RADIALS INTERNATIONAL v ACIT ITA No.485/2012 dated 25.04.2014 (Delhi HC)

Background:

Assessee is a partnership firm, engaged in the business of providing technical, marketing and maintenance services. Assessee offered the profit on sale of shares lying in PMS as capital gains. The AO held that since the motive of the transactions was the earning of profit and not a dividend, where the holding period was ranging from a few days to a few months, it was concluded that the income was business income earned by way of adventure in the nature of trade.

Commissioner of Income Tax (Appeals) held that the intention at the time of purchase and sale, the magnitude and frequency of transactions has to be seen to test whether the sum of gain made “was a mere enhancement of value by realizing a security” or a “gain made in operation of business in carrying out a scheme for profit-making”. It was concluded that the shares were not in the nature of property which yielded any income or personal enjoyment to the owner, by virtue solely of its ownership. Thus, the intention was concluded to be profit-making, and the gains were found to be business income. 

The ITAT upheld the order of the CIT(A), and found the gains to be “business income”. It held that the nature of a PMS agreement is that it “prevents holding of dormant of stocks of depreciating value”, and that the PMS is supposed to “provide the skill and expertise to steer through the complex volatile and dynamic conditions of the market”. Since the ITAT found that the gains were taxable as business income, the exemption of section 10(38) for long term capital gains for shares held longer than 12 months, as well as the claim for concession at the rate of 10% under section 111A on short term capital gains were both denied.

Assessee’s contentions:

• The shares were depicted as investments and not “stock in trade” in the accounts of the assessee and hence the gains resulting from their sale were to be considered capital gains.
• Investment was undertaken by the assessee with its own surplus funds, and not borrowed funds, and second, that the holding period for a majority of the transactions was substantial. 
• The PMS agreement, by its terms alone or by the fact of agency being handed over to the portfolio manager, cannot be the basis for inferring an intention to profit or that the transactions are in the nature of trade. 

HELD:

• From the terms of the agreement it does not emerge that the intention of the investor is to make profits. 
• The terms on the other hand, indicate that regardless of the level of discretionhanded over to the portfolio manager, there is neither any guarantee that the securities invested in will appreciate nor is the portfolio manager responsible to the client for any loss from the deficiency of value of the securities. Thus, thePMS agreement at best, embodies the intention to appoint an agent with limited liability, who will invest on behalf of the investor and nothing more.
• Reasons provided by the ITAT merely convey that intention to hold shares as investment cannot be inferred from the agreement. However, the fact that no inference of an intention to invest can be made from the agreement does not translate to the intention to trade in shares for profit either. 
• Since the intention of the assessee cannot be ascertained, and the investments are made by the portfolio manager without the knowledge of the assessee/investor in a discretionary PMS, the manner in which the securities have been treated by the assessee can and ought to be evaluated only post the fact of investment, and not at the time of depositing the money. 
• It is legally untenable to focus singularly on the intention or motive of the assessee without looking at the substantial nature of the transactions, in terms of their frequency, volume, etc.
• It is clear thus, that 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. 
• This shows that a large volume of the shares purchased were, as reflected from the holding period, intended towards the end of investment. 
• This Court is not persuaded by the argument 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. This is because the number of transactions per day, as determined by an average, cannot be an accurate reflection of the holding period/frequency of transactions. Moreover, 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.
• This Court is thus of the opinion that the Ld. ITAT erred in holding the transactions to be income from business and profession.