2007 (12) TMI 261 - AT - Income Tax

Surplus earned from sale of shares - long-term capital gain Or business income - Disallowance on interest expenses and guard salary expenses. Income From Sale Of Shares - long-term capital gain Or business income - demarcation line between business and investment is hazy or that assessee has not maintained an investment portfolio and it was dealing in shares only like a trader? - HELD THAT - We find that the assessee is dealing in shares both as a trader as well as investor. It has kept separate accounts from both types of dealings. Valuation of holdings has been done at cost (for investment portfolio). At least there is no allegation or material to come to the conclusion that valuation of investment portfolio has been done on cost or net realizable value whichever is low. The shares which are sold out of investment portfolio, this year, were purchased two to three years ago showing that assessee had intention, while purchasing them, to hold them. They were reflected in the balance sheet as investment. The assessee has enjoyed dividend income and declared the same in return of income. The frequency of such purchase or sale in this portfolio is not large enough to doubt that this portfolio is only a device to pay lesser taxes by parking some stock-in-trade in investment portfolio. We notice that in trading portfolio the assessee had purchased during the year shares worth Rs. 21,38,353 and same shares were sold for Rs. 23,89,805. There was neither opening stock nor closing stock. In investment portfolio, opening stock of shares was Rs. 19,22,203 and closing stock was Rs. 46,23,274, whereas sales out of investment portfolio were Rs. 31,80,423. It shows that turnover to stock ratio in investment portfolio is very low as compared to that in trading portfolio. In our considered view the assessee has discharged its primary onus by showing that it is maintaining separate account for two portfolios and there is no intermingling. The onus now shifted on the Revenue to show that apparent is not real. There is no material brought in by the Revenue to show that separate accounts of two portfolios are only a smoke screen and there is no real distinction between two types of holdings. This could have been done by showing that there is intermingling of shares and transactions and the distinction sought to be created between two types of portfolios is not real but only artificial and arbitrary. Therefore, in absence of any material to the contrary, and on appreciation of cumulative effect of several factors present, we hold that the surplus is chargeable to capital gains only and assessee is not to be treated as trader in respect of sale and purchase of shares in investment portfolio. As a result this ground of the assessee is allowed. Disallowance on interest expenses - HELD THAT - In our considered view there is no case for sustaining the addition. Once land has been shown as business asset in the balance sheet then it is for the Revenue to bring material on record to show that land was not a business asset but was acquired for non-business considerations. Once it is not proved that apparent is not real, payment of interest on funds borrowed for investing in the land which is apparently for business purposes, the claim of interest, therefore cannot be disallowed. This ground of the assessee is therefore allowed. Disallowance of expenses on salary of guard - HELD THAT - After hearing the parties we do not find any reason to sustain the addition. It is the discretion of the assessee to employ Chowkidar to safeguard its assets against encroachment. The business discretion of the assessee cannot be substituted for that of AO. The expenditure is clearly for business necessity. The addition is therefore deleted. As a result this ground is allowed. As a result appeal filed by the assessee is allowed.

Issues Involved:

1. Classification of income from sale of shares and securities as either long-term capital gain or business income.
2. Allegation of the use of a colorable device to evade taxes.
3. Disallowance of interest expenses amounting to Rs. 23,737.
4. Disallowance of guard expenses amounting to Rs. 19,200.
5. Overall challenge to the legality and fairness of the appellate order.

Issue-wise Detailed Analysis:

1. Classification of Income:
The primary contention was whether the income of Rs. 10,71,003 from the sale of shares should be classified as business income or long-term capital gains. The assessee argued that it maintained separate accounts for shares held as investments and those held for trading. The shares sold were held for 2-3 years, indicating an intention to invest rather than trade. The revenue, however, treated the gains as business income, arguing that the assessee's primary activity was dealing in shares and that the transactions were substantial and frequent, indicating a business motive.

The tribunal referred to various judicial precedents and CBDT Circular No. 4 of 2007, which outlines principles for distinguishing between shares held as stock-in-trade and those held as investments. The tribunal concluded that the assessee maintained clear and independent portfolios for investment and trading, with shares in the investment portfolio being held for over two years. The tribunal found no evidence of intermingling between the two portfolios and determined that the gains should be treated as long-term capital gains.

2. Allegation of Colorable Device:
The revenue alleged that the assessee used a colorable device to pay less tax by treating income from share dealings as long-term capital gains instead of business income, citing the Supreme Court's judgment in McDowell & Co. Ltd. vs. CTO. The tribunal, however, found that the assessee had maintained separate accounts for investments and trading, and there was no material evidence to support the revenue's claim of a colorable device. The tribunal held that the assessee's classification of the gains as long-term capital gains was legitimate.

3. Disallowance of Interest Expenses:
The AO disallowed Rs. 23,737 out of interest expenses, arguing that the assessee borrowed money to invest in land, which was not a business asset. The assessee contended that the land was a business asset, as shown in the balance sheet, and the borrowed funds were used for business purposes. The tribunal agreed with the assessee, stating that once the land is shown as a business asset, the interest on borrowed funds for its purchase should be allowed as a business expense. The tribunal found no evidence to contradict the assessee's claim and allowed the interest expense.

4. Disallowance of Guard Expenses:
The AO disallowed Rs. 19,200 for guard expenses, arguing that there was no business connection and that land could not be stolen. The assessee argued that the guard was employed to protect the land from encroachment. The tribunal held that the employment of a guard was a business necessity to safeguard the asset and that the business discretion of the assessee could not be substituted by the AO's judgment. The tribunal allowed the guard expenses as a legitimate business expense.

5. Overall Challenge to the Appellate Order:
The assessee challenged the appellate order as being contrary to law, facts, and principles of natural justice. The tribunal, after a detailed examination of the facts and legal principles, found in favor of the assessee on all grounds, concluding that the appellate order was not justified in its disallowances and reclassification of income.

Conclusion:
The tribunal allowed the appeal filed by the assessee, holding that the income from the sale of shares should be treated as long-term capital gains, the disallowance of interest and guard expenses was not justified, and there was no evidence of a colorable device to evade taxes.

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