The Central Board of Direct Taxes on Friday directed tax officials to assess liability for those transacting in shares on the basis of principles laid down by the Authority of Advance Rulings (AAR).

These principles distinguish between shares held as stock-in-trade (trading assets) and those held as investments.

The clarification is important as income from trading assets is treated as business income, attracting a tax of slightly over 30 per cent. Income from investments attracts capital gains tax -- 10 per cent for short-term (less than 12 months) and no tax on long-term gains.

The circular implies that tax assessing officers will henceforth have to look into the holding pattern of the securities bought and sold, the sale-purchase ratio, the time involved, the funding sources and the overall trade volume when determining the tax liability involved among others.

The circular, which supplements an 18-year-old one, provides clarity on a controversial issue that has seen massive litigation by many including FIIs.

The circular directs assessing officers to three principles culled out by the AAR from the Supreme Court's decisions for determining tax liability.

The AAR has said ordinarily the purchase, sale of shares with a motive of earning profits amounts to business income, while investments made for earning income through dividend may be treated as capital gain.

The CBDT has also said taxpayers can have two portfolios -- an investment one, comprising securities treated as capital assets, and a trading one, comprising stock-in-trade, treated as trading assets.

Amarjeet Singh, partner, KPMG, said, "This circular does not make a huge material difference as it is just an aggregation of previous principles. In the case of litigation, this clarification gives FIIs an upper hand. Now, I have principles on the basis of which I can ask the court to give me benefit (in litigation on tax treatment)".

"The intention of the tax department is to clarify ambiguities. The government is giving an indication that tax treatment will be based on individual, specific cases," said VS Wahi, direct tax expert at Khaitan & Co.