US-based Fidelity Group, one of the largest foreign investors in Indian stocks, has put to test the tax treatment of income from trading in shares of portfolio investors.
Close to 40 offshore schemes managed by the group have sought advance rulings on the tax liability on profits from sale of shares. The rulings have been sought in the hope of getting a short-term capital gains tax waiver. An exemption is possible if the income is categorised as business income and not as capital gains.
The Authority for Advance Ruling (AAR), a quasi-judicial body, has bunched together all the applications of the Fidelity Groups offshore schemes, said a senior revenue department official. Cases are normally bunched when the issues are similar. The hearing is scheduled for next month.
The trigger for seeking advance rulings on tax liability on income from sale of Indian equities by different off-shore funds managed by the Fidelity Group has been an earlier ruling given by AAR in the case of Fidelity Advisor Series VIII. This sub-account of the FII registered with Sebi has been exempted paying capital gains tax in India.
AAR took the view that Fidelity Series VIII does not have a fixed place of business in India. It looked at the frequency of purchase and sale of shares and ruled that the gains from trading in shares are in the nature of business income and taxable only in the US.
The AARs ruling is binding on the tax-payer and the revenue department. It also has a persuasive value. The timing (of seeking rulings on a similar issue) is significant, considering that the Central Board of Direct Taxes (CBDT) is set to finalise a fresh set of norms to determine whether a tax-payer is an investor or a trader in shares. A domestic tax-payer will have to pay a higher tax if he is a share-trader.
Portfolio investors coming from destinations other than Mauritius and Singapore have to pay a 10% short term capital gains tax if they hold shares for less than a year and their income from sale of shares is treated as capital gains.
Simply put, they have to pay tax on short term capital gains from sale of shares, if categorised as investors. They are, however, exempted long term capital gains tax because they pay the Securities Transaction Tax (STT).
Mauritius based FIIs, on the other hand, are exempted both short term and long term capital gains tax because Mauritius does not tax capital gains. FIIs routing their investments from Mauritius stand to gain if they are categorised as investors.
Nearly 99% of the FIIs come from countries that have a tax-treaty with India and most of them do not have a permanent establishment (PE) or a fixed place of business in India. In such cases, if their income from sale of shares is categorised as business income, they will not have to pay any tax in India.
In short, FIIs do not have to pay tax on their business income in India if they are categorised as traders in shares provided they do not have a PE and are covered by a double taxation avoidance treaty.
The issue at stake, therefore revolves around the question, whether an FII is an investor or a trader in shares. The offshore schemes managed by the Fidelity Group have sought advance rulings on the characterisation of income from sale of securities whether the gains from trading in equities will be treated as business income or capital gains.
The other crucial issue is the existence (or not) of a PE in India, said an official. CBDTs draft instructions to assessing officers listed out 15 parameters to check if an assessee is a trader or an investor.
The criteria included the scale of activity, ratio of sales to purchases and holding, frequency of transactions, stated objects in the memorandum and articles of association in the case of a corporate assessee etc. The instructions to assessing officers applied to all market participants including domestic and foreign players.