Profit from Conversion of Stock-in-trade into Investments is Business Income

Profit from Conversion of Stock-in-trade into Investments is Business Income
Related Case Law :

ITO Vs M/s. Nupur Carpets Pvt. Ltd.,(Kolkata ITAT), ITA No. 783/Kol/2009 A.Y. 2005-06, Date of decision –01-07-2015

Briefs of Case

In the case ITO Vs. M/s. Nupur Carpets Pvt. Ltd. the Hon’ble Kolkata ITAT held by converting the stock-n-trade into investment, it does not alter the character, nature and intention of that particular transaction especially in the context of capital gain versus business income. By bringing in stock-in-trade under the head investment the assessee could reduce the tax incidence considerably. The activity of ‘trading in shares’ carried out separately in the AY 2004-05 and again brought forward to be continued in the next AY i.e. 2005-06 under the head ‘investment’ is to be considered as trading activity only. Subsequent conversion and treatment given in the books of accounts do not alter the character of commercial transaction. Accordingly, the profit that has been attributable to this trading activity corresponding to conversion of stock-in- trade into investment is to be treated as ‘business income’ and accordingly to be taxed.

The Hon’ble ITAT concluded that the income from investment is to be taken as ‘capital gains’ and conversion of stock-in-trade to investment is to be taken as ‘trading income’.

Facts of the Case

The assessee-company is deriving the income from business as well as from investments. The assessee is engaged in the business of carpets, garments, shares and stocks etc., The assessee has disclosed its income from sale of shares as LTCG and STCG as the case may be. The AO during the course of assessment proceedings noticed that assessee-company has LTCG and STCG from numerous sale and purchase transactions of units of mutual funds/shares through own investment/off market sale and through Kotak PMS. The AO required the assessee to explain as to why the profit on sale of shares be not treated as ‘business income’ instead of LTCG/STCG.
According to AO, assessee is carrying on the activities of shares transactions in a systematic manner and according to him, the same is in the nature of business. Accordingly, he assessed the income arising out of sale and purchase of shares and mutual funds as ‘business income’ at Rs.2,78,47,070/-. Aggrieved, assesse preferred appeal before CIT(A), who after considering the submission of assesse treated the profit arising out of sale of shares as LTCG but issue of conversion of investment in stock-in-trade as ‘business income’

Against the decision of CIT(A), Revenue went in appeal against the treatment of profit arising out of sale as CG and assessee filed Cross Objection against treatment of conversion and investment into stock-in-trade as business income.

Contention of the Assessee

As regards the AO’s observation that the assessee carried out numerous transactions with larger volumes, the assessee submitted that the volume of transactions carried out in terms of total holding is not large. It further submitted that out of 113 scrips including mutual funds only 8 scrips were sold. According to assessee most of surplus (capital gain) was on account of sale/redemption of investment held for a long period. It is submitted that out of total net capital gain of Rs.2,78,47,070/- the major capital gain amounting to Rs.2,43,14,169/- pertains to sale of shares of J.J. Exports which were held from AY 1992-93 onwards. According to assessee the net surplus was not a business income but on account of capital gain. To decide whether a transaction is in the nature of ‘investment’ or ‘trading’ the crucial test that laid down by various courts is that the ‘intention’ of the assessee at the time of purchase of shares.
As regards AO’s observation that purchases were effected out of borrowed funds, the assessee argued that the sources for acquisition of shares are from share capital, reserves and surplus funds. In this regard, Ld. counsel for the assessee filed summary of accounts from AYs 1993-94 to 2005-06.
Contention of the Revenue

The Ld. DR of Department relied on the orders of the lower authorities.

Held by CIT(A)

The Ld. CIT(A) was of the opinion that the original intention of the appellant was to treat shares as investment and not stock in trade as evident from the entries made in the books of accounts and balance sheet. The volume of transactions, frequency of transactions, period of holding etc., would not alter the nature of transaction from investment to trading when the initial intention of the appellant was to hold the shares under investment and accordingly recorded in the books. As such the assets (shares) categorized under the head ‘investment’ are to be treated as capital assets and the profit on sale of such assets are taxable under the head ‘capital gains’.
He further relied on the judgement of Hon’ble ITAT Kolkata Bench in the case of Reliance Trading Enterprises Ltd. Wherein it was observed that the shares were purchased with an intention of earning dividend in addition to the prospect of making profit on sale of such investment shares at an opportune moment without making any hurry for sale ignoring dividend. Accordingly it was directed to the AO to give effect taking into consideration both investment account and trading account separately. The profit attributable to trading activity (conversion of stock-in-trade into investment) shall be taxed under the head ‘business income’. The net surplus resulted out of ‘investment account’ shall be taxed under the head ‘capital gains’. In the result the appellant’s ground on this issue (Ground No. b) is partly allowed.”

Held by ITAT

ITAT held that as seen from the principles laid down by various courts, the main test prescribed is the ‘initial intention’ of the assessee to decide whether an activity amounts to ‘trading activity’ or ‘investment activity’. As seen from the above facts, the assessee is justified in its argument that its original initial intension is to hold the shares as ‘investments’ and not as ‘stockin- trade’. The intention of the assessee as is evident from the circumstances at the time of purchase of shares/units, is a relevant factor and often a conclusive factor in determining whether a transaction is in the nature of trade or in the nature of investment. The assessee had been keeping its holdings in certain companies from a few months to a few years, which clearly indicates that the motive and intention of the assessee is to earn returns in the form of capital gain apart from dividend income.
The Hon’ble ITAT noticed that separate ledger accounts in respect of conversion of stock-in-trade into investment are maintained. By converting the stock-n-trade into investment, it does not alter the character, nature and intention of that particular transaction especially in the context of capital gain versus business income. By bringing in stock-in-trade under the head investment the assessee could reduce the tax incidence considerably. The activity of ‘trading in shares’ carried out separately in the AY 2004-05 and again brought forward to be continued in the next AY i.e. 2005-06 under the head ‘investment’ is to be considered as trading activity only. Subsequent conversion and treatment given in the books of accounts do not alter the character of commercial transaction. Accordingly, the profit that has been attributable to this trading activity corresponding to conversion of stockin- trade into investment is to be treated as ‘business income’ and accordingly to be taxed.
Thus, In view of the findings of CIT(A) that the income from investment is to be taken as ‘capital gains’ and conversion of stock-in-trade to investment is to be taken as ‘trading income’, which is based on facts of the case and need no disturbance. Accordingly, the findings of CIT(A) was duly confirmed by the Hon’ble ITAT.

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