TaxTMI 
TaxTMI 
2010 (3) TMI 107
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....e of "Business Income" in the hands of the applicant under the provisions of the Act read with the Treaty? • 3. Since the applicant does not have a permanent establishment (PE) in India as per Article 5 of the Treaty, whether "Business income" of the applicant (referred to in the question 1 and 2 above) will not be taxable in India under Article 7(1) of the treaty? 2. Thus, two types of transactions are referred to in the application: The first category is profits earned/losses incurred from transactions in future contracts and option contracts traded on the stock exchanges. The second category is a proposed transaction, viz., the purchase and sale of shares and futures that are carried on as a part of an "index arbitrage activity". 3. The applicant is a public company incorporated under the Bank Act of Canada and is engaged in the business of banking and other financial services. It also trades in securities (including derivatives) in various parts of the world including India. In India, the applicant is registered as Foreign Institutional Investor (FII) with the Securities and Exchange Board of India ((SEBI) since March 2008 and is mainly dealing in the derivat....
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....hanges hand. The Exchange may however insist on some margin money to be retained by the brokers of contracting parties. These contracts can be squared up anytime before the expiry date and it is at the time of squaring up the sum equal to profit (or loss) is received (or paid) through Stock Exchange. Mostly, the applicant has been trading in futures. 'Options', on the other hand, are contracts which give the right but not obligation to buy or sell the underlying assets at a stated date and at a stated price. A buyer of the option pays premium to buy the right to exercise his option. The seller (writer) of the option is the one who receives the option premium and is therefore obliged to sell or buy the asset if the buyer exercises his option. 5. As per the answers to Frequently Asked Questions (FAQ) given by NSE of India, Futures & Options Contract have a maximum trading cycle of 3 months. 6. The applicant submits that the derivative transactions undertaken by it are part of its trading activity. The object in purchasing derivative is to resell the same at appropriate time and earn income. Sometimes, the applicant sells derivatives first and then purchases them. Further, the n....
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....rther contends that the applicant's income from dealing in derivatives/shares/securities has necessarily to be brought within the purview of section 115AD which is a self contained code applicable to the FIIs. It was argued that, for the FIIs, section 115AD contemplates income from dividend, interest and capital gains only. Therefore, the applicant could only have earned 'capital gains' from the transfer of securities which would be taxable in India under the provisions of section 115AD of the Income-tax Act, 1961 ('the Act'). 10. The question is whether the income derived from the dealings in 'Derivatives' ought to be treated as capital gain or trading profit. The exchange traded derivatives are those which derive values from underlying securities which may be a particular asset (e.g. Reliance stock) or index (e.g NIFTY, NSC etc). Future contracts are entered into based on the value of the stock. Income is earned only on a settlement of transaction which could be either profit or loss. Income is derived from the transfer but not from the instrument and there will be no physical delivery of shares. Annexure-III to the Paper Book filed by the applicant shows a large number of tra....
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....derivatives traded between April 1, 2003 and March 31, 2004, which are on record. They indicate substantial nature of transactions, the magnitude of purchases and sales is enormous (amounting to Rs.3,932 crores in a year) and the ratio of purchases and sales is very high. On these facts, applying the principles noted above, it cannot but be said that the income from transactions of trading in derivatives is "business income" and not "capital gains". 14. Then, it was held after elaborate discussion that the applicant therein did not have any permanent establishment in India (PE) and therefore the business income cannot be taxed in India. 15. This ruling of the Authority has a direct bearing on the present case. 16. Reference has also been made by both sides on the later decision of this Authority in Fidelity North Star Fund [288 ITR 641]. There the question did not relate to the income from Derivatives. The question was whether profits from the sale of portfolio investments in India i.e. purchase and sale of shares and securities held for considerable time could be treated as business income. This Authority came to the conclusion that "the transactions are only in the natur....
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....ffer 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 marketing 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." 18. Thus, the conclusion was reached by this Authority looking at the intention at the time of first purchase of the shares. The AAR proceeded on the premise that there was prohibition in law against trading in shares and securities and therefore an intention could not be attributed to trade in shares. This ruling has been criticized on many counts by the learned senior counsel for the applicant, especially while dealing with the second question. As far as the first question with which we are concerned, the ratio in Fidelity North Star Fund has no application because this A....
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....pose 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 the case of Fidelity Advisor Series VIII [2004] 271 ITR 1 the Authority while laying down the aforementioned principles, noted the criteria to determine the said question. In spite of being aware of this position and even though the applicants are required to maintain such accounts under the SEBI Regulations, copies of the accounts maintained by them are admittedly not filed before the Authority to verify whether the requirements of the first principle is satisfied. In the absence of accounts we cannot but draw an adverse inference against the applicant, namely, had the accounts been produced before us they would have shown that the secu....
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....ts can be done and purchases of shares can only be on capital/investment account. Hence, irrespective of frequency and volume of the transactions and the expression 'trade' employed in, Regulation No.5(6) of the FEM (Transfer of issue of Security by a non-resident) Regulations, 2000, the word 'trade' is used in a generic sense and it shall be confined only to investment. We do not see any warrant to place such restriction on an expression of wide import especially in the context in which it is used. Secondly, Regulation No.3 of the FEM (Derivatives) Regulations, 2000 referred to by this Authority in Fidelity North Star case prohibits a person from entering into a foreign exchange Derivative contract without the prior permission of Reserve Bank. That the Reserve Bank permitted the Derivative contracts is not in dispute. Therefore, the observations of this Authority in regard to exchange traded derivatives cannot be faulted. 22. Coming to SEBI (FII Regulations 1995), Regulation 15 deals with 'Investment Restrictions'. Regulation 15(1) in so far as it is quoted below : Investment restrictions 15(1) A foreign institutional investor may invest only in the following: (a) secu....
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.....2007 shows that a resolution has been passed inter alia to purchase, sell, issue, underwrite and otherwise deal in securities (including equity and debt securities, options and futures). 25. What remains to be considered is Section 115AD on which the Revenue has placed strong reliance seeking support from certain observations made in Fidelity North Star. 26. Section 115AD bears the heading "Tax on income by foreign institution investors from securities or capital gains arising from their transfer". The relevant portion thereof is extracted below: Section 115AD (1) Where the total income of a foreign institutional investor includes- (a) income, other than income by way of dividends referred to in section 115-O received in respect of securities (other than unit referred to in section 115AB); or (b) Income by way of short-term or long term capital gains arising from the transfer of such securities, the income-tax payable shall be the aggregate of - (i) the amount of income-tax calculated on the income in respect of securities referred to in clause(a), if any, included in the total income, at the rate of twenty per cent; (ii) the amount of income-tax calcula....
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....ing securities, i.e. dividend, interest, etc. like fruits from tree and is not intended to cover income on account of transfer of securities. In fact, there is a clear indication in the Section itself that the business income is not covered by the said section. It is pointed out that the very fact that deductions under sections 28 to 44 C are not allowed under sub-section (2) of Section 115AD is indicative of the fact that business income is not intended to be brought within the scope of cl (a) of sub-section (1). It is also pointed out that the applicant does not have a business place in India so as to generate business income. It is further contended that the expression 'income is received' necessarily excludes business profits. Another point made out is that if section 115AD is construed as including business income, it will be in the teeth of SEBI Regulations in as much as those regulations will be violated. The interpretation which results in such violation should be avoided. 28. None of the above contentions of Revenue based on Section 115AD have any force. It appears to us that the purpose and purport of Section 115AD is to provide for special or concessional rate of taxa....
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....rgument of the learned counsel for the Revenue that clause (a) of sub-section(2) which excludes the deduction admissible to business income a clear pointer that income on account of trading in all types of securities is not contemplated by section 115AD does not appeal to us. The obvious reason for enacting sub-section (2) is to ensure that the assessee (FII) shall not have enjoyed the double benefit of concessional rates as well as deductions. In fact sub-section (2) may militate against the contention of the Revenue because the said provisions has been inserted on the premise that the income under clause (a) of sub-section (1) can be in the nature of business income. Thus viewed from any point of view, we do not find any substance in the Revenue's arguments based on section 115AD. 29. There is yet another angle from which the issue can be viewed. Irrespective of the provisions of the domestic law i.e. IT Act, the applicant can also seek the benefit of the treaty provisions. If the income derived by the applicant can be characterized as business income rather than the capital gain, such income cannot be taxed in India in the absence of permanent establishment. If, on the other ....