- The applicant is a public company incorporated in Canada. It is engaged in the business of banking and other financial services. It also trades in securities (including derivatives) in various parts of the world.
- The applicant is registered as a Foreign Institutional Investor (FII) with Securities Exchange Board of India (SEBI) and is mainly dealing in the derivatives segment of the Indian Stock Exchanges.The applicant is trading in stock / index futures and stock / index options. It has also proposed to undertake the purchase and sale of shares and futures that are carried on as a part of an ?index arbitrage activity?.
- The applicant sought a ruling on following issues:
(i) whether the income from futures and options contracts (derivative transactions) and income from trading in equity shares or other securities are in the nature of Business Income; and
(ii) In the absence of its Permanent Establishment (PE) in India, whether the above referred business income would be taxable in India.
Contentions of the Applicant
- The derivative transactions are undertaken as a part of trading activities i.e. the object in purchasing derivative is to resell them at an appropriate time and earn income. At times the applicant sells the derivatives and buys them later. The number of transactions undertaken is substantial and carried out frequently. Therefore, the character of income from this source should be ?Business income?.
- The representative office of the applicant in India does not play any role in carrying out the transactions in derivatives etc. The applicant has no PE in India and hence its business income from trading in derivatives, shares and other securities on Indian Stock Exchanges is not taxable in India in terms of the Article 7 of the tax treaty between the India and Canada.
Contentions of the Revenue
- Under the SEBI and Foreign Exchange Regulations the FII‘s are only allowed to make ?investments‘ in the capital market in India. They can operate in India only as investors and not as traders in securities. The trading of derivatives on stock exchanges would also amount to an investment activity and the income earned from such an activity would be capital gains.
- Section 1 15AD (see note 1 below) is a self contained code applicable to the FIIs which contemplates income of FII‘s from dividend, interest and capital gains only and not business income. FII‘s cannot have any income outside section 115AD. The applicant‘s income from trading in derivatives! Shares/ securities has to be brought within the purview of section 115AD and therefore chargeable to tax as capital gain.
Ruling of the AAR
- On contextual interpretation under the SEBI Regulations, the expression ?investment‘ has to be understood in a broad sense and in conjunction with the word ?traded on‘. Investment in derivatives does not necessarily exclude trading transactions.
- The purpose and purport of Section 11 5AD is to provide for special or concessional rate of taxation in relation to income received or arising from the securities of FII‘s. The income referred in clause (b) of sub section (1) of section 11 5AD (see note 2 below) includes income by way of short term or long term capital gain on account of transfer of securities. The income in clause (a) includes income other than dividend received ?in respect of securities?. The expression ?in respect of? is of wide import, synonymous with the expression ?in connection with‘ or ?in relation to‘. The fact that capital gain arising from transfer of securities is dealt in clause (b) does not preclude transfer of securities in the course of trading outside the ambit of clause (a) of section 11 5AD.
- There is no warrant to place a restricted construction on clause (a) of sub-section (1) of section 11 5AD that only the income on account of holding the securities is covered by clause (a).
- The characterisation of income is also essential from the perspective of tax treaty. This classification has to be done in accordance with the ordinary and well settled principles. A special provision in the domestic tax law cannot be pressed into service to deny the benefit which is otherwise due to FII under the tax treaty provisions notwithstanding their conflict with the domestic law of income tax.
- Derivatives have short life and they do not yield any income like dividends and therefore investment of money to derive income is not feasible. Income can be derived only on their sale and purchase. Therefore profits/ losses from futures and options are in the nature of business income. In the absence of PE in India the applicant is not chargeable to tax in India on its business income.
- Even though advance ruling can be sought in respect of transactions ?proposed to be undertaken‘ but where the determination of question depends on assessment of crucial facts and modus operandi of transactions, it would not be appropriate to give a definite ruling. Therefore, on the proposed income from trading in equity shares/ trad able securities in futures, the actual facts need to be analyzed to decide the actual state of affairs. Hence, no ruling given on question of characterization of income from proposed transactions.
FII‘s income from trading in futures and options is in the nature of business income. Special provisions under the domestic tax laws i.e. Section 115AD does not preclude FII‘s from earning business income in India.
Source: M/s Royal Bank of Canada, AAR No. 816/2009 (Authority for Advance Ruling) dated 22 March, 2010.
1. 115AD provides for tax on income of FII‘s from securities or capital gains arising from their transfer.
2. 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