Convert Stocks into Investment

I have been into trading of shares. If I discontinue this business activity and hold closing-stock-of-shares as investment, what would be the tax implications?
Sudarshan Kumar, New Delhi

Stock in trade can be converted into a capital asset or vice versa merely by declaring the intention to do so and by supporting such an intention by adequate documents and by the way in which the transactions are recorded.

The differential tax treatment of any business activity when compared to an investment activity may prompt a tax-payer to redefine the activity in a particular manner in a given situation. This can be done to minimise tax liability.

While conversion of capital assets into stock-in-trade and taxability of resultant profit or loss is specifically dealt under Section 45(2) of the Income Tax Act there is no specific provision to deal with reverse situation involving conversion of stock-in-trade into capital asset or investment. Conversion of capital asset into stock: Sale of converted asset results into capital gain or capital loss in the year in which such stock is sold. This is calculated by subtracting the cost at which the original asset was carried from the fair market value on the date of conversion.

Conversion of stock into capital asset: Based on the interpretations of various sections and prudence my comments are as follows:

1. Stock may be converted into investment in a running business or at the time of closure.
2. No capital gain would arise on the date of conversion. However when the investment is sold, it will result into capital gain or loss to be calculated taking book value as cost of acquisition.
3. In view of differential tax rates applicable on type of capital gain, period of holding of capital asset is relevant to distinguish long term gain from short-term gain. Period of holding in this case
will be reckoned from the date of acquisition of original stock of shares.

This technique of converting stock into investment or vice versa can be effectively used as tool of tax planning.

This article was originally published on December 19, 2002.