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January 9, 2007
The
Authority for Advance Rulings overturns its own decisions
The
Fidelity group held taxable in India after all
Deviating from its own rulings in earlier cases,
the Authority for Advance Rulings (“AAR”) held, in the
matter of 39 American and Canadian Fidelity group entities, that
the income of a Foreign Institutional Investors (“FII”)
would be characterized as capital gains and not business income -
suggesting that FIIs may legally only invest in shares and
not trade in shares.
This position not only differs from the decisions
of the AAR in the matters of In
re: Fidelity Series VIII and In
re: General Electric Pension Trust, but also appears to
digress from the soon to be finalized draft
instructions issued by the Central Board of Direct Taxes (“CBDT”)
on the various factors that would be determinative of the nature
of income from trading in shares as ‘income from business’.
This is surprising given that the structure and method of
operation of the Fidelity entities in these cases was
substantially similar to that followed by the applicants in the
earlier cases, in respect of which the AAR had held that income
from transacting in securities on a frequent
basis would be business income. This new decision appears
to deviate from various classic judgments, including decisions of
the Supreme Court.
Although an advance ruling is binding only on the
tax department and the applicant in the matter, the decisions of
the AAR no doubt have persuasive value in all other similar cases.
The tax department is likely to use this new decision of the AAR
to revisit the tax treatment of the income of all FIIs. The AAR
had so far taken into account the volume and frequency of trade,
manner and method of operation, etc and ruled that the income of
FIIs being its ‘business income’ would not be taxable in India
in the absence of a permanent establishment (“PE”)
under the applicable tax treaty.
As a result, FIIs, especially from treaty countries such as
the USA were not taxable in India in the absence of a PE. This has
apparently changed.
Now, irrespective of the existence of a PE in
India, capital gains from trading in Indian shares would be
taxable in India. The FIIs that will not be adversely effected by
this ruling are those investing through jurisdictions like
Mauritius or Singapore.
While one hopes that this will not unsettle the
booming Indian capital markets, it must be noted that the decision
is indeed a blow to the ends of stability and certainty in
taxation of non-residents; the end with which the AAR had been
constituted.
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