Investments by Portfolio Managers result in Capital Gains
The Mumbai Bench of the Income Tax Appellate Tribunal (“Tribunal”) in the case of I.T.O. v. Radha Birju Patel1 examined the taxation of income earned by investors through portfolio management schemes and held that the transactions carried out by a Portfolio Manager for its client cannot be said to be the business income of the client.
A portfolio manager registered with the Securities and Exchange Board of India (“SEBI”) under SEBI (Portfolio Managers) Regulations, 1993 (“Regulations”), is allowed to provide discretionary and non-discretionary portfolio management services to its clients. A “discretionary portfolio manager” as defined under Regulation 2(af) of the Regulations means a portfolio manager who exercises or may, under a contract relating to portfolio management, exercise any degree of discretion as to the investments or management of the portfolio of securities or the funds of the client, as the case may be;
In the present case, Ms. Radha Birju Patel (“Taxpayer”) was a working lady earning retainer fees. She had invested her surplus funds partly in shares and stocks for growth and capital appreciation through the services of a Portfolio Manager, ASK Raymond James under their “Portfolio Management Scheme” (PMS). In the income tax returns, the Taxpayer had disclosed short term capital gains. The Assessing Officer was of the opinion that the Taxpayer was trading in shares as opposed to making an investment and thus, the gains should be characterized as business income. For this purpose, reliance was placed on the CBDT Circular of 2007.
The Taxpayer appealed to the Commissioner of Income Tax (Appeals) (“CIT(A)”) against the order of the Assessing Officer on the grounds that she had only placed her surplus funds with ASK Raymond James for making investments on her behalf on a discretionary basis and had no knowledge of how and where her funds were being invested. The CIT(A) held in favour of the Taxpayer, which decision was appealed by the income tax authorities in the Tribunal.
Ruling of the CIT (A) and Tribunal
The CIT (A), after examination of the facts of the case, made the following observation:
“She has chosen ASK Raymond James for managing surplus funds in their Portfolio Management Scheme. The aforesaid Portfolio Management Scheme is discretionary and the assessee has no control over it so far as method of investment, number of transaction, etc, is concerned. The business is always conducted by the person himself/herself directly under his/her supervision. The facts in the present case, the lady appellant has invested her surplus fund in a qualified agency. She has done only 9 transaction of LTCG and 2 transaction of STCG. She has also dealt in Mutual Funds. From the totality of the facts, it is obvious that this appellant does not have any hallmark of trade whether in terms of source of deployment of funds, frequency or volume of transaction.”
On the basis of the above and relying on the principles laid down by the Supreme Court in G.Venkataswami Naidu & Co v. CIT2, the CIT (A) held in favor of the Taxpayer.
The Tribunal agreed with the CIT(A) that since the present transactions are carried out by the Taxpayer’s Portfolio Manager, these items are clearly in the nature of transactions meant for maximization of wealth rather encashing the profits on appreciation in value of shares. The Tribunal also noted that the very nature of Portfolio Management Scheme is such that the investments made by the assessee are protected and enhanced and in such a circumstance, it cannot be said that Portfolio Management is scheme of trading in shares and stock.
Based on the above, the Tribunal held that gains from investments made by a portfolio manager on behalf of its clients (on a discretionary basis) cannot be said to be business income in the hands of the Taxpayer and must be treated as capital gains. Accordingly, the appeal filed by the Assessing Officer was dismissed by the Tribunal.
The Tribunal’s ruling reiterates the principle that whether the income from sale of shares is capital gains or business income is essentially a question of facts and it is important to analyse the situation from a holistic perspective. While determining whether holding of shares is in the nature of investment or business, the main object of holding shares is to be taken into account. In case the shareholding is in a systematic manner through a portfolio management scheme, it is clear that the investment and divestment in securities is controlled by the portfolio manager and the Taxpayer has no control or discretion with regards to the method or amount of investment, frequency and number of transactions. As held in this decision, availing the services of portfolio management is a factor indicating that the shares were acquired as part of investment and not a trading activity.
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1 I.T.A No. 5382 Mum/2009
2 35 ITR 594