We are pleased to release a Tax alert which summarizes a recent ruling of the Delhi High Court (HC) in the case of Radials International (Taxpayer) on the issue of characterization of income from sale of shares, invested under discretionary Portfolio Management Scheme (PMS), as “business income” or “capital gains” under the Indian Tax Laws (ITL).
In this ruling, the Taxpayer, a partnership firm, engaged in business of providing technical, marketing and maintenance services for heavy vehicles and trading in tyres, entered into an agreement with a Portfolio Manager (PM) under discretionary PMS wherein funds were placed with PM for investing in shares and securities at PM’s discretion. The Taxpayer made such investment from own funds and entered it as “investment” in its books of account. During the year under reference, though there were about 4 to 5 transactions on a daily basis; substantial number of shares were held for a period longer than 6 months and gains from such shares comprised more than 80% of total gains during the year. PM provided details on transactions on regular basis to the Taxpayer.
Delhi HC, considering the facts of the case, held that income from sale of shares under PMS in the present case was in the nature of “capital gains” and not assessable as “business income”. The HC held that the Taxpayer’s intention as revealed from overall conduct, nature of transactions, frequency, volume etc. was not to make profits but to appoint an agent with limited liability for making investment in shares.
While there are conflicting rulings of Tribunals on characterization on income from sale of shares under discretionary PMS, the present ruling is the first HC ruling which upholds a taxpayer’s claim of capital gains characterization. The HC has applied well settled principles of distinction between investment and trading in shares in the context of discretionary PMS. The HC has emphasized that mere nomenclature as PMS or mode of investment through PM is not determinative of the issue and one has to holistically look at the actual conduct in terms of nature of transactions, frequency, volume, use of borrowed funds, book treatment etc. The HC ruling, therefore, provides guidance that characterization of PMS investment like any other investment is a mixed question of facts and law.
In this ruling, the Taxpayer, a partnership firm, engaged in business of providing technical, marketing and maintenance services for heavy vehicles and trading in tyres, entered into an agreement with a Portfolio Manager (PM) under discretionary PMS wherein funds were placed with PM for investing in shares and securities at PM’s discretion. The Taxpayer made such investment from own funds and entered it as “investment” in its books of account. During the year under reference, though there were about 4 to 5 transactions on a daily basis; substantial number of shares were held for a period longer than 6 months and gains from such shares comprised more than 80% of total gains during the year. PM provided details on transactions on regular basis to the Taxpayer.
Delhi HC, considering the facts of the case, held that income from sale of shares under PMS in the present case was in the nature of “capital gains” and not assessable as “business income”. The HC held that the Taxpayer’s intention as revealed from overall conduct, nature of transactions, frequency, volume etc. was not to make profits but to appoint an agent with limited liability for making investment in shares.
While there are conflicting rulings of Tribunals on characterization on income from sale of shares under discretionary PMS, the present ruling is the first HC ruling which upholds a taxpayer’s claim of capital gains characterization. The HC has applied well settled principles of distinction between investment and trading in shares in the context of discretionary PMS. The HC has emphasized that mere nomenclature as PMS or mode of investment through PM is not determinative of the issue and one has to holistically look at the actual conduct in terms of nature of transactions, frequency, volume, use of borrowed funds, book treatment etc. The HC ruling, therefore, provides guidance that characterization of PMS investment like any other investment is a mixed question of facts and law.
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