Many investors in the stock market, especially high net-worth individuals or investors who have no investing experience, use the services of portfolio managers to manage their share and / or debt portfolios. Such services of expert portfolio managers are used to maximise the returns on investments. The portfolio managers charge the investors an annual fee for their services. Such fee is normally charged as a percentage of the value of the portfolio and may also include a fee linked to the performance of the portfolio. For instance, if the likely returns at the end of the year exceed a particular threshold percentage, the portfolio manager may get a percentage of the excess return over the threshold rate of return by way of a fee. Often, particularly for high net-worth individuals, such fees may constitute a substantial amount. Such fees include STT, stamp duty and other charges and are apart from the brokerage on purchase and sale of shares.
Investors have sought to claim deduction of such portfolio management fees in the computation of capital gains. There have been several conflicting decisions of the Tribunal on the deductibility of portfolio management fees while computing the capital gains. While the Mumbai Bench has held in several cases that such portfolio management fees are not deductible, the Pune, Delhi and Kolkata Benches, and even some Mumbai Benches of the Tribunal, have held that such fees are an allowable deduction in the computation of capital gains.
DEVENDRA MOTILAL KOTHARI’S CASE
The issue first came up before the Mumbai Bench of the Tribunal in the case of Devendra Motilal Kothari vs. DCIT 132 ITD 173, a case relating to A.Y. 2004-05.
In this case, the assessee declared certain long-term capital gains (LTCG) and short-term capital gains (STCG) after setting off the long-term capital losses and short-term capital losses. In the course of assessment, the A.O. noticed that the assessee had added portfolio management fees of Rs. 85,63,233 to the purchase cost of the shares while computing the capital gains. According to the A.O., the fees paid by the assessee for portfolio management services were not a part of the purchase cost of the shares. He, therefore, asked the assessee to explain why these fees should not be disallowed while computing the capital gains. The assessee submitted that the fees and other charges formed part of the cost of purchase and / or expenditure incurred by him and therefore must be taken into account whilst determining the chargeable capital gain. The assessee claimed that such fees and other expenses incurred by him as an investor, including fees for managing the investments, constituted the cost of purchase and were allowable for the purpose of computing the STCG or LTCG.
The A.O. disallowed the claim of the assessee while computing the STCG and LTCG, holding that these did not form part of the cost of acquisition of the shares.
In the appeal before the Commissioner (Appeals), it was contended by the assessee that the portfolio management fees constituted the cost of purchase of shares and securities and therefore was allowable as deduction while computing the capital gains. It was also submitted that without payment of these fees, no investments could have been made by the assessee and the question of realisation of capital gains would not have arisen. Alternatively, it was also contended that the portfolio management fees paid could be allocated between the purchase and sale of shares for the purpose of computing capital gains.
The Commissioner (Appeals) requested the assessee to submit a working, allocating the portfolio management fees paid in connection with the purchase and sale of shares, and also in relation to the opening and closing stock of shares during the year under consideration. The assessee submitted that the management fees paid was an allowable expenditure for the purpose of computing capital gains. Alternatively, it was also submitted that these fees could be allocated on the basis of the values of opening stock, long-term purchases, short-term purchases, long-term capital sale, short-term capital sale and closing stock, and based on such allocation, deduction may be allowed while computing LTCG and STCG.
The Commissioner (Appeals) found, on the basis of two portfolio management agreements filed with him, that the quantification of the fees was based on either the market value of the assets or the net value of the assets of the assessee as held by him either at the beginning or at the end of each quarter. He held that the assessee could not explain as to how the fees paid to the portfolio managers on such explicit basis could be considered differently so as to constitute either the cost of acquisition of the assets or expenditure incurred for selling such assets. He noted in this context that nothing was furnished by the assessee to establish any such nexus.
He held that the quarterly payment of fees by the assessee to the portfolio manager had no nexus either with the acquisition of the assets or the transfer of specific assets. He also held that it was just not possible to break up the fees paid by the assessee to the portfolio manager so as to hold that the same was relatable to the expenditure incurred solely for the purchase or transfer of assets. The assessee was paying these fees to the portfolio managers even on the interest accrued to him and the dividend received and it was therefore not acceptable that these fees were exclusively paid for acquiring or selling of shares as claimed by the assessee. The disallowance made by the A.O. of the assessee’s claim for deduction of portfolio management fees while computing the capital gains was therefore confirmed by the Commissioner (Appeals).
Before the Tribunal, it was submitted on behalf of the assessee that he had entered into an Investment Management Agreement with four concerns for managing his investments and fees was paid to them for these services. These fees were paid for the advice given by the Investment Management Consultants for purchase and sale of particular shares and securities as well as for the advice given by them not to sell particular shares and securities. Thus, it was contended that the expenditure incurred on the payment of these fees was in connection with the acquisition / improvement of assets as well as in connection with the sale of assets. Therefore, the fees were deductible in computing the capital gains arising to the assessee from the sale of assets, i.e., shares and securities, as per the provisions of section 48.
Without prejudice to the contention that the portfolio management fees was deductible u/s 48 in computing capital gains and as an alternative, it was contended on behalf of the assessee that this expenditure was deductible even on the basis of Real Income Theory and the Rule of Diversion of Income by Overriding Title. It was contended that these fees were in the nature of a charge against the consideration received by the assessee on the sale of shares and securities, and therefore were deductible from the sale consideration, being Diversion of Income by Overriding Title.
It was argued on behalf of the Revenue that the relevant provisions in respect of computation of income from capital gains were very specific and the Real Income Theory could not be applied while computing the income from capital gains. It was submitted that portfolio management services were generally not required in the case of investment in shares and that was the reason why there was no provision for allowing deduction for portfolio management fees in the computation of capital gains. It was contended that the income can be taxed in generic terms applying the Real Income Theory, but this theory was not relevant for allowance of any deduction.
The Revenue further argued that the basis on which the portfolio management fees was paid by the assessee was such that there was no relationship with the purchase or sale of shares. Even without making any purchase or sale of shares and securities, the assessee was liable to pay a substantial sum as portfolio management fees.
The Tribunal noted that u/s 48 expenditure incurred wholly and exclusively in connection with transfer and the cost of acquisition of the asset and cost of any improvement thereto, were deductible from the full value of the consideration received or accruing to the assessee as a result of transfer of the capital assets. While the assessee had claimed a deduction in computing the capital gains, he had, however, failed to explain as to how the fees could be considered as cost of acquisition of the shares and securities or the cost of any improvement thereto. According to the Tribunal, the assessee had also failed to explain as to how the fees could be treated as expenditure incurred wholly and exclusively in connection with the sale of shares and securities.
On the other hand, the basis on which the fees were paid by the assessee showed that the fees had no direct nexus with the purchase and sale of shares, and the fees was payable by the assessee, going by the basis thereof, even without there being any purchase or sale of shares in a particular period. Also, when the Commissioner (Appeals) required the assessee to allocate the fees in relation to purchase and sale of shares as well as in relation to the shares held as investment on the last date of the previous year, the assessee could not furnish such details nor could he give any definite basis on which such allocation was possible.
The Tribunal concluded, therefore, that the fees paid by the assessee for portfolio management was not inextricably linked with the particular instance of purchase and sale of shares and securities so as to treat the same as expenditure incurred wholly and exclusively in connection with such sale, or the cost of acquisition / improvement of the shares and securities, so as to be eligible for deduction in computing capital gains u/s 48.
Even though the assessee was under an obligation to pay the fees for portfolio management, the mere existence of such an obligation to pay was not enough for the application of the Rule of Diversion of Income by an Overriding Title. The true test for applicability of the said rule was whether such obligation was in the nature of a charge on source, i.e., the profit-earning apparatus itself, and only in such cases where the source of earning income was charged by an overriding title it could be considered as Diversion of Income by an Overriding Title. The Tribunal noted that the profit arising from the sale of shares was received by the assessee directly, which constituted its income at the point when it reached or accrued to the assessee. The fee for portfolio management, on the other hand, was paid separately by the assessee to discharge his contractual liability. In the Tribunal’s view, it was thus a case of an obligation to apply income which had accrued or arisen to the assessee and it amounted to a mere application of income.
The Tribunal further held, following the Supreme Court decision in the case of CIT vs. Udayan Chinubhai 222 ITR 456, that the Theory of Real Income could not be applied to allow deduction to the assessee which was otherwise not permissible under the Income-tax Act. What was not permissible in law as deduction under any of the heads could not be allowed as a deduction on the principle of the Real Income Theory.
The Tribunal therefore dismissed the assessee’s appeal, holding that the portfolio management fees was not deductible in computing the capital gains.
This view of the Tribunal was followed in subsequent decisions of the Mumbai Bench of the Tribunal in the cases of Pradeep Kumar Harlalka vs. ACIT 143 TTJ 446 (Mum), Homi K. Bhabha vs. ITO 48 SOT 102 (Mum), Capt. Avinash Chander Batra vs. DCIT 158 ITD 604 (Mum), ACIT vs. Apurva Mahesh Shah 172 ITD 127 (Mum) and Mateen Pyarali Dholkia vs. DCIT (2018) 171 ITD 294 (Mum).
KRA HOLDING & TRADING (P) LTD.’S CASE
The issue again came up before the Pune Bench of the Tribunal in the case of KRA Holding & Trading (P) Ltd. vs. DCIT 46 SOT 19, in cases pertaining to A.Ys. 2002-03 and 2004-05 to 2006-07.
For A.Y. 2004-05, the assessee paid fees of Rs. 69,22,396 to a portfolio manager, consisting of termination fee of Rs. 59,15,574 and annual maintenance fee of Rs. 10,06,823. The capital gains on the sale of shares were disclosed net of such fees.
The A.O. disallowed such fees on the ground that the payment constituted ‘profit sharing fee’ paid to the portfolio manager and that the same was not authorised by or borne out of any agreement between the assessee and the portfolio manager or the SEBI (Portfolio Managers) Rules & Regulations, 1993.
Before the Commissioner (Appeals), the assessee submitted that the expenditure was incurred in connection with the acquisition of shares. Therefore, the expenditure was required to be capitalised as done by the assessee in the books of accounts. As per the assessee, this expenditure was part of the cost of acquisition of shares as there was a direct and proximate nexus between the fees paid to the portfolio manager and the process of acquisition of the securities and the sale of securities.
Without prejudice, the assessee argued that part of the fee was attributable to the act of selling of securities and, therefore, part of the fees could be said to be expenditure incurred wholly and exclusively in connection with the transfer. Further, it was argued that the fee was paid wholly and exclusively for acquiring and selling securities during the year under review. Therefore, the fees so paid should be loaded on the shares / securities purchased and sold during the year in the value proportion. In respect of the shares purchased during the year, the fees loaded would be the cost of acquisition and in respect of shares sold during the year the fees loaded would represent expenditure incurred wholly and exclusively in connection with the transfer.
The Commissioner (Appeals) dismissed the assessee’s appeal.
It was argued on behalf of the assessee before the Tribunal, that section 48 allowed deduction of any expenditure incurred wholly and exclusively in connection with transfer and this expenditure being an outflow to the assessee, should be loaded to the cost of the investments. It was claimed that what was taxable in the hands of the assessee was the actual income that reached the assessee and, therefore, the fees paid to the portfolio manager had to be deducted from the capital gains earned by the assessee.
Reliance was placed on behalf of the assessee on the jurisdictional High Court decision in the case of CIT vs. Smt. Shakuntala Kantilal 190 ITR 56 (Bom) for the proposition that when the genuineness and certainty and necessity of the payments was beyond doubt, and if it was only a case of absence of the enabling provisions in section 48, ‘such type of payments were deductible in two ways, one, by taking full value of consideration, i.e., net of such payments, or deducting the same as expenditure incurred wholly and exclusively in connection with the transfer.’ As per the High Court, the Legislature, while using the expression ‘full value of consideration’, has contemplated both additions as well as deductions from the apparent value. What it means is the real and effective consideration. The effective consideration is that after allowing the deductible expenditure. The expression ‘in connection with such transfer’ was certainly wider than the expression ‘for the transfer’. As per the High Court, any amount, the payment of which is absolutely necessary to effect the transfer, will be an expenditure covered by this clause.
On behalf of the Revenue it was contended that (i) the expenditure in question was directly unconnected with the securities in question and the same cannot be loaded to the cost of the acquisition; (ii) securities is a plural word, whereas the capital gains is calculated considering each capital asset on standalone basis, and for this there is need for identification of the asset-specific expenditure, be it for arriving at the cost of acquisition or for transfer-specific expenditure. Reliance was placed on the Mumbai Tribunal decision in Devendra Motilal Kothari (Supra).
In counter arguments, it was stated on behalf of the assessee that the Tribunal decision was distinguishable on facts. In that case, the assessee claimed the deduction which was calculated based on the global turnover reported by the portfolio manager, and where such turnover also included the dividend income, the basis was unscientific and unspecific, etc. Further, it was pointed out that the assessee in that case failed to discharge the onus of establishing the nexus that the fee paid to the portfolio manager was incurred wholly and exclusively in connection with the transfer of the assets; whereas, in the case being considered by the Pune Tribunal, the assessee not only demonstrated the direct nexus of the expenditure to the acquisition and sale / transfer of the securities successfully but also the fee in question was strictly on the NAV of the securities and not on the dividends or other miscellaneous income. It was claimed that the basis was totally and exclusively capital-value-oriented, consistently followed by the assessee and it constituted an acceptable basis. It was argued that when the expenditure of fee paid to the portfolio manager was genuine and an allowable claim, the claim must be allowed under the provisions of section 48.
The Tribunal observed that the scope of section 48 as per the binding judgment of the High Court in Shakuntala Kantilal (Supra) was that the claim of bona fide or genuine expenditure should be allowable in favour of the assessee so long as the incurring of the expenditure was a matter of fact and the necessity of making such a payment was the imminent requirement for the transfer of the asset. According to the Tribunal, it was now binding on its part to take the view that the expression ‘in connection with’ had wider meaning than the expression ‘for the transfer’.
The Tribunal observed that for allowing the claim of deduction in the computation of the capital gains, the expenditure had to be distinctly and intricately linked to the asset and its transfer. The onus was on the assessee to demonstrate the said linkage between the expenditure and the asset’s transfer. It was evident and binding that if the expenditure was undisputedly, necessarily and genuinely spent for the asset’s transfer within the scope of the provisions of section 48, the claim could not be disallowed for want of an express provision in section 48.
The Tribunal noted the following facts:
(i) the assessee made the payment of fee to the portfolio manager and the genuineness of the said payment was undisputed;
(ii) the Revenue authorities had also not disputed the requirement or necessity of the said payments;
(iii) quantitatively speaking, in view of the adverbial expression ‘wholly’ used in section 48(i), the payment of fee @ 5% was only restricted to the NAV of the securities and not the global turnover, including the other income;
(iv) regarding the purpose of payment in view of the adverbial expression, ‘exclusively’ used in section 48(i), the same was intended only for the twin purposes of the acquisition of the securities and for the sale of the same;
(v) the NAV was defined as the ‘net asset value of the securities of the client’ and the assessee calculated the fee linked to the securities’ value only and not including other income, such as interest or dividend, etc.
The Tribunal was of the opinion that:
(i) the expenditure was directly connected to the asset and its transfer;
(ii) it was genuinely incurred as accepted by the Revenue;
(iii) it was a bona fide payment made as per the norms of the ‘arm’s length principle’ since the portfolio manager and the assessee were unrelated;
(iv) the necessity of incurring of expenditure was imminent and it was in the normal course of the investment activity;
(v) the provisions of section 48 had to be read down in view of the ratio in the case of Shakuntala Kantilal (Supra) to accommodate the claim of such expenditure legally.
According to the Tribunal, the expression ‘in connection with such transfer’ enjoyed much wider meaning and, therefore, the fee paid to the portfolio manager had to be construed to have been expended for the purposes of acquisition and transfer of the investment of the securities. The Tribunal was of the view that the expression ‘transfer’ involved various sub-components and the first sub-component must be of purchase and possession of the securities. Unless the assessee was in possession of the asset, he could not transfer the same. Therefore, the expression ‘expenditure’ incurred wholly and exclusively in connection with ‘such transfer’ read with ‘as a result of the transfer of the capital asset’ mentioned in section 48 and 48(i) must necessarily encompass the transfer involved at the stage of acquisition of the securities till the stage of transfer involved in the step of sale of the impugned securities. Such an interpretation of section 48 of the Act was a necessity to avoid the likely absurdity.
The Tribunal therefore held that the expenditure was allowable u/s 48.
The view taken by the Pune Bench of the Tribunal in this case has been followed by the Pune and other Benches of the Tribunal in the cases of DCIT vs. KRA Holding & Trading (P) Ltd. 54 SOT 493 (Pune), Serum International Ltd. vs. Addl. CIT [IT Appeal No. 1576/PN/2012 and 1617/PN/2012, dated 18th February, 2015], RDA Holding & Trading (P) Ltd. vs. Addl. CIT [IT Appeal No. 2166/PN/2013 dated 29th October, 2014], Hero Motocorp Ltd. vs. DCIT [ITA No. 6282/Del/2015 dated 13th January, 2021], Amrit Diamond Trade Centre Pvt. Ltd. vs. ACIT [ITA No. 2642/Mum/2013 dated 15th January, 2016], Shyam Sunder Duggal HUF vs. ACIT [ITA No. 2998/Mum/2011 dated 22nd February, 2019] and Joy Beauty Care (P) Ltd. vs. DCIT [ITA No. 856/Kol/2017 dated 5th September, 2018].
OBSERVATIONS
A portfolio manager’s services, his fees and many related aspects are governed by the SEBI (Portfolio Managers) Regulations, 2000. Services include taking investment decisions on behalf of the client that can largely be classified into three parts:
a. identifying the scrip and the time and value of purchase,
b. decision as to retention of an investment, and
c. identifying the scrip and the time and price for exit.
The services do not include brokerage. Fees, though composite, are payable for performing the above-listed functions. The Regulations require the portfolio manager to share the manner of charging the fees and, importantly, for each service rendered to the client in the agreement. These fees are annually charged on the basis of the value of the portfolio or any other agreeable basis. In addition, though not always, fees are charged by sharing a part of the profit that accrues to the client.
In the context of section 48 of the Income-tax Act, the part of the fees attributable to the advisory services leading to the purchase should qualify to be included in the cost of acquisition and the other part of the fees attributable to the advisory services leading to the sale of the scrip should qualify to be included in the expenses incurred for the transfer. Unless otherwise stated in section 48, deduction of these parts of the fees should not be resisted. At the most, there could be a need to scientifically identify the parts of the fees attributable to these activities and allocate the parts rationally. Paying a lump sum or a composite fee should not be a ground for its blanket disallowance, nor should the manner of such payment take away the fact that the major part of the fees is paid for advising or deciding on various components of the purchase and sale of the scrip. No one pays the fees to a portfolio manager only for advice to retain the investment, though that part is relevant, but it is not a deciding factor for seeking the services of the portfolio manager. Besides, the advice to continue to retain a scrip is intended to fetch a better price realisation for the scrip and such advice should therefore also be construed as advice in relation to the sale of the investment.
Even otherwise, this should not discourage the claim for its allowance once it is accepted that the fees are paid mainly for advice on purchase and sales of investment; in the absence of a provision similar to section 14A, no part of an indivisible expenditure can be disallowed.
The issue in case of composite charges should not be whether it is allowable or not, at the most it could be how much out of the total is allowable. Even the answer here should be that no part of it could be disallowable where no provision for its segregation exists in the Act. [Maharashtra Sugars Ltd. 82 ITR 452(SC) and Rajasthan State Warehousing Corporation Ltd. 242 ITR 450(SC).]
As regards the fees representing the sharing of profit, we are of the considered opinion that such part is diverted at source under a contract which is not an agreement for partnership and surely is for payment for services offered.
The lead dissenting decision in the case of Devendra Motilal Kothari (Supra) was delivered against the claim for allowance, largely on account of the inability of the assessee to provide the basis for allocation of expenses on rational basis. This part is made clear by the Tribunal in its decision, making it clear that the expenditure could have been allowed in cases where the allocation was made available.
The other reason for dissenting with the decision of the Pune Bench in the KRA Investment case (Supra) was that the Bench had followed the Bombay High Court decision in Shakuntala Kantilal (Supra ) which, as noted in Pradeep Harlalka’s case (Supra), was overruled by the same Court in its later decision in Roshanbanu’s case (Supra). With great respect, without appreciating the facts in both the cases and, importantly, the part that had been overruled, it was incorrect on the part of the Mumbai Bench to proceed to disallow a legitimate claim simply because the decision referred to or even relied on was overruled. The reasons and rationale provided by the Court and borrowed by the Pune Bench for allowance of the expenditure could not have been ignored simply by stating that the decision relied upon by the Bench was overruled.
The Pune Bench of the Tribunal in KRA Holding & Trading’s case (Supra), placed substantial reliance on the Bombay High Court decision in the case of Shakuntala Kantilal (Supra) while deciding the matter. In Pradeep Kumar Harlalka’s case (Supra), the Tribunal noted that in the case of CIT vs. Roshanbanu Mohammed Hussein Merchant 275 ITR 231 (Bom), the Bombay High Court had observed that the decision in the case of Shakuntala Kantilal (Supra) was no longer good law in the light of subsequent Supreme Court decisions in the cases of R.M. Arunachalam vs. CIT 227 ITR 222, VSMT Jagdishchandran vs. CIT 227 ITR 240 and CIT vs. Attili N. Rao 252 ITR 880. All these decisions were rendered in the context of deductibility of mortgage debt and estate duty u/s 48 as expenditure incurred for transfer of the property.
Had the Bench looked into the facts of both the court cases and the conclusions arrived at therein, it could have appreciated that it was only a part of the decision, unrelated to the allowance of the expenditure of the PMS kind that was overruled.
It’s important to note that the following relevant part of the Shakuntala Kantilal decision continues to be valid:
‘The Legislature while using the expression “full value of consideration”, in our view, has contemplated both additions to as well as deductions from the apparent value. What it means is the real and effective consideration. That apart, so far as (i) of section 48 is concerned, we find that the expression used by the Legislature in its wisdom is wider than the expression “for the transfer”. The expression used is “the expenditure incurred wholly and exclusively in connection with such transfer”. The expression “in connection with such transfer” is, in our view, certainly wider than the expression “for the transfer”. Here again, we are of the view that any amount the payment of which is absolutely necessary to effect the transfer will be an expenditure covered by this clause. In other words, if without removing any encumbrance including the encumbrance of the type involved in this case, sale or transfer could not be effected, the amount paid for removing that encumbrance will fall under clause (i). Accordingly, we agree with the Tribunal that the sale consideration requires to be reduced by the amount of compensation.’
These parts of the decision are not overruled by the decision of the Supreme Court. With due respect to the Bench of the Tribunal that held that the expenditure on fees was not allowable simply because the decision of one court was found, in the context of the facts, to be not laying down the good law, requires reconsideration. The fact that the many parts of the decision continued to be relevant could not have been ignored. It is these parts that should have been examined by the Tribunal to decide the case for allowance or, in the alternative, it should have independently adjudicated the issue without being influenced by the observation of the Apex Court made in the context of the facts in the case before it.
In Shakuntala Kantilal, the Bombay High Court examined the meaning of the terms ‘full value of consideration’ (to mean the real and effective consideration, including both additions to and deductions from the apparent value), and ‘expenditure incurred wholly and exclusively in connection with such transfer’ (to mean any amount the payment of which is absolutely necessary to effect the transfer), in deciding the matter regarding deductibility of compensation paid to previous intending buyer of the property.
In R.M. Arunachalam’s case (Supra), the Supreme Court examined the deductibility of estate duty paid as cost of improvement of the inherited asset. In this decision, the Supreme Court did not examine any issue relating to full value of consideration, cost of acquisition or expenses in connection with transfer at all. The Court specifically refused to answer the question regarding diversion of income by overriding title, which involved the question whether apart from the deductions permissible under the express provision contained in section 48, deduction on account of diversion was permissible, since the issue had not been raised before the Tribunal or the High Court.
In V.S.M.R. Jagdishchandran’s case (Supra), the Supreme Court considered whether the discharge of a mortgage debt created by the owner himself amounted to cost of acquisition of the property deductible u/s 48. The Court in this case did not examine the issue regarding full value of consideration or expenditure in connection with transfer. In Attili N. Rao’s case (Supra), the assessee’s property had been mortgaged with the Excise Department for payment of kist dues, the property was auctioned by the Government and the proceeds, net of the kist dues, was paid to the assessee. In this case, two of the questions before the Supreme Court were whether the charge was to be deducted in computing the full value of consideration, or could it be regarded as an expenditure incurred towards the cost of acquisition of the capital asset. The Supreme Court did not answer these questions while holding that the gross realisation was to be considered for computation of capital gains.
The Supreme Court, therefore, does not seem to have specifically overruled the Bombay High Court decision in the case of Shakuntala Kantilal (Supra), specifically those aspects dealing with the expenses in connection with the transfer.
On the other hand, in a subsequent decision in Kaushalya Devi vs. CIT 404 ITR 536, the Delhi High Court had an occasion to examine a situation identical to that prevailing in the Shakuntala Kantilal case. While holding that the payment of liquidated damages to the previous intending purchaser was an expenditure incurred wholly and exclusively in connection with the transfer, the Delhi High Court observed that,
…the words ‘wholly and exclusively’ used in section 48 are also to be found in section 37 of the Act and relate to the nature and character of the expenditure, which in the case of section 48 must have connection, i.e., proximate and perceptible nexus and link with the transfer resulting in income by way of capital gain. The word ‘wholly’ refers to the quantum of expenditure and the word ‘exclusively’ refers to the motive, objective and purpose of the expenditure. These two words give jurisdiction to the taxing authority to decide whether the expenditure was incurred in connection with the transfer. The expression ‘wholly and exclusively’, however, does not mean and indicate that there must exist a necessity or compulsion to incur an expense before an expenditure is to be allowed. The word ‘connection’ in section 48(i) reflects that there should be a causal connect and the expenditure incurred to be allowed as a deduction must be united, or in the state of being united with the transfer, resulting in income by way of capital gains on which tax has to be paid. The expenditure, therefore, should have direct concern and should not be remote or have an indirect result or connect with the transfer. A practical and pragmatic view in the circumstances should be taken to tax the real income, i.e., the gain.
The Delhi High Court further observed that: ‘the words “wholly and exclusively” require and mandate that the expenditure should be genuine and the expression “in connection with the transfer” require and mandate that the expenditure should be connected and for the purpose of transfer. Expenditure, which is not genuine or sham, is not to be allowed as a deduction. This, however, does not mean that the authorities, Tribunal or the Court can go into the question of subjective commercial expediency or apply subjective standard of reasonableness to disallow the expenditure on the ground that it should not have been incurred or was unreasonably large. In the absence of any statutory provision on these aspects, discretion exercised by the assessee who has incurred the said expenditure must be respected, for interference on subjective basis will lead to unpalatable and absurd results. As in the case of section 37 of the Act, jurisdiction of the authorities, Tribunal or Court is confined to investigate and decide as to whether the expenditure was actually incurred, i.e., the expenditure was genuine and was factually expended and paid to the third party’.
If one applies this ratio to the deductibility of portfolio management charges in computing capital gains, the portfolio manager is paid for the services of advising on what shares to buy and when to buy and sell the shares, and of carrying out the transactions. To the extent that the services are rendered in connection with the purchase of the shares, the fees constitute part of the cost of acquisition of the shares, and to the extent that the fees relate to the sale of shares, the fees are expenses incurred wholly and exclusively for the transfer of the shares. In either situation, the fees should clearly be deductible in computing the capital gains, as held by the Pune Bench of the Tribunal.
If one analyses the facts of the cases as well, it can be clearly observed that the decision in Devendra Motilal Kothari’s case was to a great extent influenced by the fact that the assessee was unable to apportion the fee between the purchases, sales and the closing stock on a rational basis, whereas in KRA Holding & Trading’s case, the assessee was able to demonstrate such bifurcation on a reasonable basis. Therefore, if a rational allocation of the fees is carried out, there is no reason as to why such fees should not be allowed as a deduction, either as cost of acquisition or as expenses in connection with the transfer.
It may also be noted that as observed by the Tribunal in Joy Beauty Centre’s case (Supra), the Department had filed an appeal in the Bombay High Court against the Pune Tribunal’s decision in the case of KRA Holding & Trading (Supra). The appeal has been admitted by the Bombay High Court only on the question of whether the income was in the nature of business income or capital gains. Therefore, the Pune Tribunal’s decision in respect of allowability of portfolio management fees has attained finality.
There is no dispute that the objective behind the hiring of the portfolio manager’s services is to seek advice on purchase and sale of scrips, which expenses, without much suspicion, are allowable in computing the capital gains.
It would be inequitable to disallow a genuine expenditure incurred for earning a taxable income on the pretext that no express and specific provision for its allowance exists in the Act. In our opinion, the existing provisions of section 48 are wide enough to support the deduction of the fees.
Any attempt to isolate a part of the expenditure for disallowance should be avoided on the grounds of the composite expenditure and the expense in any case representing either the cost of acquisition or an expense in connection with the transfer.
As clarified by the Tribunal in the KRA Holding’s case, where the assessee demonstrated the direct nexus of the expenditure to the acquisition and sale / transfer of the securities successfully, and also the fee in question was strictly on the NAV of the securities and not on the dividends or other miscellaneous income, such fee should be allowable in computing the capital gains.
The better view of the matter, therefore, seems to be that portfolio management fees are deductible in computing the capital gains, as held by the Pune, Delhi, Kolkata and some Mumbai Benches of the Tribunal.
