* IN THE HIGH COURT OF DELHI AT NEW DELHI
Reserved on: 17.04.2014
Pronounced on: 25.04.2014
+ ITA No.485/2012
RADIALS INTERNATIONAL ..... Appellant
Through: Mr. Kaanan Kapur, Advocate.
Versus
ASSTT. COMMISSIONER OF INCOME TAX ..... Respondent
Through: Mr. N.P. Sahni, Sr. Standing Counsel.
CORAM:
HON'BLE MR. JUSTICE S. RAVINDRA BHAT
HON'BLE MR. JUSTICE R.V. EASWAR
MR. JUSTICE S. RAVINDRA BHAT
%
1. This is an appeal filed against the order of the Income Tax
Appellate Tribunal ("ITAT") which upheld the action of the Revenue
in treating the profit made by the appellant on sale of equity shares
under the Portfolio-Management Schemes ("PMS") as business
income and not as capital gains, as claimed by the appellant.
The question of law that arises for determination before the Court is:
"whether, the shares invested through a portfolio management
ITA No.485/2012 Page 1
scheme, in the circumstances of this case resulted in gains taxable as
capital gains or as business income?"
2. The facts are that the Appellant (hereafter "assessee"), is a
partnership firm, engaged in the business of providing technical,
marketing and maintenance services for earth mover, aircraft and truck
tyres. It also trades in tyres. For the assessment year 2006-07, the
assessee had declared a total income of 3,17,80,943/- on 31.10.2006.
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
ITA No.485/2012 Page 2
NSDL), the transactions were intended as investments and not
adventure in the nature of trade.
3. 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
4. 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.
ITA No.485/2012 Page 3
5. The ITAT upheld the order of the CIT(A), and found the gains
to be "business income". It held that the nature of a PMS agreement is
that it "prevents holding of dormant of stocks of depreciating value",
and that the PMS is supposed to "provide the skill and expertise to
steer through the complex volatile and dynamic conditions of the
market". The order may be extracted in relevant part:
"10. Under PMS a person deposits the money under the
contract for a period normally not less one year. After
depositing the money the investment in securities is left to
the choice of the portfolio manager. The assessee has no
control either on selecting the securities or the period of
holding. The portfolio manager normally gives the
account quarterly on the basis of which the investor
comes to know about the profit earned and the securities
in which the transactions were done by the port Folio
manager on behalf of the assessee. The shares purchased
and sold are credited and debited to the DEMAT account
of the party, which remains in the control of portfolio
manager. It is the portfolio manager who can only deal
with the DEMAT account of a particular person. At the
time of depositing the amount the assessee will definitely
make entry in his books of account as investment in PMS.
But he is not aware of the transactions in the shares
being entered into by the portfolio manager on his behalf
as his agent. The portfolio manager charges his fee for
the services rendered and other expenses incurred on the
same lines as is done in a case where the agent charges
from his principal. Since the assessee comes to know
about the purchase and sale of shares in the PMS after
the expiry of a period of three months, the accounting
treatment in the books of the assessee in respect of shares
purchased/sold by the portfolio manager under PMS
cannot be entered in the books of the assessee. It is at the
end of the year the shares available in the DEMAT
account can be entered. Therefore, at the time of deposit
ITA No.485/2012 Page 4
of amount, the intention of the assessee was to maximize
the profit. The purchase and sale of shares under PMS
was not in the control of the assessee at all. Therefore, it
cannot be said that the assessee had invested money
under PMS with intention to hold shares as investment.
The portfolio manager has carried out trading in shares
on behalf of his clients to maximize the profits. Therefore
it cannot be said that shares were held by the assessee as
investment.
13. ... Merely because the purchase and sale of shares
had occurred through DEMAT account on delivery
based; it would no change the nature of the transaction.
Since the portfolio manager in the capacity of an agent
has traded in shares on behalf of the assessee, the profits
arising therefrom, will be in the nature of business
profits. Further simply because the assessee has treated
the deposits made under PMS as investments and balance
shares lying in DEMAT account as on the last day of the
accounting year under the head ,,investment would not
change the character of trading done by the portfolio
manager on behalf of the assessee. The shares purchased
and sold during the year have not been recorded in the
books of accounts as investment nor is it feasible to
record as the details were not available with the assessee
and the assessee has no control or say as to when and the
type of shares or the period of holding of the shares.
Therefore in our considered opinion, the transactions are
in the nature of business. The decision relied upon by the
assessee in the case of Gopal Purohit (supra) is not
applicable to the facts of the assessees case."
6. The ITAT also observed that the frequency of sale and purchase
of shares indicated trading activity. Finally, the ITAT observed that
the principle of res-judicata is not applicable in Income Tax
proceedings and therefore, the argument that the AO was barred from
taking a view different from his earlier view was untenable in law.
ITA No.485/2012 Page 5
Since the ITAT found that the gains were taxable as business income,
the exemption of section 10(38) for long term capital gains for shares
held longer than 12 months, as well as the claim for concession at the
rate of 10% under section 111A on short term capital gains were both
denied.
7. Counsel for the Appellant argued that the transactions must be
considered by themselves, while applying the tests to determine
whether they are investments or adventure in the nature of trade. It is
urged that the PMS agreement, by its terms alone or by the fact of
agency being handed over to the portfolio manager, cannot be the
basis for inferring an intention to profit or that the transactions are in
the nature of trade. The Revenue, on the other hand, emphasizes that
the fee paid to the broker is more than the return on the property, thus
indicating that the portfolio management scheme itself is one intended
to earn profit. Of the total of 1248 transactions that have taken place in
the relevant period, the Counsel urges that there were on average,
about 4-5 transactions daily, only 8 of which entailed a holding period
of longer than 365 days. Thus, it is urged that the order of the Ld.
ITAT must be upheld.
8. This Court has considered the submissions of both parties. At
the outset, it would be pertinent to note some of the relevant terms of
the PMS agreement. Clauses 7(b) and 7 (c) of the PMS agreement
between Radial and Kotak Securities Ltd. indicate that only in a
discretionary portfolio, unlike in a non-discretionary portfolio, the
manager has full discretion to invest in respect of the client's account
in any type of security, and make such changes in the investments as
ITA No.485/2012 Page 6
he deems fit. Clause 18 (b) of the agreement states that the manager
shall
"not be responsible for any loss or expenses resulting to one
person as client, from the insufficient or deficiency of value of
or title to any property or security acquired or taken on behalf
of the client".
While the agreement entered into between Radial and Reliance
appears to be a discretionary portfolio, as indicated in clause 9
(by which client "unconditionally and irrevocably" grants
power of attorney to the portfolio manager to make decisions on
the investments), clause 10 states that the portfolio manager
provides no warranty as to the appreciation of the securities in
which he applies the client's funds. Therefore, it is clear that a
PMS agreement can be an instrument by complete authority and
discretion over the transactions to be entered into, is
surrendered to the portfolio manager by the investor.
9. From the terms of the agreement it does not emerge that the
intention of the investoris to make profits. The terms on the other
hand, indicate that regardless of the level of discretion handed over to
the portfolio manager, there is neither any guarantee that the securities
invested in will appreciate nor is the portfolio manager responsible to
the client for any loss from the deficiency of value of the securities.
Thus, the PMS agreement at best, embodies the intention to appoint an
agent with limited liability, who will invest on behalf of the investor
and nothing more.
ITA No.485/2012 Page 7
10. The Ld. ITAT reasons that "at the time of deposit of amount,
the intention of the assessee was to maximize the profit" because first,
while the assessee enters the PMS as investments in the books of
account at the time of depositing the money, the assessee does not
know what specific transactions will be entered into by the manager,
second, that the assessee finds out the details of the transactions only
after three months have expired and, only at the end of the year can
the shares in the DEMAT account be entered into the books of
account, third, the assessee has no control over the shares bought or
sold under the PMS and thus the portfolio manager enters into
transactions on behalf of his clients to maximize profits. From this, the
ITAT infers that "it cannot be said that the assessee had invested
money under PMS with intention to hold shares as investment".The
reasoning of the Ld. ITAT does not find favour with this Courtfor
three reasons.
11. First, the three reasons provided by the ITAT merely convey
that intention to hold shares as investment cannot be inferred from the
agreement. However, the fact that no inference of an intention to
invest can be made from the agreement does not translate to the
intention to trade in shares for profit either. As was noted in Raja
Bahadur KamakhyaNarain Singh v. CIT-Bihar, (1969)3SCC791 =
(1970) 77 ITR 253 (SC) :
"The surplus realised on the sale of shares, for instance,
would be capital if the assessee is an ordinary investor
realising his holding; but it would be revenue, if he deals
with them as an adventure in the nature of trade. The fact
that the original purchase was made with the intention to
ITA No.485/2012 Page 8
resell if an enhanced price could be obtained is by itself
not enough but, in conjunction with the conduct of the
assessee and other circumstances, it may point to the
trading character of the transaction. For instance, an
assessee may invest his capital in shares with the
intention to re-sell them if in future their sale may bring
in higher price. Such an investment, though motivated by
a possibility of enhanced value, does not render the
investment a transaction in the nature of trade.
12. As indicated here, while a transaction may be motivated by
the intention to resell at an enhanced value, it would not be possible to
evaluate whether the transaction was actually in the nature of trade,
until the securities are actually resold. Moreover, in a discretionary
PMS, it becomes all the more relevant and necessary to evaluate the
intention of the assessee in conjunction with his conduct and other
circumstances, since the intention of the assessee cannot be
ascertained at the time of depositing the money in the investment,
because the actual sale and purchase of securities happens at the hands
of the portfolio manager, a mere agent.
13. Second, since the intention of the assessee cannot be
ascertained, and the investments are made by the portfolio manager
without the knowledge of the assessee/investor in a discretionary
PMS, the manner in which the securities have been treated by the
assessee can and ought to be evaluated only post the fact of
investment, and not at the time of depositing the money. This
proposition is supported by the judgment of the Supreme Court
reported as CIT-Calcutta v. Associated Industrial Development
ITA No.485/2012 Page 9
Company, AIR 1972 SC 445 = (1971) 82 ITR 586 (SC), in which it
was held that:
"...it was open to the assessee to contend that even on the
assumption that it had become a dealer and was no
longer an investor in shares the particular holdings
which had been cleared and the sales of which had
resulted in the profit in question had always been treated
by it as an investment. It can hardly be disputed that
there was no bar to a dealer investing in shares. But then
the matter does not rest purely on the technical question
of onus which undoubtedly is initially on the revenue to
prove that a particular item of receipt is taxable. Whether
a particular holding of shares is by way of investment or
forms part of the stock-in-trade is a matter which is
within the knowledge, of the assessee who holds the
shares and it should, in normal circumstances, be in a
position to produce evidence from its records as to
whether it has maintained any distinction between those
shares which are its stock-in-trade and those which are
held by way of investment.
The assessee can only show that the holdings in question were always
treated as an investment (despite having made a profit on clearing
them) post the fact of investment. It would also be necessary to
acknowledge that the characterization of a transaction, i.e as a
portfolio management scheme or investment, itself is not
determinative. It is settled law that nomenclature of a document or
deed is not conclusive of what it seeks to achieve; the court has to
consider all parts of it, and arrive at a finding in regard to its true
effect (Ref. Puzhakkal Kuttappu v. C. Bhargavi & Ors AIR 1977 SC
105 and Faqir Chand Gulati, Appellant(s) V. Uppal Agencies Pvt. Ltd
2008 (10) SCC 345). In the income tax law, the position is no
ITA No.485/2012 Page 10
different, as can be seen from the judgment of the Supreme Court in
CIT Vs. Motors & General Stores (P) Ltd. (1967) 66 ITR 692 (SC),
following Duke of Westminister (1935) 19 Tax Cas. 490 and
Commissioner of Inland Revenue Vs. Wesleyan & General Assurance
Society (1948) 16 ITR (Supp.) 101.
14. Lastly, the way in which the tests are to be applied was made
clear in the CBDT Circular no. 4 of 2007, which states:
"8. The Authority for Advance Rulings(AAR) (288 ITR
641), referring to the decisions of the Supreme Court in
several cases, has culled out the following principles :-
(i) Where a company purchases and sells shares, it must
be shown that they were held as stock-in-trade and that
existence of the power to purchase and sell shares in the
memorandum of association is not decisive of the nature
of transaction;
(ii) the substantial nature of transactions, the manner of
maintaining books of accounts, the magnitude of
purchases and sales and the ratio between purchases and
sales and the holding would furnish a good guide to
determine the nature of transactions;
(iii) ordinarily the purchase and sale of shares with the
motive of earning a profit, would result in the transaction
being in the nature of trade/adventure in the nature of
trade;but where the object of the investment in shares of
a company is to derive income by way of dividend etc.
then the profits accruing by change in such investment
(by sale of shares) will yield capital gain and not revenue
receipt.
...
11. Assessing Officers are advised that the above
principles should guide them in determining whether, in a
given case, the shares are held by the assessee as
investment (and therefore giving rise to capital gains) or
as stock-in-trade (and therefore giving rise to business
ITA No.485/2012 Page 11
profits). The Assessing Officers are further advised that
no single principle would be decisive and the total effect
of all the principles should be considered to determine
whether, in a given case, the shares are held by the
assessee as investment or stock-in-trade.
15. It was also held in P.M. Mohammed Meerakhan v CIT-Kerala,
(1969)2SCC25 = (1969) 73 ITR 735 (SC) :
"...it is not possible to evolve any single legal test or
formula which can be applied in determining whether a
transaction is an adventure in the nature of trade or not.
The answer to the question must necessarily depend in
each case on the total impression and effect of all the
relevant factors and circumstances proved therein and
which determine the character of the transaction.."
16. Therefore, it is legally untenable to focus singularly on the
intention or motive of the assessee without looking at the substantial
nature of the transactions, in terms of their frequency, volume, etc.
17. This Court thus concludes 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,
ITA No.485/2012 Page 12
frequency, volume etc. must be taken into account to evaluate
whether the transactions are adventure in the nature of trade
18. 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.
19. 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 < 90 days 90-180 181-365 >365 days Total
holding days days
Quantity of 32,750 18,063 38.140 90.649 179,602
shares
Percentage 18.23% 10.06% 21.24% 50.47%
to total
quantity
Gain or loss 236,121.87 803,149.68 2,446,125.84 2,217,955.77 5,723,353.16
Percentage 4.12% 14.03% 43.09% 38.75%
of CG/L to
total
CG/loss
20. 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
ITA No.485/2012 Page 13
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.
S. RAVINDRA BHAT
(JUDGE)
R.V. EASWAR
(JUDGE)
APRIL 25, 2014
ITA No.485/2012 Page 14
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