TMI Blog2010 (3) TMI 107X X X X Extracts X X X X X X X X Extracts X X X X ..... ness income” in the hands of the applicant under the provisions of the Act read with the Agreement for Avoidance of Double Taxation between India and Canada (Treaty). This income is not taxable under section 115AD - the purpose and purport of Section 115AD is to provide for special or concessional rate of taxation in relation to securities received or arising from the income of FIIs (Foreign Institutional Investor). No advance ruling is given on the issue of profits/losses from transactions relating to purchase and sale of equity shares or other tradable securities on the Indian stock exchanges - No doubt, the advance ruling can be sought in respect of a transaction “proposed to be undertaken”. But where the determination of the question depends on assessment of certain crucial facts, the actual pattern of dealings or the modus operandi of the transactions, it would not be appropriate to undertake the task of giving a definite ruling at this juncture, especially when we are called upon to reconsider the earlier ruling of this Authority on the same issue. It may also be relevant to consider whether the actual modalities of the transactions have the attributes of index arbitrage t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o undertake derivative transactions the applicant has appointed Citi Bank, Mumbai as settlement agent and domestic custodian and transactions are executed on-line through the brokers registered with Stock Exchanges in India. The applicant also proposes to undertake purchases and sales of equity shares and other securities in the near future on the stock exchanges in India. It is stated that such purchase and sale of shares/securities on the Stock Exchanges would be carried out as a part of 'index arbitrage trading strategy' and would be for the purposes of earning trading profits. It is claimed that the primary purpose of such activity would not be to purchase and hold shares/securities for the purpose of earning any dividend income, though some incidental dividend may arise. The index arbitrage trading is explained as involving simultaneous purchase (or sale) of equities and sale (or purchase) of index futures. Such activity seeks to capitalize on the difference (or spread) between equities and index future prices. It is stated that the books of accounts of the applicant are maintained in accordance with Canadian GAPP. Profits or loss arising to the applicant from dealing in futur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... applicant is stated to have undertaken more than 1000 derivative transactions during the financial year 2008-09. It is on the basis of these facts, the applicants claims that the profits earned/or loss suffered by it from derivative transactions should be characterized as business profits or loss. 7. On the question of proposed activity of sale and purchase of shares/securities as part of index arbitrage trading activity, the applicant states that it would also be for the purpose of earning trading profits. It is claimed that shares/securities will not be held on long term basis. The applicant also expects to have trade volume of several hundred transactions per year with share volume in hundreds of thousands of shares having approximate value between 5 to 20 billion rupees. It is claimed that the income earned by the applicant by buying and selling of equity shares/securities from Indian Stock Exchanges would be in the nature of business income. 8. The applicant submits that it has no fixed place of business in India through which its business is fully or partly carried on. It does not have any branch or office in India. The representative's office of the applicant in India do ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... months (vide answers given in the booklet of NSE of India). 11. The same question about the character of income relating to exchanged traded derivative contracts having a maximum of 3 months trading cycle has been considered by this Authority in the case of Morgan Stanley Co.[271 ITR 416]. The facts noted in the said ruling are almost the same as in the present case. The following question was formulated in that case: "Whether the income derived by the applicant, a company incorporated in and tax resident of the UK, from trading in exchange traded derivative instruments in India would be taxable in India having regard to the provisions of the Double Tax Avoidance Agreement between India and UK?" 12. It was ruled that the income was not liable to be taxed in India having regard to the provisions of the DTAA between India and UK which provide that business profits can be taxed only if there is a permanent establishment. The contention of Revenue that the income was in the nature of capital gains was rejected. Several decisions of the Supreme Court starting from Raja Bahadur Visveshwar Singh vs. CIT (1961) 41 ITR 685 were referred to and the following passage in that case has ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at the transactions generated business income was not accepted. Apart from reiterating the principles laid down in the earlier ruling, the AAR relied on the dicta of Supreme Court in CIT vs. Holck Larsen (160 ITR 67) wherein the question was posed whether the conduct of the assessee was that of a dealer in shares or of an investor in shares. The opinion of Lord Reid in J.P. Harrison's case (40 TC 281) was quoted with approval. "The real question as Lord Reid said was not whether the transaction of buying and selling the shares lacks the element of trading, but whether the later stages of the whole operation show that the first step - the purchase of the shares - was not taken as, or in the course of, a trading transaction." 17. Thereafter, this Authority proceeded to consider whether the first stage i.e. the purchase of shares was not regarded as or in the course of a trading transaction. Thus, following Holck Larsen's case, the Authority gave primacy to the initial intention at the time of purchase of shares. Then the SEBI Regulations and Guidelines for 'foreign institutional investors' (FIIs) and the Regulations under FEMA were referred to at length. In particular, Regulation ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... vations which support the contention of the applicant in the present case. That crucial passage is found at page 658 of ITR 288. "It may be apposite to point out here that regulation 5(6) of the FEM Regulations (Security), 2000, specifically provides that a FII having approval under the FERA and the FEMA may trade in all exchange traded derivative contracts approved by SEBI. Further regulation 3 of the FEM Regulations (Derivative) 2000, prohibits that no person in India shall enter into a foreign exchange derivative contract without the prior permission of the Reserve Bank and accordingly the exchange traded derivative is specifically permitted. In contrast there is no provision in the aforementioned Acts, Regulations or Guidelines of the Government of India, permitting trading in other securities. The obvious inference is that trading in other securities is not permitted; in other words trading in securities other than exchange traded derivatives is prohibited." These observations fully support the case of the applicant vis- -vis the first question. 19. Apart from applying the test emphasized in Holck Larsen (supra), this Authority proceeded to discuss whether the criteria laid ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ital gains. The ratio of sales and purchases are also not noted with reference to each applicant. The above discussion of the press note containing guidelines and various other provisions of different Acts and Regulations, at the least, raises a strong presumption that the transactions of purchases and sales of shares in Indian companies by the applicant are for realizing capital gains, which could have been rebutted by the applicant by producing all relevant records including accounts. It has to be borne in mind that the transactions of sales and purchases as stock-in-trade is a fact known to the applicant but it failed to produce necessary records including the accounts to satisfy the Authority that transaction is nothing but trading." 20. The learned counsel for the applicant has contended with considerable force that the factual position is quite different in the present case and the reasons which weighed with the Authority to reach the conclusion it did in the above passage do not apply here. The transactions of the applicant are of huge volume whereas there were only few transactions in Fidelity North Star case. Further, the revenues from Derivatives transactions have been ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ck exchange in India; and (b) units of schemes floated by domestic mutual funds including Unit Trust of India, whether listed on a recognized stock exchange or not, [units of scheme floated by a Collective Investment Scheme.] (c) dated Government Securities; (d) derivatives traded on a recognized stock exchange. (e) Commercial paper (f) Security receipts 23. On a contextual interpretation, the expression 'investment' has to be understood in a broad sense and in conjunction with the word 'traded on'. Investment in Derivatives does not necessarily exclude trading transactions. The expression 'commercial paper' following clause (d) (i.e. derivatives) indicates that even in respect of such items where the investment is not involved, is intended to be covered by Regulation 15. So also, the item in clause(f) i.e. 'security receipts' bear predominant characteristics of trade. We are therefore of the view that the Revenue's contention that there is a prohibition of trading in Derivatives under the FEMA or SEBI Regulations is unsustainable. The observations at page 658 of Fidelity Northstar to the effect that there is no prohibition as far as exchange traded derivatives are conc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he amount of income-tax calculated on the income by way of short-term capital gains referred to in section 111A shall be at the rate of fifteen per cent. (iii) the amount of income-tax calculated on the income by way of long term capital gains referred to in clause (b), if any, included in the total income, at the rate of ten per cent; and (iv) the amount of income-tax with which the foreign institutional investor would have been chargeable had its total income been reduced by the amount of income referred to in clause (a) and clause(d). 2. Where the gross total income of the foreign institutional investor- (a) consists only of income in respect of securities referred to in clause(a) of sub-section(1), no deduction shall be allowed to it under sections 28 to 44C or clause (i) or clause (iii) of section 57 or under Chapter VIA.; (c) includes any income referred to in clause (a) or clause (b) of sub-section(1), the gross total income shall be reduced by the amount of such income and the deduction under Chapter VIA shall be allowed as if the gross total income as so reduced, were the gross total income of the foreign institutional investor. 3. Nothing contained in the firs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ransfer of securities; it may be short term or long term capital gains. The income in clause (a) is received "in respect of securities"; however, it excludes income by way of dividends. It must be noted that the expression "in respect of" is of wide import, more or less synonymous with the expression 'in connection with' or 'in relation to'. There is no particular reason why the income on account of trading in securities is excluded from the purview of section 115AD. The fact that the transfer of securities giving rise to capital gains is dealt in clause (b) is not a valid reason that the transfer of securities in the course of trading in them is outside the ambit of section 115AD. The basic question to be addressed is about the characterization of income. It cannot be denied that the securities can be transferred as a part of trading activity. If so, the real question would be whether the resulted income should be more appropriately treated as trading profit or capital gains. As stated earlier, this raises the question of the correct classification or characterization of income. We find it difficult to subscribe to the view that clause (b) of sub-section (1) of section 115AD will ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... classification has to be done in accordance with the ordinary and well settled principles. A special provision in the Income-tax Act cannot be pressed into service to deny the benefit which is otherwise due to FII under the tax treaty provisions notwithstanding their conflict with the domestic law of income tax. Viewed from this perspective, we come back to the issue of characterization of income irrespective of section 115AD. The Revenue's argument is liable to be rejected for this additional reason also. 30. We are therefore of the view that the first question has to be answered in the affirmative. The third question in so far as it is related to question no. (1) is also answered in the affirmative. That means, the business income of the applicant arising from the 'derivative transactions' is not liable to be taxed in India by virtue of article 7(1) of the DTAA between India and Canada. 31. On the second question the ruling is sought on the proposed activity of purchase and sale of equity shares and other securities. It is the contention of the applicant that the income from these transactions should also be classified as 'business income' and not as 'capital gain. The natur ..... X X X X Extracts X X X X X X X X Extracts X X X X
|
