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2016 (1) TMI 793 - THE AUTHORITY FOR ADVANCE RULINGS NEW DELHI

2016 (1) TMI 793 - THE AUTHORITY FOR ADVANCE RULINGS NEW DELHI - [2016] 381 ITR 55 - Taxability of Settlement amount received - trading business or capital receipts - Settlement Amount to be received by Aberdeen US as trustee for the Claims trusts from Satyam - Held that:- The nature of settlement amount is of capital receipt and it cannot be categorized as income. Further this amount has been received against surrender of right to sue which cannot be considered for the purpose of capital gains .....

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on of class action or right to sue would not have arisen. However, this does not mean that the settlement arrived with the approval of 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 t .....

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le 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:- 19-1-2016 - Justice V.S. Sirpurkar (Chairman) and A.K. Tewary, Member (Revenue) For The Appellant : Mr. Rajesh Simhan, Advocate Mr. Prateek Bagharia, Advocate For The De .....

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vices Limited (Satyam) and Price Water House Coopers (PWC) under the provisions of the Income-tax Act, 1961. Therefore, all three applications have been taken together for hearing and a common order is being passed. Facts 2. The facts related to Aberdeen US and Aberdeen UK are summarized below:- (i) Twelve mutual funds, namely, (i) Aberdeen EAFE plus Sri Fund, a series of Aberdeen Delaware Business Trust, United States; (ii) Aberdeen EAFE plus Ethical Fund, a series of Aberdeen Claims Trust, Uni .....

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apital Class, Canada; (x) Aberdeen Canada - Socially Responsible International Fund, Canada; (xi) Aberdeen Canada - Socially Responsible Global Fund, United States; (xii) NCB Capital Company, Bahrain; Raiffeisen Kapitalangage - Gessellsc mbg R 77 - Fonds Segment B, Austria were all holders of American Depository Shares ( ADS ) (collective ADS Holders ) of Satyam Computer Services Ltd.( Satyam ) (ii) Seven mutual funds, namely, (i) First Trust/Aberdeen Emerging Opportunity Fund; (ii) Aberdeen Eme .....

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nd, 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 th .....

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its directors, gave rise to legal claims by the Aberdeen Investors against inter alia Satyam and PwC ( Legal Claims ). The Aberdeen Investors thus decided to establish two Trusts, namely, Aberdeen Claims Trust and Aberdeen Claims Trust (II) (together referred to as claims trust ) and granted, assigned, conveyed and transferred the aforesaid Legal Claims to the trust ( Assigned Claims ), while retaining all beneficial interest in the Trust. The Aberdeen Investors also appointed Aberdeen claims Ad .....

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am Computers Ltd, 2:09-CV-5453-NS ( Aberdeen Civil Action ), filed in United States District Court of the Eastern District of Pennsylvania ( Pennsylvania Court ), seeking unliquidated damages caused on account of inter alia Satyam s and PwC s wrongdoing. Aberdeen US estimated that the total of Aberdeen Investor s losses for which recovery was sought would exceed US $68 Million. (vii) On November 17, 2009 the Aberdeen Civil Action was transferred to the United States District Court for the Southe .....

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with the US Class Action Litigation and on May 12, 2011, the New York Court entered an order preliminarily ( Preliminary Approval Order") certifying a class for settlement purpose in connection with the US Class Acton Litigation ( Settlement Class ). In the preliminary Approval 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 .....

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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, without limitation, enhance its credibilit .....

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st Satyam and agreed to be forever barred and enjoined from commencing, instituting, prosecuting or maintaining the Legal Claims. This was also agreed vice-versa. Both Satyam and the Aberdeen Investors extinguished their mutual legal claims. (xi) The ADS Holders were deemed members of the Settlement Class and were bound by the terms of the Class Action Settlement. However in the event ADS holders recovered less than US$ 6,000,000 from the Class Action Settlement, Satyam remains obligated to pay .....

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Escrowed Funds remained the property of Satyam. Aberdeen US agreed to file the present application to seek an advance ruling regarding taxability of the Primary Settlement Amount and if occasioned, the Supplemental Consideration ( Satyam Settlement Account ). (xii) Under the terms of the Aberdeen US-PwC Settlement Agreement: (a) PwC entered into the Settlement to, without limitation, eliminate burden, expenses, uncertainty and distraction of further litigation with its attendant risk of monetar .....

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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 A .....

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ary 7, 2013 ( Escrow Agreement ). (c) The Settlement Agreement provided for a full, final and complete resolution of all claims asserted or which could have been asserted by the Applicant/Aberdeen Investors with respect to the Released Claims . 4. For the sake of convenience the chronology of events in the case of Aberdeen US (Application No. 1364/2012) is mentioned below:- LIST OF DATES Date Event 2003-2009 Investment funds managed by Aberdeen or its affiliates ( Aberdeen Investors ) purchased .....

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Stock and ADRs. January 9, 2009 Further disposal of Satyam Common Stock and ADRs by Aberdeen Investors. September 1, 2009 Aberdeen Claims Trust and Aberdeen Claims Trust II ( Claim Trusts ) were formed under laws of Pennsylvania, having the Applicant as trustee of both Claim Trusts to investigate and prosecute the claims of various Aberdeen Investors against Satyam November 17, 2009 The Applicant , as trustee of the Claim Trusts initiated legal action against Satyam in Aberdeen Claims Administr .....

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Limited Securities Litigation, No.09-md-2027 ( Class Action ). February 16, 2011 Satyam 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 .....

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The Applicant entered into a settlement agreement with inter alia Satyam Computer Services Limited ( Aberdeen Settlement Agreement ) in relation to settlement amount of US$ 12,000,000 and Supplemental consideration of USD 1,500.000 ( Aberdeen Settlement Amount ). July 30, 2012 The New York Court passed a consent order stating that the Applicant s request for exclusion from the Settlement Class is valid and exclusive with respect to the Aberdeen Common Stock investors. August 24, 2012 Applicant .....

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s in the case of Aberdeen UK. 6. Questions for Ruling in Application No.1364 Q.1 Whether, on the facts and circumstance of the case, the Settlement Amount to be received by Aberdeen US as trustee for the Claims trusts from Satyam in accordance with the terms of the Settlement Agreement entered into between Aberdeen US and Satyam on July 27, 2012 is taxable under the provisions of the Income-tax Act, 1961? Q.2 If answer to question number 1 is in the affirmative, what would be the basis and metho .....

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atyam Amount by Satyam in the Escrow Account? Questions for Ruling in Application No.1370 Q.1 Whether , on fact and circumstances of the case, the consideration to be received by Aberdeen US, as trustee for the Claim Trusts from PwC in accordance with the terms of the Settlement Agreement entered between the Applicant and 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 metho .....

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er 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 7. The stand o .....

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ived in India, income that accrues or arises to them in India or is deemed to accrue or arise in India. (b) The Impugned Settlement Amounts would not qualify as income for the purposes of the ITA. The Impugned Settlement Amounts are neither received in the ordinary course of business of the Applicant, nor is the Applicant engaged in the business of suing and seeking settlement from third parties. The Impugned Settlement Amounts cannot be said to be deemed to accrue or arise in India in terms of .....

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ement Amounts cannot be brought to tax under Section 9 read with Section 4 and Section 5 of the ITA. This is on the basis that the Impugned Settlement Amounts are not connected with the Applicant s business in India but for release of claims of Aberdeen Investors against Satyam/PwC under the Aberdeen Civil Action initiated in United States, and to end reputational harm caused to Satyam/PwC in United States. Therefore, the Impugned Settlement Amounts have no territorial nexus with India. The appl .....

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on 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 f .....

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ITR 636) while examining the treatment of capital receipt from settlement and extinguishment of right to sue as Capital gains. The relevant portion of the Gujarat High Court s decision is reproduced below: The amendment of clause (e) of section 6 by the deletion of the italicized words has brought into sharp focus the distinction between property and a mere right to sue. Before the amendment, only the right to sue for damages arising out of a tortuous act fell within the ambit of the said claus .....

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asset cannot be equated with the extinguishment of any right in a capital asset, as it would amount to extinguishment of the capital asset itself. Section 2(47) defines transfer in relation to a capital asset to include (i) the sale, exchange or relinquishment of the asset; or (ii) the extinguishment of any rights therein . The legislature in its wisdom has specifically distinguished sale, exchange and relinquishment of the asset from extinguishment of rights in a capital asset. Thus while in t .....

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s the applicants have not quoted the relevant portion. (g) The cost of acquisition and cost of improvement of a right to sue cannot be computed. In such a situation the mechanism for computation of Capital Gains under Section 48 of the ITA would fail in the present situation. The applicants have relied on the decision of the Supreme Court in CIT vs B.C. Srinivasa Setty (128 ITR 294) (h) Satyam equity shares and ADS held by the Aberdeen Investors were in the nature of capital assets. At the time .....

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[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 o .....

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d/or of the ITA upon deposit in the Escrow. Clause 11 of the Aberdeen USSatyam Settlement Agreement provides that the Primary Settlement Amount when in the Escrow shall remain to be the property of Satyam. Clause 12 further provides that the Primary Settlement Amount shall be transferred to the Applicant only under limited circumstances upon receipt of (a) a joint instruction letter by Satyam and the Applicant, (b) a consent order by the relevant US court and (c) a copy of the ruling of the Hon .....

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e mode of sharing of profit between the fund and the participants depends on the scheme of the fund and would not be a relevant factor to decide the nature of the activity. (b) The loss was incurred by the Aberdeen Funds in the course of their business activities of dealing in securities. (c) The recipients of the settlement amounts are the Aberdeen funds (and not participating investors) who are in the business of purchase and sale of securities. (d) The Mutual Funds (like Aberdeen Funds) inves .....

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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 mat .....

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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 he trying to recover? (f) If the sum paid or payable is for destruction of the profit making apparatus or crippling of the recipient s profitmaking apparatus, it would be a capital receipt. However, when the structure of the recipient s business is so fashioned as to absorb the shock as one of the norm .....

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aid by Satyam is to be seen under Indian Tax laws. The nature of the income (whether from business of capital gains) is to be determined in the light of the tests laid down by Indian Courts. The Revenue has also relied upon circular No.4 of 2007 issued by CBDT and decision of the ITAT in the case of Binay Mittal ITA 1172 of 2011. (h) The amount of the compensation was received in the course of business of the Aberdeen Funds. Hence, it would constitute a business receipt and would be part of thei .....

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loss of potential income suffered by Aberdeen Funds in the course of their business operations. (k) The Revenue has relied on the judgment of Allahabad High Court in CIT vs Smt Shanti Meattle 1973 90 ITR 385 and decision in the case of CIT vs GR Karthikeyan 201 ITR 866 (SC). Inferences 9. We have carefully considered the submissions and counter submissions of applicants and Revenue respectively. Similar question was involved in application No. 1060 & 1070 of 2010 wherein we had analyzed vari .....

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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 .....

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also notice that the most important point here is that we have to consider the nature of receipt in the hands of QSF which is not doing any activity to earn such receipt which may qualify as income. QSF is not in the business of suing and seeking settlement amount. Surrender of right to sue has also been made by investors and not by QSF. Under no circumstances the theory of loss of future income would apply to QSF as neither is it owner of ADS nor it is doing any business relating to ADS. We are .....

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n 2(24) of the Act specifically includes (vi) any capital gains chargeable under section 45 within the ambit of income. Thus a capital receipts would be chargeable to tax only if it falls under section 45 of the Act (as capital gains) though capital receipt as such is not taxable. This principle was described by the Income Tax Appellate Tribunal (Mumbai) in Dhruv N. Shah v. Commissioner of Income Tax 88 ITD [2004] 118 as follows: Further, all receipts are not taxable under the Income Tax Act. Se .....

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e under section 45 which has been treated as income under section 2(24). Further under section 2(24)(vi), the Legislature has not 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, wh .....

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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 mere right to sue cannot be transferred . Therefore, a right to sue is property and thus Capital Asset as defined under section 2(14) of the Act but is not transferable. The .....

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ion between property and a mere right to sue. Before the amendment, only the right to sue for damages arising out of a tortuous act fell within the ambit of the said clause. The right to sue arising ex-contractual, therefore, did not fall within the mischief of the clause even if it were a mere right to sue. After the amendment a mere right to sue, whether arising out of tortuous act or ex- contractual is not transferable. - "Chagla C.J. had an occasion to consider this aspect of the law in .....

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can be assigned but in order that there should be an actionable claim, there must be a debt in the sense of an existing obligation. But inasmuch as a breach of contract does not result in any existing obligation on the part of the person who commits the breach, the right to recover damages is not an actionable claim and cannot be assigned. - In my opinion, it would not be true to say that a person who commits a breach of the contract incurs any pecuniary liability, nor would it be true to say th .....

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e 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 determinati .....

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actionable claim and this position is made amply clear by the amendment in section 6(e) of the Transfer of Property Act, which provides that a mere right to sue for damages cannot be transferred. " The Supreme Court endorsed the views of J. Chagla "This statement in our view represents the correct legal position and has our full concurrence. If right to sue cannot be transferred and it has no cost of acquisition, the question of considering the same for the purpose of capital gains u/ .....

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in Section 2(47) and to the decision of this court in Vanias case. In our view, the definition clearly contemplates the extinguishment of rights in a capital asset distinct and independent of such extinguishment consequent upon the transfer thereof. We do not approve, respectfully, of the limitation of the expression extinguishment of any rights therein to such extinguishment on account of transfers or to the view that the expression extinguishment of any rights therein cannot be extended to mea .....

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Act, 2012 but effective from 1.4.1962. This explanation reads as under:- Explanation 2 - For 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 .....

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tty (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 fall within the charging section . The Apex Court also held that none of the provisions pertaining to the head capital gains suggests that they include an asset in the acquisition of which no cost of acquisition at a .....

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deration for any capital asset and cannot be characterized as capital gains. It is only as an alternative argument that they have brought the issue of capital gains. In this case also we reiterate our views expressed in above-mentioned judgment as relevant facts are almost identical. 10. The nature of settlement agreement in the case of Aberdeen US and Aberdeen UK is same and we take the same view in this case also that the nature of settlement amount is of capital receipt and it cannot be categ .....

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part of their business receipt because these applicants are representing mutual funds which invest their funds after careful research of the market on the basis of expectation of potential upside in the market price of share and unlike an investment, mutual funds book their profits frequently and sometimes prefer even booking loses. According to the Revenue these are characteristics of a trader and not of an investor. As regards the treatment of income of such mutual funds as FIIs as capital gai .....

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here 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 n .....

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rities; from the operation of such income is excluded the income by way of dividends referred to in section 115O and from the operation of securities is excluded unit referred to in section 115AB. The expression income receipt of securities in clause (a) connotes the income therefrom when the securities held by a FII are intact, e.g. dividends, interest etc. like fruits from a tree or a rent from an immovable property. The term income employed therein, having regard to the context, can, by no st .....

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to 44C of the Act, the provisions relating to computation of profits and gains of business , should be excluded. We are not persuaded to accede to the contention of the learned counsel. We have pointed out above that income in respect of securities, referred to in clause (a)of sub-section (1) of section 115AD, refers to income in the nature of dividends, interest income of debenture and the like. For the purpose of realizing such income, an investor/a FII would naturally engage staff and incur e .....

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BI Regulations whereunder a sub-account of FII is registered as FII for the limited purpose of deriving the benefit under section 115AD, it becomes clear that this is for the purpose of deriving the benefit of reduced rates of tax. 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 intere .....

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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 purchases and sales. In this case the shares of Satyam were purchas .....

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object of the investment is not to have business profit because the shares of Satyam were not being purchased and sold at regular interval. In the light of this even CBDT Circular No.4 of 2007 does not support the stand of Revenue that Aberdeen investors were engaged in trading business. 13. The next point to be considered is whether the settlement amount was received to compensate part of the business receipt as claimed by the Revenue or it was received because a fraud was committed by Satyam .....

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