2016 (2) TMI 694 - AT - Income Tax

Treatment of income of Portfolio Management Fees (PMS) - STCG or business income - Held that - Finding of AO for treating the income from PMS is income from business and not STGC are erroneous and the same is set-aside and we direct the AO to treat the income from PMS as income on account of STGC. Disallowance of STCL u/s 94(7) - Held that - As we have noticed that the assessee purchased mutual fund of three different companies on 12.04.2004 and sold on 14.12.2004 on a total loss of 41, 431/- thus all the transaction/sale/purchase were made within 9 months hence the assessee is not entitle to claim STCL.

Issues Involved:

1. Classification of income from short-term capital gains as business income.
2. Determination of whether share trading activity was conducted through Portfolio Management Services (PMS).
3. Treatment of appreciation earned through PMS as business income.
4. Assessment of the motive behind share trading activities.
5. Evaluation of whether taking help from experts amounts to trading in shares.
6. Disallowance of short-term capital loss under section 94(7) of the Income Tax Act.
7. Non-allowance of loss from mutual funds to be set off against income.

Detailed Analysis:

1. Classification of Income from Short-Term Capital Gains as Business Income:
The assessee filed returns declaring short-term capital gains (STCG) for AY 2005-06 and 2006-07. The Assessing Officer (AO) reclassified the STCG as business income, citing the high volume and frequency of transactions. The CIT(A) upheld this reclassification, noting that the assessee engaged in share trading through PMS, which involved expert management aimed at maximizing profits. However, the ITAT referenced the principle of consistency and previous judgments, including the Delhi High Court's decision in Redial International Vs Asst. CIT and ITAT Mumbai's ruling in ITO Vs Radha Birju Patel, to conclude that income from PMS should be treated as STCG, not business income. Thus, the ITAT directed the AO to treat the income as STCG.

2. Determination of Whether Share Trading Activity Was Conducted Through PMS:
The AO and CIT(A) determined that the assessee's share trading activities were conducted through PMS with ASK Raymond James Securities Pvt. Ltd. and Fortis Securities Ltd. The CIT(A) emphasized that PMS involves professional management, which is distinct from casual investment by an individual. The ITAT, however, noted that similar transactions in subsequent years were treated as STCG by the revenue, reinforcing the principle of consistency. Consequently, the ITAT ruled in favor of treating the income as STCG.

3. Treatment of Appreciation Earned Through PMS as Business Income:
The AO and CIT(A) held that the appreciation earned through PMS constituted business income, based on the professional management and frequent trading aimed at profit maximization. The ITAT disagreed, citing consistent treatment of similar income as STCG in subsequent years and relevant judicial precedents. Therefore, the ITAT directed the AO to treat the appreciation as STCG.

4. Assessment of the Motive Behind Share Trading Activities:
The AO assumed that the assessee's motive was to engage in trading rather than investment, given the high volume and frequency of transactions. The CIT(A) supported this view, noting the involvement of PMS professionals. The ITAT, however, found that the assessee's investments were managed by PMS operators, and similar income was treated as STCG in subsequent years. Thus, the ITAT ruled that the motive should not change the classification of income from STCG to business income.

5. Evaluation of Whether Taking Help from Experts Amounts to Trading in Shares:
The CIT(A) concluded that taking help from PMS experts amounted to trading in shares, thus classifying the income as business income. The ITAT countered this by referencing consistent treatment of similar income as STCG in subsequent years and relevant judicial precedents, ultimately ruling that expert management through PMS does not convert STCG into business income.

6. Disallowance of Short-Term Capital Loss Under Section 94(7) of the Income Tax Act:
The AO disallowed a short-term capital loss of Rs. 41,431 under section 94(7), citing dividend stripping provisions. The CIT(A) upheld this disallowance, noting that the transactions involved mutual funds purchased and sold within nine months, with dividends received exceeding the loss. The ITAT reviewed the AO and CIT(A)'s findings and confirmed the disallowance, agreeing that section 94(7) applied, and the assessee was not entitled to claim the short-term capital loss.

7. Non-Allowance of Loss from Mutual Funds to Be Set Off Against Income:
The AO disallowed a loss of Rs. 3,489 from mutual funds to be set off against income. This ground was not pressed by the assessee during submissions, leading the ITAT to dismiss it as not pressed.

Conclusion:
The ITAT partly allowed the appeal for AY 2005-06, directing the AO to treat the income from PMS as STCG, while confirming the disallowance of short-term capital loss under section 94(7) and dismissing the non-allowance of mutual fund loss as not pressed. For AY 2006-07, the ITAT allowed the appeal, directing the AO to treat the income from PMS as STCG.

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