2014 (5) TMI 18 - HC - Income Tax

Treatment of sale of equity shares under Portfolio management scheme Business income OR capital gains Held that - The PMS Agreement was a mere agreement of agency and cannot be used to infer any intention to make profit - 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 - Along with the intention of the assessee, other crucial factors like the substantial nature of the transactions, frequency, volume etc. must be taken into account to evaluate whether the transactions are adventure in the nature of trade - 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. The source of funds of the assessee were its own surplus funds and not borrowed funds - about 71% of the total shares have been held for a period longer than 6 months, and have resulted in an accrual of about 81% of the total gains to the assessee - only 18% of the total shares are held for a period less than 90 days, resulting in the accrual of only 4% of the total profits - a large volume of the shares purchased were intended towards the end of investment the contention 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 cannot be accepted - the number of transactions per day, as determined by an average, cannot be an accurate reflection of the holding period/frequency of transactions - 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 thus, the Tribunal had erred in holding the transactions to be income from business and profession Thus the order of the Tribunal is set aside Decided in favour of Assessee.

Issues Involved:
1. Classification of gains from the sale of shares under Portfolio Management Schemes (PMS) as business income or capital gains.
2. Evaluation of the intention behind the transactions.
3. Application of legal principles and precedents.
4. Analysis of the nature and frequency of transactions.
5. Treatment of transactions under Income Tax provisions.

Detailed Analysis:

1. Classification of Gains from Sale of Shares:
The primary issue was whether the profit made on the sale of equity shares under PMS should be treated as business income or capital gains. The Revenue treated the gains as business income, while the appellant claimed them as capital gains. The ITAT upheld the Revenue's view, reasoning that the transactions under PMS were intended to optimize returns, indicating a profit motive and thus classifying the gains as business income.

2. Evaluation of Intention Behind Transactions:
The assessee argued that the shares were depicted as investments and not "stock in trade" in their accounts. The intention was to invest surplus funds, not borrowed funds, and the holding period for most transactions was substantial. The relationship between the investor and the portfolio manager was one of principal and agent, with transactions being delivery-based, indicating investment rather than trading.

3. Application of Legal Principles and Precedents:
The court referred to several legal precedents and principles to evaluate the nature of the transactions. It emphasized that merely having an intention to resell at an enhanced value does not necessarily indicate a trading transaction. The court noted that the intention must be evaluated in conjunction with the conduct of the assessee and other circumstances. It cited the Supreme Court's judgment in Raja Bahadur Kamakhya Narain Singh v. CIT-Bihar, which stated that the surplus realized on the sale of shares would be capital if the assessee is an ordinary investor, but revenue if it deals with them as an adventure in the nature of trade.

4. Analysis of the Nature and Frequency of Transactions:
The court analyzed the frequency and volume of transactions. It noted that about 71% of the total shares were held for more than six months, resulting in 81% of the total gains. Only 18% of the shares were held for less than 90 days, contributing to only 4% of the total profits. This indicated that a significant volume of shares was intended for investment rather than trading. The court dismissed the Revenue's argument that an average of 4-5 transactions daily indicated trading activity, emphasizing that the number of transactions per day does not accurately reflect the holding period or frequency.

5. Treatment of Transactions Under Income Tax Provisions:
The court referred to the CBDT Circular no. 4 of 2007, which provided guidelines for determining whether shares are held as investments or stock-in-trade. The circular emphasized that no single principle is decisive and that the total effect of all principles should be considered. The court also cited the Supreme Court's judgment in CIT-Calcutta v. Associated Industrial Development Company, which held that the characterization of a transaction as an investment or stock-in-trade is within the knowledge of the assessee and should be supported by evidence from its records.

Conclusion:
The court concluded that the PMS agreement was a mere agreement of agency and could not be used to infer an intention to make a profit. The intention of the assessee must be inferred holistically, considering the conduct, circumstances, and substantial nature of the transactions. The court found that the ITAT erred in holding the transactions as business income and set aside the ITAT's order, answering the appeal in favor of the assessee. The transactions were thus classified as capital gains, not business income.

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