Taxation in Securities market

Security Market

It’s where trades of securities such as stocks and bonds take place based on demand and supply. Securities markets determine price and participants can be both professional and non-professional.

Securities markets can be split into two levels: primary markets, where new securities are issued, and secondary markets where existing securities can be bought and sold. Secondary markets can further be split into organised exchanges, such as stock exchanges and over-the-counter, where individual parties come together and buy or sell securities directly. For securities holders knowing that a secondary market exists in which their securities may be sold and converted into cash increases the willingness of people to hold stocks and bonds and thus increases the ability of firms to issue securities.

There are a number of professional participants of a securities market and these include; brokerages, broker-dealers, market makers, investment managers, speculators as well as those providing the infrastructure, such as clearing houses and securities depositories.

A securities market is used in an economy to attract new capital, transfer real assets in financial assets, determine prices which will balance demand and supply and provide a means to invest money both short and long term.

The securities market encompasses organised exchanges, as well as over-the-counter markets where trading is done directly between brokers and dealers.

Securities fall into three main categories:

  • Equity securities. This is just a posh name for stocks. When you buy shares, you own part of a company.

  • Debt securities. Also known as fixed-income securities, these are better known as bonds. When you buy them you're lending money to a company.

  • Derivative securities. With these, you're granted the right to trade financial securities at pre-agreed terms instead of owning shares outright. Options contracts are a type of derivative security.

Securities Transaction Tax or STT

Securities transaction tax is a type of tax levied on gains from securities. This includes mainly equities and futures and options. The rate of taxation is different for different types of securities. STT can basically be understood as a type of tax levied on transactions done in the domestic stock exchange. Securities transaction tax is a direct tax and is levied and collected by the central government of India.

The most prominent point about securities transaction tax is that STT charge is applicable only on share transactions made through a recognized stock exchange in the country. Off-market share transactions are not covered under STT.

Securities Transaction Tax and Income Tax

Taxation on the money made via share market trading depend largely on the purpose for which share transactions are done. An individual can trade shares for business purposes or as an investment activity. In both the cases the STT that is levied by the government, varies. Depending upon this factor, following two heads can be differentiated.

  • Income from Capital Gains:

Income from capital gains is applicable when the assesse is a salaried or self-employed person who deals in stock transactions only for investment purposes and trading in securities is not what he does as his main line of profession. Gains of losses in such cases can be grouped as short-term capital gains or long-term capital gains depending upon the period for which the stocks are held. If the holding period is less than a year, then the gains are classified as short-term capital gains whereas for share holdings with a holding period more than one year, the term long-term capital gains is applicable.

  • Income from Share Trading as a Profession:

This case arises when the income from trading of stocks is being made as a professional choice and is being carried out from business point of view. In such cases the losses as well as gains from share trading is classified as business income. This is then taxed at the regular income tax rates set by the government. Securities transaction tax paid on income from taxes can then be claimed as deduction under section 36 of the income tax act.

If the investor holds the listed equity shares for more than 12 months before selling them off, the gains derived from such shares would be long-term in nature, else they are categorized as short term.

The capital gains derived from the sale of listed equity shares in India are categorized into long-term and short-term gains depending upon the period of holding. The period of holding refers to such a period for which the shares are held by the investor i.e., the period from the date of acquisition to the date of sale of such shares.

Taxation on gains from Equity shares

Tax on short-term capital gains

Short term capital gains are taxable at 15%. What if your tax slab rate is 10% or 20% or 30%? Special rate of tax of 15% is applicable to short term capital gains, irrespective of your tax slab. Also, if your total taxable income excluding short term gains is below taxable income i.e Rs 2.5 lakh – you can adjust this shortfall against your short term gains. Remaining short term gains shall be then taxed at 15% + 4% cess on it.

Tax on long-term capital gains

Long term capital gain on equity shares listed on a stock exchange are not taxable up to the limit of Rs 1 lakh. As per the amendments in budget 2018, the long term capital gain of more than Rs 1 lakh on the sale of equity shares or equity-oriented units of the mutual fund will attract a capital gains tax of 10% and the benefit of indexation will not be available to the seller.These provisions apply to transfers made on or after 1 April 2018.

Loss from Equity Shares

Short-term capital loss

Any short term capital loss from sale of equity shares can be set off against short term or long term capital gain from any capital asset. If the loss is not set off entirely, it can be carried forward for a period of 8 years and adjusted against any short term or long term capital gains made during these 8 years.

It is worthy to note that a taxpayer will only be allowed to carry forward losses if he has filed his income tax return within the due date. Therefore, even if the total income earned in a year is less than the minimum taxable income, filing an Income Tax Return is a must for carrying forward these losses.

Long-term capital loss

Long-term capital loss from equity shares until Budget 2018 was considered to be a dead loss – It can neither be adjusted nor carried forward. This is because long-Term Capital gains

from listed equity shares were exempt. Similarly, losses from them were neither allowed to be set off nor carried forward.

After the Budget 2018 has amended the law to tax such gains made in excess of Rs 1 lakh @ 10%, the government has also notified that any losses arising from such listed equity shares, mutual funds etc would be allowed to be carried forward.

The income tax department has vide its FAQs issued dated 4 February 2018, inter alia clarified that long-term capital loss from a transfer made on or after 1 April 2018 will be allowed to be set-off and carried forward in accordance with existing provisions of the Act. Therefore, the long-term capital loss can be set-off against any other long-term capital gain and unabsorbed long-term capital loss can be carried forward to subsequent eight years for set-off against long-term gains.

Guidance for treating share sale as business income

Certain taxpayers treat gains or losses from the sale of shares as ‘income from business’, while certain others treat it as ‘Capital gains’. Whether your gains/losses from sale of shares should be treated as business income or be taxed under capital gains, has been a matter of much debate.

In case of significant share trading activity (e.g. if you are a day trader with lots of activity or if you trade regularly in Futures and Options), usually your income is classified as income from business. In such a case you are required to file an ITR-3 and your income from share trading is shown under ‘income from business & profession’.

Calculation of income from business v. capital gains

When you treat the sale of shares as business income, you are allowed to reduce expenses incurred in earning such business income. In such cases, the profits would be added to your total income for the financial year, and consequently be charged at tax slab rates.

If you treat your income as capital gains, expenses incurred on such transfer are allowed for deduction.Also, long-term gains from equity above Rs 1 lakh annually are taxable, while short term gains are taxed at 15%.

What should be classified as significant share trading activity though has lead to uncertainty and a lot of litigation? Taxpayers receive notices from the tax department and end up spending a lot of time and energy explaining why they chose a particular tax treatment for the sale of shares.

New clarification from CBDT

Taxpayers have now been offered a choice of how they want to treat such income. Once they choose, they must however continue the same method in subsequent years too, unless there is a major change in circumstances of the case. Do note that the choice has been made applicable only to listed shares or securities.

With a view to reducing litigation in such matters, CBDT has issued the following instructions (CBDT circular no 6/2016 dated 29th February 2016)– If the taxpayer himself opts to treat his listed shares as stock-in-trade, the income shall be treated as business income. Irrespective of the period of holding of listed shares. The AO shall accept this stand chosen by the taxpayer.

If the taxpayer opts to treat the income as capital gains, the AO shall not put it to dispute. This is applicable for listed shares held for a period of more than 12 months. However, this stand once taken by a taxpayer in a particular assessment year shall be applicable in subsequent assessment years also. And the taxpayer will not be allowed to take a different stand in subsequent years.

In all other cases, the nature of transaction (whether capital gains or business income) shall continue to be decided basis the concept of ‘significant trading activity’ and the intention of the taxpayer to hold shares as ‘stock’ or as ‘investment’. The above guidance would prevent unnecessary questioning from Assessing Officers regarding the classification of income.

How to treat sale of unlisted shares in this context

However, in case of sale of unlisted shares for which no formal market exists for trading, the department has given its view. Income arising from transfer of unlisted shares would be taxed under the head ‘Capital Gain’, irrespective of period of holding, with a view to avoid disputes/litigation and to maintain uniform approach. (As per CBDT circular Folio No.225/12/2016/ITA.1I dated the 2nd of May, 2016 )