CA Sandeep Kanoi
The AO, after selecting the case for scrutiny assessment, found on 18.11.2008 that the gains realized by the assessee on sale of shares were in the nature of business income, and not capital gains. The assessee, in its reply to the AO stated that the shares were depicted as investments and not “stock in trade” in the accounts of the assessee and hence the gains resulting from their sale were to be considered capital gains. The assessee also attempted to produce evidence to show that the intention had not been to earn trading profit: first, the investment was undertaken by the assessee with its own surplus funds, and not borrowed funds, and second, that the holding period for a majority of the transactions was substantial. Moreover, the assessee sought to show that the relationship between the investor (the assessee) and the investment manager (the portfolio manager), as indicated by the agreements entered by Portfolio Management Schemes (“PMS”), was one of principal and agent. It was also sought to be shown that since the transactions made by the PMS were delivery based, where delivery of the scripts was taken/given on purchase/sale of shares (as reflected in the D-MAT account with the NSDL), the transactions were intended as investments and not adventure in the nature of trade.
The AO held by its order dt. 30.10.2008 first, that a sum of 51,47,172/- was to be added as business income of the assesse (profits from trade less the PMS charges, treated as expenses wholly and exclusively for the purpose of business), second, that penalty proceedings under Section 271(1)(c) were to be initiated and third, that the claim for rebate under Section 88E, as an alternative, was to fail since no evidence of the Securities Transaction Tax paid was furnished. It was reasoned that the purpose of a portfolio manager was to optimize returns of the investor. Since the motive of the transactions was the earning of profit and not a dividend, where the holding period was ranging from a few days to a few months, it was concluded that the income was business income earned by way of adventure in the nature of trade.
The Commissioner of Income Tax (Appeals) (“CIT(A)”)held that the intention at the time of purchase and sale, the magnitude and frequency of transactions has to be seen to test whether the sum of gain made “was a mere enhancement of value by realizing a security” or a “gain made in operation of business in carrying out a scheme for profit-making”. It was concluded that the shares were not in the nature of property which yielded any income or personal enjoyment to the owner, by virtue solely of its ownership. Thus, the intention was concluded to be profit-making, and the gains were found to be business income.
The ITAT upheld the order of the CIT(A), and found the gains to be “business income”.
High Court held that
a. The PMS Agreement in this case was a mere agreement of agency and cannot be used to infer any intention to make profit
b. The intention of an assessee must be inferred holistically, from the conduct of the assessee, the circumstances of the transactions, and not just from the seeming motive at the time of depositing the money
c. Along with the intention of the assessee, other crucial factors like the substantial nature of the transactions, frequency, volume etc. must be taken into account to evaluate whether the transactions are adventure in the nature of trade
Therefore the block of transactions entered into by the portfolio manager must be tested against the principles laid down, in order to evaluate whether they are investments or adventures in the nature of trade.
Coming to the facts of this case, it is not contested that the source of funds of the assessee were its own surplus funds and not borrowed funds. This Court notices from Annexure 4 (p. 90) that the following is the volume of transactions on the basis of holding period.
|Period of holding||< 90 days||90-180 days||181-365 |
|Quantity of |
|Gain or loss||236,121.87||803,149.68||2,446,125.84||2,217,955.77||5,723,353.16|
of CG/L to
It is clear thus, that about 71 % of the total shares have been held for a period longer than 6 months, and have resulted in an accrual of about 81 % of the total gains to the assessee. Only 18% of the total shares are held for a period less than 90 days, resulting in the accrual of only 4% of the total profits. This shows that a large volume of the shares purchased were, as reflected from the holding period, intended towards the end of investment. This Court is not persuaded by the argument of the Revenue that an average of 4-5 transactions were made daily, and that only eight transactions resulted in a holding period longer than one year. This is because the number of transactions per day, as determined by an average, cannot be an accurate reflection of the holding period/frequency of transactions. Moreover, even if only a small number of transactions resulted in a holding for a period longer than a year, the number becomes irrelevant when it is clear that a significant volume of shares was sold/purchased in those transactions.
This Court is thus of the opinion that the Ld. ITAT erred in holding the transactions to be income from business and profession. The order of the ITAT is consequently set aside and the appeal is answered in favour of the assessee.