Tax Planning: Convert FNO profits to STCG

Taxation
35

Thanks @Quicko .

Thanks to @Jason_Castelino 's comments, I went and took a closer look at the case law around this issue. Here is what I learned: my assertion that a frequent trader does not have recourse to claiming STCG is not entirely true. Instead, here is what I now believe (Note: I am not an expert in any of this):

  1. If you are a frequent trader, and you claim STCG on some sales, then the AO can (and has, in many cases) assess these instead as business income and apply the higher tax rate (and possibly, the fines that come along with this revision). You will have to fight the system to get this assessment overturned. Sometimes this fight goes on for many years, across various appellate authorities, up to the High Court/Supreme Court.

  2. If you are a frequent trader, and you wish to claim STCG on some sales, then the safest thing is to keep separate portfolios for the two types of trades. I saw a few judgments where the court ruled in favour of the assessee because the assessee was able to convince the court that they had two sets of portfolios, one for investment and one for trading. I am not entirely sure what would suffice as “keeping separate portfolios”. Here is what I think:

    • If you do the two types of trades from separate demat accounts, you are fine.

    • If you do both types of trading from the same demat account, then keeping track of different ledgers for the two types of trades should also suffice.

  3. If you are a frequent trader, and you claim STCG on some sales, and you haven’t used “separate portfolios”: if your AO thinks you are trying to wiggle out of paying tax, they will do the re-assessment of these profits as business income, and then it is up to you whether to fight it in appeals. The eventual (after various rounds of litigation) outcomes of these appeals fall on both sides: in some cases the final judgment favours the AO, and in others, the assessee. I could not suss out a clear pattern to the reasoning applied by the various courts.

I now summarise the points that may be of interest to this community, from the most recent judgment that I could find on this matter. The case is Ramilaben D. Jain Vs ACIT (Bombay High Court). The date of the judgment is 20 Aug 2018, and the case pertains to Assessment Year 2007-08.

Note that this is a paraphrasing based on my (possibly faulty) understanding of the order; please see the linked page for the original judgment. It is written in clear language which we can all understand (except for some very long sentences, perhaps!).

  1. The assessee is a housewife, and she claimed both STCG on sale of shares and speculative income from trading in her returns for AY 2007-08.

  2. The AO denied this distinction, and treated the entire income as business income. (I assume this resulted in higher tax for the assessee, along with fines for delayed payment etc.)

  3. The assessee went on appeal to the Commissioner. The Commissioner denied this appeal, and upheld that all of the claimed STCG should in fact be treated as business income.

  4. The assessee went on appeal to the Income Tax Appellate Tribunal, Mumbai. The Tribunal denied her appeal.

  5. The assessee went on appeal to the Bombay High Court against this ruling of the ITAT. The Court denied her appeal, in the linked order.

    The order lists the following about the assessee’s transactions in FY 2006-07, in support of the judgment denying the appeal (I am paraphrasing, please see the original judgment for the verbatim text):

    • 73 transactions in total, of which only one is in the LTCG category
    • Of the 72 transactions on which STCG was claimed, only 10 have holding period more than one month
    • In the majority of transactions the holding period is less than one week
    • Just 10 transactions having holding period of more than one month is not enough to make all these 72 transactions eligible for STCG treatment
    • The trend that the assessee sold more than 80% of their holdings within a week of purchase, supports the finding (by lower authorities) that these trades were all in the nature of business

Here is some verbatim text from the judgment which may be of interest:

The intention of the assessee in indulging in these transactions is to earn profit at the earliest possible occasion and when there is a rise in the price. The assessee is moving as per the stock market trend. At the first available opportunity, the assessee is selling the shares. This type of activity of sale and purchase is rightly termed, not as an investment, but actuated by motive of sale and purchase so as to earn profit at the earliest occasion.

One more point that went against the assessee in this order: she had, in her returns for the previous AY (2006-07), offered all the profit from share sales as business income. The order said that she cannot just flip this and claim STCG for the same type of income in the next year. So this is one other thing to keep in mind if you wish to both do frequent trading and claim STCG.

I am not a lawyer or an expert in taxation/tax law; these are what I understood as a lay person. Please consult your CA/tax lawyer before taking action based on what you read above!

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