Shri Mahendra C Shah, Mumbai Vs Additional Commissioner of Income Tax – I T A No: 6289/Mum/2008 – (Assessment Year: 2005- 06)
Additional Commissioner of Income Tax Vs Shri Mahendra C Shah Mumbai – I T A No: 4932/Mum/2009–(Assessment Year: 2006- 07)
Assessee by: Mr R G Tralshawala
Revenue by: Mr R S Srivastav
O R D E R
R V EASWAR, PRESIDENT:
These are two appeals, one by the assessee which relates to the assessment year 2005-06 and the other by the revenue which relates to the assessment year 2006-07. Since they were heard together, they are disposed of by a common order for the sake of convenience.
2. The assessee is an individual deriving income in Futures and Options, speculation in shares, commission agency and from partnership in trading firms, share dealings, etc.
3. In respect of the assessment year 2005-06, the first ground taken by the assessee is that the CIT(A) erred in treating the short term capital gain of Rs. 38,1 1,620/- and the long term capital gain of Rs. 1 1,53,849/- on sale of shares as business income. This ground is connected with the ground raised by the department in its appeal. In the said ground the department has questioned the order of the CIT(A) for the assessment year 2006-07, in which he had directed the Assessing Officer to treat the surplus of Rs. 79,92,714/- arising on sale of shares as short term capital gains instead of business income as held by the Assessing Officer. We thus have two contrary decisions taken by the CIT(A) for the two years under appeal on the same issue. These grounds can be taken up together for decision.
4. In the return for the assessment year 2005-06, the assessee declared loss of Rs. 14,37,338/- from Futures and Options in the share market and claimed the same to be business loss. Loss from speculative business was shown at Rs. 3,87,61 6/-. The assessee also declared short term capital gains of Rs. 38,1 1,627/- and long term capital gains of Rs. 1 ,68,863/- on sale of shares. These details were examined by the Assessing Officer. He first proceeded to examine the nature of the share transactions. From the details filed by the assessee, he noted that there were extensive share transactions including speculative dealings and Futures and Options transactions. He therefore called upon the assessee to show cause as to why he should not be treated as a person dealing in shares as against the claim of the assessee that he was an investor in the shares. The assessee submitted that he was an active working partner of several partnership firms and proprietor of a firm dealing in yarn and he was not a trader in shares, that he has been making investment in shares with the specific object of making profit, that the shares bought and sold are taken delivery of and passed through the assessee’s Demat account, that any profit and loss arising on sale of shares within a year from the date of purchase is shown as short term capital gain and any profit arising on sale of shares after one year from the date of purchase is shown as long term profit, that every purchase and sale of shares is delivery based and therefore he was only an investor. The Assessing Officer considered the assessee’s submissions from the following points of view, namely –
(i) Motive for purchase of securities;
(ii) Period of holding;
(iii) Frequency of transactions;
(iv) Source of acquisition;
(v) Infrastructure employed; and
(vi) Co-relation with other activities of the assessee.
So far as the motive is concerned, he noted that the assessee was carrying on business in Futures and Options and also speculative transactions. He further noted that a majority of the transactions were settled in a short span of 30 days. Thus, according to the Assessing Officer, the basic intention of the assessee was to earn quick profits. As far as the period of holding is concerned, he noted from an analysis of the details furnished by the assessee, that more than 30% of the profit is from transactions where the purchase and sales took place within the period of one month. With regard to frequency of transactions, the Assessing Officer noted from the scrip-wise details filed by the assessee that before 01.10.2004 7,78,1 00 shares were transacted for a gain of Rs. 4,06,79,566/- and after the above date 8,82,879 shares were transacted for a gain of Rs. 5,47,31 ,228/-. According to the Assessing Officer such huge frequency of the transactions would have taken considerable time of the assessee which makes him a dealer in shares rather than an investor. As regards the source of acquisition of the shares, the Assessing Officer found that the assessee had borrowed Rs. 1,10,16,076/- as on 31 .03.2005 from India Bulls Securities Limited and has claimed the interest as deduction. The outgo of interest was almost 30% of the short term capital gains. The Assessing Officer further noted that the assessee had own capital of Rs. 4,00,00,000/- but apparently this was not sufficient for the share dealings and therefore had to resort to the borrowings. As regards the infrastructure employed by the assessee and its co-relation with the other activities of the assessee, the Assessing Officer reiterated that the assessee was deeply engaged in share speculation business and Futures and Options transactions and was also utilizing substantial borrowed funds and the investment in shares and debentures and the balances with brokers were almost 75% of the assessee’s total funds. Referring to the above aspects of the case, the Assessing Officer summed up the position in the following words in para 3.11 of his order: –
“3.11 In the light of the aforesaid analysis, I have no doubt in my mind of whatsoever nature that the assessee cannot be treated as an investor in shares but he is clearly a trader in shares and as such the entire short term capital gains / long term capital gain shown by him would also be liable to be treated as business income considering the background discussed hereinabove. The substantial use of borrowed funds volume of the transactions, intention of the assessee to make quick money by making dealings in shares as a career, supports the aforesaid finding. In fact the contention of the assessee that he is basically a trader and dealing in shares is his investment activity is quite contrary to the analysis of his balance sheet”.
5. In the assessment order for the assessment year 2006-07, the Assessing Officer took the same view and for almost the same reasons. The assessee filed an appeal to the CIT(A) for both the years. In the appeal for the assessment year 2005-06 the CIT(A) endorsed the decision of the Assessing Officer and his findings may be summed up as follows: –
(a) The purchase and sale of securities were not an occasional independent activity, but the assessee was engaged in some real, substantial and systematic business activity.
(b) The word “business” which is defined in section 2(13) of the Income Tax Act, 1961, is a word of large and indefinite import. The assessee purchased the shares with the intention to resell them at a profit.
(c) A substantial number of shares were purchased out of borrowed funds. The assessee borrowed from M/s India Bulls, M/s Shah Enterprises and M/s Chandra Sales Corporation.
(d) The assessee has devoted substantial time in the purchase and sale of shares and also earned substantial profits.
In support of the aforesaid factual findings, the CIT(A) referred to the guiding principles laid down in the following judgments of the Supreme Court: –
(1) Raja Bahadur Visheshwara Singh (Deceased) vs. CIT (1961) 41 ITR 685 (SC)
(2) Dalhousie Investment Trust Co. Ltd. vs. CIT (1968) 68 ITR 486 (SC)
(3) CIT vs. Sutlej Cotton Mills Supply Agency Ltd. (1975) 100 ITR 706 (SC)
By adopting the above line of reasoning, the CIT(A) concluded that the assessee was engaged in business activity as far as share purchase and sales were concerned and he was not an investor but a trader.
6. In respect of the assessment year 2006-07, the appeal to the CIT(A) was decided by a different incumbent. He held on an analysis of the facts and circumstances brought on record that –
(a) The assessee was a partner in three partnership firms which were carrying on the activity of trading in yarn and commission agency. The assessee was the only male partner in these firms and had to look after the entire business for the past several years. The aggregate turnover of these firms was around Rs. 33.00 crores. In respect of the assessee’s individual business which is that of commission agency in yarn, the turnover was around Rs. 13.56 crores on which the assessee derived commission of Rs. 8.21 lakhs. The assessee thus was left with no time to engage in the business of shares.
(b) Even going by the volume of transactions, which in any case is not decisive of the question, the transactions are not voluminous. The short term capital gains arose from sale of 57 scrips and the total transactions were around 120. This is a small number and it cannot be said that there was huge frequency of share transactions. The average comes to less than one transaction per day.
(c) As against the total turnover of around Rs. 84.00 crores both in the proprietary and partnership firms carrying on yarn business, the turnover in share transactions was only Rs. 1 2.00 crores.
(d) Out of the total of 128 transactions, the holding period was within one month in respect of 27 transactions and it was within one to two months in respect of 35 transactions. In respect of the balance, the holding period was more than two months. Thus the shares held by the assessee were short term capital assets and their sale gave rise to short term capital gains.
(e) Though there is some force in the argument of the Assessing Officer that the assessee was indulging in Futures and Options transactions and therefore cannot be said to be an investor, in law there is no prohibition on an assessee from both being an investor and a dealer in shares and this position has been recognized even by the CBDT in Circular No: 665 dated 05.10.1992.
(f) It is true that a person engaged in investment activity would not like to take the risk of investing out of borrowed funds and pay huge interest. However, in law there is no prohibition on a person from borrowing funds for the purpose of making investment, just as a trader in shares can also use borrowed funds as well as owned funds in the business activity. Further the assessee’s own capital was Rs. 5.15 crores which was sufficient to cover the investment of Rs. 3.32 crores in the shares.
(g) In the past many years the assessee was showing the transactions as investment in his books of account and this stand was also accepted by the department except in the assessment year 2005-06. The assessee always took delivery of the shares and the transactions were routed through Demat account. The holding period of more than one month satisfies section 2(42A), which defines a “short term capital asset”.
(h) Even in respect of the long term capital gains declared by the assessee, though the Assessing Officer has treated them as business income, he is not right in doing so since the period of holding in all the share transactions was several years. Thus the surplus on sale of shares held for more than one year has to be treated as long term capital gains only and not as business income.
7. In addition to the aforesaid findings which were all in favor of the assessee, the CIT(A) also distinguished his predecessor’s order for the assessment year 2005-06 in the following words: –
“2.3(n) I have considered the facts of the year under consideration and also of the immediately preceding year including the appeal order of my predecessor for AY 2005-06. In the year under consideration the AO has formed an independent opinion on the basis of facts and figures of the year under consideration only. Except mentioning the stand taken in earlier year, the AO has not utilized any facts and figures of preceding assessment year 2005-06. On the basis of facts of the year under consideration I am of the considered opinion that the appellant was engaged in share investment activities and not in share trading activities. During the year under consideration the purchase and sale of shares were not an independent activity as the average transactions of share was not even one transaction per day. There is no denial of the fact that every economic / financial activity is carried out with the intention of profit only and not with the intention of loss. Thus if the shares were purchased with the intention of re¬sale at a profit, the profit would be asses sable as capital gain on sale of shares held as investment. Though, apart from his own capital, appellant has also utilized borrowed capital on which interest was paid at Rs.15.73 lakhs but during the year no new borrowings were made by the appellant. During the year the appellant made repayment of loan taken in earlier years. The loan amount as at 31.03.2005 amounting to Rs.1.10 crores was reduced to Rs.49 lakhs only as on 31.03.2006. Thus keeping in view the entirety of facts and circumstances and in view of above discussion, I am of the considered opinion that the appellant was engaged in investment activity. The surplus earned on sale of shares held for less than 1 year was asses sable as a short term capital gain whereas surplus earned on shares held for more than 1 year was asses sable as long term capital gain. The AO is directed to treat the appellant’s income on sale of shares as short term capital gain and long term capital gain accordingly”.
For the above reasons the CIT(A) held that the short term capital gains and long term capital gains declared by the assessee in the amounts of Rs. 79,92,71 4/- and Rs. 1 5,04,211/- have to be assessed as such and not as business income as held by the Assessing Officer. It may be clarified at this juncture that the department’s appeal does not question the decision of the CIT(A) for the assessment year 2006-07 that the long term capital gains should be assessed as such and not as business income. The ground before us refers only to the short term capital gains of Rs. 79,92,71 4/-.
8. Both the assessee as well as the department have addressed elaborate arguments in support of their positions. The main contention of the learned counsel for the assessee was that in all the assessment years starting from 2001-02 to 2004-05 the assessee’s stand that the shares were held as investment was accepted by the revenue and it was pointed out that for the assessment years 2001-02 and 2004-05 the assessments were completed after a scrutiny under section 143(3) of the Act. In these years the assessee declared both short term and long term capital gains and held 42 scrips which were shown at Rs. 98,35,984/-. In respect of the assessment year 2004-05 the assessee declared short term capital gain which was accepted by the Assessing Officer. The investment in shares was shown at Rs. 1 ,69,96,403/-. It was pointed out that in the Balance Sheet as on 31 .03.2004 the assessee had shown outstanding liability of Rs. 18,49,862/- in favour of Orbis Securities Private Limited and Rs. 1 ,55,654/- in favor of Orbis Securities indicating borrowings used for the investment, but still the Assessing Officer has accepted the assessee’s claim that he was an investor in shares in the scrutiny assessment made for that year. It was thus contended that the assessee has been consistently treated as an investor in shares and not as a dealer.
9. In respect of the assessment year 2005-06, in which the assessee is in appeal, it has been submitted by the learned counsel for the assessee that the investments were shown at Rs. 3,24,59,391/-. However, the assessee started Futures and Options dealings this year and it was only in respect of this activity that the assessee had borrowed funds from M/s India Bulls. It was again pointed out that the capital account balance of Rs. 4,1 9,60,788/- was more than the investment in shares and our attention was drawn to page 149 of the paper book to the statement set out therein showing the number of transactions and the number of scrips, giving rise to short term capital gains, long term capital gains, speculation income and Futures and Options income for the assessment years 2005-06 to 2007-08.
10. It was further contended on behalf of the assessee as follows:-
(a) The assessee’s main business activity has always been trading in yarn or commission agency, either as proprietor or as a partner. So far as the shares are concerned, he has always been an investor for the past 40 years.
(b) For the assessment year 2006-07, for which year the department is in appeal, they have not challenged the finding of the CIT(A) that the long term capital gains declared by the assessee have to be assessed as such and not as business income. The conduct of the department in not challenging this finding is consistent with the assessee’s claim that he is only an investor in shares.
(c) The chart set out by the CIT(A) in para 2.2(c) of his order for the assessment year 2006-07 showing the number of companies whose scrips were held by the assessee, the number of shares and the total value thereof as shown in the Balance Sheet as investment also supports the assessee’s claim that he has only been an investor and not a trader in shares.
(d) In the assessment year 2007-08, even though the department was aware of the stand it took in the earlier years, it accepted the assessee’s claim that the surplus on sale of shares was asses sable only as short term capital gains.
11. The learned DR put forth the following contentions: –
(a) The assessee is carrying on Futures and Options transactions as well as speculation transactions and a major part of his activity is constituted by these transactions.
(b) The Balance Sheet of the assessee as on 31.03.2005 (page 4 of the paper book) shows the investment in Futures and Options transactions at Rs. 1,03,01 ,657/- which constitutes almost 1/3rd of the investment of Rs. 3,24,59,391/- in shares. It is inconceivable that a person who has indulged in Futures and Options transactions to such a large extent would also be inclined to hold the shares as investment
(c) The assessee has utilized huge borrowings from M/s India Bulls in acquiring the shares and in law it has been held that if a person borrows money for the purpose of acquiring an asset, it is a strong indication of a business motive, provided the asset is one which is normally traded. An average investor would invest his own funds rather than borrow for interest which involves a huge risk.
(d) The fact that the assessee initially started as a yarn trader does not mean that he can never be capable of doing share business.
(e) In page 6 of the assessment order the Assessing Officer has adopted a very important test in paragraph 3.9.1. This is the test of employment of infrastructure and its co relation with the other activities of the assessee. The assessee was deeply engaged in share speculation transactions and Futures and Options. There is a heavy bearing of the borrowed funds towards the carrying on of these activities. If the PPF balance and the investment in gold and in house properties are excluded from the total of the individual assets in the Balance Sheet, it would be clear that the investment in shares and debentures and balances with brokers was almost 75% of the assessee’s funds. Thus the infrastructure employed by the assessee is heavily oriented towards the share transactions and this is a strong indication that the share transactions amount to a business.
(f) So far as the assessment year 2006-07 is concerned, though the CIT(A) has referred to the correct principles to be applied, but he has not properly applied them to the facts of the case. For instance, the time devoted to the share transactions is a wrong test to adopt and it is out of tune with the technology available today where share transactions can be entered into and managed online with the aid of computer technology. The CIT(A) has also adopted criteria which are not very important such as frequency and volume of transactions. Thus the wrong application of the settled principles to the facts and the inappropriate criteria adopted by the CIT(A) has vitiated his findings for the assessment year 2006-07.
12. In his reply the learned counsel for the assessee made the following points: –
(a) The figures of turnover in the share transactions are more indicative of the nature of the transactions – whether it is by way of investment or by way of business. He referred to the correct figures of turnover of the different businesses carried on by the assessee and set out in page 17 of the paper book.
(b) There can be no thumb rule that a person cannot borrow monies for the purpose of making investments, as laid down by the Pune Bench of the Tribunal in the case of B Balan Alias Shanmugam Balakrishnan Chettiar vs. DCIT (2009) 120 ITD 469 (Pune).
(c) The fact that the assessee borrowed monies for interest and utilized the same for making investment in shares does not ipso facto mean that the purchase of shares was for the purpose of trading therein. It is not a conclusive factor. Even the Income Tax department has accepted the assessee’s claim that the interest cost should be added to the cost of the investment. In this behalf the learned counsel for the assessee filed two sets of accounts with M/s India Bulls which show that M/s India Bulls Financial Services Limited has paid the monies to M/s India Bulls Securities Limited on behalf of the assessee for acquiring the shares. It is admitted that the borrowing is in effect by the assessee.
13. The learned counsel for the assessee also put forth an alternative plea that even if the assessment orders are to be upheld and the assessee is to be treated as a dealer in shares, he must be given the option of valuing the closing stock of shares on any of the recognized methods as was held by the Mumbai Bench “J” in the case of M/s J M Shares and Stock Brokers Limited in ITA Nos: 2801 and 2802/Mum/2000 and ITA No: 5488/Mum/2001, dated 30.11.2007 (copy of the order filed).
14. We have carefully considered the rival contentions. The question whether the surplus on the sale of shares is to be assessed as capital gains (short term or long term) as claimed by the assessee or as business income as claimed by the Assessing Officer is a question of fact to be decided according to the cumulative effect of several facts and circumstances of the case. The intention of the assessee, the nature of the commodity sold, whether the assessee has used his own funds or borrowed funds, the treatment given to the asset in the books of account, the consistent stand taken by the revenue authorities in respect of the sale proceeds of the asset in the earlier years, the frequency and volume of the transactions, the period of holding the shares, whether the assessee took or gave delivery of the shares, are all questions which have to be considered before a decision is taken as to whether the assessee held the shares as capital assets (investment) or as stock-in-trade. It is also recognized by the revenue that the same assessee can hold the shares in two different portfolios – one portfolio for stock-in-trade and another portfolio as investment. This position has been recognized by the CBDT in its Circular No: 665 dated 05.10.1992.
15. In the present case the commodity in question is shares which are generally traded. But that is not conclusive because it is common knowledge that shares are also held as investment particularly shares of blue chip companies which may yield consistent dividend and may also appreciate in value over a period of years, the appreciation being similar to the appreciation in the value of other investments such as fixed deposits with banks, real estate, gold and other precious metals, etc. It is a fact that in the present case the assessee has shown the shares as investment in his Balance Sheets. The relevant details are given in para 2.2(c) of the order of the CIT(A) for the assessment year 2006-07. The same is set out below: –
