9911796707
TMI Blog2007 (1) TMI 545X X X X Extracts X X X X X X X X Extracts X X X X ..... e circumstances of the case, if it is found that the applicant has a permanent establishment in India under the treaty and if the income is found to be in the nature of business income, the business income of the applicant in India from the sale of portfolio investments will be taxable in India at the rate of 20 per cent. in the light of section 115AD of the Income-tax Act, 1961 (hereinafter referred to as the " ITA" ) ? - A. A. R. Nos 678, 679, 680, 681, 682, 683, 684, 685, 686, 694, 695, 696, 697, 698, 699, 700, 701, 702, 703, 704, 705, 706, 707, 708, 709, 710, 711, 712, 713, 714, 715, 716, 717, 718, 719, 720, 721, 722 and 733 of 2006 - - - Dated:- 8-1-2007 - SYED SHAH MOHAMMED QUADRI J., A. S. NARANG AND A. SINHA,JJ. Nishith Desai, for the appellant T. N. Chopra, for the respondent RULING 1. Syed Shah Mohammed Quadri J. (Chairman)-In this batch of forty cases, thirty applications are filed by the Fidelity group of the USA, nine by the Fidelity group of Canada and one by the Matthews India Fund. All these applications are filed under section 245Q(1) of the Income-tax Act, 1961 (for short the Act ) to seek advance rulings of the Authority on the questions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... een acknowledged and approved by the SEBI. On these facts the applicant seeks advance ruling of the Authority on the following questions : 1. Whether, on the facts and in the circumstances of the case, the profits arising to Fidelity Hastings Street Trust : Fidelity Discovery Fund (hereinafter referred to as the applicant ) from the sale of portfolio investments in India will be treated as business income of the applicant ? 2. Whether, on the facts and in the circumstances of the case, the applicant can be regarded as having a permanent establishment ( PE ) in India in accordance with article 5 of the Agreement for Avoidance of Double Taxation and Prevention of Fiscal Evasion with Respect to Taxes on Income entered into between the Government of the Republic of India and the Government of the United States of America (hereinafter referred to as the treaty ) ? 3. Whether, on the facts and in the circumstances of the case, if the income is found to be in the nature of business income, in the absence of a PE in India and in the light of the provisions of article 7 read with article 5 of the Treaty, such business income of the applicant will be taxable in India ? ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y the income shall be deemed to accrue or arise in India in view of the provisions of section 9(1)(i) of the Act. It is submitted that for the purpose of characterization of income the following are the relevant factors: (1) the provisions of the FII scheme under which the applicant has been allowed to operate in India ; (2) special provisions of the Act ; and (3) nature of transactions and operating processes of the applicant. To attract investment from abroad guidelines were issued by the Government of India vide Press Note dated September 14, 1992 (see [1992] 197 ITR (St.) 173 ) for the benefit of FIIs, which were subsequently modified. Clause (f) of para 2 of the SEBI regulations, which defines FII, says that an institution is registered as FII only when it proposes to make investment in India. Regulation 18 imposes an obligation to maintain books of account and records. The said regulations show that FII shall make investment to realize only capital gains on transfer of securities. Even the old regulations postulate repatriation of only capital gains, dividends and interest income. There is no provision which entitles the applicant to repatriate the business profits out of Ind ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... exure II of the application ; (ii) Trust deed-article (V) of sec tion 1 ; (iii) SEBI' s letter dated December 21, 2005. 6. On the contrary they show that the activities of the applicant were in the nature of investments in capital assets for earning capital gains. From various transactions in securities in India by the applicant it is seen that the applicant is in the habit of keeping its holding in various Indian companies from a few months to a few years which clearly indicates that the motive and intention of the applicant is to earn returns in the form of capital gains rather than earn business profits. In the case of trading, the securities which are the subject matter of purchases and sales would be termed stock-in-trade and not investments. The intention of the FII, as is evident from the circumstance at the time of purchases of securities, is a relevant factor and often a conclusive factor in determining whether a transaction is in the nature of trade or in the nature of investment. A fund manager who is located outside India, is appointed for the purpose of managing the applicant's fund in India and he takes decision to acquire and sell securities in India, inst ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... espective contentions of the parties. 9. Mr. T. N. Chopra, learned counsel appearing for the Commissioner, has put forth a preliminary objection as to the jurisdiction of the Authority to entertain these applications. The premise on which this objection proceeds is that section 245N of the Act defines advance ruling as determination by the Authority in relation to a transaction which has been undertaken or is proposed to be undertaken by a non-resident applicant so also in relation to the tax liability of a non-resident in relation to a transaction, but in each of these applications a series of transactions are involved, therefore, the Authority has no jurisdiction to pronounce ruling in regard to series of transactions. Mr. Nishith Desai, learned counsel appearing for the applicant, has argued that as per section 13 of the General Clauses Act, 1897, in all Central Acts and Regulations, words in the singular shall include the plural and vice versa. We may observe that on the face of it the preliminary objection raised by the Commissioner lacks not only merit but also rationality. After some reluctance Mr. Chopra has given up this objection. We, therefore, do not propose to de ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r books of account and this also indicates that FIIs are permitted to invest to earn capital gains and not for carrying on trading activities in securities. It is argued that trading is permitted only in respect of derivative contracts and that there is no regulation, which permits trading in securities. Learned counsel has also relied on section 115AD of the Act to point out that this special provision deals only with two types of income of FIIs, namely, income received in respect of securities like dividends and interest etc., and income by way of short-term and long-term capital gains arising from the transfer of such securities. 11. We find no force in the contention of Mr. Desai that for the purpose of classification of income the terminology or the context used in the FII Regulations cannot be used to determine the nature of the transaction as the FII Regulations are drafted in a generic manner and cannot be determinative of the character of income as the Income-tax Act and the regulations and other enactments are not pari materia. We are of the view that the classification of income has to be done under the law of the land and once it is classified under any of the heads ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... investment (by sale of shares) will yield capital gain and not revenue receipt. 14. In this case it is common ground that the intention of the investors is an important factor in determining the above question. In applying the aforementioned principles, it will be useful to bear in mind the following extracts from the decision of the hon' ble Supreme Court in CIT v. H. Holck Larsen [1986] 160 ITR 67 (page 75) : The second question is what are the legal principles applicable to the facts of these types of cases to determine whether the conduct was that of a dealer in shares or of an investor in shares . . . How in the case of sale of shares, the object or the purpose of selling the shares, in order to determine whether one was a dealer in shares or an investor in shares, should be viewed, may be looked at from the angle of Lord Reid in J. P. Harrison (Watford) Ltd. v. Griffiths (H.M. Inspector of Taxes) [1962] 40 TC 281 (HL), when he observed (page 295) : ' The question has been asked in a number of cases : If this was not trading, what was it ? With all deference to those who have used that argument, I do not think that it is v ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d to India, subscribe/renounce rights offerings of shares, investment on all recognized stock exchanges through a designated bank branch, and to appoint a domestic custodian for custody of the investments held . . . 9. (d) make investments in securities in India out of the balance in the rupee account ; . . . (f) repatriate the capital, capital gains, dividends, incomes received by way of interest, etc., and any compensation received towards sale/renouncement of rights offerings of shares subject to the designated branch of a bank/the custodian being authorized to deduct withholding tax on capital gains and arranging to pay such tax and remitting the net proceeds at market rates of exchange . . . 10. There would be no restriction on the volume of investment- minimum or maximum-for the purpose of entry of FIIs, in the primary/secondary market. Also there would be no lock-in period prescribed for the purposes of such investments made by FIIs. It is expected that the differential in the rates of taxation of the long-term capital gains and short-term capital gains would automatically induce the FIIs to retain their investments as longterm investments . . . 18. FIIs investin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Income of Foreign Institutional Investors from securities shall be subject to deduction of tax at source. However, no deduction of tax shall be made from any income by way of capital gains arising from the transfer of securities. In order that the tax on capital gains arising to FIIs can be realized, each FII, while applying for initial registration with the Securities and Exchange Board of India, will have to specify an agent, including a person who is treated as an agent under section 163 of the Income-tax Act for the said purpose . . . . 18. In conformity with the said policy, various enactments and regulations were passed ; among them are : the Securities and Exchange Board of India Act, 1992 (for short the SEBI Act ), the SEBI (Foreign Institutional Investors) Regulations, 1995* (hereinafter referred to as the SEBI Regulations ) framed in exercise of the powers conferred by section 30 of the SEBI Act ; the Finance Act, 1993, which inserted section 115AD in the Act for the purpose of levy of Income-tax at a concessional rate on the income of FIIs from securities and capital gains arising from their transfer, (we shall advert to this provision presently) ; the Foreign ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the registration of FII. It is provided in regulation 3(1) that no person shall buy, sell or otherwise deal in securities as a foreign institutional investor unless he holds a certificate granted by the Board under these regulations. The SEBI Regulation 12 speaks of application for registration of sub-accounts. Subregulation (3) of the SEBI Regulation 13 is worth quoting (see [1996] 85 Comp Cas (St.) 84, 89) : A sub-account granted registration in accordance with sub-regulation (2) of this regulation shall be deemed to be registered as a foreign institutional investor with the Securities and Exchange Board of India for the limited purpose of availing of the benefits available to foreign institutional investors under section 115AD of the Income-tax Act, 1961 (43 of 1961). 19. This sub-regulation shows that a sub-account is granted registration as FII with the SEBI for the limited purpose of availing of the benefits available to FIIs under section 115AD of the Act. It is enjoined by regulation 14 of the SEBI Regulations that a FII shall not make any investments in securities in India without complying with the provisions of Chapter III (comprising of regulati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Investment on repatriation basis is defined in clause (vi) of regulation 2 of the FEM Regulations (Security) of 2000 to mean an investment the sale proceeds of which are, net of taxes, eligible to be repatriated out of India. Regulation 11(2) of the FEM Regulations (Security) of 2000 provides that an authorized dealer may allow the remittance of sale proceeds of a security (net of applicable taxes) to the seller of shares resident outside India subject to conditions contained in the proviso thereto. 22. The application form for registration of FIIs contains a declaration and undertaking. The relevant portion of the undertaking is reproduced hereunder :- 1. to 2 . . . 3. We further undertake that we shall comply with the provisions of the Act, and regulations issued thereunder and all other relevant laws including guidelines issued by the Reserved Bank of India and the Government of India. 4. We further undertake that as a condition of grant of certificate of registration, we shall abide by such operational instructions/directives as may be issued by the Securities and Exchange Board of India and by the Reserve Bank of India from time to time under the provisions of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t and distinguishable from carrying on business. Transact business is a general term which refers to carrying on all types of activities whereas business transaction refers to only commercial trading activities. 25. Thus it follows that the aforementioned words and expressions, in the context in which they are used, do not deal with the subject of trading in securities much less do they permit activities of trading in securities by a FII. In no way, can the framework of the provisions of the Guidelines, Acts and Regulations, discussed above, be so interpreted as to lead to the inference that trading in Indian securities is open to FIIs. 26. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rty. The term income employed therein, having regard to the context, can, by no stretch of imagination, be assumed as income arising from the transfer of such securities for the simple reason that such type of income is referred to in clause (b) where the income is specified as being by way of short-term and long-term capital gains arising from the transfer of such securities. Clause (a) of sub-section (2) is called in aid to support the contention that income in clause (a) of sub-section (1) includes business income also, and it is argued that otherwise there is no reason why sections 28 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 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 debentures and the like. For the purpose of realizing such income, an investor/a FII would naturally engage staff and incur expenditure by way of salaries of the staff, etc. ; incur expenditure in obtaining loan, pay interest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... FIIs, who responded to the offer of investment in securities in response to the guidelines, got themselves registered under the SEBI Regulations and undertook to abide by those regulations that they would, in the very first step itself, have intended to violate all the legislative requirements which provided them the opportunity to enter the capital market in India. That the FIIs could not have intended to trade in the first step of purchase of shares, is also strengthened by the fact that in the Income-tax returns filed by many of them, in consonance with the above legislative provisions, they have shown their income as capital gains. For the sake of brevity we have mentioned, in annexure A to this ruling, how the applicants treated the income from the investments in Indian securities. From the above survey of the legislative provisions, it has been concluded that the scheme was meant for the FIIs to invest in securities in Indian companies for the purpose of earning income by way of dividends, interest etc and realizing capital gains on transfer of such securities and indeed they so acted in the first few years and that the first step was not taken in the course of trading transa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es of shares are in five companies which are noted at pages 107-109 and sales of shares in six companies are noted at pages 110-123. In regard to 2005 the purchases by the said fund relate to shares in two companies which are noted at page 124 and the sales transacted are noted from pages 125-133. The applicant (in paper book-4), has submitted details of sales and purchases of shares of each trust for the period 2005-06. They are reproduced in annexure B to this ruling. Even on close scrutiny of the particulars mentioned in annexure B it has not been possible for us to co-relate the sales and purchases of shares. That apart, for the purpose of the application of the principles discussed above, we have no clue about the maintenance of the accounts by the applicants. From the accounts we would have been in a position to ascertain whether the shares have been entered therein as stock-in-trade or capital assets. Under the principle of accountancy the stocks-in-trade have to be valued at the end of each year in the case of trading to arrive at the profits of the business whereas in the case of investment in capital assets the gains can be determined only on the sale of such assets. In t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be an investor and had become a dealer though it dealt only in shares of managed companies. On a reference the High Court upheld the findings of the Tribunal. On an appeal by the Revenue the hon'ble Supreme Court reversed the decision of this High Court making the above noted observations. 36. Even assuming for the sake of argument that it is open to the applicant to trade in securities the material placed on record does not support the claim that the applicant ever intended or indeed has done any trading in securities in India. We are, therefore, constrained to hold that the facts as disclosed and the material placed before the Authority do not help us to determine the criteria and therefore, we are unhesitatingly led to the conclusion that the transactions are only in the nature of investment in capital assets to earn capital gains. 37. Application No. AAR/733/2006 relates to Matthews India Fund. Attachment 7 is the list of purchases of shares in various Indian companies (pages 88 to 95) ; at page 96 sales and purchases in two companies are noted. From the perusal of the same it is not clear as to how the purchase and sales of shares were transacted in US dollars if th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as capital gains or business profits. The contention of the Revenue was that it was capital gains and not profits of business. It was noted that the life of the exchange derivatives was less than three months and they could not be held as capital assets for any length of time. Having considered the definition of capital asset and noting that the stock-in-trade is excluded from the definition of capital assets and the facts of the case in the light of the principles noted above, it was held that the applicant was having business income. That case is clearly distinguishable on its facts. 39. In all those cases the judgment of the hon'ble Supreme Court in CIT v. H. Holck Larsen [1986] 160 ITR 67 was not referred to and the test laid down thereon was not applied. Further the question being essentially a mixed question of law and fact on the facts and the records that were placed before the Authority in those cases, the conclusion of the Authority was recorded in them. Therefore, those judgments cannot be an authority to hold that in this case also the income arising from purchase and sale of shares is business profit. 40. Questions Nos. (1) to (4) are common in all the ap ..... X X X X Extracts X X X X X X X X Extracts X X X X
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