Transactions Concerning Mutual Funds Not In The Nature Of Investment And Not Motivated By Trade: Delhi High Court

The Delhi High Court has held that transactions concerning mutual funds were in the nature of investment and not motivated by trade.

The bench of Justice Rajiv Shakdher and Justice Girish Kathpalia has observed that the intent has to be ascertained keeping in mind the magnitude and frequency of the transactions, the period for which shares are held, the purpose for which they are held, and how transactions are disclosed in the books of account. There is no presumption in law that the acquisition of shares by an assessee is necessarily for trade as opposed to investment.

In the first round, the respondent or assessee approached the Tribunal against the order dated March 12, 2011, passed by the Commissioner of Income Tax [CIT] under Section 263 of the Income-tax Act, 1961.

The CIT, exercising its powers under Section 263 of the Income Tax Act, had set aside the assessment order. Significantly, the assessment order was framed under Section 143(3) of the Act, albeit after scrutiny. The CIT, however, took the view that the assessment order was both erroneous and prejudicial to the interests of the revenue and, in this regard, flagged two issues.

Firstly, the gain made by the respondent or assessee on redemption of mutual funds should have been treated as business income, not short-term capital gain.

Secondly, the capital contribution received by the respondent or assessee should be taxed in its hands as a dividend under the provisions of Section 2(22)(e) of the Income Tax Act.

The conclusion arrived at by the CIT in his order passed under Section 263 of the Income Tax Act was taken in appeal to the Tribunal by the assessee. The Tribunal, while holding that the CIT had correctly allowed the appeal of the assessee on the ground that even where the CIT had rendered “specific findings on certain issues," he had directed the Assessing Officer (AO) to reframe the assessment order as per the correct provisions of law and after giving adequate opportunity of hearing in the matter.

According to the Tribunal, the CIT could not have returned findings on specific issues and, at the same time, issued a direction to reframe the assessment. Consequently, the Tribunal modified the order dated March 12, 2011 passed by the CIT and directed the AO to reframe the assessment order without being bound by the findings returned by the CIT.

It is this direction of the Tribunal that led to a fresh assessment order being framed on December 21, 2011. The AO, thus, added the gain made on redemption of mutual funds under the heading "profits and gains of business or profession," and likewise, the capital contribution made by the two companies, i.e., Kwality Processed Food Services and Equipments Private Limited (KPFSE) and Kwality Ice Creams India Private Limited (KICIPL), amounting to Rs. 21,08,38,530/-, was added, treating it as a deemed dividend under Section 2(22)(e). The AO also issued a direction for the levy of interest under Sections 234A, 234B, 234C, and 234D.The AO also initiated penalty proceedings under Sections 271(1)(c) and 271B.

The assessee brought the matter in appeal to the CIT (A). The CIT (A) dealt with the appeal concerning the AY in issue, i.e., 2006-07 and AY 2009-10. Thus, by a common order, the CIT (A) partly allowed both appeals.

As regards the gain made by the respondent or assessee upon redemption of mutual funds, the CIT (A) found the original partnership deed concerning the assessee was amended on August 31, 2005. Both partnership deeds referred to the expression "business." In the amended partnership deed, it was indicated that the respondent or assessee would “invest in stocks, shares, debentures, bonds, mutual funds, or any other securities and carry on the business of lending monies for interest or on other terms and conditions out of own funds or arranged funds." The assessee had invested in mutual funds from its own resources. It had not borrowed funds for making investments in mutual funds, which is usually the case when an investor indulges in trading operations. The motive of the assessee was not to maximize profits but to create wealth.

The CIT (A) concluded that the gains derived by the respondent or assessee on the transfer of mutual funds were chargeable under the heading "capital gains.".

The Tribunal held that the gain made on redemption of mutual funds should be treated as capital gain, not business income.

The appellant/department contended that the assessee intended to trade in mutual funds. This is demonstrable if one considers that the respondent or assessee had invested Rs. 86.19 crore in mutual funds in the period in issue, of which only Rs. 3 crore was invested through portfolio managers. During the period in issue, the respondent or assessee earned a profit and a dividend. Thus, the motive was to earn profit on transactions. The dividend earned by the respondent or assessee was incidental to the trade in mutual funds carried out by it.

The issue raised was whether the transactions carried out by the respondent or assessee concerning mutual funds were in the nature of “investment” or "stock-in-trade.”.

The court observed that the CIT(A) and the Tribunal, after appreciating the material on record, have concluded that the transactions concerning mutual funds were in the nature of investment and not motivated by trade. The CIT(A) and the Tribunal, among other things, looked at the transactions from the following prisms: quantum of trade, value, purpose, the period for which mutual funds were held, and how disclosure had been made in the books of accounts and financial statements.

“For the sake of brevity, we are not setting forth the findings returned on the said aspects by these statutory authorities once again. None of these findings have been assailed before us as being perverse,” the court said.

Counsel For Petitioner: Zoheb Hossain

Counsel For Respondent: S. Ganesh

Case Title: PCIT Versus M/S Wig Investment

Citation: 2024 LiveLaw (Del) 60

Case No.: ITA 169/2020

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