cannot be accepted that Assessee held these shares as investment and gain arising from transfer of such shares are short-term capital gains as large number of transactions are being done and services of an expert was also being utilized for that purpose.
• Subsequently, AO challenged the order of ITAT before the Hon’ble High Court that whether ITAT was right in holding the gain on transfer of shares as long-term capital gains. However, the Assessee did not challenge the findings of ITAT with respect to short term capital gains.

Observation And Conclusion:

Hon’ble High Court of Kolkata held that:

• One of the reason, basis which the CIT(A) held profits of transfer of shares was held as business profits instead of capital gains was whether the source of funds utilized were Assessee’s own surplus funds or borrowed funds. The findings of ITAT clearly shows that sale and purchase of shares was not done in a systematic manner. Further, the investment made in such shares was many times lesser not only from the capital and reserves, but even from the profit of the current financial year of the Assessee.
• Where the profits of the entire business including the sale proceeds were deposited in the mixed overdraft account and in the case the investment is less than the amount of profit earned or which could reasonably be deemed to have been earned, it has to be presumed that the investment was made from out of the profits, for which reliance was placed on the decision in case of C.E.S.C Limited v/s Commissioner of Income Tax, Kolkata–II in ITA No. 105 of 2004. In the decision of Hon’ble Supreme Court in case of South Indian Bank Limited it was held that when the assessee has mixed funds and payment is made out of that mixed fund, the investment must be considered to have been made out of the interest free funds.
• Circular No. 4 of 2007 dated 15.06.2007 was issued with regard to the distinction between shares held as stock-in-trade and shares held as investment. When a person maintain two set of portfolios, one is investment portfolio and other is trading portfolio, the person may have the income under the both capital gains and business profits head respectively. Further, CBDT issued 2 circulars dated 29.02.2016 and 02.05.2016 to maintain consistency and reduce litigations wherein circular dated 29.02.2016 clarifies that in respect of listed shares and securities classifiable as long term as per the provision of the Act, it is a matter of choice to treat the income from transfer of such shares as capital gains and the same shall not be questioned by AO subjected that same stand was taken in subsequent years as well.
• Therefore, for all the above reasons, the Hon’ble High Court answer the substantial question of law in favour of the Assessee.

SW Point of View:

In case where a person is having income from transfer of listed shares or securities classifiable as long term as per the provisions of the Act or unlisted shares irrespective of their period of holding, the person has an irrevocable choice to offer such income to tax as “capital gains” or “business profits” as per the CBDT circulars. Further, as these circulars were beneficial in nature to the Assesssees, Hon’ble High Court of Kolkata held such clarification to be applicable retrospectively.

Lakshay Prakash Jonwal, Direct Tax Associate, SW India