This may benefit high net-worth individuals who use the services of portfolio managers to sell and buy securities.
The fee ranges between 2 per cent and 10 per cent depending on the services being taken and the assets under management.
The ruling will help taxpayers save 20 per cent tax on short-term capital gains and 30 per cent on long-term gains.
For instance, if a taxpayer has made a capital gain of Rs. 100 crore (Rs. 1 billion) and his assets are to the tune of Rs. 500 crore (Rs. 5 billion), the portfolio management fee of 2 per cent will amount to Rs. 10 crore (Rs. 100 million).
The taxpayer will get a deduction and will have to pay tax on only Rs. 90 crore (Rs. 900 million).
Under Section 48 of the Income Tax Act, deduction is allowed for expenditure incurred in relation to an asset transfer as well as the cost of acquisition and improvement of the transferred asset.
"Tax authorities do not allow this deduction for portfolio management fee. It is not a transaction cost but the taxpayer still has to bear it. The issue is whether this ruling will be sustained or the tax department will challenge it," said Vishal Malhotra, tax partner, Ernst and
NC Hegde, partner, Deloitte, said: "This will mainly benefit HNIs, most of who use the services of portfolio managers to invest."
He, however, said taxpayers should be careful while claiming such deduction as each case could be based on separate facts.
In this case, the taxpayers, KRA Holding & Trading and ARA Trading & Investments, paid a fee to Enam Asset Management.
They argued that the taxable income should not include this fee.
In its ruling, Pune Income Tax Appellate Tribunal said the fee was directly connected to securities and their transfer and was a bona fide payment in the normal course of investment activity.
It acknowledged the general principles of deductibility such as direct nexus, allocation of expenditure and reliance on accounting principles.
However, the tax department called it a 'profit-sharing fee' saying it was paid when the agreement between the two parties was renewed. It was computed on the basis of the net asset value on the date of termination of the period of agreement, it said.
Earlier, in a similar case, Mumbai ITAT had refused to allow the deduction. Pune ITAT, however, said the decision of Mumbai ITAT was distinguishable on facts.
Since Pune ITAT ruling was given by a special bench, it might prevail over the earlier one, Malhotra said.