JUNE 17, 2020

By Navneet Singal

ABSTRACT

THIS article deals with the requirement of Tax Audit u/s 44AB of the Income-tax Act, 1961 ('the Act') in respect of the transactions in securities which inter alia includes transaction in derivatives of shares, stocks etc. It defines what should be included for the purpose of determination of the turnover for the applicability of the Tax Audit and how it should be valued. It also interprets the nature of income from transactions in securities and whether it should be construed as business income or income from capital gain and further speculative or non-speculative income from business in the light of judicial rulings and provisions of the Income-tax Act. It describes with examples how the guidelines issued by ICAI should be read in the light of Income-tax provisions where ICAI has missed referring to the definition of speculative and non-speculative transactions under the Act and have not differentiated between them.

INTRODUCTION

Section 44AB of the Act stipulates the requirement of Tax Audit on a person carrying on business, if his total sales, turnover or gross receipts (as the case may be) in business for the year exceed or exceeds Rs. 1 crore. This provision is not applicable to the person who opts for presumptive taxation scheme under section 44AD and his total sales or turnover doesn't exceed Rs. 2 crores.

W.e.f. FY 2019-20, the threshold limit, for a person carrying on business, is increased from Rs. 1 Crore to Rs. 5 crores in case when cash receipt and payment made during the year does not exceed 5% of total receipt or payment, as the case may be. In other words, more than 95% of the business transactions should be done through banking channels.

The Act does not define how the value of the turnover should be calculated and what should be included or excluded while computing the same. For this purpose, we need to refer to the Guidance Note on Tax Audit u/s 44AB issued by the ICAI which specifically describes the guidelines which determine the value of turnover or gross receipts in shares, securities and derivatives. This study interprets whether a transaction in securities should be a part of turnover or not and if yes, what value should be considered.

TRANSACTION IN SECURITIES, WHETHER BUSINESS OR INVESTMENT

Whether or not a transaction in securities should be considered for calculating the turnover depends upon its nature of business or investment. In case such transactions are for the purposes of investment and profit/(loss) arising therefrom, it is to be computed under the head 'Capital Gains', then the value of such transactions are not to be included in sales or turnover. However, in case such transactions are in the course of business, then those should be included in the sale, turnover or gross receipts as the case may be.

Central Board of Direct Taxes ('CBDT') has issued Instruction No. 1827 dated August 31, 1989 which has been further supplemented by the Circular No. 4/2007, dated June 15, 2007, where CBDT has described the principles to determine the nature of transactions based on the different Apex Court rulings, High Court rulings and AAR rulings. After going through all these rulings, we can summarize the following factors to determine the nature of the transactions i.e.

1. Intention behind investment: The purchase and sale of shares with the motive of earning profits would result in the transaction being in the nature of trade but where the object of the investment in shares is to derive income by way of dividend etc. then the profits accruing by change in such investment will yield capital gain and not revenue receipt.

2. Accounting treatment in the Financials: Where a taxpayer purchases and sells shares in the course of his business, it must be shown that they were held as stock-in-trade and in case of Investment it should be shown as part of Investment Heading. Only the existence of the power to purchase and sell shares in the objectives of the business through memorandum of association or otherwise, is not decisive factor to determine the nature of transaction.

3. Frequency and volume of transactions: High frequency and volume of transaction indicate the business intent of the taxpayer rather than investment strategy.

The following case laws can be referred to understand the nature of the transactions where the issues have been discussed under different circumstances:

- CIT vs. Ahmedbhai Umarbhai & Co. - 2002-TIOL-579-SC-IT-CB

- Sarder Indra Singh & sons Ltd. Vs. CIT (1953) 24 ITR 415 (SC)

- CIT Vs. Associated Industrial Development Co. (P) Limited - 2002-TIOL-558-SC-IT

- CIT, Bombay Vs H. Holck Larsen - 2002-TIOL-531-SC-IT

- SBH. Vs.CIT (1988) 151 ITR 703 (AP)

- Fidelity North star Fund, In re - 2007-TIOL-03-ARA-IT,  Authority for Advance Rulings (AAR)

- Sanjeev Mittal Vs. CIT, ITA No. 520 of 2014 (2015), (Delhi HC) - 2015-TIOL-2543-HC-DEL-IT

- Pr. CIT-1 (S), Vs. Shah Investor's Home Limited, Tax Appeal No. 418 of 2016 - 2016-TIOL-1151-HC-AHM-IT (Gujarat)

It can be opined that it is the total effect of all relevant factors and circumstances that determines the character of the transaction. CBDT has further emphasized that it is possible for a taxpayer to have two portfolios, i.e., an investment portfolio and trading portfolio.

CALCULATION OF VALUE OF TRANSACTION TO BE CONSIDERED AS TURNOVER

The ICAI has issued the Guidance Note on Tax Audit u/s 44AB and clause 5.14 on page no. 25 of it provides guidelines to determine the value of turnover or gross receipts in shares, securities and derivatives. The Income-tax Act, 1961 also stipulates the definition of Speculative and non-speculative transactions u/s 43(5). After a cumulative reading of provisions and guidelines, the transaction can be of two types for the purpose of calculation of turnover i.e.

(1) Delivery based transaction

In respect of the delivery based transaction, total sales value of the shares, stocks or commodities should be considered as turnover. However, it should be applicable only in the case of transactions considered as business income and not as investment income.

(2) Non-delivery based transaction

All the derivatives transactions are generally non-delivery based transactions e.g. future contracts, forward contracts, options (call/put), margin contracts, swaps etc., hence, any value derived from such transactions should be considered for the purpose of calculation of Turnover/Receipts for applicability of Tax Audit.

(a) Speculative Transaction: Section 43(5) of the Act defines "speculative transaction" means a transaction in which a contract for the purchase or sale of any commodity, including stocks and shares, is periodically or ultimately settled otherwise than by the actual delivery or transfer of the commodity or scrip. It further provides that an eligible transaction in respect of trading in security derivatives or commodity derivatives from a recognized stock exchanges should not be considered as speculative transaction.

ICAI guidelines suggests that each transaction resulting into whether a positive or negative difference is an independent transaction and the aggregate of all speculative transactions shall be taken to calculate the turnover. Hence, it can be opined that the absolute value of the Profit/(loss) of each transaction should be considered for turnover computation, e.g. the taxpayer has incurred profit of Rs. 45 lakhs in one transaction and loss of Rs. 65 lakhs in another transaction, then the value of turnover should be considered as Rs. 1.10 Crs.

(b) Non-speculative Transactions: The transactions other than speculative transactions should be considered as non-speculative transaction as the Act does not define any separate definition for it. The turnover in such type of transactions is to be determined as follows:

(i) The total of favorable and unfavorable differences shall be taken as turnover.

The ICAI guidelines does not define that whether it should be absolute value of the transactions or net of profit/(loss) account which should be considered to determine the value of turnover. Analysts have different view on it, however, as per my opinion it should be considered as absolute value rather than total value.

While calculating the value of turnover or gross receipts of any business the net profit/(loss) element of all the transactions should not be considered as it does not impact the turnover of the business. A business which is in loss is also eligible for Tax Audit similar to a business in profit so netting off the same is not advisable.

(ii) Premium received on sale of options is also to be included in turnover. E.g., in options, if you buy 2 lots (50 quantity) of Nifty 8,200 calls at Rs.20 and sell at Rs.30. Firstly, the profit of Rs 500 (10 x 50) is the turnover. But premium received on sale also has to be considered for turnover, which is Rs 30 x 50 = Rs 1,500. So total turnover on this option trade will be of Rs. 2,000.

(iii) In respect of any reverse trades entered, the difference thereon should also form part of the turnover.

The ICAI guidelines do not differentiate between speculative and non-speculative transaction and also does not refer to the definition of the same as per the Act. The exclusion of derivatives transaction through stock exchanges was introduced in Section 43(5) by Finance Act, 2005 w.e.f. April 1, 2006, however, after that Guidelines for Tax Audit u/s 44AB has been revised many times but this aspect was missed. Hence, it is suggested that the the definition of speculative and non-speculative transactions as per the Act should be referred to in the Guidance Note along with examples elaborating the different scenarios to remove any ambiguity.

CONCLUSION:

In my opinion, it can be concluded that while calculating the value of turnover, sales or gross receipt u/s 44AB of the Income-tax Act, 1961, the following principles should be followed -

(1) Only the business transactions should be considered and not the investment transactions.

(2) In respect of delivery based business transactions, the total sales value of the transactions should be included.

(3) In respect of non-delivery based transactions, the absolute value of Profit/(loss) from each transaction should be taken rather then the net value of profit/(loss) through all the transactions of the business during the year.

(4) For options and reverse trades, in addition the point no. (3), the premium received on sale of options and difference value in reverse trade should be included respectively.

(The author is Head of Taxation, Syngene International Ltd. and the views expressed are strictly personal.)