RAMESH G PORWAL,,PUNE vs. ASSISTANT COMMISSIONER OF INCOME-TAX,,

आदेश / ORDER

PER ANIL CHATURVEDI, AM :

Assessee is an individual stated to be trading in shares, hire purchase and leasing of automobiles and having income from business, capital gains and other sources. Assessee filed his return

of income for A.Y. 2005-06 on 31.10.2005 declaring total income of

Rs.55,07,620/-. The case was selected for scrutiny and thereafter

the assessment was framed under Section 143(3) of the Act vide

order dated 14.12.2007 and the total taxable income was

determined at Rs.77,84,720/-. Aggrieved by the order of AO,

assessee carried the matter before Ld.CIT(A), who vide order dated

06.06.2014 (in appeal No.PN/CIT(A)-III/Rg-5/624/2009-10)

granted partial relief to the assessee. Aggrieved by the order of Ld

CIT(A), assessee is now in appeal before us and has raised the

following grounds :

“1. On facts and circumstances prevailing in the case and as per provisions & scheme of the Act it be held that a sum of Rs.12,31,771/- be treated as income derived from short term capital gain in place of income computed under head" Business & profession" by assessing officer & consequential reliefs may please be granted to the appellant.

to press ground No.5 and therefore the ground No.5 is dismissed as

not pressed.

income as against it treatment by assessee as short term capital

gains.

4.1. During the course of assessment proceedings, AO noticed

that assessee had disclosed short term capital gains of

Rs.38,23,839/- which were split into 2 categories namely, short

term capital loss (--Rs.10918/-), the transactions of which were

conducted before 01.10.2004 and short term capital gains, the

transactions which were conducted after 01.10.2004 and offered to

tax @ 10% (Rs. 38,34,755/-). He also noticed that assessee had

suo moto converted mutual funds amounting to Rs.50,76,007/-

from stock in trade to capital asset on 01.04.2004. He further

noticed that till earlier year, assessee had been treating the

aforesaid mutual funds as stock in trade, valuing it at lower of cost

or market value, diminution in value of stock was claimed as

business loss and assessee was enjoying the advantage of debiting

business expenses against the profits made from sale of mutual

funds. The assessee was therefore asked to show cause the change

for treating the stock of mutual funds from stock in trade to

investments. The submissions of the assessee were not found

acceptable to the AO. AO concluded that the change in treatment

was to take the advantage of 10% tax rate on short term capital

gains introduced from the year under consideration. AO thereafter,

on the basis of working sought from assessee, considered the

amount of profits of Rs.12,31,771/- as business income instead of

capital gains offered by the assessee. Aggrieved by the order of AO,

assessee carried the matter before Ld.CIT(A), who upheld the order

of AO by holding as under :

“4.2. I have given careful consideration to the submissions made. The facts are undisputed that the appellant was consistently holding the mutual fund portfolio as a business stock including and upto A.Y. 2004-05. The total value of such business and current assets as on 31.03.2004 was Rs.1,53,98,504/-, which was inclusive of stock-in-trade of Rs.1,02,45,799/-. The appellant continued to trade in shares and to hold the same as business assets during this year. In the circumstances, the decision on the part of the appellant to convert only the mutual fund portfolio as a investment or capital asset cannot be termed as legitimate and genuine. The principle of consistency which was adopted by the appellant in the earlier years cannot be reversed without providing genuine reasons why such conversion was necessitated. In this regard the reverse logic of the Bombay High Court cited by the appellant in the case of CIT vs. Gopal Purohit (228 CTR 522) could be well applied in the background of fact that the appellant had followed consistent practice with regard to the nature of activities relating to the trading of shares and mutual funds and a very heavy onus was cast upon him to show that the intention behind the conversion of stock in trade into investment was bona-fide. he appellant has relied upon the decision of the Mumbai ITAT in the case of CIT vs. Bright Star Investment Pvt. Ltd. (120 TTJ 498) for the proposition that in the absence of specific provision in section 45(2) to deal with a situation where stock in trade is converted into investment and later on such investment were sold at a profit, the formula which is favourable to the assessee should be accepted. However this decision was rendered for A.Ys 2000-01 & 2001-02 wherein there was no differentiation in the tax rate between long term capital gain (as shown by the appellant in that case) and business profit where as in the present case the appellant has attempted to disguise the business profits as short term capital gains for taking advantage of the lower rate of taxation of 10% as introduced by section 111A for transactions entered into after 01.10.2004 i.e. the date on which Chapter VII of the Finance Act 2004 came into force. There are certain other issues, as pointed out by the Assessing Officer, which should not be lost sight of and are relevant for deciding the issue. The appellant has taken full advantage of business losses in the preceding years by way of valuation of the closing stock at cost or market price. He has also had the benefit of claiming business expenditure against the mutual fund transactions in the earlier years. Taking into account all the above factors, the action of the Assessing Officer in bringing into tax Rs.12,31,771/- as business profit as against short term capital is affirmed. Ground no.1 is dismissed.”

Aggrieved by the order of Ld.CIT(A), assessee is now in appeal

before us.

lower authorities and further submitted that there is no bar on

conversion of stock in trade into investments and therefore the act

of assessee of transferring stock in trade to investments was a

permissible act. He further relied on the decision of Mumbai ITAT in

the case of ACIT Vs. Brightstar Investment Pvt. Ltd., reported in

120 TTJ 498. Ld DR on the other hand took us through the order

of AO and supported the order of lower authorities.

material on record. It is an undisputed fact that the investments in

mutual funds were hitherto classified by the assessee as “stock in

trade” but during the year (as on 01.04.2004) the assessee

converted the stock in trade to investments and thereafter some of

the mutual fund units were sold and the profit earned was treated

by the assessee as short term capital gains, whereas in the opinion

of AO, the profit had to be treated as income from business and the

act of conversion of stock to investments was for the purpose of tax

evasion. We find that the statute does not reject conversion of

stock in trade into investment and the conversion from stock in

trade to investment is permissible. The mere fact that due to the

amendment introduced in the statute due to which with effect from

1st April, 2004, the tax rate applicable to short term capital gains

at10% does not mean that the said conversion was improper or

illegal. Further, no material has been brought on record by Revenue

to demonstrate that the assessee subsequently continued to treat

and regard the mutual funds as stock in trade and not investment

or the transaction was a sham transaction. We further find that

Hon’ble Delhi High Court in the case of Ld.CIT Vs. Express

Securities Pvt. Ltd., (ITA No.406/2013 order dt.22.10.2013) has

noted that after the introduction of Sec.10(38) by Finance Act 2004

w.e.f. 01.04.2005, the assessee on noticing the tax benefit was

entitled to convert and change his holding from stock in trade to

investment and that such conversion cannot be rejected on the

ground that Sec.10(38) of the Act was introduced w.e.f. the said

date. It has further noted that conversion may be rejected for

other reasons and grounds like the intention was not to convert and

the assessee had continued to treat and regard the shares as stock

in hand and not investments. Considering the totality of aforesaid

facts and in the light of aforesaid decision of Hon’ble Delhi High

Court, we are of the view that in the present case, the action of AO

in treating the profits on sale of mutual funds as business income

instead of short term capital gains as offered by AO and upheld by

Ld.CIT(A), cannot be upheld. We therefore set aside the order of

Ld.CIT(A) and thus the ground of assessee is allowed.

considered together:

7.1. AO on perusing the short term capital gains noticed that

assessee had claimed loss of Rs.6,38,912/- on account of sale of

shares of Punjab National Bank and Bharati Shipyard Ltd. He

noticed that the sale of shares was to its sister concern (Phoenix

Warehousing Pvt Ltd), the transaction was not through recognised

stock exchange but an off market transaction and the transaction

was effected just before the closure of the financial year. He also

observed that the shares of Punjab National Bank were sold at Rs.

386.18 per share as compared to the opening and closing price of

those shares of Rs.405/- and Rs.387.90 respectively prevailing on

the date of sale. In case of sale of shares of Bharati Shipyard it was

AO’s observation that the sale was affected at Rs.122.18 per share

whereas the lowest price at Bombay Stock Exchange on that day

was Rs.131.40 per share. He further observed that Phoenix

Warehousing had in turn sold the shares between April 2005 and

August 2005 at a price much higher than the price at which the

assessee sold the shares and has made a profit of Rs.7,59,120/-

which were offered to tax at 10% by it. He also noticed that these

shares were acquired by the assessee by obtaining loan from J.M.

Financial Products Ltd., and had paid interest of Rs.11,72,172/-

and since such interest was for acquiring the shares, the dividend

income from which will be exempt u/s 10(38) of the Act, the

expenses were not allowable u/s 14A of the Act and it cannot be

considered to be towards acquisition of assets. He therefore held

that the transaction has been effected by the assessee to incur

artificial loss (where assessee is taxable at 30%) and to book capital

gains in the hands of sister concern where it was offered to tax at

10%. He thereafter worked out the gains (being the difference

between the final sale price by sister concern and the cost of

acquisition of shares (excluding interest) at Rs.13,09,460/- and

held it to be additional business income of the assessee. Aggrieved

by the order of AO, assessee carried the matter before LD.CIT(A),

who upheld the order of AO by holding as under:

“5.2 I have considered the submissions of the appellant. The issues to be decided with regard to these grounds are three-fold, namely: (a) whether the interest borrowed for investment in the shares in question can form part of the cost of acquisition particularly in the background that there is transfer of the asset (b) whether the transaction is capital in nature or is a business venture and (c) whether the final sale price in the hands of sister concern can be adopted for calculation of business profits. 5.2.1 To take up the second issue first, as it is germane to not only this ground of appeal but also ground no. 6, what need to be determined is whether the two share transactions in question, and indeed the other transactions undertaken during the year are capital gains or are business transactions. 'Business' is a term of wide import, and would include any activity that engages the time, attention, effort or even one's resources on a regular basis in pursuit of economic gain. The legal position, with regard to the distinguishing features of business income, with reference to a number of decisions by the apex court, as under, has neither been disputed nor is disputable:

(a) Raja Bahadur Visheshwara Singh V. CIT (1961) 41 ITR 685(SC); (b) Dalhousie Investment Trust Co. Ltd. v. CIT [1968] 68 ITR 486 (SC);

(c) CIT v. Sutlej Cotton Mills Supply Agency Ltd. [1975] 100 ITR 706 (SC); (d) A.V. Thomas & Co. Ltd. v. CIT [1963] 48 ITR 67 (SC); (e) CIT v. P.K.N. Co. Ltd. [1966] 60 ITR 65 (SC); and (f) CIT v. Associated Industrial Development Co. (P.) Ltd.[1971] 82 ITR 586 (SC).

5.2.1.1. The Assessing Officer examined the details of the transactions which totaled 198 for the whole year, including multiple transactions that had been clubbed together on one single date. A perusal of the relevant transactions, detailed at pgs.12 to 17 of the assessment order, reveals a holding period of less than 90 days generally, and in fact less than 10 days in at least 35 transactions. The frequency and regularity of the transactions exhibit a systematic activity. In fact, only one who is well versed with the market would undertake transactions in such volume, frequency, regularity, also assuming financial risk by incurring interest-bearing debt. The AO also found that though the appellant had asserted that physical delivery of the shares had been taken and reflected in the demat account, the detailed chart as per Annexure 9 to the submissions dated 12.11.2007 showed that out of 123 total capital gains

transactions, the delivery of only 25 shares had been given through the appellant's own demat account and the remaining deliveries had been given through the demat account of the broker. I am inclined to agree with the AO's conclusion that the unwillingness to take delivery of shares indicates that the appellant intended to indulge in further trading of the shares through the broker's pool account and does not reveal an intention to keep the shares as an investment. It is found that a large majority (57%) of the shares purchased through the IPO (Rs.1,86,84,441/-) have been sold during the year (Rs.1,07,82,255/-). In the same way, the appellant has sold 56% of the shares (Rs.2,61,01,072/-) of the total shares purchased during year (Rs.4,59,73,546/-). The AO also found that despite the assertion that no borrowed funds had been utilized for purposes of making the investments, there had been borrowings of almost Rs. 1 crore for deployment in the activity of investment in shares and mutual funds. He has corroborated this by drawing attention to the substantial interest cost incurred on the two transactions relating to Bharati Ship Yard and Punjab National Bank. 5.2.1.2 During the year under consideration, the appellant offered substantial short term gains in both 10% and 30% categories which arose out of trading in shares and mutual funds in the same way as the business profits offered to tax in earlier years and such trading continued during the impugned year also. As already discussed above, in the preceding years, the entire income from such trading was being shown as business income. However the appellant has relatively large amount of borrowed funds on which net interest payment amounting to Rs. 12,47,266/- has been made during the year, indicating that for such trading activity, borrowed funds were systematically arranged and leaving no room for doubt that it was not a case of genuine investment. The papers filed before me indicate that the appellant applied for 24,00,000 shares of Bharti Shipyard Ltd, funds of Rs. 15,04,80,000/- for which were provided by J.M. Financials. Similarly, 1,99,995 shares of Punjab National Bank Ltd. were applied by availing funds of Rs. 7,01,98,245/- from the same concern. The volume of shares applied for in these two IPOs and the manner of their funding leave no room for doubt that the appellant was no mere investor. He continued to systematically engage in the business of share trading. 5.2.1.3. It has also been found that though the appellant claims to have maintained separate portfolios for the purposes of trading as well as for investment, the Assessing Officer has brought on record the fact that there is no clear cut demarcation and that the same demat account shows credit of the investments as well as stock in trade. Undoubtedly the Supreme Court in the case of CIT VS Associated Industrial Development Company (82 ITR 586) held that the issue in particular holding a share is by way of investment or forms part of stock in trade is a matter which is within the knowledge of assessee, but it also laid down the thumb rule that the assessee should be in a position to produce evidence from its record as to whether it has maintained any distinction between those shares held as its stock-in-trade and those which are held by way of investment. It is very apparent that since both the portfolios are maintained in the demat account, no such distinction is maintained. Undoubtedly it is the appellant's prerogative to manage the affairs of his business. However the appellant has to follow consistent method in accounting policies and in the treatment of its assets. It may also be emphasized that the appellant is maintaining the same set of

books of account for both his business transactions (speculative share trading, others) and the purported investment activity out of the same common pool of funds. The distinction drawn between the investment and business (trading) activity by the appellant is hypothetical and his records are incapable of leading to the said distinction, the onus for which is only on him. All his transactions are imbibed with same profit motive, which continued not only throughout the year, but also from year to year. The appellant has taken the plea that the Income Tax Act recognizes the concept of short term capital assets with regard to securities listed in recognized in stock exchange u/s.2(42A) of the Income Tax Act, Similarly, the specific provision of section 111A would apply with regard to the shares purchased after 01.04.2004. Undoubtedly this is correct, but as the Assessing Officer has mentioned, the conduct of the appellant 'in unilaterally converting a part of its stock-in-trade into investments does not appear to be bona-fide. The reasons for the same have already been discussed above. The purchase of shares of Bharti Ship Yard and Punjab National Bank are reflective of the manipulation undertaken by the appellant through off-market dealing to purchase losses, particularly when the appellant has paid heavy interest on funding of these shares. The facts are self- speaking, and leave me in no manner of any doubt of the appellant being engaged in trade in shares and securities - in all its various aspects. Consequently the Assessing Officer's findings that the appellant has arranged losses to offset the short term capital gains, solely with the object of tax avoidance are affirmed and it is held that the 2 transactions in question are purely business transactions. In the chart furnished by the appellant at para 5.1 supra, it appears very obvious that the prices of the shares that were sold to M/s. Phoenix Warehousing Pvt. Ltd. were in fact, much below the market price prevailing on the date of sale and not ‘little less’ than the market price. For example, the 11703 shares of Bharti Ship Yard have been sold at Rs.122.18 per shares which are much below the opening price of Rs. 141 and closing price of Rs. 132.50 per share.

5.2.2. Coming to the first issue as to whether the interest component can be claimed as the part of acquisition, the appellant has sought to place reliance on the Pune ITAT decision in the case of S. Balan vs. DCIT reported in 120 TTJ 397 by stating that the interest was paid on amount borrowed for investments in shares and such interest was not claimed as revenue expenditure but was capitalized. And that therefore once it is established that the appellant had borrowed funds for acquisition of shares and the interest thereon was capitalized, the interest component cannot be segregated from the amount of investment. However, in the present case, the facts are substantially different as all along till the previous year preceding the year under appeal, the appellant was a trader in shares and the interest on borrowed capital was being claimed' as a revenue expenditure. As on 1.4.2004, the appellant has apparently converted most of his stocks as investments and has worth of shares left in the stock-in-trade then, an interest expenditure of Rs.12,47,266/- has been claimed during the year under appeal. Additionally, the appellant claims to have paid interest of Rs.11,72,172/-to M/s. J.M. Financial on account of these two transactions. Undoubtedly, the dividend received on shares and mutual funds is exempt from tax by virtue of section 10(34) and the appellant receives substantial income by way of dividends that are exempt from tax. Applying the same analogy

to my finding that the transactions in question were business transactions, the appellant is held to be entitled to the interest component as business expenditure, but the same cannot be allowed to be capitalized as has been done by the appellant. Coming to the Assessing Officer's reliance on section 14A as an additional reason for disallowing the interest on the transaction" he has not questioned the fact that such interest' expenditure of Rs.11,72,172/- has indeed been incurred in the process of acquiring the shares. However, he was perhaps not justified in disallowing the entire quantum of the interest expenditure u/s.14A. Section 14A prescribes that 'no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income'. The Assessing Officer has worked out the quantum of interest that is disallowable in terms of section14A at para 8 of the assessment order. For the reasons mentioned in the subsequent part of this order, he is directed to include the interest of Rs.11,72,172/- and rework the disallowance u/s.14A. 5.2.3. Finally it needs to be decided whether the AO has rightly computed the business profits relating to the sale of scrips of Bharti Ship Yard and Punjab National Bank, by taking the sale consideration arising in the hands of the sister concern. The appellant admittedly sold the shares to M/s. Phoenix Warehousing Pvt. Ltd. on 28th and 29th of March 2005. As has been argued by the appellant the provisions of section 40A(2)(b) do not have any bearing on the issue as they do not relate to expenditure incurred. Although the transactions are indeed suspicious, in the absence of proof being brought on record that the transaction in question were fictitious or that the appellant was the actual seller of shares in the subsequent assessment year, there does not appear any justification on the part of the Assessing Officer to compute the business profit/income by taking into account the sale price at which the scrips were subsequently sold by M/s. Phoenix Warehousing Pvt. Ltd. and that too for a transaction that took place in subsequent assessment year. 5.2.4. In the light of the aforesaid observations the Assessing Officer is directed to compute the business loss in the hands of the appellant by taking into account the sale consideration of Rs.23,73,260/- and allowing the cost of the shares along with the interest thereon. He is also directed to take into account the interest paid of Rs.11,72,172/- for the purpose of calculating disallowance u/s.14A. Grounds 2 to 4 stand allowed subject to these directions.”

Aggrieved by the order of Ld.CIT(A), assessee is now in appeal

before us.

lower authorities and further submitted that assessee had borrowed

funds for the purpose of purchase of shares and the interest paid to

JM Financial Services was for the purpose of acquisition of shares

of Punjab National Bank and Bharati Shipyard and therefore the

interest forms part of the cost of shares and therefore it cannot be

considered for disallowances u/s 14A of the Act. Ld DR on the other

hand supported the order of AO.

material on record. The issue in the present ground is with respect

to treatment of profits earned from sale of share of Bharati Ship

Yard and Punjab National Bank and disallowance u/s 14A of the

Act. It is an undisputed fact that assessee had sold the aforesaid

listed shares to its sister concern through “off market” transaction

and the profits were treated as capital gains by assessee. AO has

noted that the sale price of the shares to sister concern was lower

than the lowest prevailing price for the sale of shares on that

particular day for sale of shares of Bharati Shipyard Limited and in

case of sale of shares of Punjab National Bank, it was sold at the

price which was lower than the opening and closing price of the

shares on that day. AO held the income to be business income. We

find that Ld.CIT(A) while upholding the action of AO has granted

partial relief in the sense that he has held that the profit is to be

computed on the basis of sale price realized by assessee and not on

the basis of sale price of shares subsequently sold by the sister

concern. In arriving at this conclusion, we find that Ld.CIT(A) has

noted that though the assessee has mentioned that he has

maintained separate portfolios for the purpose of trading and

investment but there is no clear cut demarcation and that the same

demat account has been used for purpose of trading and

investments. The aforesaid findings of lower authorities have not

been controverted by assessee by placing any material on record

and therefore we find no reason to interfere with the order of

Ld.CIT(A). As far as the disallowance u/s 14A is concerned, it is

assessee’s contention that the interest was paid for borrowings

made for acquisition of the aforesaid shares. When the interest has

been paid for borrowings the shares and once they are included for

determining the cost of shares, we are of the view that no

disallowance u/s 14A of the same interest is called for more so

because the aforesaid interest is not claimed as expenses but is

capitalized to cost of investments and it forms part of cost of

investment. In such a situation, we are of the view that no

disallowance u/s 14A is called for and to this extent we set aside

the order of Ld.CIT(A). Thus, the ground of the assessee is partly

allowed.

income from business instead of capital gains.

10.1. AO, on the basis of details furnished by the assessee noticed

that assessee had earned gains on sale of shares/mutual funds.

According to AO, the frequency of transactions were high, assessee

had borrowed funds for making the investments. He accordingly

treated the transactions of purchase and sale of shares as an

organized activity of business activity and therefore treated the

income of Rs.22,36,567/- as business income as against the claim

of the assessee as capital gains. Aggrieved by the order of AO,

assessee carried the matter before Ld.CIT(A), who confirmed the

order of AO. Aggrieved by the order of LD.CIT(A), assessee is now

before us.

and LD.CIT(A) and further relied on the CBDT Circular No 6/2016

dated 29.02.2016. He also relied on the decision of Bombay High

Court in the case of Gopal Purohit reported in 336 ITR 287. Ld DR

on the other hand supported the order of lower authorities.

material on record. The issue in the present ground is the

treatment to profits earned on sale of shares i.e. whether it is to be

considered as business income as held by the AO or to be treated

as capital gains as held by assessee. We find that the CBDT in the

recent circular issued by it (supra) has held that treatment given by

the assessee to the shares as stock in trade or investments will not

be put to dispute by AO but however the stand once taken shall

remain applicable for subsequent years. In the light of the aforesaid

Circular, we hold that the treatment given to the profit earned by

the assessee as capital gains cannot be disturbed in the present

case. Thus, the ground of the assessee is allowed.

Order pronounced on 16th day of March, 2018.

Sd/- Sd/- (SUSHMA CHOWLA) (ANIL CHATURVEDI) �या�यक सद�य / JUDICIAL MEMBER लेखा सद�य / ACCOUNTANT MEMBER

पुणे Pune; �दनांक Dated : 16th March, 2018. Yamini

आदेश क� ��त�ल�प अ�े�षत/Copy of the Order forwarded to :

आदेशानुसार/ BY ORDER,स

// True Copy //

व�र�ठ �नजी स�चव / Sr. Private Secretary आयकर अपील�य अ�धकरण ,पुणे / ITAT, Pune.