Pune tribunal favours individual investors in distinction between business transaction and investment transaction. However, this matter will continue to be decided by the assessing officer on a case-by-case basis

The Income-Tax Appellate Tribunal (ITAT) in Pune has held that a person/entity investing funds through Portfolio Management Services (PMS) will be categorised as an investor and not as a person dealing in shares, for the purposes of tax calculation. This implies that an average investor no longer runs the risk of having his PMS investment treated as business income, which used to be charged at a higher rate.

The ITAT held in a recent order that the taxpayer cannot be said to be in the business of dealing in shares merely because the portfolio manager entered into a large number of transactions on behalf of the taxpayer.

According to Ameet Patel, partner, Sudit K Parekh & Co, a chartered accountants firm, "In India, capital gains arising from sale of investments entitles the investor to several tax concessions, but business income is generally subjected to tax at normal rates. This distinction between a business transaction and an investment transaction has considerable significance. In the past couple of years, there has been a lot of litigation in India on this matter. The latest decision of the Pune ITAT is a reasoned and detailed order and is in favour of the taxpayer."

The tax authorities have ruled in a number of cases, where the volume or frequency of transactions is large, that the same should be considered as business of trading in shares instead of an investment activity. On the other hand, the concerned taxpayer would naturally have liked it if the gains from such transactions were treated as capital gains, thereby allowing for lower or no tax. There are several appellate and judicial decisions on this issue which are fact-specific in nature.

The recent case involves the assessee, KRA Holding & Trading, in Pune, where the company had entrusted substantial funds to five portfolio managers. The portfolio managers were granted sole discretion with respect to making investments, but they were not allowed to enter into speculative transactions, or to settle any transactions without giving/taking delivery of shares.

Most of the transactions were carried out through only one of the five portfolio managers. In its books of accounts, as well as its tax returns, the company treated the gains/losses from its various portfolios as capital gains/losses and offered its income for tax accordingly. The assessing officer (AO) and the first appellate authority, commissioner of income-tax (appeals) [CIT(A)], were of the view that the assessee was a dealer in shares and thus, the income from the various transactions was to be taxed under the head 'Profit and Gains of Business and Profession' and not under the head 'Capital Gains'.

The ITAT's decision was based on the fact that the predominant intention of the assessee company was to hold shares as investments and not as stock in trade. The assessee had not traded in shares and was entirely dependant upon its portfolio managers and hence could not be termed as a 'dealer' in shares. The predominant objective was to create wealth on a long term basis and to earn maximum profit out of these investments.

According to the order, accretion to capital does not become income merely because the original capital was invested in the expectation that it would, in due course of time, rise in value. ITAT said the share transactions by the assessee through various portfolio managers were to be classified as investment activity and the income arising from such transactions was to be taxed under 'Capital Gains' and not 'Profits and Gains of Business or Profession'.

It must be noted that such disputes are fact specific and each matter must be decided on a case-to-case basis. The assessing officer will take his own decision on each case of investors who file returns.