TMI Blog2004 (9) TMI 100X X X X Extracts X X X X X X X X Extracts X X X X ..... rovisions of the Investment Company's Act, 1940 of USA. It is a trust, set up to provide investors a continuous source of managed investments in securities. The investment of the applicant is mainly in equity security with a view to provide long term capital appreciation to its investors under a scheme of an investment fund organized as a Massachusetts Business Trust governed by the laws of Commonwealth of Massachusetts, USA. The applicant is registered with the Securities and Exchange Board of India (SEBI) as a sub-account of "Fidelity Management Research Company and a "Foreign Institutional Investors" under the SEBI (Foreign Institutional Investors) Regulations, 1995. It has invested in equity shares of various companies in India and in other countries like Hong Kong, Indonesia, Korea , Singapore and United Kingdom. Under the FII regime the applicant has invested in the listed Indian companies. As per Regulation 16(1) of the SEBI FII Regulations, 1995 all registered FIIs are required to appoint a domestic custodian in India. Accordingly an FII or a global custodian acting on behalf of the FII is required to enter into an agreement with a domestic custodian of securities for the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... merica? Whether on the facts and the circumstances of the case, any penal provisions of the ITA would be invoked due to non-filing of tax returns by the applicant under section 139 of the ITA? 3. After the Authority passed order under section 245R (2) of the Act, the Commissioner forwarded its comments stating that the applicant has not provided the facts in any detail, therefore, it cannot be determined as to whether it would be having any permanent establishment in India under article 5 of the Treaty. Going by the nature of the operations proposed to be carried out by the applicant in India, it would be required to maintain a branch office or a place of management for entering into transactions in securities, it must be availing the advice of some investment advisors but no details are given. It is only on examining the role of investment advisor that one can say whether the domestic guardian is a dependent agent of the applicant in India. It is pointed out that para 6 of article 7 of the Treaty made specific distinction among various heads of income which have to be dealt with separately under other articles even if such items of income form part of business income of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the reframed questions: Whether on the facts and the circumstances of the case, the gains arising from the sale of portfolio investments in India will be treated as part of the applicant's business income and hence be covered within the provisions of Article 7 of the Convention dated December 20, 1990 regarding the Agreement for Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital gains entered into between the Government of the Republic of India and the Government of United States of America (hereinafter referred to as the " Treaty" )? Whether on the facts and the circumstances of the case, the applicant has a permanent establishment in India in terms of Article 5 of the Treaty? 8. Mr. Nishith Desai argued that the applicant was carrying on the business as an Investment Trust; the income arising to the trust could only be characterized as a business income and in view of the provisions of the Treaty between India and USA, the profits of business could be taxed in India only if the applicant had a permanent establishment in India; the applicant had no branch office or place of business in India, nor did it have any e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dealt with separately in other articles of the convention, then, the provisions of those articles shall not be affected by the provisions of this article. For the purposes of the Convention the term "business profits" means income derived from any trade or business including income from the furnishing of services other than included services as defined in article 12 (royalties and fees for included services) and including income from the rental of tangible personal property other than property described in paragraph 3(b) of article 12 (royalties and fees for included services). Article - 13 (Gains) Except as provided in article 8 (Shipping and Air Transport) to this Convention, each Contracting State may tax capital gains in accordance with the provisions of its domestic law. 12. A plain reading of para 1 of article 7, suggests that profits of an enterprise (applicant) of a contracting state (USA) shall be taxable only in that state (USA) unless the enterprise (the applicant) carries on business in the other contracting state (India) through a permanent establishment situate therein. If the enterprise (the applicant) carries on business as aforesaid, the profits of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ned reading of article 7 and article 13, it follows that business profits of the applicant, dealt with in article 7 of the Treaty, may be taxed in India if business activities or operations are carried on through its permanent establishment in India and income falling under other heads will be treated as postulated under other articles of the Treaty; capital gains will be taxed as provided in article 13 of the Treaty. The expression "permanent establishment" is defined in article 5 of the Treaty. It is not necessary to delve into it here. 17. Whether a company is an investment company or trading company or whether any amount received by a person is a revenue receipt or a capital receipt is a mixed question of law and fact which has to be decided on the facts and in the circumstances of each case. Before adverting to the facts of this case on this question, it will be useful to refer to the decisions cited by the parties. 18. In Raja Bahadur Visheshwara Singh Others V. Commissioner of Income Tax, Bihar Orissa, (41 ITR 685), the assessee purchased shares during a period of 10 years from his own funds. He then borrowed substantial amounts for making further purchases o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ale of those shares was in the nature of revenue receipt or a capital gain. It was held by the Hon'ble Supreme Court that the appellant purchased and sold the shares of the company and the allied companies as stock in trade and that they were in fact purchased even initially not as investments but for the purpose of sale at a profit and therefore the transactions amounted to an adventure in the nature of trade and the profit derived by the appellant from the sale of shares was a revenue receipt and as such liable to income tax. The fact that the department in the earlier years treated the transactions in the nature of investments was not binding in the proceedings for assessment during the subsequent years. In Commissioner of Income Tax, Nagpur v.. Sutlej Cotton Mills Supply Agency Ltd. (100 ITR 706), the respondent assessee subscribed for 3,49,000 shares of a new issue of Gwalior Rayon and paid the application and call moneys. Subsequently, he sold 1,58,200 shares with a profit. The Income Tax Appellate Tribunal found that the transaction constituted business being an adventure in the nature of trade and that the profit was liable to income tax. On reference to the H ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s and accordingly the amount in question was paid to promote the Rodier Textile Mills Ltd. Repelling that contention the Hon'ble Supreme Court observed that a memorandum of Association is not conclusive as to the real nature of transaction which has to be deduced from the circumstances in which the transaction took place and not from the memorandum. As a fact it was found that different versions given in the books of accounts of the assessee-company, belied the assertion. What this decision lays down is that mere recital in the memorandum of association is not conclusive of the nature of transaction, there must be some material to show that in furtherance of the object clause in the memorandum steps are taken and it is given effect to. In CIT v.. P.K.N.Co.Ltd. (Supra), the question for consideration before the Hon'ble Supreme Court was whether the profits realized by the assessee company from the sale of properties could be brought to tax. It is observed that the question whether in purchasing and selling land, the assessee company enters upon a business activity has to be determined in the light of the facts and circumstances; the purpose or the object for which it is incorp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r which was within the knowledge of the assessee who held the shares and he should, in normal circumstances, be in a position to produce evidence from his records to show that the shares were held as stock in trade. 19. From the above discussion the principles that emerge are:- where a company purchases and sells shares, it must be shown that they were held as stock in trade and that existence of the power to purchase as sell shares in the memorandum of association is not decisive of the nature of transaction; substantial nature of transactions, manner of maintaining books of accounts, magnitude of purchases and sales and the ratio between purchases and sales and the holding would furnish a good guide to determine the nature of transactions; ordinarily purchase and sale of shares with the motive of earning a profit, would result in the transaction being in the nature of trade/an adventure in the nature of trade; but where the object of the investment in shares of a company is to derive income by way of dividend etc. then the profits accruing by change in such investment (by sale of shares) will yield capital gain and not revenue receipt. 20. Keeping in view the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of purchases and sales, we are persuaded to conclude that the applicant held shares and securities as business assets and the profits from the purchases and sales of shares are in the nature of business income. In view of this finding, the business profits of the applicant could be taxed in India under article 7 of the Treaty but only if the applicant has a permanent establishment in India. 21. The expression permanent establishment is defined in Article 5 (5) of Treaty which reads as under:- "An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm's-length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph". 22. It is stated in the applica ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unds. Our contractual relationship is with the Global Custodian and not directly with the FII. We attach a copy of the custody agreement between Brown Brothers Harriman and Standard Chartered Ban and also a letter from the Department of the Treasury, Internal Revenue Services in relation to Fidelity Advisor Emerging Asia Fund Inc. Yours faithfully, Sd/ Manisha Dutt Senior Manager, Client Services" It is evident that the domestic custodian is registered with the Securities and Exchange Board of India (SEBI) as a custodian under the SEBI Custodian of Securities Regulation, 1996 and it is currently providing custodial services to many FIIs, domestic mutual funds and having contractual relationship with global custodian and not directly with the FII. These aspects are not denied by the revenue. Indeed the grievance of the Revenue has been that no details have been given by the applicant which, we are afraid, is unsustainable. In our view there is enough material to determine whether the applicant has a permanent establishment In India. 25. On a perusal of the agreement of the global custodian and the domestic custodian and the letter of the domestic custodian, ..... X X X X Extracts X X X X X X X X Extracts X X X X
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