2004 (11) TMI 102 - AAR - Income Tax

In view of the fact that custodian cannot be treated as a permanent establishment brokers and bankers cannot also be treated as a permanent establishment held that income derived by the applicant a company incorporated in and a tax resident of the UK from trading in exchange traded derivative instruments in India would not be taxable in India having regard to the provisions of the Double Taxation Avoidance Agreement between India and the UK.

Issues Involved:
1. Classification of income from derivative transactions as "capital gains" or "business income".
2. Determination of whether the applicant has a Permanent Establishment (PE) in India.

Issue-wise Detailed Analysis:

1. Classification of Income from Derivative Transactions:

The applicant, a non-resident company incorporated and tax resident in the UK, sought to expand its derivative trading operations in India. The applicant argued that the income from trading in derivatives should be classified as business income, not capital gains, as derivatives are held as stock-in-trade and not as investments. The applicant's representative emphasized that derivatives have a short life of about three months, do not yield income like dividends, and are traded with the objective of reselling at an appropriate time, thus constituting a trading activity yielding business income.

The Commissioner contended that the income from derivatives should be classified as capital gains, arguing that derivatives are in the nature of capital assets, and the gains thereon should be taxed under the head of capital gains according to Article 14 of the Treaty. The Commissioner also highlighted that the applicant's dealings in shares are taxed as capital gains, and the same treatment should apply to derivatives to maintain tax consistency.

The Authority analyzed relevant case law and provisions of the Income Tax Act, including Section 45, which deals with capital gains, and Section 28, which defines business income. The Authority concluded that the substantial nature of transactions, the magnitude of purchases and sales, and the short-term holding period of derivatives indicate that the income from derivative transactions is business income. Furthermore, derivatives held as stock-in-trade are excluded from the definition of capital assets, reinforcing the classification of the income as business income.

2. Determination of Permanent Establishment (PE):

The applicant argued that it does not have a fixed place of business in India, and the service providers like brokers, custodians, and bankers are independent parties acting in the ordinary course of their business, thus not constituting a PE in India.

The Commissioner argued that the brokers should be considered dependent agents of the applicant, and therefore, the applicant should be deemed to have a PE in India under Article 5 of the Treaty. The Commissioner relied on the decision of the ITAT in the case of DHL Operations B.V. Netherlands, which interpreted the difference between dependent and independent agents from the perspective of the principal.

The Authority examined Article 5 of the Treaty, which defines PE and distinguishes between dependent and independent agents. The Authority found that the brokers, custodians, and bankers are acting in the ordinary course of their business and provide services to multiple clients, including the applicant. Therefore, they do not fall within the mischief of paragraph 5 of Article 5 of the Treaty, which excludes agents whose activities are devoted wholly or almost wholly to the enterprise. The Authority also noted that the brokers and custodians do not have the authority to conclude contracts on behalf of the applicant without instructions and are not dependent agents.

Conclusion:

The Authority ruled that the income derived by the applicant from trading in exchange-traded derivative instruments in India would not be taxable in India under the provisions of the Double Taxation Avoidance Agreement between India and the UK. The income from derivative transactions is classified as business income, and the applicant does not have a PE in India.

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