Wednesday 18 January 2012

Profits on share transactions carried through Portfolio Management Scheme (PMS) taxable as business income and not capital gains

Facts
 The taxpayer was engaged in the business of providing technical, marketing and maintenance services for earthmover tyre and trading in tyres. The taxpayer had invested surplus funds generated from business activities in mutual funds and shares, either directly or under PMS and were reflected in the balance sheet as investments.
 The taxpayer claimed exemption under Section 10(38) for long term capital gains and concessional tax rate under Section 111A for short term capital gains arising from the sale of shares through PMS. The tax payer further claimed that the investment in shares was made with the intention of earning dividend from such investments.
 The Assessing Officer (AO) treated the gains as business profits, contending that the taxpayer had purchased and sold shares with the motive of earning profit and concluded that the transactions involving sale and purchase of shares under PMS were adventure in the nature of trade and not a sale of investments.
 The taxpayer preferred an appeal before the Commissioner of Income-tax (Appeals) [“CIT(A)”]. The CIT(A) observed that the taxpayer had entered into numerous and frequent transactions on regular basis to carry out the trading venture in shares and therefore concluded that the taxpayer was dealing in shares in a systematic and organized manner. Further at the time of purchasing shares, the taxpayer had the intention to sell them subsequently at a profit, thereby establishing a commercial motive. Accordingly, the profit was taxable as business income.
 The taxpayer preferred an appeal before the Income-tax Appellate Tribunal (“ITAT”).
Issue before the Delhi ITAT
 Whether the profits earned on share transactions carried on through PMS should be taxable as “business income” or income under the head “capital gains”.
Observations and Ruling of the Delhi ITAT
 Under PMS as per SEBI, the term „Portfolio‟ means a collection of securities owned by an investor, representing the total holding of securities belonging to any person.
 A Portfolio Manager is an agent who buys and sells shares on behalf of the client and proceeds systematically to manage on an ongoing basis the collection of securities in custody in tune with market variations to optimize the returns in the process.
 At the time of deposit of the amount under the PMS, the intention of the taxpayer was to maximize profit out of the investments. The purchase and sale of shares under PMS was not in the control of the taxpayer. Therefore, it cannot be said that the taxpayer had invested money under PMS with intention to hold shares as investment. The portfolio manager has carried out trading in shares on behalf of clients to maximize the profits.
 There is a difference in investment in mutual fund and PMS. In case of mutual fund, the investor is allotted units for the amount invested by him in the mutual fund. The mutual fund manager purchases and sells shares frequently and makes profit/loss. The profit/loss so earned/incurred, increases/decreases the net asset value of the units. The units are also tradable depending upon the lock in period and terms of the fund. However, in the case of PMS the amount is invested under the scheme. No units or instruments are issued, which can be traded. The portfolio manager undertakes trading in shares to maximize the profits on behalf of the investor. Therefore, the investment in PMS cannot be equated with that of investment in units of mutual fund.
 Merely because the shares are credited to DEMAT account at the time of purchase and debited at the time of sale would not make the transactions in the nature of investment. What is important is the intention at the time of purchase, frequency of transactions and volume of the transactions even if the taxpayer has employed his own funds.
 Further, even though the taxpayer has considered the deposits made under PMS as investments and balance shares lying in DEMAT account under the head „investment‟, the same would not change the character of trading done by the portfolio manager on behalf of the taxpayer.
 The shares purchased and sold during the year have not been recorded in the books of account as investment nor it is feasible to record as the details were not available with the assessee and the assessee has not control or say as to when and the type of shares or the period of holding of shares. Therefore, the transactions are in the nature of business.
 The shares have been traded frequently with a motive to maximize profit and not with a view to hold them as investment. The volume of the transaction is very high. Since the portfolio manager in the capacity of an agent has traded in shares on behalf of the taxpayer, the profits arising therefrom will be in the nature of business profits. Accordingly, availing of the exemption under Section 10(38) and concessional rate of tax under Section 111A would not arise.
Conclusion
The ruling reiterates the principle that the characterisation of income from the sale of shares and other securities as „business income‟ or „capital gains‟ has to be determined with reference to the intention of the assessee at the time of purchase. If it is impressed with the character of a commercial transaction with a view to earn profits, the income earned therefrom would be in the nature of „business income‟.

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