Brief of the Case
Authority for Advance Rulings held In the case of Lead Counsel of Qualified Settlement Fund (QSF), USA, that it is clear that even if right to sue is considered as 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’. Further the income in the nature of settlement amount in lieu of surrender of ‘right to sue’ is not covered in section 56 (1). Therefore, the question of treating the same as income from other sources would not arise at all. In the circumstances, the issue of taxability of QSF being a separate legal entity as per US law or being assessable as representative assessee in India becomes irrelevant. The QSF is merely acting as a custodian of the amount to be distributed to authorized claimants after the order of the US court is available. Such amount can be characterized Custodia Legis only and is not to be considered for tax purposes.
Facts of the Case
The Satyam Computers Services Limited is an Indian company incorporated under the Companies Act, 1956. Its shares were listed on the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). In May 2001, it issued 14.5 lakhs American Depositors Shares (ADS) which were listed on the New York Stock Exchange (NYSE). In May, 2005 it issued another 130.41 lakhs ADS and listed on NYSE. On 7.1.2009, the then Chairman of Satyam filed a letter to the Board of Directors admitting that the company’s balance-sheet was inflated on account of false inflated receipts, incomes and profits over several years. As a result of public disclosure of this fraud, the prices of. Satyam ADS fell on NYSE from USD 9.35 on 7.1.2009 to USD 1.14 on 9.1.2009. Several US investors of Satyam filed suits against Satyam in various jurisdictions in United States claiming damages. All these suits were consolidated on 9.4.2009 by the United States judicial panel on multi district litigation into one proceeding in the United States Court.
The Plaintiffs claimed that as a direct and proximate result of wrongful acts and misconduct of Satyam and its auditors, the plaintiffs suffered damages for which Satyam and other defendants were liable. On 16.2.2011 a settlement agreement was arrived at between Lead Plaintiffs and Satyam whereby in lieu of Satyam paying US dollar 125 million, the Lead Plaintiffs and the class members agreed to release and waive their claims against Satyam. Following the announcement of the Satyam settlement, PWC entities and Lead Plaintiffs commenced negotiations regarding claims against PWC entities. Subsequently the PWC entities also entered into the settlement agreement to eliminate the burden, expense, uncertainty and distraction of further litigation and agreed to pay US dollars 25.5 millions as a consideration for their release in terms of the stipulations
As per the scheme of payments when the amount was kept in segregated account in Indian currency in India, Satyam/PWC remained owner of such account. When the amount was transferred to Initial Escrow Account in US, the amount still remained the property of Satyam and it was only when the amount was transferred to Final Escrow Account, the amount did not remain the property of the Satyam. Further, as per Settlement agreement. all funds in the Initial Escrow Account or Final Escrow Account shall be deemed to be in the custody of the US Court and shall remain subject to the jurisdiction of the US Court until these are disposed of under orders of the US Court. It is only upon transfer into the Final Escrow Account that the settlement funds became Qualified Settlement Fund (QSF). Under US Treasury Regulations, a QSF is a fund, account or trust established pursuant to US Court Order to resolve or satisfy contested or uncontested claims arising out of a tort, breach of contract, or violation of law, subject to continuing jurisdiction of US Court. QSF is a separate taxable entity under US Tax Law. However, the amount transferred to QSF to resolve or satisfy a disputed law is excluded from its gross income for US tax purposes.
In this case the rulings were pronounced on 27.8.2012 holding that the settlement amount will be regarded as sum chargeable to tax as required under section 195 of the Act and the deduction of the tax will be made by the payer when the amount is moved from the segregated account in India to the initial Escrow Account in the US. Satyam had already transferred USD 125 million from the segregated account in India to Initial Escrow Account in New York on 27.04.2011. After the ruling payer i.e. Satyam, deducted the tax @ 30% from amount lying in Initial Escrow Account and paid to the Government Account. The balance of the amount was transferred to the Final Escrow Account opened by Lead Counsel in USA and it became Qualified Settlement Fund (QFS).
The question Nos. 2, 3, 4 & 5 relate to deduction of tax at source on the transfer of the settlement amount to the QSF and on further distribution of this amount by QSF to the authorized claimants. In view of the fact that taxes have already been deducted at source in accordance with the rulings given, the only question which survives is question No.1. The taxes have been deducted by the payers and refund, if any, can be paid to QFS only on filing of returns of income. The TDS certificates are issued by payer-deductor and the Revenue has no role in this. There is no provision in the Income-tax Act by which a payer can obtain refund. Therefore, all issues raised by the applicant now relating to wrong deduction of tax at source by payer and non-issue of TDS certificate are not relevant and has no bearing on the main issue, i.e. whether the settlement amount payable by Satyam to the QSF can be regarded as sum chargeable in the hands of QSF under the provisions of the Act. While setting aside the earlier ruling, the Hon’ble High Court has also asked this authority to examine the position, first of all, in the light of whether the receipts were in the nature of capital receipts or revenue receipts and thereafter to determine as to whether those receipts were chargeable to income-tax in India.
Submission of Applicant
The applicants have submitted that the transfer of funds in the Segregated Account remains the property of Satyam and Section 195 of the Act relating to the deduction of tax at source was not attracted. As per paragraph 1(x) of the Settlement Agreement the settlement amount and earnings thereon in the Initial Escrow Account also remains property of Satyam and Section 195 was not attracted at this stage also. After transfer of amount to the Final Escrow Account the legal title over the settlement amount gets transferred to QSF. However, QSF is a pass through entity and the settlement amount remains with QSF till a competent Court decides on the legal claims to such amount. The applicants have argued that such amount is a capital receipt in the hands of QSF and not its income and even though QSF is a separate taxable entity, settlement amount is not its income either in United States or in India.
He further submitted that at the time when the Settlement amount was transferred to the QSF, the identities of the eventual authorized claimants were not known and there was no payment or credit to the account of any person liable to be assessed to tax. The applicants have relied upon the judgment of Hon’ble Supreme Court in the case of GE India Technology Centre Private Limited vs. CIT 2010 327 ITR 456 (SC) and UCO Bank vs. Union of India 2014 369 ITR 335 (Delhi). The applicants have mentioned that after the ruling dated 27th August, 2012 Satyam was directed by the Income Tax Department to deduct tax on the settlement amount but at that time the identities and shares of amount of eventual claimants were not known and in such a situation there would be no liability of TDS under Section 195 because the amount payable to the non-resident had not became due. The applicant has put its reliance on judgment in ACIT vs. Motors Co.(2001)249 ITR 141 (Karnataka).
According to the applicants the Settlement Amount is capital receipt. Complaint filed by Lead Plaintiffs shows that the wrongs alleged in the complaint related to filing of false and fraudulent statements by Satyam as a result of which the Plaintiffs were defrauded into payment of inflated prices on purchase of Satyam securities. Therefore, they exercised their right to sue Satyam/PWC in US for damages under US Laws for injury caused to them in US. The applicants have argued that the settlement amount is a compensation received by Plaintiffs in lieu of their agreeing not to pursue the class action complaint and it is a capital receipt in the hands of both QSF and the authorized claimants. The applicants have further submitted that this amount is not for making good any lost income as the class action did not allege any loss of income due to normal price fluctuations in stock exchanges. On the question of distinction between capital and Revenue receipt, the applicants relied upon the judgment in Kettlewell Bullen and Co. Ltd. vs. CIT (1964) 53 ITR 261 SC and Bombay- Burmah Trading Corpn. Ltd. vs. CIT (1971) 81 ITR 777 (Bombay).
According to the applicants the Settlement Amount neither arises nor accrues nor can be deemed to arise or accrue in India under section 5(2) of the IT Act and the right to receive the Settlement Amount accrues in favour of QSF only on the US Court passing the final judgment and, therefore, such right accrued in the US and not in India.
The applicants have further argued that a mere right to sue is not a capital asset from which capital gains can arise. A mere right to sue is neither an actionable gain nor ‘property of any kind’ and, therefore, is not a capital asset within the meaning of Section 2(14) of the Income-tax Act. Reliance has been placed on the judgment in Union of India vs. Raman Iron Foundry, AIR 1974 SC 1265. It has been further stated that a mere right to sue cannot be transferred and it has no cost of acquisition.
The applicants have further stated that the Settlement Amount cannot be taxed as ‘income from any other source’ as the Settlement Amount allowed the Plaintiffs to partially recoup their losses and the estimated recovery was USD 1.36 per ADS against issue prices of 9.71 USD per ADS in May 2001 and USD 21.50 per ADS in May 2005. Therefore, there was no income that could be taxed under the head ‘Other Sources’.
Submission of Department
The Department has pointed out that the amount was paid by Satyam to QSF, which is a legal entity under the US Law and would also be an assessable entity under the Indian Law as an artificial jurisdictional person or as an association of persons deriving its existence from the laws of the United States and, therefore, it is incorrect to suggest that TDS machinery has failed in this case. In fact, the machinery has already worked. It is open to Satyam to issue certificate of tax deduction to the payees who are taxable entities in their own rights and also in their representative capacity representing a class of Members.
The Department has further submitted that Indian tax laws also stipulate the initiation of proceedings and making of assessments of persons in respect of income of other persons in respect of which they are assessable as Representative Assessee. The definition of “assessee” in section 2(7) includes representative assesses. The provisions contained in sub-clauses (i) and (iii) of Section 160(1) clearly provides for the circumstances under which an entity may be regarded as representative assessee and the entire procedure/machinery for levy and collection of taxes is applicable to such representative assesses by virtue of the provisions contained in section 161.
According to the Department, the claim of the recipient, with regard to the settlement amount, is against the ‘lost income’. Satyam was in no way concerned with the loss of capital (Share or ADs in this case) of the claimants. The shares had already been sold by the investors on their own. The damages were determined / settled long after the sale of the asset (shares or ADs). Hence, the compensation payable by Satyam was in no way related to the loss of income generating asset (shares) but to the income which the investors would have earned from the asset (if the fraud had not taken place).
As regards capital gains, the Department submits that the income payable by Satyam may not be characterized as capital gains since it is paid as compensation for the loss of income to the payees arising as a result of fraud and manipulations of accounts done by Satyam. It is not paid in consideration for transfer of any capital asset (which by its very definition in section 2(14) would include property of any kind extending the scope to all rights and entitlements). Hence the income not being exempt in section 10 (Chapter III) and not falling under any other head would need to be characterized as “Other Income” chargeable to tax under section 56(1).
According to the Department the income accrued/arose in India. The judgment of the US Court was only one of the different options available to enforce the rights which existed in India, as the company was located in India and the fraud happened in India. The efficacy of the option and its final choice would not alter the place of accrual. The proximate cause of the compensation was the fraud and misrepresentation happening in India. The agreement between the parties on the amount of compensation was to compensate for the damage suffered as a direct consequence of fraud. In terms of section 9(1) (i) of the Act, any income arising directly or indirectly through or from an asset or source of income in India shall be deemed to arise in India.
Held by AAR’s
The AAR held that complaint filed by Lead Plaintiffs before the US Court was in respect of the fraud committed by Satyam by filing various false annual reports and quarterly reports before US authorities for 2004 and 2005 along with a certificate of verification by PWC to artificially inflate market price of its securities. This action caused injury to non-resident investors who paid high premium for ADS which were traded on NYSE and not in India. Thus, these torts were committed by Satyam and PWC in USA and for this reason SEC had the jurisdiction to levy penalty. The settlement agreement clarifies that Satyam entered into the settlement without any admission of any wrong doings on its part and to enhance its credibility and business opportunities in the US. On the other hand, the plaintiffs entered into the settlement recognizing the inherent risks associated in prosecuting a complex action of this nature through trials and appeals etc. The final judgment of the US Court dated 13.09.2011 is a decree issued by the Court under US Federal Rules of Civil Procedure. The Court directed that lead plaintiffs and Members of class shall be deemed to have fully and finally released and discharged their claims under Satyam. It is clear that the settlement amount is a compensation received for not pursuing the class action complaint and liability of Satyam arose only after the decree of the US court.
In the case of CIT vs Barium Chemicals  31 Taxman 471 AP, a general principle was enunciated that if the payment is received in the ordinary course of the business for loss of stock in trade it is revenue receipt and if, on the other hand, the receipt is towards compensation for extinction or sterilization partly or fully of profit earning source (capital assets) such receipt not being in the ordinary course of the business, it must be construed as capital receipt. When this general principle to identify capital or revenue receipt is applied to the facts in this case, it is clear that the nature of settlement amount in the hands of QSF is capital only because this has been received not to compensate the loss suffered but in lieu of surrender of right to sue.
The Revenue has argued that the nature of income has to be examined from the perspective of payees of such income and according to them the claim of the recipient is against the ‘lost income’. It is not possible to accept the stand of revenue that the settlement amount is a claim against the ‘lost income’ on the ground that the compensation payable by Satyam was related to the income which the investors would have earned from the assets if the fraud had not taken place. It is also not possible to accept that the settlement amount represents higher realization value of shares and, therefore, would be revenue because the surrender of “right to sue” can never qualify as income.
The settlement amount received as per the Court Order is not a periodical monetary return. As it is against surrender of ‘right to sue’, it is not linked with income generating apparatus, i.e. shares of Satyam. It can also not be said that it relates to any sort of business activity carried on by the QSF. In the circumstances, the settlement amount has to be characterized as capital receipt. Once the character of receipt is capital in nature, it goes outside the scope of income chargeable to tax unless it is specifically brought within the ambit of income by way of specific provisions of the Income-tax Act.
The most important point here is that we have to consider the nature of receipt in the hands of QSF which is not doing any activity to earn such receipt which may qualify as income. QSF is not in the business of suing and seeking settlement amount. Surrender of ‘right to sue’ has also been made by investors and not by QSF. Under no circumstances the theory of loss of future income would apply to QSF as neither is it owner of neither ADS nor it is doing any business relating to ADS. We are required to give ruling whether settlement amount in the hands of QSF is chargeable to tax. We are not considering whether investors were doing any business of purchase and sell of shares. In any case the settlement award to investors also has been given only because they have agreed not to pursue the complaint. QSF is only custodian of this amount till it is finally disbursed.
Whether settlement amount can be treated as capital gains in the hands of QSF
Section 2(24) specifically includes “(vi) any capital gains chargeable under section 45” within the ambit of income. Thus a capital receipts would be chargeable to tax only if it falls under section 45 of the Act (as capital gains) though capital receipt as such is not taxable. This principle was described by the Income Tax Appellate Tribunal (Mumbai) in Dhruv N. Shah v. Commissioner of Income Tax 88 ITD  118. In this case, it was held that all receipts are not taxable under the Income Tax Act. Section 2(24) defines “income”. It is no doubt that this is an inclusive definition. However, a capital receipt is not income under section 2(24) unless it is chargeable to tax as capital gain under section 45. It is for that reason that under section 2(24) (vi), the Legislature has expressly stated, inter alia, that income shall include capital gain chargeable under section 45. Under section 2(24) (vi), the Legislature has not included all capital gains as income. It is only capital gain chargeable under section 45 which has been treated as income under section 2(24).
Further, section 2(14) defines Capital Asset to mean “property of any kind held by an assessee, whether or not connected with his business or profession”. Section 6 of the Transfer of Property Act states that “property of any kind may be transferred, except as otherwise provided by this Act or by any other law for the time being in force.” Section 6 (e) notes that “a mere right to sue cannot be transferred”. Therefore, a ‘right to sue’ is property and thus Capital Asset as defined under section 2(14) of the Act but is not transferable. There cannot be any transfer of a right to sue under Indian law and any capital receipt arising from a right to sue cannot thus be considered capital gains under section 45.
So, it is clear that right to sue may be considered for the purpose of capital gains within the terms of section 45 of the IT Act 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 BC Srinivasa Setty1981 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.” It is clear that even if right to sue is considered as capital asset covered under the definition of transfer within the meaning of section 2(47) of the IT Act, 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’.
According to Revenue all kinds of income, which are not exempt and which are not chargeable under other heads (profit, salary, business and capital gains) would be taxable as other income and the amount paid by Satyam not being exempt in section 10 of the Act (Chapter III) and not falling under any other head would need to be categorized as other income chargeable to tax u/s 56(1) of the Act. There is no force in this argument. The income in the nature of settlement amount in lieu of surrender of ‘right to sue’ is not covered in this. Therefore, the question of treating the same as income from other sources would not arise at all.
Finally, QSF has no ownership over the amount. In the circumstances the issue of QSF being a separate legal entity as per US law or being assessable as representative assessee in India becomes irrelevant. The QSF is merely acting as a custodian of the amount to be distributed to authorized claimants after the order of the US court is available. Such amount can be characterized Custodia Legis only and is not to be considered for tax purposes.
Accordingly, the settlement amount is not chargeable to tax either as capital gains or as income from other sources. The settlement amount in the hands of the QSF is not chargeable to tax.