Writ petition No. 866 of 2010 filed with the Bombay High Court
Prudential Assurance Company Limited (‘the Petitioner’ or ‘the Company’), a sub-account duly registered with the Securities and Exchange Board of India (‘SEBI’) filed a writ petition (Writ petition No. 866 of 2010 ) with the Bombay High Court against the show -cause notice issued under section 263 of the Income Tax Act, 1961 issued by the Commissioner of Income-tax (Commissioner). The Commissioner was seeking to revise an assessment order determined on the basis of a ruling of the Authority for Advance Ruling (‘the AAR’) in the case of Fidelity North star Fund (AAR No. 678/2006).
The Bombay High Court has quashed a show-cause notice issued by the Commissioner and held that the assessment order passed by the Assessing Officer (AO) after applying the AAR ruling in petitioner’s own case, cannot be regarded erroneous or prejudicial to the interests of the tax department.
Further, the High Court also observed that as per section 245S of the Income-tax Act, 1961 (the Act), the ruling in the case of Fidelity North star Fund cannot displace the binding character of the advance ruling rendered between the Petitioner and the tax department.
Facts of the case
· The petitioner, a company incorporated in United Kingdom, is engaged in the business of insurance. In India, the company is registered as a sub-account of a Foreign Institutional Investor (‘FII’) with SEBI and is engaged in making portfolio investments i.e. the activity of buying and selling the Indian securities and such activity forms part of its insurance business.
· The company had obtained a ruling from the AAR in the year 2001 (AAR No. 445/98) wherein it was held that purchase and sale of shares by it was in the ordinary course of business and the income which resulted from such activity comprised ‘business profits’ and not ‘capital gains’. The AAR held that gains from realization of portfolio investments in India shall be treated as part of the company’s business profits and not taxable in India in accordance with the provisions of Article 7 of the India-UK tax treaty, as the company did not have a permanent establishment in India.
· Further, the Assessing Officer had duly examined the claim of the company in the returns of income filed for Assessment Year (AY) 2004- 05 and 2005- 06 during the course of assessments/ reassessments and issued favorable reassessment orders.
· Subsequently, Commissioner framed an opinion that these orders were erroneous and prejudicial to the interests of the tax department and issued a notice under section 263 of the Act to the company requiring it to show cause why the assessments for AY 2004- 05 and AY 2005- 06 should not be set aside. The Commissioner relied on the decision of the AAR in the case of Fidelity where it has held that profits derived on account of purchase and sale of equities is capital gains and chargeable to tax accordingly. The AAR in the case of Fidelity had also observed that FIIs are not permitted to trade in equities.
· Thus, in his view, the subsequent ruling clarifying the position on the subject as to the tax ability of and nature of income was applicable to the facts of the company case.
Issues for consideration before the Bombay High Court
· Can the benefit of a favorable ruling obtained by the company be denied by the tax authorities as a result of a contrary ruling issued by the AAR in another applicant’s case?
· Is Commissioner justified in invoking revisionary powers under section 263 of the Act to set aside the orders issued by the AO who has followed a binding ruling obtained by the applicant from the AAR under section 245S of the Act?
· A ruling rendered by the AAR is binding on the applicant who has sought it; in respect of the transaction in relation to which it is sought; and on the Commissioner and the income tax authorities subordinate to him, in respect of the applicant and the said transaction (Sub-section (1) of section 245S of the Act).
· An advance ruling shall be binding unless there is a change in law or facts on the basis of which the advance ruling has been pronounced (Sub-section (2) of section 245S of the Act).
· The Assessing officer had followed the binding ruling of the AAR in the company own case.
· The Commissioner cannot seek recourse to the jurisdiction under section 263 of the Act, where the AO has followed a binding ruling issued under section 245S of the Act.
· The ruling in the case of Fidelity could not constitute a change in law for the purposes of section 245S(2) of the Act.
Tax department’s contentions
· Only a notice has been issued under section 263 of the Act and there is no reason for the High Court to exercise its extra ordinary jurisdiction under Article 226 of the Constitution.
· The CBDT had issued a circular dated 15 July 2007 directing the Assessing Officers to evaluate whether, in a given case, shares are held by the assessee as investment or as stock-in-trade having regard to the pronouncement of the AAR in the Fidelity’s case. The Assessing Officer, not having done so, the Commissioner is justified in seeking recourse to his revisional jurisdiction under section 263 of the Act.
· Jurisdiction under section 263 of the Act is invoked on the basis that the AAR in its ruling in the case of Fidelity held that the profits derived on the account of the purchase and sale of equities are capital gains and are chargeable to tax accordingly.
High Court’s ruling
· Once a ruling has been pronounced by the AAR, its binding effect can only be displaced in accordance with the procedure which has been stipulated in law. Unless such happens, that ruling must continue to operate and be binding between the petitioner and the tax department.
· The Commissioner made a determination contrary to the plain language of Section 245S of the Act by holding that the ruling of the AAR in the case of Fidelity would apply to the case of the company.
· The ruling in Fidelity cannot possibly, as a matter of the plain intendment and meaning of Section 245S displace the binding character of the advance ruling rendered between the Petitioner and the tax department.
· Where the Assessing Officer has followed a binding principle of law laid down in a precedent which has binding force and effect, it is not open to the Commissioner to exercise his revisional jurisdiction under section 263 of the Act (Please See Note 1 below).
· The assessment order which gives effect to a binding precedent, in this case of the AAR, cannot be regarded as being erroneous or as being prejudicial to the interests of the tax department.
· Since the invocation of the jurisdiction was not proper, the company should not be relegated to pursue the proceedings initiated under Section 263 of the Act.
· The High Court quashed the show cause notice issued under section 263 of the Act treating the jurisdiction exercised as improper.
· The High Court did not inquire into the correctness of the ruling of the AAR obtained by the company having regard to the nature of the jurisdiction exercised by the Commissioner and left it open to the tax department to take recourse to such remedies in law in respect of the ruling of the AAR.
· The High Court reinforced the principle of law that the AARs are binding on the assessee, the Commissioner and its subordinate authorities; merely because there is an adverse ruling of the AAR in some other case with similar facts, the circumstances does not vitiate the binding nature of the earlier AAR.
· The Commissioner cannot exercise revisionary powers under section 263 of the Act in such situations since subsequent adverse ruling of an AAR on similar facts and circumstances cannot be regarded as change in law as contemplated under section 245S of the Act.
· The High Court has not dealt with the issue of business income versus capital gains on merits but only on the jurisdiction of the
The principle was laid down in the judgement of the Calcutta High Court in Russel Properties Pvt Ltd. Vs. A. Choudhury, ACIT, West Bengal (1977) 109 ITR 229 (Cal) which was followed by Divisional Bench of Bombay High Court in CIT Vs. Paul Brothers (1995) 216 ITR 548 (Bom) and Rajan Ramkrishna Vs. Comm. of Wealth Tax, Gujarat (1981) 127 ITR 1 (Guj).