Pune Income Tax Appellate Tribunal (ITAT) in the case of the KRA Holding & Trading (P) Ltd. (ITA Nos. 500,1320/ PN/08, 434/PN/09) and ARA Trading & Investments (P) Ltd. (ITA Nos. 499, 1321,1322/PN/08,806/PN09) on the issue of deductibility of portfolio management fees in computing ‘capital gains’ under the Indian Tax Laws (ITL) held that such fees was directly connected to the acquisition and sale of securities and was incurred in the normal course of the investment activity. It was held that the payments would be allowed as a deduction in computation of capital gains under the ITL.
Background and facts – Section 48 of the ITL (Section) provides for the mode of computation of capital gains. From the full value of consideration, deduction is allowed in respect of (i) expenditure incurred ‘wholly and exclusively’ in connection with such transfer and (ii) the cost of acquisition as well as cost of improvement of the asset transferred. The Taxpayers had engaged ENAM Asset Management R Ltd. (ENAM) for portfolio management services. For the relevant tax year, the ITAT had concluded that the Taxpayers had securities which were held as investments and were capital assets. Accordingly, any income earned by the Taxpayers from sale of such securities was in the nature of ‘capital gains’ under the ITL. During the same tax year, the Taxpayers had paid certain fees to ENAM for the portfolio management services (Fee). The Fee was paid on the termination of period of agreement with ENAM which was subsequently renewed and it was computed on the basis of the Net Asset Value (NAV) on the date of termination of period of agreement. The Taxpayers were of the view that the Fee was paid in connection with the acquisition/sale of securities and claimed the above as a deduction in computation of capital gains for the tax year. The Tax Authority disallowed the claim by classifying the Fee as a ‘profit sharing fee’. It contended that such Fee was in violation of the SEBI (Portfolio Managers) Rules & Regulations, 1993 (applicable to portfolio managers) which prohibited portfolio managers from charging fee on a return sharing basis. The first appellate authority also dismissed the appeal of the Taxpayers. Aggrieved by the order, the Taxpayers appealed before the ITAT.
Issue for consideration- Whether fees paid by the Taxpayers for portfolio management services would be allowed as a deduction while computing capital gains under the ITL?
Tax Authority’s contentions – For the purposes of capital gains, each asset is to be considered on a standalone basis and computation of cost of acquisition should be asset specific. Hence, there is a need for identification of the asset specific expenditure. The Fee paid to ENAM is not asset specific as it is based on the NAV on the termination date of period of the agreement. Reliance was placed on a recent decision of the Mumbai ITAT in the case of Davendra Kothari [136 TTJ 188] a similar issue wherein the fee paid to portfolio managers was not allowed as a deduction while computing capital gains under the ITL. Under the ITL, no deduction is permitted in respect of expenditure which is in infringement of any law.
Taxpayers’ Contentions
The Section allows deduction of any expenditure incurred wholly and exclusively in connection with transfer. It is the real income, i.e. the actual income that reaches the taxpayers, which should be taxable as also held in Rajkot Dist Gopalak Co-op Milk Products Union v CIT [204 ITR 590] .
Reliance was placed on the decision of the jurisdictional High Court (HC) of Mumbai in the case of CIT v Shakuntalal Kantilal [190 ITR 56] to contend that if the genuineness, certainty and necessity of a payment is beyond doubt, such a payment is deductible even in the absence of specific enabling provisions of computation of capital gains. The deduction is computed either by taking full value of consideration as net of the payments or deducting the same as expenditure incurred wholly and exclusively in connection with transfer.
The decision of Mumbai ITAT in the case of Davendra Kothari, as relied by the Tax Authority, was distinguishable for the following reasons:
