THE DDIT (IT)-4(1), MUMBAI V. M/S. LG AISAN PLUS LTD, MUMBAI

ITA 2691/MUM/2008

• Counselvise Citation: [2011] 140 COUNSELVISE.COM (IT) 49002 (ITAT-MUMBAI)
• Duration Of Justice: 3 year(s) 1 month(s) 9 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 27-05-2011
• Appeal Filed By: Department
• Order Result: Dismissed
• Bench Allotted: L1
• Next Hearing Date: 18-03-2010
• Assessment Year: 2004-2005
• Appeal Filed On: 17-04-2008
• Result in Favour of: Assessee
• Court: TRIBUNAL
• Department Lawyers: USHA S NAIR
• Keywords: Capital asset; Business income; Transactions in derivatives; Speculation loss; Futures and options; Speculative transactions; Set aside
• Section: 43(5)

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL, MUMBAI BENCH A,MUMBAI BEFORE SHRI R.S. SYAL (AM) & SHRI VIJAY PAL RAO (J M) I.T.A.NO.2645/MUM/2008 (A.Y. 2004-05)) M/S. LG ASIAN PLUS LTD., C/O. S.R. BATLIBOI & CO., 18 TH FLOOR, EXPRESS TOWERS, NARIMAN POINT, MUMBAI-400 021. PAN: AAACL8243K VS. ASST.DIRECTOR OF INCOME-TAX (INTERNATIONAL TAXATION)-3(2), 1 ST FLOOR, SCINDIA HOUSE, BALLARD PIER, MUMBAI-400 038. APPELLANT RESPONDENT I.T.A.NO.2691/MUM/2008 (A.Y. 2004-05) ASST.DIRECTOR OF INCOME-TAX (INTERNATIONAL TAXATION)-4(1), 133, SCINDIA HOUSE, BALLARD PIER, MUMBAI-400 038. VS. M/S. LG ASIAN PLUS LTD., C/O. S.R. BATLIBOI & CO., 18 TH FLOOR, EXPRESS TOWERS, NARIMAN POINT, MUMBAI-400 021. PAN: AAACL8243K APPELLANT RESPONDENT DEPARTMENT BY MS. USHA S. NAIR. ASSESSEE BY SHRI RAJ AN VORA. O R D E R PER R.S. SYAL, AM : THESE TWO CROSS APPEALS ONE BY THE ASSESSEE AND T HE OTHER BY THE REVENUE ARISE OUT OF THE ORDER PASSED BY THE LD. CIT(A) ON 29.01.2008 IN RELATION TO THE ASSTT. YEAR 2004-05. 2. THE REVENUE HAS RAISED THE FOLLOWING EFFECTIVE G ROUND IN ITS APPEAL : ON THE FACTS AND IN THE CIRCUMSTANCES OF THE CASE AND IN LAW, THE LD. CIT(A) ERRED IN DIRECTING THE ASSESSING OFFICER TO TREAT THE LOSSES INCURRED BY THE ASSESSEE ON FUTURES AND OPTIONS ON ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 2 INDEXES AS LOSS UNDER THE HEAD INCOME FROM BUSINESS OR PROFESSION AND TO RE-COMPUTE THE INCOME AND CHARGE TAX AS PER THE PROVISIONS OF SECTION 115AD OF THE ACT. 3. THE ASSESSEE IS AGGRIEVED AGAINST THE IMPUGNED O RDER ON THE FOLLOWING TWO EFFECTIVE GROUNDS : 1. IN TREATING THE SHORT-TERM CAPITAL LOSS OF RS.112,744,596 ARISING FROM EXCHANGE TRADED DERIVATIVE TRANSACTIONS AS A BUSINESS LOSS AND IGNORING THE SPECIAL PROVISIONS CONTAINED IN SECTION 115AD OF THE ACT, APPLICABLE TO YOUR APPELLANT, BEING A FOREIGN INSTITUTION INVESTOR (FII). 2. IN TREATING THE SHORT-TERM CAPITAL LOSS OF RS.18,818,500 ARISING FROM NON-INDEXED EXCHANGE TRADED DERIVATIVE TRANSACTIONS AS SPECULATIVE LOSS AND THEREBY, DISALLOWING ITS SET- OFF AGAINST SHORT-TERM CAPITAL GAINS EARNED ON EQUITY SHARES. THE OTHER GROUNDS TAKEN BY THE ASSESSEE ARE IN SUPP ORT OF THE MAIN ISSUE CONTAINED IN GROUND NOS.1 & 2 AS REPRODUCED A BOVE. 4. BRIEFLY STATED, THE FACTS OF THE CASE ARE THAT T HE ASSESSEE IS A COMPANY INCORPORATED IN CAYMAN ISLANDS AND A TAX RE SIDENT OF CAYMAN ISLANDS. AT THE MATERIAL TIME, THERE WAS NO DOUBLE TAXATION AVOIDANCE AGREEMENT BETWEEN INDIA AND CAYMAN ISLAND S. THE ASSESSEE IS REGISTERED WITH THE SEBI AS A SUB-ACCOU NT OF LLOYD GEORGE INVESTMENT MANAGEMENT (BERMUDA) LTD., WHICH IS REGI STERED WITH SEBI AS A FOREIGN INSTITUTIONAL INVESTOR (HEREINAFT ER CALLED FII). THE STATUS OF THE ASSESSEE IN THE TITLES OF THE ASSESSM ENT ORDER HAS ALSO BEEN GIVEN AS FII. THE ASSESSEE SHOWED SHORT-TERM C APITAL GAIN OF RS.34.73 CRORES AND SHORT-TERM CAPITAL LOSS OF RS.2 5.98 CRORES. THESE ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 3 TWO AMOUNTS COMPRISED OF SHORT-TERM CAPITAL GAIN/LO SS ON SHARES TO THE TUNE OF RS.31.06 CRORES AND RS.11.04 CRORES RES PECTIVELY, THEREBY LEAVING THE REMAINING AMOUNT OF RS.3.67 CRORES AND 14.94 CRORES AS GAIN/LOSS FROM DERIVATIES BOTH UNDER OPTION CONTR ACTS AND FUTURE CONTRACTS. THERE IS NO DISPUTE AS GAIN/LOSS OFFERED BY THE ASSESSEE ON SALE OF SHARES, WHICH HAS BEEN ACCEPTED AS SHORT-TE RM CAPITAL GAIN. THE CONTROVERSY IS ON THE TREATMENT OF THE LOSS IN DERIVATES TO THE TUNE OF RS.11.27 CRORES (RS.14.94 CRORES LOSS AS RE DUCED BY RS.3.67 CRORES GAIN ON DERIVATES). THE AMOUNT OF LOSS OF R S.11.27 CRORES WAS ADJUSTED BY THE ASSESSEE AGAINST THE SHORT-TERM CAP ITAL GAIN FROM THE SHARES AS DISCUSSED ABOVE, AS A RESULT OF WHICH THE TAXABLE SHORT- TERM CAPITAL GAIN STOOD REDUCED TO THAT EXTENT. ON BEING CALLED UPON TO EXPLAIN AS TO WHY THE TRANSACTIONS IN DERIVATIVE S BE NOT TREATED AS SPECULATIVE TRANSACTIONS, THE ASSESSEE SUBMITTED IT S REPLY THROUGH VARIOUS LETTERS. THE AO OBSERVED THAT THE DERIVATI VES OPTION CONTRACTS AND FUTURE CONTRACTS - WERE ROUTED THROUG H THE STOCK EXCHANGE WITHOUT ANY ACTUAL DELIVERY. CONSIDERING T HE PROVISIONS OF SEC. 43(5), HE HELD THAT BEFORE THE INSERTION OF PR OVISO (D) BY THE FINANCE ACT, 2005, TRANSACTIONS IN RESPECT OF TRADI NG IN DERIVATES WERE TO BE CONSIDERED AS SPECULATIVE. IT WAS ALSO OPINED BY HIM THAT THE INSERTION OF PROVISO (D) BY THE FINANCE ACT, 2005, COMMANDING THAT THE TRANSACTIONS IN RESPECT OF TRADING IN DERIVATIV ES SHALL NOT BE DEEMED TO BE SPECULATIVE TRANSACTIONS, IS PROSPECTI VE AND HENCE COULD NOT APPLY TO THE YEAR UNDER CONSIDERATION. IN VIEW OF THE ABOVE OPINION, THE AO HELD THAT THE LOSS OF RS.11.27 CROR ES ARISING ON ACCOUNT OF DERIVATIVE TRANSACTIONS WAS TO BE ASSESS ED AS SPECULATION ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 4 LOSS AND HENCE THE SAME WAS NOT ELIGIBLE FOR SET OF F AGAINST THE SHORT- TERM CAPITAL GAIN EARNED BY THE ASSESSEE FROM THE S ALE OF SHARES. 5. THE ASSESSEE WENT UP IN APPEAL BEFORE THE LD. CI T(A) CONTENDING THAT IT WAS REGISTERED AS FII AS PER SEB I REGULATIONS, WHICH ENTITLED IT ONLY TO MAKE INVESTMENTS IN SECUR ITIES. IT WAS, THEREFORE, CONTENDED THAT `INVESTMENT IMPLIED PURC HASE AND SALE OF CAPITAL ASSETS AND NOT EARNING OF ANY BUSINESS INCO ME. IT WAS ALSO ARGUED THAT THE ASSESSEE WAS GOVERNED BY THE SPECIA L PROVISION CONTAINED IN SEC. 115AD AND AS SUCH THE RESULTANT I NCOME FROM THE DERIVATIVES COULD BE TAXED ONLY UNDER THE HEAD CAP ITAL GAINS. THE LD. CIT(A) NOTED THAT THE ASSESSEE TRADED IN FUTURE CON TRACTS BASED ON INDIVIDUAL COMPANYS SHARES AND ALSO NIFTY INDEXES. HE NOTICED THAT THE INDEX FUTURES WERE THE ARTIFICIAL TRADE INSTRUM ENTS CREATED BY STOCK EXCHANGES WHICH COULD HAVE A LIFESPAN OF NOT MORE THREE MONTHS AND HENCE IT WAS NOT POSSIBLE TO HAVE THE PH YSICAL/ACTUAL DELIVERY BECAUSE THE UNDERLYING INDEX WAS NOT A PHY SICAL COMMODITY. ONCE THESE ARTIFICIAL SECURITIES WERE NOT CAPABLE O F DELIVERY FROM ONE PERSON TO ANOTHER, HE HELD THAT THE SAME COULD NOT BE CONSIDERED AS A COMMODITY AND HENCE THE PROVISIONS OF SEC. 43(5) WO ULD NOT APPLY. AS REGARDS LOSS FROM THE NON-INDEX BASED DERIVATIVE S, THAT IS, WHERE THE UNDERLYING ASSET IS SOME SPECIFIC SHARE, THE LD . CIT(A) HELD THAT THE SAME WOULD QUALIFY AS SPECULATIVE TRANSACTION INASMUCH AS THERE WAS A POSSIBILITY OF DELIVERY OF SHARES UNDERLYING SUCH FUTURES AND HENCE THE RESULTANT LOSS WOULD BE SPECULATIVE LOSS. HE FINALLY HELD THAT THE LOSS INCURRED BY THE ASSESSEE IN NON-INDEX BASE D DERIVATIVES WAS ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 5 HIT BY THE PROVISIONS OF SECTION 43(5) AND LIABLE T O BE TREATED AS SPECULATIVE LOSS, BUT THE LOSS FROM THE INDEX BASED DERIVATIVES WOULD FALL UNDER THE HEAD `PROFITS AND GAINS OF BUSINESS OR PROFESSION AND HENCE BECOME NON-SPECULATION BUSINESS LOSS. BOTH T HE SIDES ARE IN APPEAL BEFORE US AGAINST THEIR RESPECTIVE STANDS IN TERMS OF THE GROUNDS POSITIONED SUPRA . 6. WE HAVE HEARD THE RIVAL SUBMISSIONS AND PERUSED THE RELEVANT MATERIAL ON RECORD. IT IS SEEN THAT THE ASSESSEE CL AIMED NET LOSS OF RS.11.27 CRORES FROM DERIVATIVES UNDER THE HEAD CA PITAL GAINS, WHEREAS THE AO HELD SUCH LOSS TO BE SPECULATION BUS INESS LOSS U/S. 43(5) OF THE ACT. THE LD. CIT(A) BIFURCATED SUCH LO SS INTO TWO PARTS VIZ., NON-SPECULATION I.E. NORMAL BUSINESS LOSS (FR OM INDEX BASED DERIVATIVES) AND SPECULATION LOSS (FROM NON-INDEX B ASED DERIVATIVES I.E. BASED ON INDIVIDUAL SHARES). NOW THE ASSESSEE WANTS THAT THE ENTIRE LOSS SHOULD BE TREATED AS SHORT TERM CAPITAL LOSS AND THE REVENUE CONTENDS THAT THE ENTIRE LOSS SHOULD BE HEL D AS SPECULATION LOSS. I. TRANSACTIONS IN DERIVATIVES SEC. 43(5) 7. SECTION 43(5) DEFINES SPECULATIVE TRANSACTION TO MEAN A TRANSACTION IN WHICH A CONTRACT FOR THE PURCHASE O R SALE OF ANY COMMODITY, INCLUDING STOCKS AND SHARES, IS PERIODIC ALLY OR ULTIMATELY SETTLED OTHERWISE THAN BY THE ACTUAL DELIVERY OR TR ANSFER OF THE COMMODITY OR SCRIPS . SUCH A TRANSACTION IS DEEMED TO BE SPECULATIVE TRANSACTION UNLESS A CASE FALLS UNDER ANY OF THE SP ECIFIC CLAUSES OF THE ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 6 PROVISO TO THIS SUB-SECTION. HERE, IT IS IMPORTANT TO MENTION THAT UP TO ASSESSMENT YEAR 2005-06, THERE WERE THREE CLAUSES, (A) TO (C) TO THIS PROVISO. HOWEVER, BY THE FINANCE ACT, 2005, W.E.F. 01-04-2006, THE FOLLOWING CLAUSE (D) HAS BEEN INSERTED, WHICH READS AS UNDER : (D) AN ELIGIBLE TRANSACTION IN RESPECT OF TRADING IN DERIVATIVES REFERRED TO IN CLAUSE (AC) OF SECTION 2 OF THE SECURITIES CONTRACTS (REGULATIONS) ACT, 1956 (42 OF 1956) CARRIED OUT IN A RECOGNIZED STOCK EXCHANGE. 7.2. THE EFFECT OF THIS INSERTION FROM THE ASSESSMENT YEAR 2006- 07 IS THAT TRANSACTIONS IN RESPECT OF TRADING IN DE RIVATES ARE NOT TO BE DEEMED AS SPECULATIVE TRANSACTIONS, AS A RESULT OF WHICH THE GAIN OR LOSS FROM SUCH TRANSACTIONS SHALL NOT BE CONSIDERED AS GAIN OR LOSS FROM SPECULATION BUSINESS. THE SPECIAL BENCH OF THE TRIBUNAL IN SHREE CAPITAL SERVICES LTD. VS. ACIT (2009) 28 DTR 1 (KOL .) (SB) (TRIB.) HAS HELD THAT THE `DERIVATIVE IN WHICH UNDERLYING ASSE T IS A SHARE, FALLS UNDER THE EXPRESSION `COMMODITY U/S 43(5) AND THUS LOSS ON ACCOUNT OF TRANSACTIONS IN FUTURES AND OPTIONS DERIVATES WI TH THE UNDERLYING ASSETS AS SHARES IS SPECULATIVE LOSS UP TO ASSESSME NT YEAR 2005-06. IT HAS FURTHER BEEN HELD IN THIS CASE THAT THE INSERTI ON OF CLAUSE (D) OF PROVISO TO SEC. 43(5), TAKING SUCH TRANSACTIONS OUT SIDE THE PURVIEW OF THE SPECULATIVE TRANSACTIONS, IS PROSPECTIVE IN OP ERATION AND APPLIES ONLY FROM ASSESSMENT YEAR 2006-07. THUS THE SPECIAL BENCH OF THE TRIBUNAL IN THE AFORENOTED CASE HELD THAT THE TRANS ACTIONS IN DERIVATIVES WITH THE UNDERLYING ASSETS AS NON INDEX ARE SPECULATIVE TRANSACTIONS UPTO A.Y. 2005-06. IT IS FURTHER NOTI CED THAT THE HONBLE JURISDICTIONAL HIGH COURT IN CIT VS. SHRI BHARAT R. RUIA (HUF) VIDE ITS RECENT UNREPORTED JUDGMENT DATED 18-04-2011 HAS HEL D THAT ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 7 TRANSACTIONS IN EXCHANGE TRADED FINANCE DERIVATIVES ARE SPECULATIVE TRANSACTIONS AS DEFINED IN SEC. 43(5) AND FURTHER C LAUSE (D) INSERTED TO THE PROVISO TO SEC. 43(5) W.E.F. 01-04-2006 IS PROS PECTIVE. IN VIEW OF THE JUDGMENT OF THE HONBLE JURISDICTIONAL HIGH COU RT AND ALSO THE SPECIAL BENCH TRIBUNAL ORDER, IT BECOMES APPARENT T HAT THE TRANSACTIONS IN THE EXCHANGE TRADED FINANCE DERIVAT IVES ARE TO BE CONSIDERED AS SPECULATIVE TRANSACTIONS WITHIN THE M EANING OF SEC. 43(5) IN RELATION TO THE ASST. YEAR 2004-05 UNDER C ONSIDERATION. 7.3 IT IS NOTICED THAT THE LD. CIT(A) HAS DRAWN A D ISTINCTION BETWEEN THE TRANSACTIONS IN INDEX BASED DERIVATES AND INDIV IDUAL SHARES BASED DERIVATIVES BY HOLDING THE FORMER AS BUSINESS TRANS ACTIONS AND LATER AS SPECULATIVE TRANSACTIONS. THE REASONING GIVEN BY HIM IN SUPPORT OF SUCH A DISTINCTION IS THAT THERE IS A POSSIBILITY O F DELIVERY OF SHARES IN THE NON-INDEX BASED DERIVATIVES BECAUSE THE UNDERLY ING ASSET ON WHICH THE VALUE IS DERIVED IS THE SHARE OF THE COMP ANY. AS REGARDS LOSS FROM THE INDEX BASED EXCHANGE TRADED DERIVATIV E TRANSACTIONS, THE LD. CIT(A) HELD IT TO BE `BUSINESS LOSS ON TH E GROUND THAT NO PHYSICAL DELIVERY IS POSSIBLE BECAUSE THE UNDERLYIN G ASSET ON WHICH THE VALUE IS DERIVED IS AN INDEX WHICH IS NOT A PHY SICAL COMMODITY. IN OUR CONSIDERED OPINION, THE LD. CIT(A) WAS NOT JUST IFIED IN DRAWING SUCH A LINE OF DEMARCATION BETWEEN THE TWO SETS OF TRANSACTIONS. IT IS FOR THE REASON THAT THE DERIVATES ARE FINANCE INSTR UMENTS WHOSE VALUE DEPEND ON THE VALUE OF THE OTHER UNDERLYING FINANCE INSTRUMENTS. THE UNDERLYING ASSET MAY BE A PARTICULAR SHARE OR THE I NDEX SUCH AS BSE INDEX AND NIFTY INDEX. IN OTHER WORDS, THE INDEX B ASED DERIVATIVES ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 8 ARE NOT BASED ON THE VALUE OF A PARTICULAR SHARE IN THE FUTURES BUT ON THE INDEX AS A WHOLE, WHICH COMPRISES OF A NUMBER O F SHARES INCLUDED IN SUCH INDEX. DERIVATIVE, IN ITSELF, CANNOT BE COM PARED WITH THE UNDERLYING SHARE OR INDEX. IN FACT, THESE ARE FUTUR ES CONTRACTS IN BOTH INDEX AS WELL AS STOCKS WHICH CAN BE PURCHASED OR S OLD THROUGH RECOGNIZED STOCK EXCHANGE. IT HAS BEEN NOTICED BY THE HONBLE JURISDICTIONAL HIGH COURT IN THE ABOVE NOTED CASE I N PARA 31 THAT FUTURES CONTRACTS EXPIRE ON THE LAST THURSDAY OF T HE EXPIRY MONTH. ALL FUTURES CONTRACTS ARE SETTLED IN CASH EITHER ON A DAILY BASIS OR AT THE EXPIRY OF THE RESPECTIVE CONTRACTS AS THE CASE MAY BE. CLIENTS/TRADING MEMBERS ARE NOT REQUIRED TO HOLD AN Y STOCK OF THE UNDERLYING FOR DEALING IN THE FUTURES MARKET. IT I S STILL FURTHER NOTICED THAT IN THE CASE OF SHREE CAPITAL SERVICES LTD. (S UPRA), THE SPECIAL BENCH DEALT WITH DERIVATIVES IN WHICH THE UNDERLYIN G ASSETS WERE SHARES, AND SUCH TRANSACTIONS HAVE BEEN EVENTUALLY HELD TO BE A SPECULATIVE TRANSACTIONS. FROM THE ABOVE DISCUSSIO N, IT IS CLEAR THAT THE TRANSACTIONS IN DERIVATES, WHETHER HAVING UNDER LYING ASSETS AS SHARES OR INDEX, ARE SPECULATIVE TRANSACTIONS WITH IN THE MEANING OF SEC. 43(5). AS SUCH, WE HOLD THAT THE LD. CIT(A) W AS NOT JUSTIFIED IN COMING TO THE CONCLUSION THAT THE INDEX BASED DERIV ATIVE TRANSACTIONS BE TREATED AS NORMAL BUSINESS OR NON-SPECULATIVE TR ANSACTIONS. WE, THEREFORE, OVERTURN THE IMPUGNED ORDER TO THE EXTEN T OF HOLDING THAT THE LOSS IN OPTION TRADING IN INDEX FUTURES BE CONS IDERED AS NON- SPECULATIVE. THE NET RESULT IS THAT IN A NORMAL CAS E, THE LOSS IN OPTION TRADING ON INDIVIDUAL SHARES OR INDEX HAS TO BE HEL D AS SPECULATIVE LOSS. ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 9 II. SECTION 115AD AND INCOME FROM DERIVATIVES BY F.I.IS. 8. HAVING HELD THAT TRANSACTIONS IN DERIVATIVES, B OTH INDEX BASED AND INDIVIDUAL SHARES BASED, ARE TO BE CONSIDERED A S SPECULATIVE TRANSACTIONS U/S.43(5) IN A NORMAL CASE, THEIR NAT URE NEEDS TO BE EXAMINED IN THE HANDS OF FIIS. THE LD. A.R. CONTEND ED THAT SEC. 115AD DEALS WITH TAXATION ON INCOME OF FIIS FROM SE CURITIES OR CAPITAL GAINS ARISING FROM THEIR TRANSFER AND THAT BEING A SPECIAL PROVISION WOULD OVERRIDE THE GENERAL PROVISIONS INCLUDING SEC . 43(5). WHILE REFERRING TO SUB-SEC. (1) OF SEC. 115AD, THE LD. A. R. POINTED OUT THAT INCOME FROM TRANSFER OF DERIVATIVES IS TO BE CONSID ERED AS CAPITAL GAIN ALONE, DEPENDING UPON THE PERIOD FOR WHICH SUCH DER IVATIVES ARE HELD SO AS TO FURTHER CLASSIFY THEM AS SHORT-TERM OR LON G-TERM CAPITAL GAIN. HE SUBMITTED THAT SUB-SECTION (1) OF SEC. 115AD ALO NE GOVERNS THE TAXABILITY OF INCOME BY WAY OF SHORT-TERM OR LONG-T ERM CAPITAL GAINS ARISING FROM THE TRANSFER OF SUCH SECURITIES AND IT WAS WRONG ON THE PART OF THE AUTHORITIES BELOW TO CONSIDER SUCH INC OME UNDER THE HEAD PROFITS AND GAINS OF BUSINESS OR PROFESSION, WHE THER AS SPECULATION OR NON-SPECULATION. HE ALSO REFERRED TO THE DEFINI TION OF FOREIGN INSTITUTIONAL INVESTORS GIVEN UNDER SECURITIES AND EXCHANGE BOARD OF INDIA (FOREIGN INSTITUTIONAL INVESTORS) REGULATION, 1995, TO MEAN AN INSTITUTION WHICH PROPOSES TO MAKE INVESTMENT IN IN DIA IN SECURITIES. IT WAS CONTENDED THAT THE PERMISSION TO CARRY ON AC TIVITIES IN INDIA IS SUBJECT TO THE TERMS AND CONDITIONS STIPULATED IN S UCH REGULATIONS, AS ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 10 PER WHICH THE FIIS CAN ONLY MAKE INVESTMENT IN SECU RITIES AND NOT UNDERTAKE TRADE IN THEM. 8.2 IN THE OPPOSITION, THE LD. D.R. RELIED ON THE I MPUGNED ORDER TO CONTEND THAT SEC. 115AD(2) ENVISAGES THE EXISTENCE OF BUSINESS INCOME, DISTINCT FROM CAPITAL GAINS QUA THE DEALINGS IN SECURITIES. IT WAS SUBMITTED THAT THE ARGUMENT ADVANCED ON BEHALF OF THE ASSESSEE THAT THERE CAN BE NO BUSINESS INCOME FROM THE TRANS ACTIONS IN DERIVATIVES, WAS DEVOID OF ANY FORCE. 8.3 IN ORDER TO APPRECIATE THE RIVAL CONTENTIONS , IT WOULD BE APPOSITE TO CONSIDER THE MARGINAL NOTE AS WELL AS THE PROVIS IONS OF SEC. 115AD, AS UNDER: TAX ON INCOME OF FOREIGN INSTITUTIONAL INVESTORS FROM SECURITIES OR CAPITAL GAINS ARISING FROM THEIR TRANSFER 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 UNITS 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, THE INCOME-TAX PAYABLE SHALL BE THE AGGREGATE OF (I) THE AMOUNT OF INCOME-TAX CALCULATED ON THE INCOME IN RESPECT OF THE SECURITIES REFERRED TO IN CLAUSE (A), IF ANY, INCLUDED IN THE TOTAL INCOME, AT THE RATE OF TWENTY PER CENT; (II) THE AMOUNT OF INCOME-TAX CALCULATED ON THE INCOME BY WAY OF SHORT-TERM CAPITAL GAINS REFERRED TO IN ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 11 CLAUSE (B), IF ANY, INCLUDED IN THE TOTAL INCOME, AT THE RATE OF THIRTY PER CENT; PROVIDED THAT THE AMOUNT OF INCOME-TAX CALCULATED ON THE INCOME BY WAY OF SHORT- TERM CAPITAL GAINS REFERRED TO IN SECTION 111A SHALL BE AT THE RATE OF FIFTEEN PER CENT; (III) THE AMOUNT OF INCOME-TAX CALCULATED ON THE INCOME BY WAY OF LONG-TERM CAPITAL GAINS REFERRED TO IN CLAUSE (B), IF ANY, INCLUDED IN THE TOTAL INCOME, AT THE RATE OF TEN PER CENT; AND (IV) THE AMOUNT OF INCOME-TAX WITH WHICH THE FOREIGN INSTITUTIONAL INVESTOR WOULD HAVE BEEN CHARGEABLE HAD ITS TOTAL INCOME BEEN REDUCED BY THE AMOUNT OF INCOME REFERRED TO IN CLAUSE (A) AND CLAUSE (B). (2) WHERE THE GROSS TOTAL INCOME OF THE FOREIGN INSTITUTIONAL INVESTOR-- (A) CONSISTS ONLY OF INCOME IN RESPECT OF SECURITIES REFERRED TO IN CLAUSE (A) OF SUB- SECTION (1), NO DEDUCTION SHALL BE ALLOWED TO IT UNDER SECTIONS 28 TO 44C OR CLAUSE (I) OR CLAUSE (III) OF SECTION 57 OR UNDER CHAPTER VI-A; (B ) INCLUDES ANY INCOME REFERRED TO IN CLAUSE (A) OR CLAUSE (B) OF SUB-SECTION (1), THE GROSS TOTAL INCOME SHALL BE REDUCED BY THE AMOUNT OF SUCH INCOME AND THE DEDUCTION UNDER CHAPTER VI-A SHALL BE ALLOWED AS IF THE GROSS TOTAL INCOME AS SO REDUCED, WERE THE GROSS TOTAL INCOME OF THE FOREIGN INSTITUTIONAL INVESTOR. (3) NOTHING CONTAINED IN THE FIRST AND SECOND PROVISOS TO SECTION 48 SHALL APPLY FOR THE COMPUTATION OF CAPITAL GAINS ARISING OUT OF THE TRANSFER OF SECURITIES REFERRED TO IN CLAUSE (B) OF SUB-SECTION (1). EXPLANATION.FOR THE PURPOSES OF THIS SECTION, -- (A) THE EXPRESSION FOREIGN INSTITUTIONAL INVESTOR MEANS SUCH INVESTOR AS THE CENTRAL GOVERNMENT MAY, BY NOTIFICATION IN THE OFFICIAL GAZETTE, SPECIFY IN THIS BEHALF; ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 12 (B) THE EXPRESSION SECURITIES SHALL HAVE THE MEANING ASSIGNED TO IT IN CLAUSE (H) OF SECTION 2 OF THE SECURITIES CONTRACTS (REGULATION) ACT, 1956 (42 OF 1956). 8.4 FROM EXPLANATION (A) ABOVE, TWO THINGS ARE NOTICEABLE. FIRSTLY, THE FII IS AN `INVESTOR AND SECONDLY, IT CAN TRANS ACT ONLY WHEN THE CENTRAL GOVERNMENT NOTIFIES IN THE OFFICIAL GAZETTE . IT IS FURTHER NOTICED THAT THE FIIS ARE MONITORED THROUGH THE REG ULATIONS SPECIFICALLY MADE BY THE SEBI FOR FIIS, WHICH ARE K NOWN AS THE SECURITIES AND EXCHANGE BOARD OF INDIA (FOREIGN INS TITUTIONAL INVESTORS) REGULATION, 1995. REGULATION 2(F) DEFINE S FOREIGN INSTITUTIONAL INVESTORS TO MEAN AN INSTITUTION ESTABLISHED OR INCORPORATED OUTSIDE INDIA WHICH PROPOSES TO MAKE A N INVESTMENT IN INDIA IN SECURITIES . IT IS IMPERATIVE TO OBSERVE THAT THE SEBI HAS ALLOWED THE FIIS TO OPERATE IN A LIMITED FIELD. TH E RESTRICTIONS ON THE MAKING OF INVESTMENT BY THE FIIS ARE CONTAINED IN R EGULATION 15(1) WHICH READS AS UNDER : 15. (1) A FOREIGN INSTITUTIONAL INVESTOR MAY INVEST ONLY IN THE FOLLOWING:- (A) SECURITIES IN THE PRIMARY AND SECONDARY MARKETS INCLUDING SHARES, DEBENTURES AND WARRANTS OF COMPANIES UNLISTED, LISTED OR TO BE LISTED ON A RECOGNISED STOCK EXCHANGE IN INDIA; AND (B) UNITS OF SCHEMES FLOATED BY DOMESTIC MUTUAL FU NDS INCLUDING UNIT TRUST OF INDIA, WHETHER LISTED ON A RECOGNISED STOCK EXCHANGE OR NOT,UNITS OF SCHEME FLOATED BY A COLLECTIVE INVESTMENT SCHEME. (C) DATED GOVERNMENT SECURITIES; ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 13 (D) DERIVATIVES TRADED ON A RECOGNISED STOCK EXCHANGE; (E) COMMERCIAL PAPER; (F) SECURITY RECEIPTS; 8.5 FROM THE PRESCRIPTION OF REGULATION 15(1 ), IT CAN BE VIEWED THAT THERE ARE RESTRICTIONS ON A FII IN MAKING INV ESTMENTS, WHICH CAN ONLY BE IN THE SPECIFIED SECURITIES WHICH, INTER AL IA, INCLUDE SHARES, DEBENTURES AND DERIVATIVES TRADED ON A RECOGNIZED S TOCK EXCHANGE. IT IS FURTHER ESSENTIAL TO NOTE THAT THE REGULATIONS, APART FROM PROVIDING THAT A FII CAN INVEST ONLY IN THE SPECIFIED SECURIT IES, ALSO PROVIDES FOR CERTAIN ADDITIONAL CONDITIONS, WHICH HAVE BEEN LAID DOWN IN REGULATION 15(3), THE RELEVANT PART OF WHICH IS AS UNDER : (3) IN RESPECT OF INVESTMENTS IN THE SECONDARY MAR KET, THE FOLLOWING ADDITIONAL CONDITIONS SHALL APPLY:-(A) A FOREIGN IN STITUTIONAL INVESTOR OR SUB-ACCOUNT SHALL TRANSACT IN THE INDIAN SECURITIES MARKET ONLY ON THE BASIS OF TAKING AND GIVING DELIVERY OF SECURITIES P URCHASED OR SOLD: PROVIDED THAT NOTHING CONTAINED IN THIS CLAUSE SHAL L APPLY TO ANY TRANSACTIONS IN DERIVATIVES ON A RECOGNISED STO CK EXCHANGE: PROVIDED FURTHER THAT A FOREIGN INSTITUTIONAL INVES TOR OR SUB- ACCOUNT MAY ENTER INTO SHORT SELLING TRANSACTIONS O NLY IN ACCORDANCE WITH THE FRAMEWORK SPECIFIED BY THE BOAR D IN THIS REGARD;] (B) NO TRANSACTION ON THE STOCK EXCHANGE SHALL BE C ARRIED FORWARD; AND ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 14 (C) THE TRANSACTION OF BUSINESS IN SECURITIES SHALL BE ONLY THROUGH STOCK BROKERS WHO HAS BEEN GRANTED A CERTIF ICATE BY THE BOARD UNDER SUB SECTION (1) OF SECTION 12 OF TH E SECURITIES AND EXCHANGE BOARD OF INDIA ACT,1992: 8.6 IT IS FURTHER RELEVANT TO NOTE THAT EVEN AFTER THE GRANT OF INITIAL REGISTRATION BY THE CENTRAL GOVERNMENT, A F II HAS TO ADHERE TO THE REGULATIONS OF THE SEBI. ITS ACTIVITIES ARE MON ITORED ON DAY TO DAY BASIS, AS CAN BE SEEN FROM REGULATION 16, WHICH SPE LLS OUT CERTAIN OBLIGATIONS AND RESPONSIBILITIES OF THE FIIS. IT IS WORTHWHILE TO TAKE NOTICE OF REGULATION 16(2), WHICH IS AS UNDER :- THE FOREIGN INSTITUTIONAL INVESTOR SHALL ENSURE TH AT THE DOMESTIC CUSTODIAN TAKES STEPS FOR (A) MONITORING OF INVESTMENTS OF THE FOREIGN INSTITUTIONAL INVESTOR IN INDIA; (B) REPORTING TO THE BOARD ON A DAILY BASIS THE TRANSACTIONS ENTERED INTO BY THE FOREIGN INSTITUTIO NAL INVESTOR; (C) PRESERVATION FOR FIVE YEARS OF RECORDS RELATING TO HIS ACTIVITIES AS A FOREIGN INSTITUTIONAL INVEST OR; AND (D) FURNISHING SUCH INFORMATION TO THE BOARD AS MAY BE CALLED FOR BY THE BOARD WITH REGARD TO THE ACTIVITIES OF THE FOREIGN INSTITUTIONAL INVESTOR AN D AS MAY BE RELEVANT FOR THE PURPOSE OF THIS REGULATION. 8.7 THE CONSEQUENCES WHICH FOLLOW FROM NON-CO MPLIANCE OF THE RELEVANT REGULATIONS BY A FII HAVE BEEN PROVIDED F OR IN REGULATION 7A. WHEN WE VIEW REGULATION 15(1) IN JUXTAPOSITION TO R EGULATION 15(3), IT BECOMES ABUNDANTLY CLEAR THAT A FII IS ELIGIBLE TO MAKE ONLY INVESTMENTS (NOT TRADING) IN THE SPECIFIED SECURITI ES AND SECONDLY, ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 15 INVESTMENT IN THE SECONDARY MARKET CAN BE ONLY ON T HE BASIS OF TAKING AND GIVING DELIVERY OF SECURITIES PURCHASES OR SOLD. THE RESTRICTION REGARDING TAKING AND GIVING DELIVERY OF SECURITIES PURCHASED OR SOLD DOES NOT APPLY TO ANY TRANSACTION IN DERIVATES PROVIDED THESE ARE ROUTED THROUGH RECOGNIZED STOCK EXCHANGE. SECTION 2(H) OF THE SECURITIES CONTRACTS (REGULATION) ACT DEFINES SECURITIES TO INCLUDE (I) SHARES, SCRIPS, STOCKS, BONDS, DEBENTURES, DEBENTURE STOCK OR OTHER MARKETABLE SECURITIES OF A LIKE NATURE IN OR OF ANY INCORPORATED COMPANY OR OTHER B ODY CORPORATE; (IA) DERIVATIVE; (IB) UNITS OR ANY OTHER INSTRUMENT ISSUED BY ANY COLLECTIVE INVESTMENT SCHEME TO THE INVESTORS IN S UCH SCHEMES; (IC) SECURITY RECEIPT AS DEFINED IN CLAUSE (ZG) OF SECTION 2 OF THE SECURITISATION AND RECONSTRUCTION OF FINANCIAL ASSETS AND ENFORCEMENT OF SECURITY INTERE ST ACT, 2002; (ID) UNITS OR ANY OTHER SUCH INSTRUMENT ISSUED TO THE INVESTORS UNDER ANY MUTUAL FUND SCHEME; (II) GOVERNMENT SECURITIES; (IIA) SUCH OTHER INSTRUMENTS AS MAY BE DECLARED BY THE CENTRAL GOVERNMENT TO BE SECURITIES; AND (III) RIGHTS OR INTEREST IN SECURITIES; FROM THE ABOVE DEFINITION OF `SECURITIES, IT IS DI SCERNIBLE THAT DERIVATIVES AND SHARES ETC. HAVE BEEN KEPT ON A SINGLE PLATFORM . 8.8 HAVING TAKEN INSIGHT INTO THE REGULATIO NS GOVERNING FIIS, WE RETURN TO SECTION 115AD. EXPLANATION (A) DEFINES TH E EXPRESSION FOREIGN INSTITUTIONAL INVESTOR TO MEAN SUCH AN IN VESTOR AS THE CENTRAL GOVERNMENT MAY, BY NOTIFICATION IN THE OFFI CIAL GAZETTE, SPECIFY IN THIS BEHALF. ON A CONJOINT READING OF REGULATIO N 15 WITH EXPL. (A) TO SEC. 115AD, IT IS EASILY PERCEPTIBLE THAT A FII CAN ONLY `INVEST BUT ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 16 NOT TRADE IN THE SPECIFIED SECURITIES. FURTHER EXPL . (B) TO SECTION 115AD DEFINES THE EXPRESSION `SECURITIES TO HAVE THE M EANING ASSIGNED TO IT IN CLAUSE (H) OF SECTION 2 OF THE SECURITIES CON TRACTS (REGULATION) ACT, 1956 (42 OF 1956)., WHICH REFER TO DERIVATIV ES AND SHARES ETC. 8.9. IN THE LIGHT OF THE ABOVE BACKGROUND, WE WILL EXAMINE SEC. 115AD WHICH IS A SPECIAL PROVISION ENSHRINED IN THE ACT FOR CHARGING TAX ON THE INCOME OF FIIS FROM SECURITIES OR CAPIT AL GAINS ARISING FROM THEIR TRANSFER. SUB-SEC. (1) PROVIDES THROUGH CLAUS E (A) THAT THE INCOME, OTHER THAN FROM THE UNITS OF A MUTUAL FUND SPECIFIED UNDER SEC. 10(23D) OR OF THE UNITED TRUST OF INDIA, RECEI VED IN RESPECT OF SECURITIES EXCEPT THE INCOME BY WAY OF DIVIDEND FRO M DOMESTIC COMPANIES, SHALL BE CHARGED TO TAX @ 20%. CLAUSE (B ) OF SEC. 115AD(1) DEALS WITH INCOME BY WAY OF SHORT-TERM OR LONG-TERM CAPITAL GAINS ARISING FROM THE TRANSFER OF SECURITI ES. SEPARATE RATES OF TAX HAVE BEEN PROVIDED IN RESPECT OF LONG-TERM AND SHORT-TERM CAPITAL GAINS ARISING FROM THE TRANSFER OF SECURITIES. EXPL ANATION (B) DEFINES THE EXPRESSION SECURITIES TO HAVE THE MEANING AS SIGNED TO IT IN SEC. 2(H) OF THE SECURITIES CONTRACTS (REGULATION) ACT, 1956, WHICH HAS BEEN NOTED ABOVE. FROM SUCH DEFINITION OF SECURITI ES, THAT HAS BEEN BODILY LIFTED IN SEC. 115AD, IT IS EXPLICITLY OBVIO US THAT IT INCLUDES SHARES AND ALSO DERIVATIVES. FURTHER WHEN WE EXAMIN E REGULATION 15, IT CAN BE SEEN THAT A FII IS ENTITLED TO INVEST IN THE `SPECIFIED SECURITIES, WHICH ALSO, INCLUDE SHARES AND DERIVAT IVES. THUS, IT IS PATENT THAT FOR THE PURPOSES OF SECTION 115AD, BOTH THE DERIVATIVES AND SHARES HAVE BEEN CATEGORIZED AS `SECURITIES TO BE TREATED ALIKE, ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 17 NOTWITHSTANDING THE DIFFERENT TAX TREATMENT IN THE HANDS OF NON-FIIS TO THE INCOME FROM THE TRANSFER OF SHARES, WHICH MA Y VARY FROM `BUSINESS INCOME TO `CAPITAL GAINS DEPENDING UPON THE FACTS AND CIRCUMSTANCES OF EACH CASE AND FROM THE TRANSFER OF DERIVATIVES WHICH SHALL BE SPECULATIVE INCOME UP TO THE A.Y.2005-06. 8.10. WE AGAIN SLIP BACK TO SUB-SEC. (1) O F SEC. 115AD, CLAUSE (A) OF WHICH REFERS TO INCOME IN RESPECT OF SECURIT IES AND CLAUSE (B) REFERS TO INCOME WAY OF SHORT-TERM OR LONG-TERM CAP ITAL GAIN ARISING FROM THE TRANSFER OF SUCH SECURITIES. THUS, THE SCO PE OF CLAUSE (A) ENCOMPASSES THE INCOME EARNED BY RETAINING THE `SEC URITIES OTHER THAN FROM TRANSFER OF SUCH `SECURITIES AND CLAUSE (B) SPECIFICALLY DEALS WITH INCOME ARISING FROM THE TRANSFER OF SUCH `SECU RITIES. THEREFORE, IT IS MANIFEST THAT THE INCOME EARNED BY A FII EIT HER BY WAY OF RETENTION OR BY WAY OF TRANSFER OF SECURITIES (INCL UDING DERIVATES) IS SUBJECT MATTER OF SUB-SEC. (1) OF SEC. 115AD. 8.11. BEFORE WE PROCEED FURTHER, IT WOULD BE APT TO NOTE THAT SEC.115AD WAS INSERTED BY THE FINANCE ACT, 1993. T HE MEMORANDUM EXPLAINING THE PROVISIONS OF THE FINANCE BILL, 1993 REPORTED AT 200 ITR (ST) 152 PROVIDES AS UNDER : MEASURE TO PROMOTE CAPITAL MARKET TAX INCENTIVE FOR FOREIGN INSTITUTIONAL INVESTORS INVESTING IN SECURITIES WHILE PRESENTING THE BUDGET FOR 1992-93, THE FINANCE MINISTER HAD STATED THAT WAYS WOULD BE CONS IDERED OF ALLOWING REPUTABLE FOREIGN INVESTORS TO INVEST IN THE COUNTRYS CAPITAL MARKETS. IN PURSUANCE OF THIS ANNOUNCEMENT, GUIDELINES HAVE BEEN ISSUED THROUGH A PRESS NOTE DATED 14 TH SEPTEMBER, 1992, FOR SUCH INVESTMENT BY FOREIGN INSTITUTIONAL INVESTORS. INCOME ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 18 FROM SUCH INVESTMENT IS TO BE TAXED AT CONCESSIONAL RATES. ACCORDINGLY, THE BILL SEEKS TO INSERT A NEW SECTION 115AD IN THE INCOME-TAX ACT RELATING TO TAX ON INCOME OF FOREIGN INSTITUTIONAL INVESTORS FROM SECURITIES OR CAPITAL GAINS ARISING FROM THEIR TRANSFER . THE INCOME RECEIVED IN RESPECT OF SECURITIES (OTHE R THAN UNITS REFERRED TO IN SECTION 115AB) LISTED IN A RECOGNIZED STOCK EXCHANGE IN INDIA IN ACCORDANCE WI TH THE SECURITIES CONTRACTS (REGULATION) ACT, 1956, IS PRO POSED TO BE TAXED AT THE RATE OF TWENTY PER CENT. INCOME BY WAY OF LONG-TERM CAPITAL GAINS ARISING FROM THE TRANSFER O F THE SAID SECURITIES IS PROPOSED TO BE TAXED AT THE RATE OF T EN PER CENT. INCOME WAY OF SHORT-TERM CAPITAL GAINS ARISIN G FROM THE TRANSFER OF THE SAID SECURITIES IS PROPOSED TO BE TAXED AT THE RATE OF THIRTY PER CENT. HOWEVER, THESE RATE S OF TAX WILL APPLY ON THE GROSS INCOME OF THE NATURE SPECIF IED ABOVE WITHOUT ALLOWING FOR ANY DEDUCTION UNDER SECT IONS 28 TO 44C AND CHAPTER VI-A. THE FIRST AND SECOND PR OVISOS OF SECTION 48 RELATING TO COMPUTATION OF CAPITAL GA INS WILL NOT APPLY IN THE CASE OF TRANSFER OF THE AFORESAID SECURITIES BY THE FOREIGN INSTITUTIONAL INVESTORS. THE EXPRESSION FOREIGN INSTITUTIONAL INVESTOR IS PROPOSED TO BE DEFINED TO MEAN SUCH INVESTOR AS THE CENTRAL GOVERNMENT MAY, BY NOTIFICATION IN THE OFFI CIAL GAZETTE, SPECIFY IN THIS BEHALF. THE EXPRESSION SE CURITIES IS PROPOSED TO HAVE THE MEANING ASSIGNED TO IT IN C LAUSE (H) OF SECTION 2 OF THE SECURITIES CONTRACTS (REGUL ATION) ACT, 1956. THIS AMENDMENT WILL TAKE EFFECT FROM 1 ST APRIL, 1993 AND WILL, ACCORDINGLY, APPLY IN RELATION TO THE ASS ESSMENT YEAR 1993-94 AND SUBSEQUENT YEARS. (EMPHASIS SUPPLIED BY US) 8.12. FROM THE MEMORANDUM EXPLAINING THE PROVI SIONS OF THE FINANCE BILL, IT IS PALPABLE THAT THE FOREIGN INSTI TUTIONAL INVESTORS SHALL BE ALLOWED TO INVEST IN THE COUNTRYS CAPITAL MARKE T. INCOME IN RESPECT OF SECURITIES AND INCOME FROM TRANSFER OF SECURITIE S HAS BEEN MADE THE SUBJECT MATTER OF SEC. 115AD. AS PER THIS PROVI SION, THE INCOME ARISING FROM THE TRANSFER OF SUCH SECURITIES IS TO BE CONSIDERED AS SHORT-TERM OR LONG-TERM CAPITAL GAIN. ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 19 8.13. THUS, ON A CLOSE SCRUTINY OF THE SEBI (FII) REGULATIONS, 1995 TOGETHER WITH SECTION 115AD SEEN IN THE LIGHT OF THE MEMORANDUM EXPLAINING THIS PROVISIONS OF THE FINANC E BILL, 1993, IT IS VISIBLE THAT A FII IS ALLOWED TO INVEST ONLY IN THE `SECURITIES AND FURTHER THE INCOME FROM SECURITIES, EITHER FROM THE IR RETENTION OR FROM THEIR TRANSFER, IS TO BE TAXED AS PER THIS SECTION ALONE. COMING TO INCOME ARISING FROM THE TRANSFER OF SECURITIES, IT HAS BEEN PROVIDED IN SECTION 115AD THAT IT SHALL BE CHARGED AS SHORT-TER M OR LONG-TERM CAPITAL GAIN, WHICH DEPENDS UPON THE PERIOD OF HOLD ING OF SUCH SECURITIES. A FII IS NOT ALLOWED BY THE CENTRAL GOV ERNMENT TO DO `BUSINESS IN THE `SECURITIES. ONCE IT IS NOTICED THAT A FII CAN ONLY `INVEST IN `SECURITIES AND TAX ON THE INCOME FROM THE TRANSFER OF SUCH SECURITIES IS COVERED BY A SPECIAL PROVISION C ONTAINED IN SECTION 115AD, THE NATURAL COROLLARY WHICH FOLLOWS IS THAT TAX SHOULD BE CHARGED ON INCOME ARISING FROM TRANSFER OF SUCH SEC URITIES AS PER THE PRESCRIPTION OF THIS SECTION ALONE, WHICH REFERS TO INCOME BY WAY OF SHORT TERM OR LONG TERM CAPITAL GAINS. 8.14. THE LD. D.R. HAS RELIED ON SUB-SECTION (2) OF SEC. 115AD FOR CONTENDING THAT THE EXISTENCE OF `BUSINESS INCOME FROM DEALING IN SECURITIES IS ALSO ENVISAGED. WE FIND THAT SUB-SEC. (2) OF SEC. 115AD HAS TWO CLAUSES. CLAUSE (A) PROVIDES THAT WHERE THE GROSS TOTAL INCOME OF A FII CONSISTS ONLY OF INCOME IN RESPECT OF SECURITY REFERRED TO IN CLAUSE (A) OF SUB-SEC. (1) (I.E. INCOME RECEI VED IN RESPECT OF SECURITIES, OTHERWISE THAN FROM THEIR TRANSFER ), T HEN NO DEDUCTION ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 20 SHALL BE ALLOWED TO IT UNDER SECTIONS 28 TO 44C OR SECTION 57 OR CHAPTER VI-A OF THE ACT. IT IS BUT NATURAL THAT WH EN A LOWER RATE OF TAX HAS BEEN PROVIDED IN RESPECT OF INCOME EARNED B Y A FII FROM SECURITIES, THEN THAT RATE OF TAX IS FINAL AND THE ASSESSEE CANNOT CLAIM DOUBLE BENEFIT, FIRSTLY BY BEING TAXED AT LOWER RAT E AND SECONDLY BY CLAIMING NORMAL DEDUCTIONS ETC. AGAINST THIS INCOME . AS SEC. 115AD(2)(A) REFERS TO INCOME RECEIVED IN RESPECT OF SECURITIES AND NOT FROM THEIR TRANSFER, THE SAME WOULD HAVE NO APPLICA TION TO THE INSTANT CASE. ACCORDING TO CLAUSE (B) OF SUB-SEC. (2) OF S EC. 115AD, WHERE THE GROSS TOTAL INCOME INCLUDES ANY INCOME REFERRED TO IN CLAUSE (A) OR CLAUSE (B) OF SUB-SEC. (1) (I.E. INCOME RECEIVED IN RESPECT OF SECURITIES BY EITHER RETAINING THEM OR FROM THEIR TRANSFER), THEN THE GROSS TOTAL INCOME SHALL BE REDUCED BY THE AMOUNT OF SUCH INCOM E AND THE DEDUCTION UNDER CHAPTER VI-A SHALL BE ALLOWED AS IF THE GROSS TOTAL INCOME SO REDUCED IS THE GROSS TOTAL INCOME OF THE FII. A PLAIN READING OF SUB-SEC. (2) MAKES IT MANIFEST THAT THE GROSS TO TAL INCOME OF A FII MAY INCLUDE INCOME OTHER THAN THAT RECEIVED IN RESP ECT OF SECURITIES OR FROM THE TRANSFER OF SUCH SECURITIES. THE EMPHAS IS OF THE LD. DR IS ON THIS PART OF THE PROVISION TO BRING HOME THE POI NT THAT A FII MAY ALSO HAVE `BUSINESS INCOME ARISING FROM THE TRANSF ER OF SECURITIES. THE ARGUMENT IS THAT A FII MAY HAVE INCOME FROM SEC URITIES AS FALLING UNDER THE HEAD `CAPITAL GAINS, WHICH IS COVERED UN DER SECTION 115AD(1)(B) AND ALSO BUSINESS INCOME, AS COMES OUT FROM SEC. 115AD(2)(B). THIS ARGUMENT THOUGH LOOKS ATTRACTIVE AT FIRST FLUSH, BUT DOES NOT STAND SCRUTINY IN DEPTH. THE RATIONALE BEHIND SECTION 115AD(2)(B) IS THAT THE INCOME OF A FII, OTHER THAN THAT ARISING FROM ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 21 THE HOLDING OR TRANSFER OF SECURITIES, SHOULD FIND ITS PLACE IN THE TOTAL INCOME AND THE DEDUCTIONS UNDER CHAPTER VI-A BE ALL OWED BY CONSIDERING GROSS TOTAL INCOME NET OF INCOME RECEI VED IN RESPECT OF SECURITIES OR ARISING FROM THE TRANSFER OF SUCH SEC URITIES. IT IS QUITE POSSIBLE THAT A FII MAY DEPOSIT ITS SURPLUS FUNDS I N BANKS RESULTING INTO INTEREST INCOME. SUCH INTEREST INCOME, WHICH S HALL NOT FALL UNDER SUB-SEC. (1) OF SEC. 115AD, SHALL CONSTITUTE PART O F THE GROSS TOTAL INCOME. IT IS A SIMPLE AND PLAIN INTERPRETATION OF SUB-SECTIONS (1) AND (2) OF SEC. 115AD. WE WANT TO MAKE IT CLEAR THAT TH E QUESTION BEFORE US IS NOT TO DETERMINE WHETHER A FII CAN HAVE ANY B USINESS INCOME OR NOT. WE ARE CONFINED TO DETERMINING WHETHER THE INC OME FROM THE TRANSFER OF SECURITIES WOULD FALL UNDER SUB-SECTION (1) OR (2). IF IT IS PRESUMED AS A HYPOTHETICAL CASE THAT A FII MAY ALSO HAVE ANY BUSINESS ACTIVITY, WHETHER LEGAL OR ILLEGAL, THEN THE INCOME FROM SUCH ACTIVITY SHALL BE CONSIDERED AS `BUSINESS INCOME C OVERED UNDER SUB- SECTION (2)(B). THE ONLY EMBARGO AGAINST THE ABOVE PRESUMPTION IS THAT THE BUSINESS SHOULD NOT BE THAT OF DEALING IN `SECURITIES. ONCE THERE IS A SPECIAL PROVISION SLICING AWAY THE INCOM E TO A FII FROM THE TRANSFER OF `SECURITIES FROM THE OTHER INCOME, IT HAS TO FIND ITS HOME ONLY UNDER SUB-SECTION (1)(B), IRRESPECTIVE OF THE FACT THAT THE SECURITIES ARE VIEWED AS `INVESTMENT OR `STOCK IN TRADE. IF THE REVENUE VENTURES TO MAKE A DISTINCTION BETWEEN SUCH SECURITIES AS CONSTITUTING CAPITAL ASSET OR STOCK IN TRADE, WHICH IS NOT CONTEMPLATED BY THE CENTRAL GOVERNMENT AS IS EVIDENT FROM SEBI(F II) REGULATIONS AND THE DEFINITION OF FII IN EXPLANATION (A) TO SEC . 115AD, THEN THIS PROVISION WILL BECOME OTIOSE. IN OUR CONSIDERED O PINION IF A FII ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 22 RECEIVES ANY INCOME IN RESPECT OF SECURITIES OR FR OM THE TRANSFER OF SUCH SECURITIES, THE SAME CAN BE CONSIDERED UNDER S UB-SEC. (1) ALONE AND SUB-SEC. (2)(B) CANNOT BE INVOKED TO CONSTRUE I T AS `BUSINESS INCOME . 8.15. THE POSITION HAS BEEN CLARIFIED BY WAY OF A PRESS NOTE : F NO. 5(13)SE/91-FIV DATED 24.03.1994 ISSUED BY THE MINI STRY OF FINANCE, DEPARTMENT OF ECONOMIC AFFAIRS (INVESTMENT DIVISION ) , NEW DELHI, THE RELEVANT PART OF WHICH IS AS UNDER : THE TAXATION OF INCOME OF FOREIGN INSTITUTIONAL IN VESTORS FROM SECURITIES OR CAPITAL GAINS ARISING FROM THEIR TRANSFER, FOR THE PRESENT, SHALL BE AS UNDER:- (I) THE INCOME RECEIVED IN RESPECT OF SECURITIES (OTHER THAN UNITS OF OFF-SHORE FUNDS COVERED BY SECTION 115AB OF THE INCOME-TAX ACT) IS TO BE TAXED AT THE RATE OF 20%; (II) INCOME BY WAY LONG-TERM CAPITAL GAINS ARISING FROM THE TRANSFER OF THE SAID SECURITIES IS TO BE TAXED AT THE RATE OF 10%; (III) INCOME BY WAY OF SHORT-TERM CAPITAL GAINS ARISING FROM THE TRANSFER OF THE SAID SECURITIES IS TO BE TAXED AT THE RATE OF 30%; (IV) THE RATES OF INCOME-TAX AS AFORESAID WILL APPLY ON THE GROSS INCOME SPECIFIED ABOVE WITHOUT ALLOWING FOR ANY DEDUCTION UNDER SECTIONS 28 TO 44C, 57 AND CHAPTER VI-A OF THE INCOME- TAX ACT. 2. THE EXPRESSION FOREIGN INSTITUTIONAL INVESTOR HAS BEEN DEFINED IN SECTION 115AD OF THE INCOME- TAX ACT TO MEAN SUCH INVESTORS AS THE CENTRAL GOVERNMENT MAY, BY NOTIFICATION IN THE OFFICIAL GAZETTE, SPECIFY IN THIS BEHALF. THE FIIS AS ARE REGISTERED WITH THE SECURITIES AND EXCHANGE BOARD OF INDIA WILL BE AUTOMATICALLY NOTIFIED BY THE CENT RAL GOVERNMENT FOR THE PURPOSE OF SECTION 115AD. ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 23 8.16. FROM THE ABOVE PRESS NOTE, IT IS ABUNDA NTLY CLEAR THAT FIIS HAVE BEEN CONSIDERED AS INVESTORS (AND NOT AS TRA DERS). SECONDLY, INCOME FROM TRANSFER OF SECURITIES HAS BEEN VIEWED AS CHARGEABLE TO TAX UNDER THE HEAD `CAPITAL GAINS AS LONG-TERM OR SHORT-TERM CAPITAL GAIN DEPENDING UPON THE PERIOD FOR WHICH SUCH SECUR ITIES ARE HELD. 8.17. IN VIEW OF THE ABOVE DISCUSSION, IT IS OUT-AND-OUT THAT INCOME ARISING TO A FII FROM THE TRANSFER OF `SECUR ITIES AS SPECIFIED IN EXPLANATION (B) TO SEC. 115AD CAN ONLY BE CONSIDERE D AS SHORT-TERM OR LONG-TERM CAPITAL GAIN AND NOT AS BUSINESS INCO ME. AS THE `DERIVATIVES HAVE BEEN INCLUDED IN THE DEFINITION OF SECURITIES FOR THE PURPOSES OF THIS SECTION, THE INCOME FROM DERIVATIV ES SHALL ALSO BE CONSIDERED AS SHORT-TERM OR LONG-TERM CAPITAL GAIN DEPENDING UPON THE PERIOD OF HOLDING. IF THE VIEWPOINT OF THE DEPA RTMENT, TO THE EFFECT THAT INCOME FROM TRANSFER OF SHARES OR DEBE NTURES ETC. SHOULD BE CONSIDERED AS SHORT-TERM OR LONG-TERM CAPITAL GA IN (AS HAS BEEN ACCEPTED BY THE AO IN THE INSTANT CASE) BUT THAT F ROM DERIVATIVES SHOULD BE CONSIDERED AS `BUSINESS INCOME (SPECULAT ION BUSINESS), THEN IT WOULD MEAN CONSIDERING SHARES AND DEBENTURE ETC. AS DISTINCT FROM DERIVATIVES. MOREOVER THERE IS NOTHING ON REC ORD TO DEMONSTRATE THAT THE ASSESSEE WAS VISITED WITH ANY CONSEQUENCES AS PER REGULATION 7A FOR VIOLATION OF REGULATIONS 15 OR 16 . IT SHOWS THAT THE REGULATIONS HAVE BEEN CONSCIENTIOUSLY FOLLOWED BY THE ASSESSEE AS PER WHICH IT SIMPLY MADE ONLY INVESTMENT IN SECURIT IES AND THERE IS NOTHING OF THE SORT OF TRADING. ALTHOUGH IN COMMON PARLANCE, THE SHARES OR DEBENTURES ETC. ARE DISTINCT FROM DERIVAT IVES, AND THEIR ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 24 TAXATION MAY ALSO DIFFER IN THE CASE OF NON-FIIS, B UT SUCH DISTINCTION IS OBLITERATED IN THE CONTEXT OF FIIS DUE TO THE INCLU SION OF BOTH SHARES AND DEBENTURES ETC. ON ONE HAND AND DERIVATIVES ON THE OTHER, IN THE DEFINITION OF SECURITIES FOR THE PURPOSE OF SEC. 115AD AND SUB- SECTION (1) PROVIDING FOR THE INCOME FROM THEIR TRA NSFER TO BE CONSIDERED AS LONG TERM OR SHORT TERM CAPITAL GAIN. 8.18. IT IS NOTICED THAT SEC. 115AD FALLS IN CH APTER XII WHICH DEALS WITH THE DETERMINATION OF TAX IN CERTAIN SPEC IAL CASES. THIS CHAPTER CONSISTS OF SECTIONS 110 TO 115BBC. EACH SE CTION CONTAINS SPECIAL PROVISIONS DEALING WITH SPECIFIC TYPES OF I NCOMES FOR WHICH A SPECIFIED RATE OF TAX IS PROVIDED. IF A PARTICULAR ITEM OF INCOME IS COVERED IN ANY OF THESE SECTIONS, IT SHALL BE STRIC TLY GOVERNED BY THE PRESCRIPTION OF THAT RELEVANT SECTION ALONE. WE ARE REMINDED OF THE LEGAL MAXIM ` GENERALIA SPECIALIBUS NON DEROGANT , WHICH MEANS THAT SPECIAL PROVISIONS OVERRIDE THE GENERAL PROVISIONS. IT IS A WELL SETTLED LEGAL POSITION THAT SPECIFIC PROVISIONS OVERRIDE THE GENERAL PROVI SIONS. IN OTHER WORDS, IF THERE ARE TWO CONFLICTING PROVISIONS IN A N ENACTMENT, THE SPECIAL PROVISIONS WILL PREVAIL AND THE SUBJECT MAT TER COVERED IN SUCH A SPECIAL PROVISION SHALL STAND EXCLUDED FROM THE S COPE OF THE GENERAL PROVISION. THE HONBLE SUPREME COURT IN THE CASE O F BRITANNIA INDUSTRIES LTD. VS. CIT (2005) 278 ITR 546 (SC) HAS HELD THAT EXPENDITURE TOWARDS RENT, REPAIRS, MAINTENANCE OF G UEST HOUSE USED IN CONNECTION WITH BUSINESS IS TO BE DISALLOWED U/S . 37(4) BECAUSE THIS IS A SPECIAL PROVISION OVERRIDING THE GENERAL PROV ISION. ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 25 9. COMING BACK TO OUR CONTEXT, IT IS SEEN THA T INCOME ARISING FROM THE TRANSFER OF SECURITIES OF THE FIIS HAS BEEN INC LUDED UNDER SEC. 115AD(1)(B) TO BE CATEGORIZED AS SHORT-TERM OR LONG -TERM CAPITAL GAIN DEPENDING UPON THE PERIOD OF HOLDING. IN SUCH A SIT UATION, IT IS IMPERMISSIBLE TO CONSIDER SUCH INCOME AS FALLING U NDER THE HEAD PROFITS AND GAINS OF BUSINESS OR PROFESSION. SUCH INCOME ARISING FROM THE TRANSFER OF SECURITIES SHALL BE CHARGED TO TAX UNDER THE HEAD CAPITAL GAINS ALONE. ONCE INCLUSION OF SUCH INCOM E FROM THE TRANSFER OF SECURITIES IS HELD TO BE FALLING ONLY UNDER THE HEAD CAPITAL GAINS, IT CANNOT BE CONSIDERED AS `BUSINESS INCOME, WHETH ER SPECULATIVE OR NON-SPECULATIVE. 10. THE HEADING OF SECTION 43 IS : `DEFINITI ONS OF CERTAIN TERMS RELEVANT TO INCOME FROM PROFITS AND GAINS OF BUSINE SS OR PROFESSION. THE OPENING PART OF THIS SECTION IS : IN SECTIONS 28 TO 41 AND IN THIS SECTION, UNLESS THE CONTEXT OTHERWISE REQUIRES-. THEREAFTER, SIX SUB- SECTIONS HAVE BEEN GIVEN, OF WHICH SUB-SEC. (5) DEF INES SPECULATIVE TRANSACTION. IT IS, THEREFORE, CLEAR THAT SEC. 43( 5) DEFINING SPECULATIVE TRANSACTION IS RELEVANT ONLY IN THE CONTEXT OF INCOME UNDER THE HEAD `PROFITS AND GAINS OF BUSINESS OR PR OFESSION. IT RULES OUT ITS APPLICATION TO INCOME UNDER ANY OTHER HEAD. IF THAT BE THE POSITION, THE PICTURE IS CLEAR THAT SEC. 43(5) HAS NO APPLICATION TO FIIS IN RESPECT OF SECURITIES AS DEFINED IN EXPLANATIO N TO SEC. 115AD, INCOME FROM WHOSE TRANSFER IS CONSIDERED AS SHORT T ERM OR LONG TERM CAPITAL GAINS. ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 26 11. WE, THEREFORE, HOLD THAT THE LD. CIT(A) WAS NOT JUSTIFIED IN HOLDING THAT INCOME FROM INDEX BASED OR NON-INDEX B ASED DERIVATIVES BE TREATED AS BUSINESS INCOME, WHETHER SPECULATIV E OR NON- SPECULATIVE. THE IMPUGNED ORDER IS, THEREFORE, SET ASIDE BY HOLDING THAT INCOME FROM DERIVATIVE TRANSACTION RESULTING I NTO LOSS OF RS.11.27 CRORES IS TO BE CONSIDERED AS SHORT-TERM CAPITAL LO SS ON THE SALE OF SECURITIES WHICH IS ELIGIBLE FOR ADJUSTMENT AGAINST SHORT-TERM CAPITAL GAINS ARISING FROM THE SALE OF SHARES. 12. IN THE RESULT, THE APPEAL OF THE ASSESSEE IS AL LOWED AND THAT OF THE REVENUE IS DISMISSED. ORDER PRONOUNCED ON THE 27TH DAY OF MAY, 2011. SD/- SD/- (VIJAY PAL RAO) (R.S. SYAL) JUDICIAL MEMBER ACCOUNTANT MEMBER MUMBAI: 27TH MAY , 2011. NG: COPY TO : 1. DEPARTMENT. 2.ASSESSEE. 3 CIT(A)-XXVII,,MUMBAI. 4 CIT,CITY-3,MUMBAI. 5.DR,B BENCH,MUMBAI. 6.MASTER FILE. (TRUE COPY) BY ORDER, ASST.REGISTRAR, ITAT, MUMBAI. ITA NOS.2645-2691/M/09 LG ASIAN PLUS LTD.. 27 DETAILS DATE INITIALS DESIGNA TION 1. DRAFT DICTATED ON 19-05-11 SR.PS/ 2. DRAFT PLACED BEFORE AUTHOR 23-05-11 SR.PS/ 3. DRAFT PROPOSED & PLACED BEFORE THE SECOND MEMBER JM/AM 4. DRAFT DISCUSSED/APPROVED BY SECOND MEMBER JM/AM 5. APPROVED DRAFT COMES TO THE SR.PS/PS SR.PS/ 6. KEPT FOR PRONOUNCEMENT ON SR.PS/ 7. FILE SENT TO THE BENCH CLERK SR.PS/ 8. DATE ON WHICH THE FILE GOES TO THE HEAD CLERK 9. DATE ON WHICH FILE GOES TO THE AR 10. DATE OF DISPATCH OF ORDER *