Income of foreign institutional investors (FIIs) from derivatives trading will not be liable to tax in India, the Authority for  Advance Rulings has said, clearing the air on taxability of the income of foreign investors trading in Indian securities.

The ruling will help FIIs undertaking similar transactions subject to the provisions of the tax treaties with their respective countries, say tax experts. The AAR’s ruling comes in response to a plea by Royal Bank of Canada, registered with market regulator Securities and Exchange Board of India as a FII, seeking clarity on whether profit or loss from trading in securities, including derivatives, will be treated as business income and be liable to tax in respect of India-Canada Double Taxation Avoidance Agreement.

“Its been a long pending debate between tax authorities and tax payers, especially foreign investors whether the income arising in respect of securities derivative transactions is in the nature of business income or capital gains…lots of cases have been filed on these issues and the current judgement clarifies, based on the facts of Royal Bank of Canada, that in the absence of a permanent establishment the income arising from such transaction will not be subject to tax,” said Vikas Vasal, partner, KPMG.

The revenue department’s contention that the income from such activities was capital gains and hence liable to tax in India was rejected by the Authority. The authority said the profit and loss was earned by the applicant out of trading activity.

Also, the Royal Bank of Canada does not have a permanent establishment or fixed place of business in India and as per the provisions of the India-Canada tax treaty its income could not be taxed here.

It may be pointed that most FIIs in India invest via Mauritius route to enjoy the capital gains tax exemption available under Indo-Mauritius tax treaty. In such a case profits and loss from such trading are treated as capital gains or loss. However, when an entity comes from any other country the provisions of the tax treaty with that country comes into play and investors usually treat income from such activity as business income which does not have to face tax if there is no PE.

Therefore facts of each case need to be examined in detail in order to determine whether the activity per se is to be treated as a business transaction or an investment transaction. In case its is determined that these are in nature of business income the next issue to be examined is whether the foreign investor has a business connection or a permanent establishment in India for taxability of the same. If it is established that there is now PE in India then generally the business income arising there from would not be subject to tax subject to provision of relevant tax treaty. If it the PE exists then profit attributed to such PE only will be subject to tax in India.

The AAR is a quasi-judicial body, set up to give opinion to guide companies on their potential tax liabilities. While rulings by the AAR are case-specific, they have a persuasive impact on tax assessment in cases of other firms under similar circumstances.

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June 2021