2007 (1) TMI 545 - AAR - Income Tax

Court rules portfolio investment profits in India not business income.

IN RE: FIDELITY NORTHSTAR FUND AND OTHERS

The court ruled that profits from the sale of portfolio investments in India by the applicants, including Fidelity groups from the USA and Canada, and ... 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 ? 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') ? 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 ? Whether, on the facts and in the 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' ) ? Issues Involved:1. Classification of profits from the sale of portfolio investments as business income.2. Determination of the existence of a permanent establishment (PE) in India.3. Taxability of business income in the absence of a PE in India.4. Tax rate applicable if the income is classified as business income and a PE exists in India.Detailed Analysis:1. Classification of Profits from the Sale of Portfolio Investments as Business IncomeThe primary issue was whether the profits from the sale of portfolio investments in India by the applicants (Fidelity groups from the USA and Canada, and Matthews India Fund) should be treated as business income. The applicants argued that their transactions should be classified as trading in securities, implying business income. However, the Commissioner contended that the investments were intended to yield capital gains, not business profits, based on the SEBI regulations and the Income-tax Act.The judgment emphasized that the classification of income as business income or capital gains is a mixed question of law and fact, determined by the nature of transactions, the intention of the investor, and the manner of maintaining accounts. The court noted that the SEBI regulations and other legislative provisions indicated that FIIs are meant to invest in securities to earn dividends and capital gains, not to trade in securities. The court concluded that the applicants' transactions were investments in capital assets, leading to capital gains, not business income.2. Determination of the Existence of a Permanent Establishment (PE) in IndiaThis issue was to be addressed only if the transactions were deemed to give rise to business income. Since the court concluded that the transactions resulted in capital gains, the question of whether the applicants had a PE in India under Article 5 of the Indo-US and Indo-Canada treaties did not need to be answered.3. Taxability of Business Income in the Absence of a PE in IndiaSimilarly, this issue was contingent on the classification of income as business income. Given the court's ruling that the income was capital gains, the question of taxability of business income in the absence of a PE under Article 7, read with Article 5 of the treaties, was not addressed.4. Tax Rate Applicable if the Income is Classified as Business Income and a PE Exists in IndiaThis issue would only arise if the income was classified as business income and the applicants were found to have a PE in India. Since the court ruled that the income was capital gains, the question of the applicable tax rate under section 115AD of the Income-tax Act was not considered.Conclusion:The court ruled that the profits arising from the sale of portfolio investments in India by the applicants could not be treated as business income. Consequently, the related questions regarding the existence of a PE, taxability of business income in the absence of a PE, and the applicable tax rate were not addressed.US Group:- Question No. (1): The profits arising from the sale of portfolio investments in India could not be treated as business income.- Questions Nos. (2) to (4): These questions do not survive as the primary question was ruled in favor of classifying the income as capital gains.Canada Group:- Question No. (1): The profits arising from the sale of portfolio investments in India could not be treated as business income.- Questions Nos. (2) and (3): These questions do not survive as the primary question was ruled in favor of classifying the income as capital gains.Matthews India Fund:- Question No. (1): The profits arising from the sale of portfolio investments in India could not be treated as business income.- Questions Nos. (2) and (3): These questions do not survive as the primary question was ruled in favor of classifying the income as capital gains.