The first instruction were issued vide Instruction No. 1827 dated 31.08.1989 on taxation of surplus arising on sale of shares guiding the tax authorities on various criteria to be applied for treating holding of shares as stock in trade or capital asset.One of the most important criteria to be applied under these instruction was to find out the intention of the tax payer. Where the purchase has been made with the sole intention of resale at a profit and the purchaser does not have any intention to hold the property for himself or otherwise for enjoying it, the presence of such an intention is a relevant factor and it would raise a strong presumption that the transaction is in the nature of trade and such securities shall be treated as stock in trade and thus profit liable to be treated as business income. However in case one invests in securities for the sole purpose of  earning dividends/interest over the years, the same can not be treated as stock in trade and any profit on sale of such asset will have to be treated as capital gains.

Likewise the nature of trade or business carried on by the tax payer shall also be relevant for this purpose. In case of stock brokers any purchase and sale of securities shall be treated as business income unless there are other circumstances to warrant other treatment like intention to hold it for generating regular income in future. Likewise the volume of transactions in securities will also point towards it being in the nature of trade. So in case the tax payer has indulged in such transaction of purchase or sale of securities sporadically, the presumption of it being capital asset is very high.

One of the other indicators is whether a particular assessee is buying or selling the securities or whether he has merely invested his money with a view to earning further income or is holding it for carrying on his other business. In former case the surplus shall be treated as business income and in later case the same shall be treated as capital gains.

In addition to the nature of business, volume of transactions and  intention,  the treatment of the securities in the books of accounts by the tax payer as investment is also a guiding factor for treating the surplus as capital gains. However such treatment in the books alone would not be conclusive evidence in case some other facts points to other direction. For example where the tax payer has been dealing in the securities on almost daily basis though showing all such securities as investment. In such circumstances the treatment of such securities as investment in the books of accounts  itself is wrong.

The central government has issued revised instruction in 2007 vide Circular No. 4/2007 dated 15.06.2007 providing further clarity on the criteria to be used for treatment of specific security as stock in trade or capital asset. It has provided that whether a particular holding of shares is by way of investment or forms part of stock-in-trade is a matter where the knowledge and conduct of the tax payer is important. So it is the responsibility of the tax payer to provide evidence in support of his contention. It has further provided that it is the substance of the nature of transactions which is important factor like how the books of accounts have been maintained,  or the magnitude of purchases and sales of such securities or the ratio between purchases and sales. All these factors evaluated together will help the tax payers as well as the revenue authorities to arrive at a valid and rational conclusion.

It is not that all the holdings of securities of a particular assessee can either be treated as stock in trade or capital asset. The assessee can treat some of the shares as capital assets and some as stock in trade. The tax payer can even treat some shares of a Company as stock in trade and other shares of the same company as capita assets. So it is possible for an assessee to have two portfolios, one as an investment portfolio comprising of securities which are treated as capital assets and the other one as a trading portfolio comprising of stock-in-trade which the tax payer treats as trading assets. Where an assessee has two portfolios clearly segregated, the tax payer can have income from both the sources.

Various Courts have also held that when the assessee has shown some securities as capital assets in previous years and the same has been accepted by the income tax officials then, the tax officer can not take a different stand later on unless there are strong evidence to warrant such a change of opinion.

The government has also advised the tax officers that while evaluating whether particular security is stock in trade or capital asset,  it is totality of facts and circumstances which are to be considered and no  single principle would be decisive and can be considered in isolation. So the overall effect of all the various guidelines and principles should be considered to determine whether, in a given case, the securities are held by the assessee as investment or stock-in-trade. So what is important is to consider the distinctive character of the transaction and the security. In each case, it is the total effect of all relevant factors and circumstances that determines the character of the transaction.