Brief of the Case
Authority for Advance Rulings held In the case of Aberdeen Claims Administration Inc., USA and Aberdeen Asset Management Plc., UK that there is no doubt that the settlement amount is relatable to Satyam shares, i.e., if shares would not have been purchased the question of class action or right to sue would not have arisen. However, this does not mean that the settlement arrived with the approval of the US Court is to compensate business receipt of Aberdeen investors. The fact remains that the Aberdeen investors entered into a settlement agreement with Satyam considering the time, effort and costs involved in litigation and the agreement provided for a full, final and complete resolution of all claims asserted. The Aberdeen investors fully, finally and forever waived, released, discharged and dismissed each and every of their legal claims against Satyam and PwC. This was also agreed vice versa. It is clear, therefore, that the settlement amounts have been received not as part of business profit or to compensate the future income but as a result of surrender of the claim against Satyam and PwC. Surely, even in accordance with the principle of surrogatum such amount is not assessable as income because it does not replace any business income. In the light of above it is concluded that the settlement amount received by Aberdeen investors is not taxable under the provisions of the Income-tax Act.
Facts of the Case
The issues involved in all three applications relate to taxability of the settlement amount received from Satyam Computers Services Limited (Satyam) and Price Water House Coopers (PWC) under the provisions of the Income-tax Act, 1961.
Aberdeen Claims Administration Inc., USA
Twelve mutual funds, USA were holders of American Depository Shares (ADS) (ADS Holders) of Satyam Computer Services Ltd. (Satyam). Also seven mutual funds, United States were holders of ordinary equity shares (Equity Holders) of Satyam. On January 7, 2009, Ramalinga Raju, the then Chief Executive Officer of Satyam confessed that Satyam’s financial results had been manipulated and inflated over a period of years. PricewaterhouseCoopers (PwC) played a key role in preparing and auditing Satyam’s financial statements as well as Securities Exchange Commission (SEC) filings.
As a result of the public disclosure of the contents of the letter, the value of ordinary equity shares and ADS of Satyam dropped precipitously, forcing the ADS and Equity Holders (collectively, “Aberdeen Investors”) to dispose of their entire shareholding by two transactions dated January 7, 2009 and January 9, 2009. This actionable conduct of Satyam and its directors, gave rise to legal claims by the Aberdeen Investors against inter alia Satyam and PwC (Legal Claims).
The Aberdeen Investors thus decided to establish two Trusts, namely, Aberdeen Claims Trust and Aberdeen Claims Trust (II) (together referred to as ‘claims trust’) and granted, assigned, conveyed and transferred the aforesaid Legal Claims to the trust (“Assigned Claims”), while retaining all beneficial interest in the Trust. Aberdeen US, as a trustee of the Claim Trusts, initiated a civil action against inter alia Satyam and PwC. Aberdeen US estimated that the total of Aberdeen Investor’s losses for which recovery was sought would exceed US $68 Million.
Subsequently, Aberdeen US and PwC and Aberdeen US and Satyam entered into two separate Settlement Agreements dated July 18, 2012 and July 27, 2012 respectively. Under the terms of the Aberdeen US-Satyam Settlement Agreement, Satyam agreed to pay a total principal settlement amount
of US$ 12,000,000 to Aberdeen US and The Aberdeen-US fully, finally and forever waived, released, discharged and dismissed each and every of their Legal Claims against Satyam and agreed to be forever barred and enjoined from commencing, instituting, prosecuting or maintaining the Legal Claims. This was also agreed vice-versa. Both Satyam and the Aberdeen Investors extinguished their mutual legal claims.
Satyam transferred a sum of Primary Settlement Account to an Escrow Account, maintained with Citibank N.A at New York (“Escrow”). It was agreed between the parties these Escrowed Funds remained the property of Satyam. Aberdeen US agreed to file the present application to seek an advance ruling regarding taxability of the Primary Settlement Amount and if occasioned, the Supplemental Consideration (Satyam Settlement Account).
Aberdeen Asset Management Plc., UK
Aberdeen UK is a listed UK company which manages and/or advice certain investment funds (Aberdeen investors) that had invested in Satyam Shares. After the confession of manipulation of accounts of Satyam by the then CEO Sri Raju, legal action was initiated by the Aberdeen investors against Satyam and finally Aberdeen investors entered into a Settlement Agreement with Satyam. Under the terms of the Settlement Agreement, An amount of US$ 68,000,000 (approximately INR 420 crores) is to be paid by Satyam to the Applicant for further distribution to the Aberdeen Investors to settle and resolve the Aberdeen Investors’ claims against Satyam. The Settlement Agreement provided for a full, final and complete resolution of all claims asserted or which could have been asserted by the Applicant/Aberdeen Investors with respect to the Released Claims.
Submission of Applicant
The stand of the applicants in all three applications is common. The main points of submissions of the applicants are – The Impugned Settlement Amounts would not qualify as “income” for the purposes of the Income Tax Act. The Settlement Amounts are neither received in the ordinary course of business of the Applicant, nor is the Applicant engaged in the business of suing and seeking settlement from third parties. The Impugned Settlement Amounts cannot be said to be deemed to accrue or arise in India in terms of section 9 which refers to only specific streams of income. Further, the impugned Settlement Amounts are not sourced in India, being linked to a law suit that arose outside India and not the underlying shares of Satyam and hence the territorial nexus principle is not fulfilled in that respect. The applicant has relied on the decision of the Privy Council in Commissioner of Income-tax, Bengal vs Shaw Wallace & Company (ILR 59 Cal 1343 At P. 1352).
The Impugned Settlement Amounts are capital receipt in the books of Aberdeen US which does not fall for consideration under section 45. Even if the Impugned Settlement Amounts fall for consideration under Section 45, no Capital Gains arise owing to failure of computation mechanism under Section 48. The Settlement Amounts are received by Aberdeen US as compensation for the injury inflicted on capital asset of the trading (Equity and ADS shares held by Aberdeen Investors) and do not fall for consideration under Section 45. The Gujarat High Court has accepted this in Baroda Cement and Chemicals vs C.I.T. (158 ITR 636) while examining the treatment of capital receipt from settlement and extinguishment of right to sue as Capital gains. The Hon’ble Supreme Court in Vania Silk Mills Pvt. Ltd. v. C.I.T. (191 ITR 647) has laid down that receipt on account of destruction of capital assets is not subject to capital gains.
The cost of acquisition and cost of improvement of a right to sue cannot be computed. In such a situation the mechanism for computation of Capital Gains under Section 48 of the ITA would fail in the present situation. The applicants have relied on the decision of the Supreme Court in CIT vs B.C. Srinivasa Setty (128 ITR 294).
The Primary Settlement Amount is not actually or constructively received by the Applicant in India under section 5 and/or of the ITA upon deposit in the Escrow. Clause 11 of the Aberdeen US Satyam Settlement Agreement provides that the Primary Settlement Amount when in the Escrow shall remain to be the property of Satyam. Clause 12 further provides that the Primary Settlement Amount shall be transferred to the Applicant only under limited circumstances upon receipt of (a) a joint instruction letter by Satyam and the Applicant, (b) a consent order by the relevant US court and (c) a copy of the ruling of the Hon’ble Authority in the above application.
Submission of Department
The main points in the response of the Revenue are – These Aberdeen Funds which are the recipients of the respective amounts of compensation from Satyam (the applicant being only a pass-through entity) are in the business of trading in securities and thereby earning profits. The mode of sharing of profit between the fund and the participants depends on the scheme of the fund and would not be a relevant factor to decide the nature of the activity. The loss was incurred by the Aberdeen Funds in the course of their business activities of dealing in securities.
The fact that the payment has been made through an award of a law suit or through a settlement with or without giving up the right to sue, cannot be determinative of the character of the receipt. The amount of the compensation was received in the course of business of the Aberdeen Funds. Hence, it would constitute a business receipt and would be part of their business profits.
No asset was destroyed in this case. Any fall in price of share cannot be regarded as destruction of asset. In fact, in the case of business of a mutual fund, rise and fall in prices of securities, be it for one reason or the other, is a normal business incidence and neither the rise in price creates an asset nor the fall in price destroys an asset.
The amount paid by Satyam is not for relinquishment or extinguishment of the right to sue but as a compensation for the loss of potential income suffered by Aberdeen Funds in the course of their business operations. The Revenue has relied on the judgment of Allahabad High Court in CIT vs Smt Shanti Meattle 1973 90 ITR 385 and decision in the case of CIT vs GR Karthikeyan 201 ITR 866 (SC).
Held by AAR’s
The AAR held that similar question was involved in application No. 1060 & 1070 of 2010 wherein we had analyzed various arguments relating to taxability of Settlement amount received from Satyam and PwC in similar circumstances, i.e., receipt of settlement amount as a result of settlement agreement and approval by the US Court after the complaints were filed in respect of fraud committed by Satyam/PwC. In that case we have finally held that right to sue may be considered for the purpose of capital gains within the terms of section 45 which is a charging section. However the charging section and the computation provisions under section 48 must go together. The Apex Court in the case of CIT vs B.C. Srinivasa Setty (1981 128 ITR 294) had considered this issue and held that the “Charging section and the computation provisions together constitute an integrated code. When there is a case to which the computation provisions cannot apply at all, it is evident that such a case was not intended to fall within the charging section”. The Apex Court also held that “none of the provisions pertaining to the head ‘capital gains’ suggests that they include an asset in the acquisition of which no cost of acquisition at all can be conceived”. It is clear that if right to sue is considered as a capital asset covered under the definition of transfer within the meaning of section 2(47) , its cost of acquisition cannot be determined. In the absence of such cost of acquisition, the computation provisions failed and capital gains cannot be calculated. Therefore, right to sue cannot be subjected to income tax under the head ‘capital gains’. The Revenue also agrees that settlement amount is not paid in consideration for any capital asset and cannot be characterized as capital gains. It is only as an alternative argument that they have brought the issue of capital gains.”
In this case also we reiterate our views expressed in above judgment as relevant facts are almost identical. The nature of settlement agreement in the case of Aberdeen US and Aberdeen UK is same and we take the same view in this case also that the nature of settlement amount is of capital receipt and it cannot be categorized as income. Further this amount has been received against surrender of right to sue which cannot be considered for the purpose of capital gains under section 45.
Principle of surrogatum (the settlement amount received for future profits surrendered)
There is no doubt that according to the surrogatum principle the character of receipt of an award of damages or of an amount received in settlement of a claim as capital or revenue depends on what such amount was intended to replace. If the replaced amount would not have been otherwise taxable, the settlement amount may also be not taxable. However, the surrogatum principle does not apply to amounts received pursuant to a fraud. Further, in this case two important facts are noted. One, there is no dispute that at the time of the investments in the shares of Satyam, Aberdeen investors were registered as FIIs under FII regulations with the securities Exchange Board of India (SEBI). FIIs are not carrying out any trade in securities and this position was settled by this authority in the case Fidelity Northstar fund, 2007 288 ITR 641. Therefore, the settled legal position is that FIIs are not engaged in trading business. The facts of the present three cases also show that the shares were purchased as investors and not as traders. In their books of accounts also they have treated this as capital investment. In the light of this even CBDT Circular No.4 of 2007 does not support the stand of Revenue that Aberdeen investors were engaged in trading business.
There is no doubt that the settlement amount is relatable to Satyam shares, i.e., if shares would not have been purchased the question of class action or right to sue would not have arisen. However, this does not mean that the settlement arrived with the approval of the US Court is to compensate business receipt of Aberdeen investors. The fact remains that the Aberdeen investors entered into a settlement agreement with Satyam considering the time, effort and costs involved in litigation and the agreement provided for a full, final and complete resolution of all claims asserted or which could have been asserted with respect to the released claims. The Aberdeen investors fully, finally and forever waived, released, discharged and dismissed each and every of their legal claims against Satyam and PwC. This was also agreed vice versa. It is clear, therefore, that the settlement amounts have been received not as part of business profit or to compensate the future income but as a result of surrender of the claim against Satyam and PwC. Surely, even in accordance with the principle of surrogatum such amount is not assessable as income because it does not replace any business income. In the light of above it is concluded that the settlement amount received by Aberdeen investors is not taxable under the provisions of the Income-tax Act.
Accordingly, the settlement amount received by Aberdeen investors is not taxable under the provisions of the Income-tax Act.