Section 94(7) of the Income Tax Act is a provision that aims to prevent tax evasion and tax avoidance through certain transactions related to securities, including shares, debentures, bonds, and units of mutual funds. This provision applies when an assessee (an individual, Hindu Undivided Family, or any other entity liable to pay tax) buys securities, and within a period of three months, sells or transfers them to another person, who then sells or transfers them back to the assessee. This transaction is referred to as a “circular transaction.”
The objective of such circular transactions is to reduce or avoid tax liability by claiming a capital loss on the sale of the securities, which can be set off against the capital gains earned by the assessee on the sale of other securities. The provisions of section 94(7) seek to deny such tax benefits to the assessee.
As per the provisions of section 94(7), if an assessee buys securities and sells or transfers them to another person within a period of three months, and that person sells or transfers them back to the assessee within three months from the date of the first sale or transfer, the capital loss incurred by the assessee on the first sale or transfer shall be ignored for the purpose of computing the capital gains or losses arising from the subsequent sale or transfer of such securities.
For instance, let’s say an assessee buys shares worth Rs. 1 lakh on 1st January and sells them for Rs. 80,000 on 1st March, incurring a capital loss of Rs. 20,000. If the same shares are repurchased by another person on 1st April and sold back to the assessee on 1st June, the capital loss of Rs. 20,000 incurred by the assessee on the first sale will be ignored, and the gains or losses from the subsequent sale will be computed based on the purchase price of Rs. 1 lakh.
The provisions of section 94(7) are applicable only if the following conditions are satisfied:
- The assessee buys securities and sells or transfers them to another person.
- The other person sells or transfers the securities back to the assessee within a period of three months from the date of the first sale or transfer.
- The securities are held by the other person for a period of less than three months.
- The sale or transfer by the other person is not a result of any business reorganization.
- The securities are not traded on a recognized stock exchange.
The provisions of section 94(7) do not apply to the sale or transfer of securities in the ordinary course of business or as a result of any business reorganization. The section also provides for certain exceptions and exemptions in cases where the circular transaction is carried out for genuine commercial reasons and not for tax avoidance.
Section 94(7) of the Income Tax Act was introduced in the Finance Act, 2013, and is applicable from the assessment year 2014-15 onwards. The provision was introduced to counter the practice of tax evasion and tax avoidance through circular trading in securities. Circular trading involves transactions in which an assessee sells securities to another person and then buys them back from the same person within a short period, typically three months, to generate artificial losses that can be set off against gains made from other investments.
The purpose of the provision is to deny the benefit of capital loss arising from circular transactions to the assessee. Circular transactions are considered to be artificial transactions that have no commercial substance and are entered into solely for tax avoidance purposes.
The provisions of section 94(7) are intended to prevent the use of circular trading as a means to avoid paying taxes on capital gains. This provision ensures that taxpayers do not get a tax benefit by creating artificial losses through circular trading.
One of the key conditions for the application of this provision is that the securities involved in the transaction must not be traded on a recognized stock exchange. This means that the provision does not apply to securities that are traded on recognized stock exchanges.
The provision also provides an exemption in cases where the circular transaction is carried out for genuine commercial reasons and not for tax avoidance. For instance, if an assessee sells securities to another person and buys them back within three months for genuine business reasons, such as hedging against risks or meeting short-term liquidity requirements, the provisions of section 94(7) will not apply.
The provisions of section 94(7) also apply to cases where an assessee sells securities to a related party and buys them back within three months. In such cases, the capital loss arising from the first sale will be ignored for the purpose of computing the capital gains or losses arising from the subsequent sale or transfer of such securities.
It is important for taxpayers to be aware of the provisions of section 94(7) and ensure compliance with the same while carrying out transactions involving securities. Taxpayers should also ensure that they maintain proper documentation to support the commercial reasons for the transaction to avoid any disputes with the tax authorities.
In conclusion
section 94(7) of the Income Tax Act is a provision that aims to prevent tax evasion and tax avoidance through circular trading in securities. The provision is designed to ensure that taxpayers do not get a tax benefit by creating artificial losses through circular trading. The provision applies to transactions involving securities that are not traded on recognized stock exchanges and provides an exemption for transactions carried out for genuine commercial reasons. Taxpayers should be aware of the provisions of this section and ensure compliance while carrying out transactions involving securities.
Other Related Blogs: Section 144B Income Tax Act
Frequently Asked Questions (FAQs)
Q.1 What is Section 94(7) of the Income Tax Act?
Section 94(7) of the Income Tax Act is a provision that aims to prevent tax evasion and tax avoidance through circular trading in securities.
Q.2 What is circular trading in securities?
Circular trading involves transactions in which an assessee sells securities to another person and then buys them back from the same person within a short period, typically three months, to generate artificial losses that can be set off against gains made from other investments.
Q.3 When does Section 94(7) apply?
Section 94(7) applies to transactions involving securities that are not traded on recognized stock exchanges. It also applies to transactions in which an assessee sells securities to a related party and buys them back within three months.
Q.4 Does Section 94(7) apply to all types of securities?
No, Section 94(7) only applies to securities that are not traded on recognized stock exchanges.
Q.5 Is there an exemption to Section 94(7)?
Yes, there is an exemption in cases where the circular transaction is carried out for genuine commercial reasons and not for tax avoidance.
Q.6 How can a taxpayer prove that a circular transaction was carried out for genuine commercial reasons?
Taxpayers should maintain proper documentation to support the commercial reasons for the transaction, such as hedging against risks or meeting short-term liquidity requirements.
Q.7 What happens if a taxpayer violates Section 94(7)?
If a taxpayer violates Section 94(7), the capital loss arising from the first sale will be ignored for the purpose of computing the capital gains or losses arising from the subsequent sale or transfer of such securities.
