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“CAPITAL GAINS”OR

“BUSINESS PROFITS”?

Compiled by:

CA. Pankaj Ghanshyam ShahG.J. Shah & CompanyIndore

2 | P a g e By CA.Pankaj G. Shah

FOREWORDDear Readers

There is no provision in the statute regarding the question as to when can atransaction in shares and securities be regarded as a trading transaction and asinvestment transaction. The law on the subject can only be culled out from variousdecided cases on the subject.

The question as to whether shares and securities (or any other asset, for that matter)are held as capital asset or as stock-in-trade is a question that has been taxing thebrains of the tax professionals and of the judiciary for more than a century. One ofthe earliest known decisions is that of the English Court of Appeals pronounced inthe year 1904 (See Californian Copper syndicate V. Harris (5 TC 159)). The earliest knownIndian Supreme Court decision was the one pronounced in the year 1959 ( SeeG.Venkata Swami Naidu & Co. V. CIT (35 ITR 594)). Yet we find, in the year 2012, thesame issue being debated and there is substance in that debate. This is because, in sofar as capital gains on listed shares and equity oriented units of mutual funds areconcerned, if the same are held as ‘capital assets’ (in other words, as ‘investments’)then the profits are considered as capital gains. In such circumstances, short termgains would be taxed at the concessional rate of 15% and the long term gains wouldbe completely exempt. On the other hand, if shares and securities are regarded asstock-in-trade, the profits are treated as business profits. In such circumstances, theprofits would be taxed at the normal rate of tax as any other income.

Tests laid down by Courts

The Courts have, over a period of time, laid down various tests to be applied in orderto arrive at a decision, on the given facts, on the question as to whether an asset isheld as capital asset or as stock-in-trade. A single largest test, which comes out fromvarious court rulings, is “the intention at the time of purchase” (See G.Venkata SwamiNaidu & Co. V. CIT (35 ITR 594) & Rmanarain Sons Ltd Vs. CIT (41 ITR 534)). In cases whenthe purchase has been made solely and exclusively with the intention to resell at aprofit and the purchaser has no intention of holding the securities for himself, thepresence of such an intention is a relevant factor and unless it is offset by thepresence of other factors it would raise a strong presumption that the transaction isan adventure in the nature of trade. Even so, the presumption is not conclusive: andit is conceivable that, on considering all the facts and circumstances in the case, thetransaction may be regarded as that of investment and not as a business venture.


The other tests laid down by Courts from time to time are:-

Whether purchaser was a trader and the purchase of the securities and itsresale were allied to his usual trade or business or incidental to it;

The quantity of the securities purchased and re-sold (the volume oftransactions);

Any act subsequent to the purchase to show that the intention is to retain andearn dividends and other corporate benefits out of it;

Any act prior to purchase showing a design or purpose;

The similarity of the transaction to those that are usually associated withtrade or business; and

The repetition of the transactions etc.

Whether the activity of investment is a business or not may be examined havingregard to the principle that “business connotes some real, substantive and systematicor organized course of activity or conduct with a set purpose” (See Narain Swadeshi VCEPT (26 ITR 765,773 – SC) & Mazgoan Dock V. CIT (34 ITR 368, 377)(SC)). In one of thecases before the Supreme Court, for several years, the assessee who madeinvestments in shares and securities out of his cash surplus was not assessed on theprofits arising from shares and securities and the Tax Department accepted that suchshares and securities were held by him not as stock-in-trade but as investments. (Inthose years, capital gains were not taxable). However, in July 1940, the assesseeborrowed huge sums and made further purchases and sales of shares / securities andearned substantial profits in coming 4 to 5 years out of number of transactions ofpurchase and sale. The Supreme Court held that having regard to the evidence beforethe lower authority, namely, the substantial nature of transactions, the manner inwhich books had been maintained, the magnitude of the shares purchased and soldand the ratio between the purchases and sales and the holdings all indicated that theassessee was dealing in shares as business and such conclusion by the lowerauthority could not be interfered with. It also held that merely because in the pastthe assessee was not regarded as a dealer in shares could not, by itself, preclude theTax Department from holding that he was dealer in shares for the years underconsideration. It is also worth noting that, if borrowings are made for the purpose ofmaking investments in shares and securities, that would give rise to a strongpresumption that the purpose of acquisition is that of dealing in shares; the logicbeing that a person normally makes investments from his surplus fund and not fromborrowed capital. In one case, the factors which influenced the Supreme Court tocome to the conclusion that the profits on sale of shares was business profits were:


authority in the Memorandum to buy and sale shares;

past dealing in shares of other companies;

specific resolutions of the company authorising Directors to purchase and saleof shares;

purchase of shares from borrowed funds etc.

Recently, the Madras High Court in CIT V. S.Ramaamirtham (306 ITR 239) held thateven in case of a registered share and stock broker, if on facts, it was found thatseparate books of account were maintained for trading in shares and investments inshares, shares in investment portfolio were held for a long period and out of surplusfunds, etc, there is nothing in law to prohibit a trade in shares to also invest inshares, and accordingly, profit on sale of shares held in investment portfolio wereassessable as ‘capital gains’.

The CBDT, in its Instruction No.1827 dated August 31, 1989 has reiterated theprinciples discussed above and has laid down in para 10 thereof that, although thetests laid down by the courts may help determine the issue in particular cases thedecision will ultimately turn on the facts of each case. The instructions are, therefore,merely in the nature of guidelines to be followed by the Assessing Officers. Theseguidelines have been reiterated and elucidated once again in a Circular No.4 datedJune 15, 2007.

However inspite of so many decisions on the subject there is no precise law on theissue and litigations are continuously raised by the Department.

I am confident that this publication compiling precedents on this litigious issue willbe of great help to all those practicing in the field of Tax Laws.

INDORE CA. Pankaj G. ShahJune 18, 2012


INDEX

1. CBDT CIRCULAR NO. 4/2007, DATED 15-6-2007 8

TESTS FOR DECIDING WHETHER SHARES HELD AS STOCK-IN-TRADE OR INVESTMENT ............................................................... 8

2. ACIT VS. MRS. RAJPAL SETHI (ITAT MUMBAI) 10

ASSESSEE CANNOT BE HELD TO BE A TRADER IN SHARES WITH RESPECT TO DELIVERY BASIS TRANSACTION ................................ 10

3. CIT VS. GOPAL PUROHIT (BOMBAY HIGH COURT) 10

SHARES ACTIVITY TREATED AS INVESTMENT IN EARLIER YEARS CANNOT BE TREATED AS BUSINESS IN SUBSEQUENT YEARS IF FACTS ARETHE SAME .......................................................................................................................................................... 10

4. ACIT V. OM PRAKASH SURI (M.P. HIGH COURT) 11

5. DCIT VS. SMK SHARES & STOCK BROKING (ITAT MUMBAI) 11

LARGE VOLUME OF PURCHASE & SALE OF SHARES DOES NOT PER SE MEAN ACTIVITY IS BUSINESS ............................................ 11

6. JANAK S. RANGWALLA V. ACIT (ITAT MUMBAI) 12

MERE VOLUME OF TRANSACTION TRANSACTED BY THE ASSESSEE WOULD NOT ALTER THE NATURE OF TRANSACTION..................... 12

7. MANAGEMENT STRUCTURE & SYSTEMS VS. ITO (ITAT MUMBAI) 12

TESTS LAID DOWN TO DETERMINE WHETHER INCOME FROM SHARES IS “BUSINESS” INCOME OR “CAPITAL GAINS”........................... 12

8. J. M. SHARE & STOCK BROKERS VS. JCIT (ITAT MUMBAI) 13

TESTS TO DISTINGUISH SHARES HELD AS “STOCK-IN-TRADE” AND AS “INVESTMENTS” ............................................................. 13

9. BOMBAY GYMKHANA LTD. V. ITO (ITAT MUMBAI) 13

MERELY HIGH NUMBER OF TRANSACTIONS NOT DETERMINANT. ....................................................................................... 13

10. CIT V. S.RAMAAMIRTHAM (MAD HC) 14

BROKER CAN HAVE SEPARATE ACCOUNTS FOR TRADING AND INVESTMENT.......................................................................... 14

11. NEHAL V. SHAH VS. ACIT (ITAT MUMBAI) 14

MULTIPLE ORDERS FOR PURCHASE/ SALE OF SHARES MAY CONSTITUTE ONE TRANSACTION .................................................... 14

12. ACIT VS. VINOD K. NEVATIA (ITAT MUMBAI) 15

SHORT PERIOD OF HOLDING SHARES DOES NOT PER SE SUGGEST BUSINESS ACTIVITY ........................................................... 15

13. CIT V/S. H. HOLSCK LARZEN (SC) 16


14. FIDELITY NORTHSTAR FUNDS & OTHERS, 16


15. CIT VS. PNB FINANCE & INDUSTRIES (DELHI HIGH COURT) 17

THOUGH MAIN OBJECT IN MEMORANDUM OF ASSOCIATION IS TO DO BUSINESS IN SHARES, SHARES CAN BE HELD AS A CAPITAL ASSET &NOT STOCK-IN-TRADE ........................................................................................................................................... 17

16. JCIT V. DINESH KUMAR GUPTA 18

PROFIT MOTIVE ALONE WOULD NOT DISTINGUISH A TRANSACTION OF INVESTMENT FROM A TRADING TRANSACTION BECAUSE EVEN INCASE OF INVESTMENT THERE MAY BE MOTIVE THAT AN ASSESSEE SHOULD BE ABLE TO SELL SUCH INVESTMENT AT A PREMIUM......... 18


17. ITO V. WATERLOO EXPORTS PVT. LTD.(ITAT KOL.) 18

DISCLOSURE IN BALANCE SHEET ............................................................................................................................. 18

18. JCIT V. DEO KUMAR SARAF (ITAT KOL.) 18


19. COMMISSIONER OF INCOME-TAX V. MADAN GOPAL RADHEY LAL (SC) 18

INTENTION TO BE GATHERED FROM THE EVIDENCE OF CONDUCT AND DEALINGS BY THE ACQUIRER WITH THE COMMODITY. .............. 18

20. DCIT V. RELIANCE TRADING ENTERPRISES LTD. (ITAT KOL.) 19


21. ACIT VS. NAISHADH V. VACHHARAJANI (BOMBAY HC) 19

DESPITE HIGH VOLUME & SHORT HOLDING PERIOD, SHARES GAIN IS STCG ........................................................................ 19

22. NAGINDAS P. SHETH (HUF) VS. ACIT (ITAT MUMBAI) 20

DESPITE LARGE NUMBER OF TRANSACTIONS IN SHARES, PROFIT ASSESSABLE AS CAPITAL GAINS. EVEN LESS THAN 30 DAYS WASCAPITAL GAINS .................................................................................................................................................... 20

23. RAMESH BABU RAO VS. ACIT (ITAT MUMBAI) 20

LARGE VOLUME IN SHARES NOT DECIDING FACTOR TO HOLD ASSESSEE TRADER................................................................... 20

24. SHANTILAL M. JAIN VS. ACIT (ITAT MUMBAI) 21

DESPITE LARGE VOLUME ETC OF SHARE TRANSACTIONS, AO BOUND BY RULE OF CONSISTENCY TO TREAT SHARE GAINS AS STCG .. 21

25. HITESH SATISHCHANDRA DOSHI VS. JCIT (ITAT MUMBAI) 21

EVEN GAINS ON SHARES HELD FOR 30 DAYS & LESS IS STCG & NOT BUSINESS PROFITS........................................................ 21

26. SHRI DEV ASHOK KARVAT VS. DCIT (ITAT MUMBAI) 22

UNITS OF MUTUAL FUNDS ARE NOT GENERALLY TRADING INSTRUMENT............................................................................... 22

27. DEVENDRA MOTILAL KOTHARI V. DCIT (ITAT MUMBAI) 23

PMS FEES NOT ALLOWABLE ................................................................................................................................... 23

28. ARA TRADING & INVESTMENTS PVT LTD VS. DCIT (ITAT PUNE) 24

SHARES PMS TRANSACTION GAINS ARE STCG AND NOT BUSINESS PROFITS ...................................................................... 24

29. KRA HOLDING & TRADING PVT LTD VS. DCIT (ITAT PUNE) 24

SHARES PMS FEE, EVEN IF NAV BASED, IS DEDUCTIBLE IN COMPUTING PMS CAPITAL GAINS. ................................................. 24PMS TRANSACTION ASSESSABLE AS CAPITAL GAINS. .................................................................................................... 24

30. SHRI HOMI K. BHABHA VS. ITO (ITAT MUMBAI) 25

PMS FEES NOT DEDUCTIBLE AGAINST CAPITAL GAINS. DESPITE DISSENTING ORDERS, REFERENCE TO SPECIAL BENCH NOT NECESSARY ....................................................................................................................................................................... 25

31. ITO VS. RADHA BIRJU PATEL (ITAT MUMBAI) 25

GAINS ARISING FROM PMS TRANSACTIONS ARE CAPITAL GAINS & NOT BUSINESS PROFITS...................................................... 25

32. M/S. RADIALS INTERNATIONAL VS. ACIT (ITAT DELHI) 26

LONG-TERM & SHORT-TERM GAINS FROM PMS TRANSACTIONS TAXABLE AS BUSINESS PROFITS ............................................... 26

33. CIT VS. VINAY MITTAL (DELHI HIGH COURT) 26


TESTS TO DETERMINE WHERE SHARES GAIN IS CAPITAL GAINS OR BUSINESS PROFITS ............................................................ 26

34. CIT VS. SAHARA INDIA HOUSING CORPORATION LTD (DELHI HIGH COURT) 27

OBJECTIVE TESTS TO CLASSIFY SHARES GAINS AS STCG VS. BIZ PROFITS LAID DOWN ........................................................... 27

35. CIT V. NIRAJ SURTI (GUJ HC) 27

DESPITE LOAN AT HIGH RATE OF INTEREST, SHARE CAPITAL GAIN CAN NOT BE TREATED AS BUSINESS PROFIT ........................... 27


CBDT CIRCULAR NO. 4/2007, DATED 15-6-2007Tests for deciding whether shares held as stock-in-trade or investment

1. The Income Tax Act, 1961 makes a distinction between a capital asset and a trading asset.

2. Capital asset is defined in Section 2(14) of the Act. Long-term capital assets and gains are dealt with under Section 2(29A) andSection 2(29B). Short-term capital assets and gains are dealt with under Section 2(42A) and Section 2(42B).

3. Trading asset is dealt with under Section 28 of the Act.

4. The Central Board of Direct Taxes (CBDT) through Instruction No.1827 dated August 31, 1989 had brought to the notice of theassessing officers that there is a distinction between shares held as investment (capital asset) and shares held as stock-in-trade(trading asset). In the light of a number of judicial decisions pronounced after the issue of the above instructions, it is proposed toupdate the above instructions for the information of assessees as well as for guidance of the assessing officers.

5. In the case of Commissioner of Income Tax (Central), Calcutta Vs Associated Industrial Development Company (P) Ltd (82 ITR586), the Supreme Court observed that:

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 theknowledge of the assessee who holds the shares and it should, in normal circumstances, be in a position to produce evidence fromits records as to whether it has maintained any distinction between those shares which are its stock-in-trade and those which areheld by way of investment.

6. In the case of Commissioner of Income Tax, Bombay Vs H. Holck Larsen (160 ITR 67), the Supreme Court observed :

The High Court, in our opinion, made a mistake in observing whether transactions of sale and purchase of shares were tradingtransactions or whether these were in the nature of investment was a question of law. This was a mixed question of law and fact.

7. The principles laid down by the Supreme Court in the above two cases afford adequate guidance to the assessing officers.

8. The Authority for Advance Rulings (AAR) (288 ITR 641), referring to the decisions of the Supreme Court in several cases, hasculled 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 thepower 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 andthe 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 natureof 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 revenuereceipt.

9. Dealing with the above three principles, the AAR has observed in the case of Fidelity group as under:-

We shall revert to the aforementioned principles. The first principle requires us to ascertain whether the purchase of shares by a FIIin exercise of the power in the memorandum of association/trust deed was as stockin-trade as the mere existence of the power topurchase and sell shares will not by itself be decisive of the nature of transaction. We have to verify as to how the shares werevalued/held in the books of account i.e. whether they were valued as stock-in-trade at the end of the financial year for the purposeof arriving at business income or held as investment in capital assets. The second principle furnishes a guide for determining thenature of transaction by verifying whether there are substantial transactions, their magnitude, etc., maintenance of books of accountand finding the ratio between purchases and sales. It will not be out of place to mention that regulation 18 of the SEBI Regulationsenjoins upon every FII to keep and maintain books of account containing true and fair accounts relating to remittance of initialcorpus of buying and selling and realizing capital gains on investments and accounts of remittance to India for investment in Indiaand realizing capital gains on investment from such remittances. The third principle suggests that ordinarily purchases and sales ofshares with the motive of realizing profit would lead to inference of trade/adventure in the nature of trade; where the object of theinvestment in shares of companies is to derive income by way of dividends etc., the transactions of purchases and sales of shareswould yield capital gains and not business profits.

10. CBDT also wishes to emphasise that it is possible for a tax payer to have two portfolios, i.e., an investment portfolio comprisingof securities which are to be treated as capital assets and a trading portfolio comprising of stock-in-trade which are to be treated astrading assets. Where an assessee has two portfolios, the assessee may have income under both heads i.e., capital gains as wellas business income.

11. Assessing officers are advised that the above principles should guide them in determining whether, in a given case, the sharesare held by the assessee as investment (and therefore giving rise to capital gains) or as stock-in-trade (and therefore giving rise tobusiness profits). The assessing officers are further advised that no single principle would be decisive and the total effect of all theprinciples should be considered to determine whether, in a given case, the shares are held by the assessee as investment or stock-in-trade.

12. These instructions shall supplement the earlier Instruction no. 1827 dated August 31, 1989.

(F.No.149/287/2005-TPL)


ACIT Vs. Mrs. Rajpal Sethi (ITAT Mumbai)Assessee cannot be held to be a trader in shares with respect to delivery basis transactionITA No.4325/Mum/2010

AO in the case of assessee while making the assessment for the assessment year 2004-05 has accepted the short term capitalgain and the long term capital gain on sale of shares vide order dated 22.12.2006 passed u/s 143(3) of the Act, therefore, we are ofthe view that the assessee’s case is squarely covered in favour of the assessee by the decision of the Tribunal in the case of ShriSatpal Singh Sethi (supra). This being so and in the absence of any distinguishing features or contrary material brought on recordby the Revenue, we respectfully following the consistent view of the Tribunal and the ratio of the decision of the Hon’bleJurisdictional High Court in the aforementioned cases, hold that the ld. CIT(A) was fully justified in directing the AO to accept theappellant’s claim of short term capital gain and long term capital gain on share transactions, where the delivery has been taken orgiven and Security Transaction Tax has been paid.

CIT vs. Gopal Purohit (Bombay High Court)Shares activity treated as investment in earlier years cannot be treated as business in subsequent years iffacts are the same [188 Taxman 140]

The assessee was engaged in two different activities of sale and purchase of shares. The first set of transactions involvedinvestment in shares in which the assessee took delivery of the shares. The second set of transactions involved dealing inshares for business purposes. The assessee was accordingly an investor as well as a dealer. The income from investment activitywas offered as capital gains while the income from dealing activity was offered as business income. This position was acceptedby the AO in the earlier years. In AY 2005-06, the AO took a different view and held that even the shares held on investmentaccount had to be assessed as business income. The Tribunal allowed the assessee’s appeal (see 122 TTJ (Mum) 87). On appealby the Revenue, HELD dismissing the appeal:

(a) The Tribunal has correctly applied the principle of law in accepting the position that it is open to an assessee to maintain twoseparate portfolios, one relating to investment in shares and another relating to business activities involving dealing in shares.Delivery based transactions were rightly treated as being in the nature of investment transactions giving rise to capital gains.

(b) The Tribunal correctly accepted the position that though the principle of res judicata is not attracted, there ought to beuniformity in treatment and consistency when the facts and circumstances are identical. The Tribunal has noted that theassessee has followed a consistent practice in regard to the nature of the activities, the manner of keeping records and thepresentation of shares as investment at the end of the year in all the years and there is no justification for a different view beingtaken by the AO.

(c) The Tribunal applied the correct principle in holding that while entries in the books of account alone are not conclusive indetermining the nature of income, it does have a bearing.

Note: SLP dismissed by Supreme Court


ACIT v. Om Prakash Suri (M.P. High Court)(16 ITJ 185 ITAT DECISION)Following Gopal Purohit (Bom HC)

DCIT vs. SMK Shares & Stock Broking (ITAT Mumbai)Large volume of purchase & sale of shares does not per se mean activity is business(ITA No.799/Mum./2009)

The assessee, a broker in the BSE, disclosed short-term capital gains and long-term capital gains on sale of shares. The AOaccepted the LTCG as such though he held that the STCG was assessable as “business profits” on the ground that the assesseewas a stock broker & there was large volume and frequency (more than 300) transactions. On appeal, the CIT (A) reversedthe AO. On appeal by the department to the Tribunal, HELD dismissing the appeal:(i) It is no more res integra that a person can be both “Investor” as well as “Trader” in shares. (Draft Instruction No. 2005,

Instruction No. 1827 dated 31.8.1989 & Circular No. 4/2007 dated 15.6.2007 referred). The assessee has to maintain thedistinction between shares held as stock and those held as investments in its records;

(ii) While volume of transactions is an important indicator of the intention of the assessee whether to deal in shares as tradingasset or to hold the shares as investor, it is certainly not the sole criterion. The AO’s conclusion that since sale andpurchase had been determined by the volatility in the market, the same is against the basic feature of investor is notbased on sound rational reasoning. A prudent investor always keeps a watch on the market trends and, therefore, isnot barred under law from liquidating his investments in shares. The law itself has recognized this fact by taxing thesetransactions under the head “Short Term Capital Gains”. If the AO’s reasoning is accepted, then it would be against thelegislative intent itself;

(iii) The fact that the assessee did not borrow funds for investment in shares is an important aspect which cannot be lost sightoff while deciding the true intention of the assessee;

(iv) The fact that the AO accepted the assessee’s claim in earlier years that it was an investor is material because though theprinciples of res judicata do not strictly apply to income tax proceedings it is well settled law that the principles ofconsistency should not be ignored. Uniformity in treatment and consistency under the same facts and circumstances is oneof the fundamentals of the judicial principles which cannot be brushed aside without proper reason;

(v) The fact that the AO accepted the offering of LTCG also showed that the assessee’s status as investor was accepted byhim;

(vi) Some part of the STCG had arisen out the earlier investment which had been accepted as being on investment account. Asthe modus operandi of the assessee remained the same in regard to other shares purchased during the year, the assessee’sclaim could not be negated only on the basis of frequency of the transaction


Janak S. Rangwalla v. ACIT (ITAT Mumbai)Mere volume of transaction transacted by the assessee would not alter the nature of transaction(11 SOT 627 Mum)

The mere volume of transaction transacted by the assessee would not alter the nature of transaction. It is an established principlethat income is to be computed with regard to the transaction. The transaction in whole has to be taken into consideration and themagnitude of the transaction does not alter the nature of transaction. Though the principle of res judicata does not apply to theIncome-tax proceedings as each year is an independent year of the assessment but in order to maintain consistency, it is ajudicially accepted principle that same view should be adopted for the subsequent years, unless there is a material change in thefacts. [Para 6]In the facts of the instant case, the assessee was holding the shares as investment from year to year. It was the intention of theassessee which was to be seen to determine the nature of transaction conducted by the assessee. Though the investment inshares was on a large magnitude but the same would not decide the nature of transaction. Similar transactions of sale andpurchase of shares in the preceding years had been held to be income from capital gains both on long-term and short-term basis.The transaction in the year under consideration on account of sale and purchase of shares was same as in the preceding yearsand the same was to be accepted as short-term capital gains. There was no basis for treating the assessee as a trader in shares,when his intention was to hold shares in the Indian companies as an investment and not as stock-in-trade. The mere magnitude ofthe transaction does not change the nature of transaction, which are being assessed as income from capital gains in the pastseveral years. The Assessing Officer was to be directed to set off the long-term capital loss against the short-term capital gain ofthe year under consideration. [Para 7]

Management Structure & Systems vs. ITO (ITAT Mumbai)Tests laid down to determine whether income from shares is “business” income or “capital gains”( ITA No.6966/Mum/2007)

The assessee, engaged in management consultancy, offered profits of Rs. 1.03 crores earned by it on sale of shares as long-termand short-term “capital gains” depending on the period of holding. The AO took the view that as the assessee was regularly dealingin shares throughout the year, the assessee was engaged in the “business” of trading in shares and that the profits wereassessable as “business income“. This was confirmed by the CIT (A). On appeal by the assessee, HELD allowing the appeal:

(i) Though there is no fixed formula to determine whether the activity of purchasing and selling shares can be treated as atrading activity or as investment activity, certain guiding principles have been laid down in CBDT’s Circular No. 4/2007 dated15.6.2007 as well as in Gopal Purohit 122 TTJ 87 (Mum) (affirmed in 228 CTR 582 (Bom)), Saranath Infrastructure 120 TTJ216 (Luck) and other judgements. These principles of law have to be applied to the following facts:

As per the books of account, the assessee has treated the entire investment in shares as an “investment” and not as“stock-in-trade”;The assessee is not a share broker nor he is having a registration with any Stock Exchange;Almost 83% of the capital gain is from shares that were held for a long period of time;There were no derivative transactions by the assessee;There were no transactions without delivery;


The assessee used his own surplus funds for investing in shares and not borrowed any money;In the preceding years, the assessee consistently declared the gain/profit on the sale of the shares as ‘Capital Gains’ andthe same has been accepted by the A.O. Though the rule of res judicata is not applicable to income-tax proceedings, inthe absence of change in facts, there should be consistency in the approach of the Revenue;The assessee received substantial dividend on the investments.

(ii) The intention of the assessee cannot be read from his mind but it reflects in his conduct and the way he treats thetransactions. Considering the totality of the facts, the transactions of sale and purchase of shares cannot be treated to betrading in shares nor as an adventure in the nature of the trade but is assessable as ‘capital gain’.

J. M. Share & Stock Brokers vs. JCIT (ITAT Mumbai)Tests to distinguish shares held as “stock-in-trade” and as “investments”(ITA 2801/M/2000)

Where the assessee was a stock broker but it was consistently following the practice of holding some shaes as ‘stock in trade’ andother shares as ‘investments’ and the question arose whether the profits on the sale of shares held as investments constituted acapital gain or business profits, HELD:

(i) The assessee had been consistent in its practice of treating some shares as stock and others as a capital asset. While theshares held as capital asset were valued at cost in the accounts, the shares held as stock-in-trade were valued at the lower ofcost or market value;

(ii) There is no bar on a stock broker holding shares as an investment. The mere fact that the assessee is an expert in sharetrading does not mean that he cannot hold shares as a capital asset. The magnitude of the transaction does not change thenature of the transaction.

Bombay Gymkhana Ltd. v. ITO (ITAT Mumbai)Merely High Number of transactions not determinant.(27 SOT 508 Mum)

In the instant case, the real question came up for consideration was as to whether the first step, i.e., purchase of shares was in thecourse of trading transaction or in the course of investment. It was seen that the purchase of units was made as investment and thesame was shown by the assessee in its books of account as investment and in earlier years, said stand of the assessee wasaccepted by the department. If the purchase of units was accepted as purchase in course of investment, at the time of sale thereof,income arising on sale had to be assessed as capital gain and it could not be assessed as business income merely for the reasonthat quantum was high or the number of transactions were high.

As regards revenue’s contention that entries in books were not conclusive, it is a settled legal position that entries in books are notconclusive but there should be a firm basis to take a different view from entries in books of account. In the instant case, theAssessing Officer had taken a different view contrary to books of account on the basis of magnitude and number of transactionswithout bringing anything else on record that purchases of units of mutual fund were made on account of dealing in shares and noton account of investment. Therefore, the income on sale of units of mutual funds had to be assessed as capital gain as declared byassessee and set-off of brought forward capital loss had to be allowed against long-term capital gain as claimed by the assessee.


CIT V. S.Ramaamirtham (Mad HC)Broker can have separate accounts for trading and investment(306 ITR 239)

Held that even in case of a registered share and stock broker, if on facts, it was found that separate books of account weremaintained for trading in shares and investments in shares, shares in investment portfolio were held for a long period and out ofsurplus funds, etc, there is nothing in law to prohibit a trade in shares to also invest in shares, and accordingly, profit on sale ofshares held in investment portfolio were assessable as ‘capital gains’.

Nehal V. Shah vs. ACIT (ITAT Mumbai)Multiple orders for purchase/ sale of shares may constitute one transaction(ITA. No. 2733/Mum/2009)

The assessee offered short term capital gain (STCG) of Rs.1.07 crores on sale of shares. The AO held the assessee to be a traderin shares & assessed the gains as business profits on the ground that (a) there was high frequency of 127 purchase & 83 saletransactions, (b) there were instances where delivery was not taken and shares were sold within a short period, (c) 88% of theshares sold were purchased during the year and (d) the available capital was turned over 85 times to make purchases of Rs.23crores & sales of Rs. 29 crores. This was confirmed by the CIT (A). On appeal by the assessee, HELD allowing the appeal:

(i) The AO had not correctly calculated the number of transactions because sometimes a single transaction is split by thecomputers trading of the stock exchanges into many smaller transactions but that does not mean that assessee hascarried so many transactions. If someone places an order for purchase of 1000 shares and the same is executed by theelectronic trading system of stock exchange into 100 smaller transactions, it does not mean that 100 transactions have beenentered into. The assessee had carried out only 31 purchase and 25 sale transactions which cannot be said to be a greatvolume of transactions; (ii) At the end of the year, the assessee was holding shares worth Rs. 11.56 crores with a market value of Rs.17.69 crores. Ifassessee was a trader, he would have definitely realized the huge profit of almost Rs. 6 crores immediately and notcarried out the stock to the next year; (iii) The transactions in which no delivery was taken and it was settled in the same day appear to be cases where the particularswere wrongly carried out on behalf of the assessee by the broker & that’s why assessee got them settled on the same day; (iv) The assessee has not borrowed any money and he was occupied full time in the business of garments; (v) In identical circumstances in the case of the assessee’s sister, the Tribunal had decided in favour on the ground that (a) theassessee’s background did not indicate she was familiar with the share business, (b) there was no borrowing for the shares, (c)the shares were shown as a capital asset in the balance sheet, (d) the AO had accepted the LTCG, (e) the average investment inone scrip is taken was about Rs.45.00 lakhs which appeared to be too high for an individual to hold as stock-in-trade, (f) theportfolio contained many shares of blue chip companies, (g) there were no dealings in futures and options and (h) about 30 scripswere sold and there were 49 purchases & 43 sales (treating multiple lots on the same day as one transaction).


ACIT vs. Vinod K. Nevatia (ITAT Mumbai)Short period of holding shares does not per se suggest business activity(ITA No. 6556/Mum/2009)

The assessee, a stock broker with NSE, offered short-term capital gains (“STCG”) of Rs. 47.23 lakhs. The AO assessed the STCGas business profit on the ground that (a) the purchase to sale ratio was higher than the ratio in the earlier year and (b) the assesseehad borrowed funds of Rs. 21.73 crores which were mixed with common funds and not segregated and (c) the assessee had notbeen able to show his intent to hold the scrips. On appeal, the CIT (A) reversed the AO. On appeal by the department, HELDdismissing the appeal:

(i) In Circular No. 4/2007 dated 15.6.2007 the CBDT has emphasized that it is possible for a tax payer to have two portfolios,i.e. an investment portfolio and a trading portfolio;

(ii) The assessee had maintained separate books of account as well as separate demat accounts in respect of his trading &investment activity. The manner in which books are kept is an important piece of evidence as per Raja Bahadur VisheshwarSingh vs. CIT 41 ITR 685 (SC);

(iii) Whether the assessee’s conduct is that of an investor or a trader depends on the facts and circumstances of the case. Nosingle fact is decisive nor has any acid test been laid down in any judgment;

(iv) Primarily, the intention with which an assessee starts his activity is the most important factor. If shares are purchased fromown funds, with a view to keep the funds in equity shares to earn considerable return on account of enhancement in the value ofshare over a period then merely because the assessee liquidates its investment within six months or eight months wouldnot lead to the conclusion that the assessee had no intention to keep the funds as invested in equity shares but wasactually intended to trade in shares. Mere intention to liquidate the investment at higher value does not imply that theintention was only to trade in security. However, it cannot be held that in all circumstances if assessee has used its own fundsfor share activity then it would only lead to inference of investment being the sole intention. In such circumstances, frequency oftransactions will have to be considered to arrive at proper conclusion regarding the true intention of the assessee. However, if theassessee, on the other hand, borrows funds for making investment in shares then definitely it is a very importantindicator of its intention to trade in shares;

(v) On facts, the AO proceeded on the assumption that borrowed funds had been utilized for buying shares on the groundthat funds were common and could not be segregated. However, it was categorically pointed out before the CIT (A) that no part ofthe borrowed funds was utilized for acquisition of shares on investment account. Nothing was brought on record by thedepartment to controvert this fact;

(vi) Further, the AO accepted the assessee’s claim of LTCG to the extent of Rs. 2 crores which implies that he hasaccepted the assessee’s claim regarding holding investment portfolio.


CIT v/s. H. Holsck Larzen (SC)Tests to distinguish shares held as “stock-in-trade” and as “investments”[160 ITR 67]

In the instant case effect of the issue of right shares vis-a-vis original shares had not been fully kept in proper

perspective by the Tribunal in its evaluation. Further the assessee was the chairman of the company and infact that if he did not participate in buying right shares, that would have adverse effect on the value of theshares of the company, was also not kept in view by the Tribunal. Consideration of all relevant facts involvesappreciation of all the facts in their proper perspective. If that is not done, it cannot be said that there hasbeen consideration of all relevant factors. The Tribunal fell into error in not taking into consideration properlyand fully, though it noted, the fact that if the right shares were not subscribed by the assessee, his originalshares would depreciate in value. The assessee was also in need of money; he had an overdraft with bankand he had to remit money to Denmark for the purchase of a house and further when right shares wereissued had he not subscribed to these, there might have been adverse effect on the market so far as theshares of the company were concerned. In the background and the correlation of these factors the action ofthe assessee was like a prudent investor and not of a plunger in the waters of trade. The Tribunal in this casehad undoubtedly noted the assessee's contention of nursing the investment. The Tribunal, however, had notconsidered in its order the actual position as to how the nursing of the investment was necessary. TheTribunal, thus, erred. In that view of the matter the High Court was justified in interfering with the conclusionreached by the Tribunal.

Accordingly, the High Court was justified in holding that the assessee was an investor in shares and not adealer in shares.

Fidelity Northstar Funds & Others,Tests to distinguish shares held as “stock-in-trade” and as “investments”[288 ITR 641]

Where a company purchases and sells shares, it must be shown that they were held as stock in trade and that existence of thepower to purchase and sell shares in the memorandum of association is not decisive of the nature of transaction;

Substantial nature of transactions, manner of maintaining books of account, magnitude of purchases and sales and the ratiobetween purchases and sales and the holding would furnish a good guide to determine the nature of transactions;Ordinarily purchase and sale of shares with the motive of earning a profit would result in the transaction being in the nature oftrade/an adventure in the nature of trade; but where the object of the investment in shares of a company is to derive income by wayof dividend, etc., the profits accruing by change in such investment (by sale of shares) will yield capital gain and it is not revenuereceipt. [Para 11]


Further, the Supreme Court observed in said case that real question in the instant case is not whether the transaction of buying andselling the shares lacks the element of trading, but whether the later stages of the whole operation show that the first step-thepurchase of the shares - was not taken as, or in the course of, a trading transaction. [Para 12]

CIT vs. PNB Finance & Industries (Delhi High Court)Though main object in Memorandum of Association is to do business in shares, shares can be held as acapital asset & not stock-in-trade(ITA No.306/2010)

The assessee, engaged in the business of sale and purchase of shares, offered long-term capital gains of Rs. 2.08 crores on saleof shares. The AO took the view that as the main object of the assessee was to engage in the business of purchase & sale ofshares, the LTCG was assessable as business profits. This was reversed by the CIT (A) on the ground that (a) the assessee haddiscontinued trading in shares, (b) the shares were held for a long time, (c) the shares were shown as investment in the books, (d)the shares were not acquired from borrowings. The CIT (A) was upheld by the Tribunal. On appeal by the department, HELDdismissing the appeal:

(i) There is no presumption that every acquisition by a dealer in a particular commodity is acquisition for the purpose of hisbusiness. A dealer may acquire a commodity as a capital asset. In each case the question is one of intention to be gathered fromthe evidence of conduct and dealings by the acquirer with the commodity (Madan Gopal Radhey Lal 73 ITR 652 (SC) & VijayaBank 187 ITR 541 (SC) followed);

(ii) If shares are shown as a capital asset in the balance sheet from the date of purchase and no objection was taken by the AO inthe earlier years, he cannot hold it to be stock-in-trade without there being any change in facts (Gulmohar Finance Ltd 170 Taxman483 (Del) followed);

(iii) In Circular dated 15th June, 2007, the CBDT has emphasized that it is possible for a taxpayer to have two portfolios, i.e., aninvestment portfolio and a trading portfolio and income under the head capital gains as well as business income;

(iv) Though the main object is that of buying and selling shares, the nature of activity, intention and conduct has significance andplay a pivotal role in the entire gamut of transaction;

(v) On facts, as the shares were held for a long period and there was no evidence to show regular dealings in shares, the gains hadto be assessed as LTCG.


JCIT v. Dinesh Kumar GuptaProfit motive alone would not distinguish a transaction of investment from a trading transaction because evenin case of investment there may be motive that an assessee should be able to sell such investment at apremium(2 SOT 126)

It was not correct to say that profit motive alone would distinguish a transaction of investment from that of trading. Even in the caseof investment there may be a motive that the assessee should be able to sell the investment at a premium. When householdsavings are invested in gold, etc., the profit motive is there but that does not make a householder a businessman trading in gold. Inthe instant case, the assessee held the shares for certain length of time before selling the same and the funds invested wereentirely the assessee’s own funds. On those facts, it was not possible to hold that the assessee carried on trading in shares as acontinuous regular activity. Therefore, there was no reason to interfere with the order of the Commissioner (Appeals) and the samewas to be upheld. [Para 7]

ITO V. WATERLOO EXPORTS PVT. LTD.(ITAT Kol.)Disclosure in Balance Sheet(ITA No. 24/Kol/2010 dated 14.05.2010)

Held that where shares and securities were purchased for the purpose of investment and accordingly declared in the balancesheet, on sale of such shares and securities, the profit will be taxable under the head ‘capital gains’ and not business income

JCIT v. Deo Kumar Saraf (ITAT Kol.)Disclosure in Balance Sheet(ITA No.411/Kol/2009 dated 18.06.2009)

Held that the assessee has shown shares and securities as investments in the balance sheet and the said fact was supported byaudited accounts filed with the return, the CIT(A) has rightly held that profit thereon has to be taxed as ‘capital gains’ and notbusiness income.

Commissioner of Income-tax v. Madan Gopal Radhey Lal (SC)Intention to be gathered from the evidence of conduct and dealings by the acquirer with the commodity.[73 ITR 652]

There is no presumption that every acquisition by a dealer in a particular commodity is acquisition for the purpose of his business;in each case the question is one of intention to be gathered from the evidence of conduct and dealings by the acquirer with thecommodity. A trader may acquire a commodity in which he is dealing for his own purposes, and hold it apart from the stock-in-tradeof his business.


DCIT v. Reliance Trading Enterprises Ltd. (ITAT Kol.)Disclosure in Balance Sheet(ITA No.944/Kol/2008 dated 03.10.2008)

Accounts were maintained as a trader and as a investor in shares as per MOA and AOA. Accounts were maintained fortrading/business shares which are held as stock-in-trade and separately for investment shares which are held and shown inBalance Sheet under the head "investment" representing capital assets. The decision used to be taken by the assessee at the timeof purchase itself based on different factors whether any share & security was to be held as "investment" or "trading". When theshares are accounted for in the books as investment shares, the volume of transaction of such shares cannot alter its status frominvestment to trading. Profit on sale of such investment shares held as capital assets are assessable under the head capital gain.The period of holding such assets cannot determine its status or change it from investment (capital) to trading (stock-in-trade). Theaudited a/cs. for the A.Y. 2004-05 and the earlier years placed in the Paper Book made it clear that every year the assessee hadacquired shares for trading purpose and separately also for investment purpose with an intention to earn dividend income inaddition to the prospect of making profit on sale of such investment shares at an appropriate opportune moment without makingany hurry for sale ignoring dividend. The investment shares and securities purchased and held till their sale had dual purpose i.e.for earning dividend as an incidental income as well as to make profit profit on sale at appropriate time. The conclusions drawn byA.O. by treating the investment shares as trading shares was based purely on assumptions. The AO did not reject the books ofaccounts vis-à-vis the accounts u/s 145 of the IT Act before arriving at such a conclusion. The A.O.’s finding cannot, therefore, beaccepted. In view of the above, we agree with the decision of the Ld.CIT(A) that the profit on sale of investment shares, securitiesand mutual fund is assessable under the head '''capital gain". We hold accordingly."

ACIT vs. Naishadh V. Vachharajani (Bombay HC)Despite high volume & short holding period, shares gain is STCG(I.T.A. No. 6429/Mum/2009) (Upheld by Bombay HC)

The assessee, a marine consultant, offered income by way of LTCG, STCG, speculative profit & profit from futures trading. The AOheld that as the volume of transactions was high (222), the period of holding of the STCG shares was short (2 -5 Months) & therewas speculation & F&O profit, the LTCG & STCG was assessable as business profit. On appeal, the CIT (A) reversed the AO. Onappeal by the department, HELD dismissing the appeal:(i) As regards the LTCG, the shares were held for several years and so the assessee has acted as investor and not as a trader andso the gains are assessable as LTCG;(ii) As regards the STCG, the view of the CIT(A) had to be upheld because(a) there was no intra-day trading,(b) most of the shares were held for a period of 2 to 5 months,(c) In the preceding AY, the AO did not assess the STCG as business income and on the principles of consistency, a different viewcannot be taken on the same facts,(d) the assessee has no borrowings and(e) merely because there was a speculative business does not mean that even delivery based transactions of shares should beassessed under the head business.


Nagindas P. Sheth (HUF) vs. ACIT (ITAT Mumbai)Despite Large number of transactions in shares, profit assessable as capital gains. Even less than 30 dayswas capital gainsITA. No. 961/Mum/2010

The assessee HUF offered income from sale of shares as short-term capital gains (STCG). The AO held the income to be businessprofits on the ground that (i) the assessee had 158 share transactions in the year which showed the intention to trade, (ii) Theregularity and frequency of transactions showed no intention to hold shares to earn dividend and (iii) Instead of one or two demataccounts, the assessee had adopted a professional approach and transacted through several brokers. On appeal, the CIT (A) heldthat profit on sale of shares held for less than 30 days was business profits while other profits was STCG. On appeal by theassessee and department, HELD deciding in favour of the assessee: The fact that the assessee has transacted in 158 shares should not be the sole criterion to come to the conclusion that assessee isa trader in shares. The gains earned by the assessee deserve to be assessed as capital gains because: (a) the assessee was holding the shares in its books as an investor; (b) the assessee did not have any office or administration set up; (c) the shares were acquired out of own funds and family funds and not through borrowings; (d) there was not a single instance where the assessee had squared-up transactions on the same day without taking delivery ofthe shares; (e) In the previous and subsequent assessment years, the AO had vide scrutiny assessments treated the assessee as an investor.

Ramesh Babu Rao vs. ACIT (ITAT Mumbai)Large volume in shares not deciding factor to hold assessee trader(ITA No. 3719/Mum/2009)

The assessee, a retired professor, offered gains from sale of shares as short-term capital gains (STCG). The AO assessed thegains as business profits on the ground that (a) in the earlier years, the assessee had offered similar gains as business profits andthe volume of transactions was higher in the present year, (b) there were 54 scrips which were purchased and sold during the yearwhich resulted in sales of more than Rs. 24 crores, (c) In one particular share, the assessee purchased on 54 occasions and soldon on 25 occasions within a short duration. On appeal, the CIT (A) reversed the AO. On appeal by the department, HELDdismissing the appeal:

The assessee was an investor and the gains are assessable as capital gains because: (a) The assessee was a good timer of purchase and sale of shares thereby substantially increasing his gains in the stock market; (b) The large turnover was because of bulk purchases and sales in a scrip. There were very few transactions of purchase and sale,as the assessee was purchasing in block of a particular share in large volume. Accordingly, large volume cannot be a decidingfactor to hold as a trader; (c) the assessee was not a broker or sub-broker and did not have any office establishment; (d) The assessee did not do any speculative activity nor indulge in any sales without delivery; (e) The shares were shown as capital assets in the books of account; (f) The assessee had not pledged any shares with any financial institutions, nor borrowed any funds


Shantilal M. Jain vs. ACIT (ITAT Mumbai)Despite large volume etc of share transactions, AO bound by Rule of Consistency to treat share gains asSTCGITA No. 2690/Mum/2010

The assessee, engaged in the business of trading/investment in shares and securities offered STCG of Rs. 1.54 crores and LTCGof Rs. 2.91 crores. The assessee also traded in intra-day stocks without delivery and in derivatives, the gain or loss from which wasoffered as business income. While the LTCG was accepted, the AO & CIT (A) held that the STCG was assessable as businessprofits on the ground that (a) the purchases of Rs. 1098 lakhs and sale of Rs. 1241 lakhs during the year showed that thetransactions were on a regular basis and on a substantially high scale, (b) The assessee had traded in as many as 85 scrips in 188transactions and in as many as 1631852 shares during the year with frequency and regularity, (c) only in 21 scrips there have beensome opening balances. The rest of the scrips had all been purchased and sold during the year, (d) the holding period in severalshares has been merely a few days and in a few cases the purchase and sale had been on the same day and there is even oneinstance of forward sales, (e) there were no details regarding delivery of shares, (f) the assessee had not proved that the purchaseswere not out of borrowed funds and (g) there were no separate bank accounts. On appeal to the Tribunal, HELD allowing theappeal:

Though it is the case of the revenue that due to volume, magnitude, frequency, continuity, regularity, the ratio between purchaseand sale clearly indicate that income on account of purchase and sale of shares should be treated as income from business andnot as income from STCG, the AO has, from AY 2003-04 to 2008-09 (except for the impugned year 2006-07), consistentlyaccepted the income as being STCG. In these circumstances, the Rule of consistency as propounded by the Bombay HighCourt in Gopal Purohit 228 CTR 582 (Bom) is squarely applicable and the income has to be treated as STCG.

Hitesh Satishchandra Doshi vs. JCIT (ITAT Mumbai)Even gains on shares held for 30 days & less is STCG & not business profits

The assesses was engaged in the business of share trading and investments and offered income from sale of shares by way ofSTCG and LTCG. The AO treated the STCG as business profits on the ground that there was “systematic and regular course ofshare trading activity, the scale of activity was frequent and huge and the quantity purchased and sold are huge and repetitive”. Itwas also held that the ratio of purchase to opening balance and sales to closing balance made the assessee a trader in shares andnot investor in shares. On appeal, the CIT(A) held that the gain arising on shares held for more than 30 days was STCG while thegains on shares held for less than 30 days was assessable as “business profits”. On cross appeals, HELD deciding in favour of theassessee:

(i) The CIT(A)’s view that the gains could be treated as either STCG or business profits depending on whether they had been heldfor a period of 30 days or shorter is not proper because the holding period is only one of the several criteria that has to beapplied to determine whether the transaction is on trading or investment account. The principles that have to be applied are (a) theintention of the assessee at the time of purchase, (b) whether borrowed funds were used, (c) the frequency of purchase andsales, (d) the treatment in the books etc. No single criteria is conclusive and an overall view has to be taken (AssociatedIndustrial Development 82 ITR 586 (SC) & Holck Larsen 160 ITR 67 (SC) followed);


(ii) On facts, even the gains on shares held for 30 days and less had to be assessed as STCG and not business profits because:

(a) There cannot be a sub-division of transaction relating to STCG. The transactions cannot be bifurcated on the basis ofholding period of 30 days so as to classify a part of the gain as STCG and a part as business profit;

(b) The assessee had separate portfolios for investment and trading and in the books, the shares giving rise to the STCG hadbeen treated as an “investment” and not as “stock-in-trade”. The shares were valued at cost and not at lesser of market value;

(c) In view of the consistent treatment of the assessee, it is established that the intention of the assessee at the time ofacquiring the shares was for investment and not for trading;

(d) The assessee had used own funds and not borrowed funds to acquire the shares;

(e) As regards the frequency of purchase and sale of shares, transactions through the electronic system of Stock Exchange splita single order into numerous transactions. This gives an unrealistic figure of the number of transactions;

(f) The fact that the gains from shares held for less than 30 days was Rs. 15.19 lakhs as compared to the gains of Rs. 37.76 lakhson shares held for more than 30 days shows the assessee’s intention to hold the shares for a longer period and to earnincome of appreciation of the value of the shares and not earn the profit in the short period change in the price of the shares;

(g) The assessee was regularly earning dividend income;

(h) It is acceptable for an investor to reshuffle his portfolio in a short period in order to reduce the risk of loss of capital orincome;

Shri Dev Ashok Karvat Vs. DCIT (ITAT Mumbai)Units of mutual funds are not generally trading instrumentITA No.6345/Mum/2010

In Mr.Chetan R.Parikh V/s ITO in ITA No.1569/Mum/2010 (AY:2006-07) dated 25.5.2011, it has been held by the Tribunal that theunits of mutual funds are not generally a trading instrument because of comparatively low fluctuation and number of transactions inunits are also not large. Therefore in our view the purchase and sale of units has to be considered as investment activity. Applyingthe ratio of the above decisions to the facts of the present case it becomes abundantly clear that the transactions in the shares andmutual funds were made by the assessee as investor and not as a trader, therefore, the profit earned from the said transactions isshort term capital gain, not business income and accordingly, we while reversing the orders of the AO and the ld. CIT(A) on thisaccount direct the AO to treat the profit from purchase and sales of shares and mutual funds of Rs.10,52,137/- as income fromshort term capital gains and not business income.


Devendra Motilal Kothari v. DCIT (ITAT Mumbai)PMS fees not allowable[2011] 50 DTR 369

Facts :-The assessee had entered into an investment management agreement with four parties and had incurred portfoliomanagement fees. The PMS fees were claimed by the assessee as part of the cost of the acquisition of shares while computingcapital gains.The Assessing Officer (“AO”), however, held that PMS fees are not part of the cost of acquisition of shares andsecurities, and hence, not allowable as a deduction.Against the said order of the AO, the assessee preferred an appeal before theCommissioner of Income-tax (Appeals) (“CIT(A)”).The CIT(A) held that the PMS fees paid by the assessee have no connection withthe acquisition, or transfer, of specific shares. It is just not possible to break up the fees paid by the assessee so as to hold that theexpenditure is incurred solely for the purchase or transfer of shares and securities. It also held that since the PMS fees werepayable on interest and dividend income as well, they were not exclusively for the acquiring or selling of shares. Against this orderof the CIT(A), the assessee preferred an appeal before the Tribunal.

Assessee’s contentions :- PMS fees form part of the cost of acquisition, and therefore, should be taken into consideration whilecomputing capital gain. The services of the investment manager were used to obtain an advice about the purchase, sale orretention of particular shares or securities. Hence, the payment of PMS fees was in connection with acquisition/improvement andsale of an asset. Without prejudice to the above, PMS fees were deductible on the basis of real income theory and diversion ofincome by overriding title since the PMS fee is in the nature of a charge against sale consideration. Based on various judicialprecedents, PMS fees are allowable as deduction against capital gains.

Revenue’s contentions :- PMS fees were paid based on the market value of the asset or net value of the assets at the beginning orend of each quarter. A substantial amount of PMS fees would have been payable even if no purchase or sale transaction had beencarried out during the year. The provisions for computing capital gain are specific and real income theory cannot be applied to it.The case laws relied on by the assessee are distinguishable on facts.

Tribunal Ruling :- Under section 48 of the Income-tax Act, 1961 (“the Act”), only expenditure incurred wholly and exclusively inconnection with transfer and acquisition is deductible. The appellant failed to explain how these expenses can be treated asincurred wholly and exclusively in connection with the sale of shares. There is no explanation of how these expenses can beallocated among various securities. PMS fees are not inextricably linked with the particular instance of purchase and sale, hencenot incurred wholly and exclusively in connection with the sale or the cost of acquisition, or improvement. Accordingly, PMS feesare not deductible under section 48 of the Act. The test for determining the rule of diversion of income by overriding title is to knowwhether an obligation is in the nature of a charge on the source. Payment of PMS fees is an obligation to the charge and not to thesource. The theory of real time income cannot be applied to justify deductions which are otherwise not permissible under the Act.

Conclusion :- The Tribunal’s decision will have a far reaching impact on investors investing in various funds. According to industrypractice, 2% management fees are paid to portfolio/fund managers. Such fees are unlikely to be allowed as deduction to investorsconsidering this decision.


ARA Trading & Investments Pvt Ltd vs. DCIT (ITAT Pune)Shares PMS transaction gains are STCG and not business profits(www.itatonline.org)

Reasons:

Given the definitions of the term “business” and “capital asset” in s. 2(13) & 2(14), shares, if held for more than 12 months, will be along-term capital asset, inspite of continued and systematic dealings;

On facts, as the assessee had engaged a portfolio manager to look after its’ investments and all decisions to buy and sell weretaken by the portfolio manager and not by the asessee, the assessee cannot be called a “dealer”;

The object of the PMS was to maximize the value of the portfolio. It was “wealth maximization” and not “profit maximization”;

In the balance sheet, the shares were valued at cost and not at lower of cost or market value;

KRA Holding & Trading Pvt Ltd vs. DCIT (ITAT Pune)Shares PMS fee, even if NAV based, is deductible in computing PMS capital gains.PMS transaction assessable as Capital gains.(www.itatonline.org)

(i) In computing capital gains u/s 48, payments are deductible in two ways, one by taking full value of consideration net of suchpayments and the other by deducting the same as “expenditure incurred wholly and exclusively in connection with the transfer”.The expression “full value of consideration” contemplates additions and deductions from the apparent value. It means the “real andeffective consideration“, which can be arrived at only after allowing the deductible expenditure (CIT v Shakuntala Kantilal 190 ITR56 (Bom) followed);

(ii) The PMS fee, on profit sharing basis, was for the twin purposes of acquisition and sale of the securities. The fact thatbifurcation between the two is not possible is not relevant. The department’s argument that fee should be share-specific is absurdbecause fees for shares transactions is never share specific but is volume based;

(iii) Accounting Standard 13 (Accounting for Investments) issued by ICAI provides that brokerage, fees and duties have to added tothe cost of investments. The assessee’s method of accounting is to proportionately load the PMS fees on the opening portfolio andinvestments made during the year which means that no deduction is claimed for the fees on the unsold investments;

(iv) Devendra Kothari 50 DTR 369 (Mum) cannot be followed because (i) it unfortunately did not refer to the ‘read down’interpretation of s. 48 as laid down in Shakuntala Kantilal and (ii) on facts, the claim there was on the entire turnover on global basisand not restricted to only investments.

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Shri Homi K. Bhabha vs. ITO (ITAT Mumbai)PMS Fees not deductible against capital gains. Despite dissenting orders, reference to Special Bench notnecessary

(i) While, in Devendra Motilal Kothari 50 DTR 369, the Mumbai Bench held that the fees paid for portfolio management serviceswas neither diversion of income by overriding title nor cost of acquisition nor cost of improvement, the Pune Bench in KRA Holding& Trading declined to follow that by relying on the judgement of the Bombay High Court in Shakuntala Kantilal 190 ITR 56 (Bom).Subsequently, the Mumbai Bench in Pradeep Kumar Harlalka declined to follow the Pune Bench on the ground that the judgementof the Bombay High Court in Shakuntala Kantilal had been held to not be good law in Roshanbabu Mohammed 275 ITR 231 (Bom).The majority opinion (in terms of number of orders) and the latest order (in the point of time) were against the assessee.

(ii) The argument that the Mumbai Benches had not appreciated the correct position in law is not acceptable. Judicial disciplinerequires that when a particular issue has been decided by a bench, then the subsequent co-ordinate benches should normallyfollow the same though there are no fetters on its powers to doubt the correctness of the earlier order if there are compellingreasons for the same. Further, whether an earlier order should be followed or a reference to the Special Bench be made dependson whether the Bench is satisfied or not about the correctness of the earlier order and not on the view point of the aggrieved party.It is only when a subsequent Bench finds itself unable to endorse the earlier view that it may make reference for the constitution ofthe Special Bench. The aggrieved party cannot compel the later Bench to either take a contrary view or make a reference for theconstitution of the Special Bench.

ITO vs. Radha Birju Patel (ITAT Mumbai)Gains arising from PMS transactions are capital gains & not business profits(www.itatonline.org)

Transactions carried out via Portfolio Management Scheme are clearly in the nature of transactions meant for maximization ofwealth rather encashing the profits on appreciation in value of shares. The very nature of Portfolio Management Scheme is suchthat the investments made by the assessee are protected and enhanced and in such a circumstance, it cannot be said that PortfolioManagement is scheme of trading in shares and stock. Whether, the assessee is engaged in the business of dealing in shares orinvestment in shares is essentially a question of fact and it has to be determined with regard to the entirety of the circumstances.Where the assessee is engaged in systematic activities of holding portfolio through a PMS Manager, it cannot, by any stretch ofimagination, be said that the main object of holding the portfolio is to make profit by sale of shares during the course of maintainingthe portfolio investment over the period. The high number of transactions shown in the statement is misleading because these arecomputer-split transactions and not independent transactions.



M/s. Radials International vs. ACIT (ITAT Delhi)Long-term & short-term gains from PMS transactions taxable as business profits(www.itatonline.org)

In a Portfolio Management Scheme, the choice of securities and its period of holding is left to the portfolio manager and theassessee has no control. Only the portfolio manager can deal with the Demat account of the assessee. While, at the time ofdepositing the amount, the assessee will make entry in his books of account as investment in PMS, he is not aware of thetransactions in the shares being entered into by the portfolio manager on his behalf as his agent. Since the assessee comes toknow about the purchase and sale of shares under PMS after the expiry of the quarter, the accounting treatment in the books of theassessee in respect of shares purchased/sold by the portfolio manager under PMS cannot be entered in the books of theassessee. It is at the end of the year the shares available in the DEMAT account can be entered. Therefore, at the time of depositof amount, the intention of the assessee was to maximize the profit. As the purchase and sale of shares under PMS is not in thecontrol of the assessee at all, it cannot be said that the assessee had invested money under PMS with intention to hold shares asinvestment. The portfolio manager carried out trading in shares on behalf of his clients to maximize the profits. Therefore, it cannotbe said that shares were held by the assessee as investment. The fact that the transactions were frequent and its volume was highindicated that the portfolio manager had done trading on behalf of the assessee. The fact that the shares remaining at the end ofthe year were shown under the head ‘investment’ makes no difference. Even the LTCG is assessable as business profits and s.10(38) exemption is not available. The fact that the AO took a contrary view in the preceding year is irrelevant. There is nodifference between similar transactions carried out by an individual in shares and the transactions carried out by portfolio manager.There is, however, a difference between investment in a mutual fund and PMS.

CIT vs. Vinay Mittal (Delhi High Court)Tests to determine where shares gain is capital gains or business profits

(www.itatonline.org)

The assessee offered LTCG of Rs. 2.59 crores and STCG of Rs. 5.53 crores on sale of shares. The AO held that the LTCG &STCG were assessable as business profits on the ground that (a) the dividend was meager, (b) the assessee had undertaken riskby dealing in shares, (c) the holding period of most of the securities was very short, (d) the ratio of sales to purchases is was 1.77,(d) the sale and purchase transactions were frequent and (e) the scale of the activity of sale and purchase of securities wassubstantial. The CIT (A) upheld the taxability of STCG as business profits though the Tribunal deleted that as well. On appeal bythe department, HELD dismissing the appeal:To determine whether an assessee is an investor in shares or a dealer in shares, a pragmatic and common senseapproach has to be adopted always keeping in mind commercial considerations. The tests have been laid down inInstruction No.4/2007 dated 15.6.2007 & CIT vs. Rewashanker A. Kothari 283 ITR 338 (Guj). On facts, the Tribunalwas right that the STCG was not assessable as business profits because (a) the assessee was a salaried employee, (b)He maintained two separate portfolios for investment and trading, (c) the shares were held for periods ranging from2.4 months to 11 months, (d) though the quantum or total number shares was substantial, the transactions in questionwere only seven in number and the period of holding was not insignificant and small. While the quantum or totalnumber may not be determinative but in a given case keeping in view period of holding may indicate intention to makeinvestment, (e) substantial dividend income had been received, (f) the element of uncertainty and risk is always therein securities and this factor cannot be a determinative factor to decide whether the assessee is trading in shares or isan investor. Some investors do take risk, (g) The ratio of sales and purchase will always be in favour of sales when thesales are sold and (h) in the earlier assessment years, transactions in the investment portfolio were accepted by theAO.




CIT vs. Sahara India Housing Corporation Ltd (Delhi High Court)Objective tests to classify shares gains as STCG vs. biz profits laid down(www.itatonline.org)

The assessee offered gains from sale and purchase of securities as “capital gains”. The AO assessed it as business profits on theground that in the earlier years, it was offered as such. The CIT (A) & Tribunal accepted the assessee’s plea on the ground that thesecurities were shown as “investments” in the accounts and in the earlier years, the STCG was offered as business profits as therewas no difference in the tax rate. On appeal by the department, HELD reversing the Tribunal:

There was a dispute whether in the earlier years, the gains were offered as business profits or as capital gains and the Tribunal hadnot given a clear finding. The Tribunal ought to examine the issue holistically keeping in mind the parameters/tests laid down in CITvs. Rewashanker A. Kothari 283 ITR 338 (Guj) and CBDT’s Circular No.4/2007 dated 15th June 2007 on when income fromtransactions in securities should be treated as “business profits” and when as “capital gains”:

(a) Whether the initial acquisition of the subject-matter of transaction was with the intention of dealing in the item or with a view tofinding an investment?;(b) Why and how and for what purpose the sale was effected subsequently?;(c) How the assessee dealt with the subject-matter of transaction during the time the asset was with the assessee. Has it beentreated as stock-in-trade or as an investment in the balance sheet?(d) How the assessee returned the income from such activities and how the department dealt with the same in the preceding andsucceeding assessments?;(e) Whether the deed of partnership or memorandum of association, if the assessee is a firm or a company, authorises such anactivity?(f) Most importantly, what is the volume, frequency, continuity and regularity of transactions of purchase and sale of the goodsconcerned?

CIT v. Niraj Surti (Guj HC)Despite Loan at High Rate of Interest, Share capital Gain can not be treated as Business Profit(APPEAL No. 836 of 2009)

Merely because the shares had been purchased from borrowed funds obtained on high rate of interest would not change the natureof the transaction from investment to one in the nature of an “adventure in the nature of trade.A capital investment and resale do not lose their capital nature merely because the resale was foreseen and contemplated whenthe investment was made and the possibility of enhanced values motivated the investment



The Author can be contacted at following Address

G.J. Shah & CompanyChartered Accountants

404, Manas Bhawan, 11, RNT MargIndore-452001

E-mail [email protected]: 0731-2518819

Mob: +91 96918 93040

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