TMI Blog2016 (1) TMI 793X X X X Extracts X X X X X X X X Extracts X X X X ..... the US Court is to compensate business receipt of Aberdeen investors. The fact remains that the Aberdeen investors entered into a settlement agreement with Satyam considering the time, effort and costs involved in litigation and the agreement provided for a full, final and complete resolution of all claims asserted or which could have been asserted with respect to the released claims. The Aberdeen investors fully, finally and forever waived, released, discharged and dismissed each and every of their legal claims against Satyam and PwC. This was also agreed vice versa. It is clear, therefore, that the settlement amounts have been received not as part of business profit or to compensate the future income but as a result of surrender of the claim against Satyam and PwC. Surely, even in accordance with the principle of surrogatum such amount is not assessable as income because it does not replace any business income.In the light of above it is concluded that the settlement amount received by Aberdeen investors is not taxable under the provisions of the Income-tax Act and question No.1 of all three applications is answered accordingly - A.A.R. No 1364, 1370 & 1433 of 2012 - - - Dated: ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fic excluding Japan Fund a series of Aberdeen Delawre business Trust , United States; (v) Halliburton Company Employee Benefit Master Trust; United States and (vi) Thrivent Partners Worldwide Allocation Fund, a series of Thrivent Mutual Funds, United States and (vii) Aberdeen Asia Pacific including Japan Fund, a series of Aberdeen Delaware Business Trust, United States were all holders of ordinary equity shares ( Equity Holders ) of Satyam. (iii) On January 7, 2009, Ramalinga Raju, the then Chief Executive Officer of Satyam confessed that Satyam s financial results had been manipulated and inflated over a period of years. PricewaterhouseCoopers ( PwC ) played a key role in preparing and auditing Satyam s financial statements as well as Securities Exchange Commission (SEC) filings. PwC possessed the documents that showed Satyam s true financial condition, and its active participation in the fraud was thus essential and apparent. (iv) As a result of the public disclosure of the contents of the letter, the value of ordinary equity shares and ADS of Satyam dropped precipitously, forcing the ADS and Equity Holders (collectively, Aberdeen Investors ) to dispose of their entire sha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... proval Order, the Court preliminary found the settlement to be fair, reasonable and adequate. On August 15, 2011, Aberdeen US timely filed a request for exclusion from the Settlement Class. Satyam challenged the validity of, and objected to, Aberdeen s request for exclusion. On September 13, 2011 this New York Court entered final orders and judgments with respect to the settlement , certifying the Settlement Class and approving the Settlement ( Class Action Settlement ). The New York Court in the aforesaid orders and judgments, reserved decision as to the validity of Applicant s request for exclusion, and instructed Aberdeen US and Satyam to engage in discovery and briefing in connection with Satyam s objection to the validity of Aberdeen US s request for exclusion. (ix) While the aforementioned proceedings were ongoing in the New York Court, conscious of the time, efforts and cost involved in the litigation, Aberdeen US and PwC and Aberdeen US and Satyam entered into two separate Settlement Agreements dated July 18, 2012 and July 27, 2012 respectively. (x) Under the terms of the Aberdeen US-Satyam Settlement Agreement: (a) Satyam entered into the Settlement to, with ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing, prosecuting or maintaining the Legal Claims. This was also agreed vice-versa. Both PwC and the Aberdeen investors extinguished their mutual legal claims. 3. Aberdeen UK is a listed UK company which manages and/or advice certain investment funds (Aberdeen investors) that had invested in Satyam Shares. After the confession of manipulation of accounts of Satyam by the then CEO Sri Raju, legal action was initiated by the Aberdeen investors against Satyam and finally Aberdeen investors entered into a Settlement Agreement with Satyam. Under the terms of the Settlement Agreement: (a) An amount of US$ 68,000,000 (approximately INR 420 crores) ( Settlement Amount ) is to be paid by Satyam to the Applicant for further distribution to the Aberdeen Investors to settle and resolve the Aberdeen Investors claims against Satyam. (b) The Settlement Amount was deposited in an escrow account ( Escrow Account ) which shall remain the property of Satyam until disbursed from the Escrow Account. The Escrow Account is governed in terms of an escrow agreement entered into between the Applicant, Satyam and the escrow agent, Citibank N.A. (London Branch) dated February 7, 2013 ( Escrow Agreeme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m executed and entered into an Agreement of Settlement ( Class Action Settlement Agreement ) with the lead plaintiffs of the Class Action including the applicant. February 18, 2011 The Applicant filed the Second Amended Complaint in the New York Court detailing the claims of the Applicant/Aberdeen Investors against Satyam. March 21, 2011 The New York Court entered an order preliminarily certifying a class for settlement purposes ( Settlement Class ) in connection with the Class Action. The New York Court also set forth procedures and deadlines for class members to request exclusion from the Class Action Settlement Agreement. August 15, 2011 The Applicant filed a request for opt out/exclusion from the Settlement Class before the New York Court. September 13, 2011 The New York Court passed final orders and judgments certifying the Settlement Class and approved the Class Action Settlement. July 27, 2012 The Applicant entered into a settlement agreement with inter alia Satyam Computer Services Limit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... PwC on July 18, 2012 is not taxable under the provisions of the Income tax Act, 961? Q.2 If answer to question number 1 is in the affirmative, what would be the basis and method of determination of taxable income, applicable tax rate, and applicable rate of deduction of tax at source thereon? Questions for Ruling in Application No.1433 Q.1 Whether, on the facts and circumstances of the case, the settlement amount to be received by Aberdeen Asset Management PLC ( Aberdeen or Applicant ) on behalf of the Claimants form Satyam Computer Services Ltd. ( Satyam ) in accordance with the terms of the settlement agreement entered into between the Applicant and Satyam on December 12, 2012 ( Settlement Agreement ) is taxable under the provisions of the Income Tax Act, 1961 (ITA or Act ) Q.2 If answer to Question number 1 is in the affirmative, what would be the basis and method of determination of taxable income, applicable tax rate, applicable rate of deduction of tax at source thereon and at what stage (i.e. on remittance to Escrow Account or on remittance from Escrow Account to the Applicant) is such tax required to be deducted? Applicants Submissions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ceived on account of destruction of capital assets (i.e. the right to sue Satyam/PwC) and do not fall for consideration under Section 45 of the ITA. b. Even if the Impugned Settlement Amounts fall for consideration under Section 45 of the ITA no Capital Gains arise owing to failure of computation mechanism under Section 48 of the ITA and Section 48 of the ITA and Section 55 (3) of the ITA. c. Without prejudice to (a) and (b), the Impugned Settlement Amounts are received by Aberdeen US as compensation for the injury inflicted on capital asset of the trading (Equity and ADS shares held by Aberdeen Investors) and do not fall for consideration under Section 45 of the ITA. (d) A right to sue is property and thus Capital Asset as defined under Section 2 (14) of the ITA and inherently a right to sue is not transferable as a matter of public policy. Thus, there cannot be any transfer of a right to sue under Indian law and any capital receipt arising from a right to sue cannot thus be considered capital gains under Section 45 of the ITA. The Gujarat High Court has accepted this in Baroda Cement and Chemicals vs C.I.T. (158 ITR 636) while examining the treatment of capital recei ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... deen Investors were in the nature of capital assets. At the time of investments in Satyam equity shares, Aberdeen Investors were registered as Foreign Institutional Investors ( FIIs ) and/or sub-account of FIIs under the erstwhile SEBI (Foreign Institutional Investor) Regulations, 1995 ( FII Regulations ) with the Securities Exchange Board of India (SEBI). The investments made by FII entities/sub accounts are in the nature of capital assets and trading assets. The applicants have relied on the rulings given by this authority in case of Fidelity Northstar Fund [2007] 288 ITR 641 (AAR), wherein it was held as under:- 23. The circumstances and the framework of the plethora of legislative provisions unmistakably point out that a FII is not registered for carrying on trade in securities; it can only invest in securities for the purpose of earning income by way of dividends and interest and realizing capital gains on their transfer. (i) The applicants have further relied on circular No.4 of 2007 issued by CBDT setting out various tests for determination of whether shares are held as investment or stock-in-trade. The applicants have also relied on the case of Bombay Burmah Tradi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and the risk of losing was more than a chance gaining, they exit the security. These are characteristics of a trader and not of an investor. For example, the FIIs take decisions to move out a market on local as well as international factors. The buying and selling of shares is done very regularly and frequently except in case of some securities where the analyst is not able to suggest a decision to exit. The FIIs are in the business of trading in shares in Indian markets. It is quite another matter that the Government in order to attract investments, has decided to treat the gains of FIIs as capital gains. That does not alter the basic character of the activity. That only changes the matter of taxability. (e) The fact that the payment has been made through an award of a law suit or through a settlement with or without giving up the right to sue, cannot be determinative of the character of the receipt. For example, if the professional fee of a lawyer is paid to him only after a suit of recovery is filed or after the settlement is arrived at on the quantum of fee it would not make the receipt capital in nature. One has to look at it from the point of view of the lawyer what was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Satyam and PwC in similar circumstances, i.e., receipt of settlement amount as a result of settlement agreement and approval by the US Court after the complaints were filed in respect of fraud committed by Satyam/PwC. In that case we have held as under:- 28. The term income has been defined in section 2(24) of the Act. The Privy Council in CIT vs Shaw Wallace Co (ILR 59 Cal 1343) defined income as under:- Income, their Lordships think, in the Indian Income-tax Act, connotes a periodical monetary return coming in with some sort of regularity, or expected regularity from definite sources. The source is not necessarily one which is expected to be continuously productive, but it must be one whose object is the production of a definite return excluding anything in the nature of a mere windfall. The settlement account received as per the Court Order is not a periodical monetary return. As it is against surrender of right to sue , it is not linked with income generating apparatus, i.e. shares of Satyam. It can also not be said that it relates to any sort of business activity carried on by the QSF. In the circumstances the settlement amount has to be characterized ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stopped with the words any capital gains . On the contrary it is obviously stated that only capital gains which are taxable under section 45 could be treated as income . In other words, capital gains not chargeable to tax under section 45 fall outside the definition of income in section 2(24). Therefore, the words chargeable under section 45 are very important. So, whenever an amount which is otherwise a capital receipt is to be charged under section 2(24), and when specifically so provides for not charging to capital gain for any reason under section 45, the same cannot be brought to tax as income by applying the general connotation under section 2(24) 31. In this case it is to be considered whether right to sue is property and a capital asset as defined u/s 2(14) of the Act and whether it is chargeable to tax. Section 2(14) defines Capital Asset to mean property of any kind held by an assessee, whether or not connected with his business or profession . Section 6 of the Transfer of Property Act states that property of any kind may be transferred, except as otherwise provided by this Act or by any other law for the time being in force. Section 6 (e) notes that a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ract who complains of the breach has any amount due to him from the other party. As already stated, the only right which he has is the right to go to court of law and recover damages. Now, damages are the compensation which a court of law gives to a party for the injury which he has sustained. But, and this is most important to note, he does not get damages or compensation by reason of any existing obligation on the part of the person who has committed the breach. He gets compensation as a result of the fiat of the court. Therefore, no pecuniary liability arises till the court has determined that the party complaining of the breach is entitled to damages. Therefore, when damages are assessed, it would not be true to say that what the court is doing is ascertaining a pecuniary liability which already existed. The court in the first place must decide that the defendant is liable and then it proceeds to assess what that liability is. But till that determination, there is no liability at all upon the defendant. Further, the Supreme Court in Union of India v. Raman Iron Foundry, AIR 1974 SC 265 held as under: When there is a breach of contract, the party who commits ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the removal of doubts, it is hereby clarified that transfer includes and shall be deemed to have always included disposing of or parting with an asset or any interest therein, or creating any interest in any asset in any manner whatsoever, directly or indirectly, absolutely or conditionally, voluntarily or involuntarily, by way of an agreement (whether entered into in India or outside India) or otherwise, notwithstanding that such transfer of right has been characterized as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India. So right to sue may be considered for the purpose of capital gains within the terms of section 45 of the IT Act which is a charging section. However the charging section and the computation provisions under section 48 must go together. The Apex Court in the case of CIT vs B.C. Srinivasa Setty (1981 128 ITR 294) had considered this issue and held that the Charging section and the computation provisions together constitute an integrated code. When there is a case to which the computation provisions cannot apply at all, it is evident that such a case was not intended to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd it only changes the manner of taxability. The Revenue has relied on the principle of surrogatum saying that the settlement amount has been received for the future profits surrendered. The issues raised as above by the Revenue have to be examined first against the factual position in this case and then in the light of legal position. There is no doubt that according to the surrogatum principle the character of receipt of an award of damages or of an amount received in settlement of a claim as capital or revenue depends on what such amount was intended to replace. If the replaced amount would not have been otherwise taxable, the settlement amount may also be not taxable. However, the surrogatum principle does not apply to amounts received pursuant to a fraud. Further, in this case two important facts are noted. One, there is no dispute that at the time of the investments in the shares of Satyam, Aberdeen investors were registered as FIIs under FII regulations with the securities Exchange Board of India (SEBI). FIIs are not carrying out any trade in securities and this position was settled by this authority in the case Fidelity Northstar fund, 2007 288 ITR 641. The Authority held a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mstances and the framework of the plethora of legislative provisions unmistakably point out that a FII is not registered for carrying on trade in securities; it can only invest in securities for the purpose of earning income by way of dividends and interest and realizing capital gains on their transfer. Therefore, the settled legal position is that FIIs are not engaged in trading business. The facts of the present three cases also show that the shares were purchased as investors and not as traders. In their books of accounts also they have treated this as capital investment. 12. The Circular No.4 of 2007 issued by the CBDT quotes three principles laid down by this Authority in the case of Fidelity Group 288 ITR 641 in order to determine whether shares held are investment or stock-in-trade. First principle is how the shares were valued in the books of accounts, i.e., whether they were valued as stock-in-trade or held as investment. In this case the books of accounts show that the shares were held as investment. The second principle is to verify whether there are substantial transactions, their magnitude etc, maintenance of books of accounts and finding the ratio between pur ..... X X X X Extracts X X X X X X X X Extracts X X X X
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