9911796707
TMI Blog2004 (11) TMI 102X X X X Extracts X X X X X X X X Extracts X X X X ..... ey Group. With the object of investing in Indian stock market, the applicant got registered with Securities and Exchange Board of India (SEBI) as a Foreign Institutional Investors (FII) on November 23, 1994 .The object clause of the applicant, inter alia, recites to acquire, hold, dispose of, subscribe for, issue, underwrite, place, manage assets belonging to others which include, advise on, enter into contracts for transactions in relation to or involving and in any other way deal with or arrange dealings with or perform any service or function in relation to shares, stocks, debentures, loans, bonds,….., options, futures,…….., or any combination of the foregoing. Accordingly, the applicant has been investing in Indian stock markets and the income thereof is being offered for tax as capital gains. The applicant has been carrying on business in derivatives in other countries. Derivative products have been introduced in India in a phased manner starting with Index Futures Contracts in June, 2000, Index Options and Stock Options in June, 2001 and July 2001 respectively. In November, 2001 Stock Futures were also introduced. The exchange traded derivative contracts have a maximum of thr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity is sought by the applicant on the following question:- "Whether the income derived by the Applicant, a company incorporated in and tax resident of UK, from trading in exchange traded derivative instruments in India would be taxable in India having regard to the provisions of the Double Tax Avoidance Agreement between India and UK ('the DTAA')? 3. The Director of Income Tax (International Taxation), Mumbai (hereinafter referred to as the "Commissioner") submitted the following comments to the application- In the context of Section 5(2) of the Act, the situs of the "derivatives" in which the applicant will be dealing is in India, therefore the income from the transactions in derivatives would arise in India and would be liable to tax in India . But the real issue in the application is: whether the income would be liable to tax as business income or capital gains. It is stated, the scheme of the Treaty suggests that for deciding taxability of an item of income it has to be placed under a particular head of income; if that income falls under a specific head other than profits and gains of business or profession, it cannot be taxed under article 7 as "business income". This is al ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent is needed. He invited our attention to pages 1 to 25 of the compilation supplied by the applicant to show the volume of the transaction and frequency of purchases and sales. He relied on the advance ruling of the Authority in XYZ/ABC Equity Fund (TCW/ICICI) [250 ITR 194], in support of his contention that the transaction in derivatives has to be treated as business income; he refers to memorandum of association of the applicant to show the organized course of activities adopted by the applicant by entering into agreement with brokers, the custodian and bankers; he has also shown registration of the applicant with SEBI as FII and the permission of the RBI. In short, its contention is that the income of the applicant cannot be termed as capital gains; its business income is not chargeable to tax as the applicant has no PE in India. Mr. Pramjeet Singh, JDIT(IT), Mumbai who appeared for the Commissioner pointed out that the applicant is not the beneficial owner of the derivatives, the investment is by the third parties who alone will be entitled to the income and the applicant would get some commission. He submits that first it has to be seen whether the applicant is taxable under ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mputation of total income, section 14 of the Act classifies all income under five heads (A, C, D, E and F). The Treaty deals with income falling under the aforementioned heads differently in distinct articles thereof. Profits and gains of business or profession which fall under head 'D' are dealt with as 'business profits' in article 7 of the Treaty from which income falling under other heads is excluded and is dealt with in other articles thereof. In passing we may mention that income by way of "Capital Gains" is covered by head 'E' of section 14 of the Act and is the subject matter of article 14 of the Treaty. 6. A reference to articles 7 and 14 of the Treaty will be relevant here. In so far as they are pertinent to the present discussion, they are extracted hereunder: Article 7 : Business profits • The profits of an enterprise of a Contracting State shall be taxable only in that state unless the enterprise carries on business in the other Contracting state through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is directly or indirectly att ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... state i.e. India as well as UK may tax "capital gains" in accordance with the provisions of its domestic law i.e. under the Indian Income Tax Act or under the laws of U.K. 8. From a combined reading of article 7 and article 14, 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 as defined in article 5, and income falling under other heads will be treated as postulated under other articles of the Treaty. If the business profits include capital gains, the same will be taxed as provided in article 14 and not in terms of article 7 of the Treaty. In this context, it will be necessary to consider whether the income of the applicant from transactions in derivatives is a revenue receipt or a capital receipt. It is a mixed question of law and fact. Before adverting to the facts of this case on this question, it will be useful to refer to the relevant decisions cited by the applicant. In Raja Bahadur Visheshwara Singh & Others V. Commissioner of Income Tax, Bihar & Orissa, (41 ITR 685), the assessee purchased shares during a period ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld subsequently at a considerable profit. The question was whether the profit derived by the appellant from the sale of those shares was in the nature of revenue receipt or 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 ad ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... /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. In as much as the first point requires us to determine whether the income is in the nature of capital gains, it will be necessary to advert to the provisions of the Act on the subject. Section 45 of the Act deals with capital gains. Sub-section (1) of section 45 provides that any profits or gains arising from the transfer of a capital asset effected in the previous year, except those dealt in sections 54, 54B, 54D, 54E, 54EA, 54EB, 54F, 54G and 54H, be chargeable to income tax under the head "capital gains" and shall be deemed to be income of the previous year in which the transfer took place. The term "capital asset" is defined in sub section (14) of section 2 to mean property of any kind held by an assessee, whether or not connected with his business or profession, but does not include, inter alia, any stock in trade , consumable stores or raw materials held for the purposes of business or profession. Two categorie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are innovative financial transactions for risk management by business and financial investors. Their value is derived from underlying variables like asset, index or reference rate. There are three known types of derivatives (i) forward contract, (ii) futures, and (iii) options. In derivatives there will be specified cash flow between the parties after fixed time. In contra distinction to the equity, securities, shares etc. derivatives do not have either voting rights or right to control. There is no pride of possession of derivatives. They also do not involve initial investment; they are priced by reference to value derived from an underlying index, commodity or other asset and their value fluctuates with the market movement of the aforementioned items. The applicant purchases and sells derivatives and some times first sells and then purchases them and this ordinarily does not happen in share and other securities. It is stated that as they have a short life of about 3 months, they do not yield any income like dividend, therefore, investment of money in them with a view to derive any income is not feasible. Income can be derived only on their purchases and sales so they are held on ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... usiness of an enterprise is wholly or partly carried on. • The term "permanent establishment" shall include especially: • a place of management; • a branch; • an office; (d) to (k) xx xxx xxx 3. xx xxx xxx 4. A person acting in a Contracting State for or on behalf of enterprise of the other Contracting State - other than an agent of an independent status to whom paragraph 5 of this article applies - shall be deemed to be a permanent establishment of that enterprise in the first-mentioned State if : • he has, and habitually exercises in that State, an authority to negotiate and enter into contracts for or on behalf of the enterprise, unless his activities are limited to the purchase of goods or merchandise for the enterprise; or • he habitually maintains in the first-mentioned Contracting State a stock of goods or merchandise from which he regularly delivers goods or merchandise for or on behalf of the enterprise; or • he habitually secures orders in the first-mentioned State, wholly or almost wholly for the enterprise itself or for the enterprise and other enterprises controlling, controlled by, or subject to the same common control, as that enterprise. • An enterprise o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lauses - (a) to (c) thereof - applies. Clause (a) speaks of a case when he has and habitually exercises authority to conclude contract on behalf of the enterprise in the first mentioned state unless the activities are limited to the purchase of goods or merchandise for the enterprise; clause (b) speaks of case when he acts without authority, but habitually maintains a stock of goods or merchandise in the first mentioned state from which he regularly delivers them on behalf of the enterprise; and clause (c) speaks of a case when he habitually secures orders in the first mentioned State, wholly or almost wholly for the enterprise itself or for the enterprise and other enterprises controlling, controlled by, or subject to the same control, as that enterprise. Para 5 incorporates a deemed exclusion clause and says that an enterprise of a contracting State shall not be deemed to have permanent establishment in the other contracting State merely because it carries on business in the 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 business. Nonetheless when the activities of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... many other enterprises who are also their clients. In the other words only such agents will be out of purview of para 5, whose ordinary course of business comprises exclusively the work of the enterprise with little work of any other client; like the standing counsel or law officers of Central/State Government. With respect to the members of the Income Tax Appellate Tribunal, Mumbai Bench 'D', Mumbai in I.T.A. Nos. 7987 and 7988/Bom/92 (Assistant Commissioner of Income Circle 12(2), Mumbai Vs DHL Operations B.V. Netherlands), we are not persuaded to agree with their approach outlined in their Order dated 3 rd October, 2000, thus: "First condition for application of paragraph 6 is that the agent should be of independent status. The second condition to be satisfied for application of paragraph 6 is that the agent of independent status should not be carrying on the business of the non-resident wholly or almost wholly. We have no hesitation to state that second condition is capable of being misinterpreted unless one keeps in mind the first condition. For application of paragraph 6 of Article 5, agent has to be of independent status. If a person carries on wholly or almost wholly all t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the brokers, agents etc. and not their employees will be deemed PE and secondly there is nothing to suggest that the employees are doing only the work of the applicant. In any event it is a matter of internal arrangement of the brokers and their employees. In so far as application of para 4 of article 5 is concerned, we have noticed above its requirements to bring a person within the meaning of PE. The Commissioner sought to interpret it to mean a case of dependent agent and proceeded to argue that if an agent was not an independent agent within the meaning of para 5, he would be a dependent agent within the meaning of para 4. It may be pointed out that para 4 is coached in very wide language, to take in its fold a person other than an agent covered under para 5, which includes a dependent agent. But merely because an agent does not satisfy the test embodied in para 5, he does not per se become a dependent agent so as to be called deemed permanent establishment under para 4. For bringing a person within the meaning of permanent establishment under para 4, the following conditions will have to be satisfied:- • a person must be acting in a Contracting State for and on behalf of an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TSCHE SECURITIES MAUTRITIUS LIMITED. • CITIGROUP GLOBAL MARKETS ( MAURITIUS ) LIMITED. • UBS - SWISS FINANCE CORPORATION (MAURITIOUS) LIMITED. Yours faithfully, Sd/- Name: G. Praveen Kumar Designation: Authorised Representative" Refco-Sify Securities India Pvt. Ltd. "Dear Sir, This is to confirm that we, Refco-Sifty Securities India Pvt. Ltd., are registered as a broker with National Stock Exchange of India having Registration no. INF-231123333. Providing you the services for Indian Index futures and stock futures trading. As brokers, we provide only brokerage services to more than nine overseas clients including Morgan Stanley & Co. International Inc. for derivative trading. A list of few of our clients is as under: • Society General Paris • BNP Paribas • Merrill Lynch Capital Markets Espana • Geomatrix HK Ltd • Citi Group Mauritius • ABN Amro ( Mauritius ) Asia Ltd. • India Man Fund , Singapore • Marshal Fund , Australia . Yours faithfully, For Refco-Sifty Securities India Pvt. Ltd. Sd/- Vineet Bhatnagar Managing Director Motilal Oswal Securities Limited Dear Sir, This is to confirm that we, Motilal Oswal Securities Limited, are registered as a broker wi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Stanley & Co. International Ltd., we only facilitate cash transfers to and from their respective derivative clearing members. Trust the above information meets your requirements. Yours faithfully, Sd/- Anil Sharma Account Manager- Client Services Domestic Custody Services Sd/- Joseph Serrao Account Manager- Client Services Domestic Custody Services We have also perused the agreement of the applicant with the brokers and the custodian. The above material leaves no doubt in our minds that the brokers as well as custodian are acting in the ordinary course of business and providing services to various clients including the applicant. From the above discussion, it follows that the broker, custodian and banker are acting in the ordinary course of business and their activities are not devoted wholly or almost wholly on behalf of applicant itself or on behalf of the applicant and other enterprise controlling, controlled by or subject to the same control as the applicant. Therefore, they do not fall within the mischief of para 5 of article 5 of the treaty. We may mention in the passing that in this case no individual broker is doing the entire work of the applicant so the c ..... X X X X Extracts X X X X X X X X Extracts X X X X
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