2014 (4) TMI 283 - HC - Income Tax

Nature of Income Mutual funds sold - Whether the Tribunal fall into error in holding that the sum reported as long term capital gain by the assessee was to be treated as its business income Held that - CIT(A) rightly held that the surplus from the sale of the mutual funds had to be treated as long term capital gain and not business income assessee has employed its own funds out share capital and accumulated free reserves that there was no borrowing at any time also, Assessee s is lacking proper infrastructure and is only holding worth of fixed assets - units of mutual funds are not freely transferable nor tradable and thus cannot be categorized as Business - The units can be bought or redeemed with mutual fund itself - the Income Tax Act itself recognized units of mutual funds as a special category of investments as far as trusts were concerned, u/s. 11 (5) which placed this in an entirely separate class - The assessee had kept the amounts separately in an investment account and the mutual funds for about two years, the Tribunal clearly fell into error in holding that the amount was business income and not long term capital gains Decided in favour of Assessee.

Summary

Issues:
1. Characterization of income from the sale of mutual funds as business income or long term capital gain.

Analysis:
The High Court's judgment dealt with the issue of whether the income from the sale of mutual funds by the assessee should be treated as business income or long term capital gain. The assessee, primarily dealing in shares, had also invested in mutual funds and sold them, declaring the surplus as long term capital gain. The Assessing Officer (AO) disagreed and classified it as business income. The Commissioner of Income Tax (Appeals) (CIT (A)) allowed the appeal, but the Income Tax Appellate Tribunal (ITAT) sided with the Revenue, considering the profits from mutual funds as business income.

The CIT (A) highlighted various factors supporting the assessee's position, such as the absence of borrowed funds, the consistent treatment of mutual funds as investments, and the restricted frequency of transactions. The CIT (A) also emphasized that mutual funds are recognized as a distinct investment category under the Income Tax Act. The Court concurred with these arguments and noted that the volume, frequency, continuity, and regularity of transactions test, along with the maintenance of separate portfolios and the absence of borrowed capital, supported treating the surplus as long term capital gains.

The Court criticized the ITAT's reliance on irrelevant factors like infrastructure and lack of tradability of mutual funds, emphasizing that the nature of the transactions and the assessee's consistent treatment of mutual funds as investments were pivotal. The Court ultimately held in favor of the assessee, overturning the ITAT's decision and affirming the CIT (A)'s conclusion that the surplus from mutual funds should be considered long term capital gains, not business income.