Extraterritorial Application of US Securities Law: Morrison v. National Australia Bank

The US Supreme Court has delivered its judgment in Morrison v. National Australia Bank. The Court held that the Section 10(b) of the US Securities Exchange Act 1934 has no extraterritorial application. The Supreme Court has disagreed with this reasoning, and has extensively discussed the presumption against extraterritoriality. The decision of the Supreme Court impliedly overrules a large number of cases decided by the Second Circuit holding that Section 10(b) had extraterritorial application. In a number of those cases, the Second Circuit had relied on the ‘effects’ test. The Supreme Court of the United States rejects this reasoning in its entirety; and supports an extremely strong presumption against extraterritoriality.

The decision of the US Supreme Court has been analysed in this post on the Opinio Juris blog. Mr. V. Umakanth also highlights the importance of the judgment in this post on the Indian Corporate Law blog. 

(Incidentally, the effects doctrine which was relied on in some cases by the Second Circuit to establish extraterritoriality was also applied by the Bombay High Court in the Vodafone matter, holding Section 195 to have extraterritorial application - it is likely that this issue will come up once again as the Vodafone matter is now listed before the Bombay High Court in early July) 

More on Equitable Set-off: A Confusing Court of Appeal decision

Earlier on this blog, there were several discussions on the right of retention and equitable set-off (see this post and the links to previous posts contained therein). There is another decision of the Court of Appeal on the point, decided barely a couple of weeks ago – Geldof Metaalconstructie NV v Simon Carves Ltd. [2010] EWCA Civ 667. The Court of Appeal has extensively discussed the common law position on equitable setoff. The conclusions of the Court are set out in paragraph 43 of the judgment.

Following the decision in Bim Kemi, it was held that there is no requirement that the original claim and the set-off must be so closely connected that the existence of the latter impeaches the title of the former. The “impeachment of title” test is not a useful guide. Lord Denning had stated in The Nanfri, [1978] 2 QB 927, “And it is only cross-claims which go directly to impeach the plaintiff's demands, that is, so closely connected with his demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim…” This formulation has been rejected by the Court of Appeal. Nonetheless, “there is clearly a formal requirement of close connection…”

What exactly is this close connection? The Court of Appeal highlighted to importance of refusing to become “bogged down in the nuances of formulation…” Thus, it would be for the Court to determine in each specific case as to whether the claim and the set-off are closely connected – they need not be so closely connected that the latter impeaches the title of the former, but they must nevertheless be close. This simply begs the question, how close? Perhaps to answer this, the Court states that there is also a ‘functional’ requirement. “It needs to be unjust to enforce the claim without taking into account the cross-claim…” However, both these elements of close connection and injustice are elements of the same step – the analysis is not a two-stage analysis. Instead, the test is a single-stage test, and “there is both a formal element in the test and a functional element. The importance of the formal element is to ensure that the doctrine of equitable set-off is based on principle and not discretion. The importance of the functional element is to remind litigants and courts that the ultimate rationality of the regime is equity.”

It is hard to see how ‘refusing to be bogged down in the nuances of formulation’ and ‘ensuring that the doctrine is based on principle and not discretion’ are entirely reconcilable. The Court of Appeal does not provide much guidance in this regard. The Court notes that the formal and the functional element “cannot ultimately be divorced from each other. It may be that at times some judges have emphasized the test of equity at the expense of the requirement of close connection, while other judges have put the emphasis the other way…” and consequently, the best test would cover “cross-claims…so closely connected with [the plaintiff's] demands that it would be manifestly unjust to allow him to enforce payment without taking into account the cross-claim…”

With respect, what the Court of Appeal has laid down is hardly a ‘test’ – the ‘test’ simply begs the question of what degree of connection is required for one to conclude that enforcing the claim would be unjust. Undoubtedly, formulating a test is difficult. In that case, why not just recognise that difficulty and say that the matter is to be left to judicial discretion, or is to be decided as a matter of fact? Is there any use in stressing that the rule is based on principle and not on discretion, when in sum and substance the ‘principle’ is that the matter is left to judicial discretion?

Developments after Transfield: Sylvia Shipping

We had initially discussed recent developments in the law of contractual damages here and here. In particular, the posts had highlighted some observations in Transfield Shipping v. Mercator and Supershield v. Siemens. Mr. Badrinath Srinivasan, (who had earlier written a guest post for this blog) has pointed me to this litigation e-bulletin prepared by the law firm by Herbert Smith discussing the case of Sylvia Shipping Co Limited v Progress Bulk Carriers Limited [2010] EWHC 542 (Comm). The bulletin notes, “This was not a case in which either party had argued that the assumption of responsibility test should apply, and, of course, as a first instance decision, the observations of Hamblen J may not be followed in future cases. However, the judgment endorses the limiting of the assumption of responsibility test to unusual cases. This will restore order for the great majority of cases which, in Hamblen J's view, remain to be decided on orthodox principles of remoteness. Further, Hamblen J's definition of "unusual" cases in which assumption of responsibility should be applied as a stand alone test would limit significantly the use of the assumption of responsibility test. It remains to be seen how rules on remoteness are applied in future cases, but Sylvia Shipping is a step on the road to providing judicial certainty on the correct test for remoteness in a particular case…” 

Arbitration Agreements and Anti-suit injunctions

The Kluwer Arbitration Blog carries this post on a recent decision of In AES UST-Kamenogorsk Hydropower Plant LLP v UST-Kamenogorsk Hydropower Plant JSC [2010] EWHC 772 (Comm) where an anti-suit injunction was granted on the basis of the principle in Turner v Grovit [2002] 1 WLR 107, where in a case where the applicant was “relying upon a contractual right not to be sued in the foreign country” (this right essentially was through the existence of an arbitration agreement), and the House of Lords held that  “he has by reason of his contract a legitimate interest in enforcing that right against the other party to the contract” – in other words, an anti-suit injunction was granted vis-à-vis a foreign court on the basis of an arbitration agreement. 

What makes the decision in AES more interesting is that the Court makes (according to the Kluwer Arbitration Blog) a distinction “between parties seeking to enforce an arbitration clause who subsequently intend to make a claim within it and those who simply seek to enforce their contractual right not to be sued other than in arbitration…” and holds (again, as summarised by the Kluwer arbitration blog) “in respect of the former, the court will respect the principle of non-intervention… leaving the issue of the validity of the clause to the tribunal… while in the case of the latter, the intervention of the court to determine validity may be entirely appropriate…”

True and Fair View: Court of Appeal decision

On the Indian Corporate Law blog, I recently highlighted a decision of the Court of Appeal in Macquarie International Investments v. Glencore, [2010] EWCA Civ 697, on the ‘true and fair view’ in auditing. Shantanu Naravane had discussed the decision of the High Court in the same case in detail earlier, and that decision has now been upheld. The issue has been previously considered on this blog here. 

Possession by a Landlord

A while ago, I had highlighted the judgment of the Supreme Court in Sadashiv Sawant v. Anita Sawant, where the Supreme Court held that a landlord remains in legal possession of leased property. The question arose in the context of Section 6 of the Specific Relief Act, 1963, which allows a person 'dispossessed' to maintain a suit. In holding that a landlord can maintain a suit under the Section, the Supreme Court noted that "A landlord by letting out the property to a tenant does not lose possession as he continues to retain the legal possession although actual possession, user and control of that property is with the tenant. By retaining legal possession or in any case constructive possession, the landlord also retains all his legal remedies. As a matter of law, the dispossession of tenant by a third party is dispossession of the landlord..." It is submitted that as a matter of law, the position that a landlord remains in legal possession of leased property requires greater consideration.

In another post, I had noted a decision of the Supreme Court which held that the difference between a lease and a license was essentially that in the case of a license, no interest in the property passes; while in the case of a lease, it does. The Supreme Court in New Bus Stand Shop Owners v. Corporation of Kozhikode, (2009) 10 SCC 455, approved of the principle "A dispensation or
licence properly passeth no interest nor alters or transfers property in anything, but only makes an action lawful which without it would have been unlawful. The difference between a tenancy and a licence is, therefore, that, in a tenancy, an interest passes in the land, whereas, in a license, it does not..." (see passage by Vaughan CJ in Thomas v. Sorell, [1558-1774] All ER Rep 107, which was approved by Lord Denning in Errington v. Errington & Woods, [1952] 1 All ER 149). The question which arises is, what kind of interest passes in the case of a lease. The common law position was stated in Street v. Mountford, [1985] AC 809 (HL) by Lord Templeman, "To constitute a tenancy the occupier must be granted exclusive possession for a fixed or periodic term certain in consideration of a premium or periodical payments..." In a leading work, 'English Private Law' (ed. Peter Birks, 2000), it is stated, "it is clear that any arrangement which falls short of conferring a right to the exclusive possession of the land will not qualify as a lease..." These observations must apply to not just actual but also to legal possession – that would be the defining feature of a lease. As such, the Court's observations that in the case of a lease actual possession is with the tenant but legal possession is with the landlord, appear to merit some reconsideration. If the Court's reasoning is to be accepted, it would mean that the owner would ipso facto always be in possession of the property he owns. In terms of the final decision, the result might be supported perhaps by arguing that in such cases, the landlord would be able to maintain a suit even when he is not himself dispossessed. Section 6 allows a suit to be maintained by "any person dispossessed" or by "any person claiming through him"; thus, the plaintiff must either be himself dispossessed himself, or he must be claiming through someone who has been dispossessed. The decision of the Court can perhaps be supported on the second plank; but the reasoning on the first plank may need further consideration.

Airline Rotables: The Three Tests for the Existence of a PE

In a previous post, I had referred to a decision of the Mumbai Bench of the Income Tax Appellate Tribunal in Airline Rotables v. JDIT, ITA No. 3254/Mum/06/ which was concerned with the existence of a PE. This post looks at that decision in greater detail. The main question before the Tribunal was whether the assessee, a company incorporated under the laws of the United Kingdom and engaged in the business of providing aircraft spare parts and component support to aircraft operators, had a permenant establishment in India. In respect of its business, the assessee entered into an agreement with Jet Airways. Under the agreement, whenever a component of a plane belonging to Jet Airways became unfit for use, the assessee was required to repair the same, keeping in view established norms and directives. In addition to this, the assessee also provided replacement components which could be used by the client airline during the period when the original component was being repaired. In order to ensure that flight operations were not interrupted, the assessee provided a stock of spare components at the operating base of the client airlines. In addition, these components were also stored in the assessee's main storage depot in the UK. This stock – the one in the UK as well as the one stored at the operating base of the client airline – continued to be the property owned by the assessee. The stock in the operating base of the airline was in the possession of the airline in the capacity of a bailment. The airline was not allowed any use of that stored stock except by way of replacement as stipulated in the agreement.

The Assessing Officer took the view that the stores staff of Jet Airways were acting as agents of the assessee, and this relationship resulted in the assessee company having a permanent establishment in India. He was of the opinion that the stocks of the assessee were kept in the client's operating base, but were always stored separately. This place of storage was treated by the AO as a fixed place of business. The CIT(A) upheld the order of the AO. Thus, the Tribunal was called upon to decide the question of whether on the facts summarised above, the assessee had a PE in India under Article V of the India-UK DTAA (which is linked here).

In this context, the tribunal referred to the three criterions which must be satisfied before a PE can be said to exist under the basic rule – in order to hold that the assessee had a fixed place of business in India, the Tribunal clarified that it was necessary to satisfy "... the physical criterion i.e. existence of physical location, the subjective criterion i.e. right to use that place, and the functionality criterion i.e. carrying on business through that place." Importantly, the Tribunal noted that mere factual use of the place does not satisfy the test. The Tribunal relied on observations of the Special Bench of the Tribunal in Motorola Inc. V. DCIT, 95 ITD 269 SB, "one must be able to pinpoint a physical location at the disposal of the enterprise" (emphasis supplied by the Tribunal in Airline Rotables). Clarifying certain observations of the Special Bench, the Tribunal further noted that the subjective criterion is satisfied only when the foreign enterprise has a legal right to use the physical location to carry on its own business. Further, clarifying the content of the functionality criterion, the Tribunal held that the requirement is not satisfied if the place is used merely for doing some work for the owner of the physical location. The functionality criterion should indicate (to borrow from the language used by the High Court in Vishakhapatnam Port) that the physical location is a virtual projection of an enterprise of one country into the soil of another country. The Tribunal also noted the decision in ADIT v. Valentine Maritime, 2010-TIOL-195-ITAT-MUM, and held that on the basis of that decision, it is not enough "if the physical location has come into play as an end result of business having been carried out". When the physical location comes into existence as a result of a business activity, then "the business cannot be said to have been carried out on such place qua that business activity..."

To conclude this part of the discussion, the analysis by the Tribunal of the previous case-law on the point is extreemely useful in clearly bringing out the conceptual basis on which the law on the point rests; and consequently, is likely to bring clarity in this area. In the next part of this post, I will look at how the Tribunal applied these principles to the facts of the case before it; and will also look at the decision of the Tribunal on the issue of whether a dependent agent PE existed.

 

The Scope of Entry 49, List II: Part I

In a previous post, it was noted that one ground of challenge to the levying of service tax on renting of immovable property by Parliament is that such a tax would actually be under Entry 49, List II and outside the legislative competence of Parliament. This brings us to the question of the true scope of Entry 49 – a subject on which there have been several Supreme Court pronouncements. Entry 49, List II reads – ‘Taxes on lands and buildings.’ Would the scope of the words used here include taxes on renting of land and buildings?

It is possible to argue that on the face of it, Entry 49 refers to taxes on land and buildings per se; when a tax is levied on the renting of land and buildings it would not be covered under this Entry. Entry 49 is attracted only when the tax is on the land and building – the taxable event for a charge of tax covered by this entry would be the existence of land and buildings alone. The renting of such land and buildings is different from the existence thereof – consequently, a tax on renting of immovable property is different from a tax on immovable property itself. Arguably, there is some indirect support for this proposition in State of West Bengal v. Kesoram Industries, (2004) 10 SCC 201.

In Kesoram Industries, a Constitution Bench of the Supreme Court was called upon to adjudicate whether a cess on land levied by the State Legislature based on the value of the coal production from that land was within the scope of Entry 49. The Court upheld the legislative competence of the State government and observed, “Once it is held that the land or building is available to be taxed, it does not matter to what use the land is being subjected though the nature of the user may enable land of one particular user being classified separately from the land being subjected to another kind of user. The tax would remain a tax on land. It cannot be urged that what is being taxed is not the land but the nature of its user…” So too, can it be urged that in the instant case, because reference is made to immovable property, what is being taxed is not the renting/nature of use of the property but the property itself? It would appear that such an argument would not be possible.

In Assistant Commissioner of Urban Land Tax v. Buckingham & Carnatic Co., [1970] 75 ITR 603 (SC), it was held that to fall under Entry 49, List II, two tests must be satisfied. First, the tax must be directly imposed on land/buildings; and secondly, the tax must bear a definite relation to the land and buildings. In the case of tax on renting of immovable property, is the tax really imposed directly on land and buildings? In Kesoram Industries, the Court also clarified the earlier decision in India Cements v. State of Tamil Nadu, and in this context observed, “There is a clear distinction between 'tax directly on land' and 'tax on income arising from land'.” If that is so, it can be argued that there must be an equally clear distinction between a tax directly on land, and a tax on the renting of that land for use by another.

How these arguments can be countered will be discussed in a subsequent post. Comments/arguments of readers are invited.

'Service' Tax on Renting of Immovable Property: Constitutional Aspects

In a previous post, I referred to a constitutional challenge pending in several High Courts on the amendment to the Finance Act, 1994 by the Finance Act, 2010 levying service tax on renting of immovable property. In terms of the legislative competence of the Union Parliament, there are a few grounds on which a challenge to this provision can be mounted. First, one can consider the issue of whether Parliament has the competence to artificially enlarge the definition of ‘service’. Parliament appears to have that power – even if the subject-matter of the tax is not a real service conceptually, if Parliament has the power to legislate under the residuary entry (Entry 97, List I) then the mere fact that Parliament has incorrectly termed the tax as a service tax ought not to matter. It is noteworthy that similar issues may arise in several contexts – for instance, we have already considered the amendments to the Income Tax Act by Section 26 of the Finance (No. 2) Act, 2009, through which Section 56 of the Income Tax Act, 1961 was amended. As I stated in an earlier post, “among other things, the amendment has artificially expanded the definition of “income from other sources” so as to practically make transfers of immovable property without consideration subject to charge of income tax in the hands of the transferee…” Such types of artificial expansions (when made by Parliament) are possible because of Entry 97. There may be a possible line of argument against such legislative practice based on some stray observations in Kalyana Mandapam – please refer to the discussion in this post on the scope of Entry 97 in the context of Section 56 of the Income Tax Act. This line of argument however appears to be weak; and it would be a stronger case to show that competence of Parliament does not exist as the tax falls within List II (thereby not giving recourse to Parliament under Entry 97, List I). In this regard, the question which arises is – does the imposition of a ‘service’ tax on the renting of immovable property fall within the scope and ambit of Entry 49, List II? The question shall be considered in detail in the next post.

Service Tax on renting of Immovable Property

The Andhra Pradesh High Court in Trent Ltd. v. Union of India, WPMP No. 15963 of 2010 in WP No. 12681 of 2010 has stayed the retrospective imposition of service tax on renting of immovable property. The Court ordered, “The generic contentions urged on behalf of the petitioner, briefly adverted to above, are eminently arguable though we are not prima-facie satisfied to an extent warranting interdiction of the operation of the provisions of Section 65 (105) (zzzz) in so far as their prospective application is concerned. The challenge as to the retrospectivity of the provisions, in our considered view and prima-facie is on more substantial grounds. On the prima-facie analysis above, the respondents are directed, pending further orders in this application or in the writ petition, not to initiate any coercive steps for recovery of the service tax on the renting of immovable property by the petitioners, on the basis of the provisions of Section 65 (105) (zzzz) as amended by the Finance Act, 2010, for the period 01/06/2007 to 01/04/2010. Petitioner shall, however, be liable to pay the applicable service tax as per the provisions of Section 65 (105) {zzzz), for the period subsequent to 01/04/2010 but subject to the result of the writ petition, notice.” A copy of the judgment is available here. Insofar as prospective application goes, there is no stay from the Andhra Pradesh High Court - the stay is only on the retrospective application. The Court has stated that the propositions are "eminently arguable" but that it was not "prima facie satisfied" that a stay on prospective application was warranted. It is not clear why the Court was not even prima facie satisfied after finding that the propositions were eminently arguable. Meanwhile, the Delhi High Court had also issued a stay on recovery of tax under the amended provision in Home Solutions Retail v. Union of India, WP (Civ) No. 3398/2010. A copy of that judgment is available here.

The Delhi High Court had previously held in Home Solutions Retail that levying service tax on immovable property was ultra vires the Finance Act, 1994. Following this judgment, the Finance Act, 1994 was amended retrospectively by the Finance Act, 2010 to indicate that renting of immovable property was in itself a taxable service. This amendment has now been challenged. Insofar as the retrospective application of this provision is concerned, I had discussed possible issues in the general context of retrospective taxation here and here. Another ground of challenge before the Andhra Pradesh and Delhi High Courts is based on legislative competence, and that aspect will be discussed subsequently.

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Event Announcement: Conference on GST

The School of Law, Christ University, in collaboration with Lakshmi Kumaran & Sridharan, Bangalore, are organizing a conference on the GST on 26 June 2010. Gautam Chawla sends the following invitation, which might be on interest to readers of this blog:

The replacement of the state taxes by the Value Added Tax in 2005 marked a significant step forward in the reform of domestic trade taxes in India. Buoyed by the success of the State VAT, the Centre and the States have now embarked on the design and implementation of the perfect solution alluded to in the Bagchi Report. As announced by the Empowered Committee of State Finance Ministers in November 2007, the solution is to take the form of a ‘Dual’ Goods and Services Tax (GST), to be levied concurrently by both levels of Government. The Conference is an endeavor to discuss the political, social and economic character of GST and its impact on different sectors of the economy, and households in different social and economic strata of the nation.

The objective of this Conference is to bring about a multidisciplinary discussion on the subject so as to explore the implications of GST in India. Broadly the Conference has been divided into two themes – the Interplay between the State Tax Laws and GST and the Interplay between the Central Tax Laws and GST.  Please find attached the official invite and the School of Law brochure.

The themes will be discussed in two sessions. Each session will constitute of a Tax practitioner, a Senior Chartered Accountant, a Government Official (Commissioner / Additional commissioner of Sales Tax) and a representative from the Industry (Consulting firms / Manufacturers).

The confirmed speakers include:

v                             Mr. B.T. Manohar, FKCCI Chairman

v                             Mr.S. Venkataramani, Tax practitioner

v                             Mr. Pradeep Singh Kharola, I.A.S,  Commissioner of Commercial Taxes

v                             Mr. V. Raghuraman, Advocate, Partner, Raghuraman & Chythanya, Advocates

v                             Mr. G. Shivadass, Partner, Lakshmi Kumaran & Sridharan, Bangalore

v                             Mr. Nagendra Kumar, LTU Commissioner

The Conference will be held at Christ University Auditorium between 9:30am and 6pm on Saturday, 26 June 2010. Kindly confirm your participation by indicating the number of heads attending latest by Tuesday, 22 June 2010 by emailing at the below mentioned addresses. A nominal registration fee is being charged based on the following table. The registration fee is payable in cash on the Registration Desk between 8:30am and 9:30am on the Conference Day.

Category	Amount
Professionals /  CA’s	Rs. 1500 per delegate
Academicians and Research Scholars	Rs. 1000 per delegate
Students	Rs. 250 per delegate

For registration or any further queries, please feel free to write back or contact the Student Coordinators at:

Prarthna Kedia                                                            Shambhavi

+91 99868 92464                                                        +91 99457 85819

prarthana.kedia@law.christuniversity.in                    shambhavi@law.christuniversity.in

Trade, Law & Development: Special issue on International Investment Law

‘Trade, Law and Development’ has published its newest issue – a special issue on international investment arbitration. It includes contributions by Gus van Harten and Stephan Schill. Dolores Bentolila has an article about the applicability of the Barcelona Traction rule to ICSID arbitrations, and whether shareholder’s can claim under the ICSID for indirect damages. Omar Garcia-Bolivar’s note analyses the scope of ICSID protection; looking at the limits on ICSID jurisdiction. My article examines the law on umbrella clauses, a subject briefly discussed on this blog. All the articles can be viewed from this link.

Scope of Presumption under Section 139, NI Act.

In a recent judgment, Rangappa v. Sri Mohan, a three-Judge Bench of the Supreme Court has clarified the scope of the presumption under Section 139 of the Negotiable Instruments Act; and appears to have overruled the decision of two Judges in Krishna Janardhan Bhat v. Dattatraya Hegde. Section 139 of the Act reads, “Presumption in favour of holder. It shall be presumed, unless the contrary is proved, that the holder of a cheque received the cheque of the nature referred to in section 138 for the discharge, in whole or in part, or any debt or other liability.” The relevant portions of the judgment of the Bench (Justice S.B. Sinha and Justice H.S. Bedi) in Krishna Janardhan Bhat’s case are as follows:

“Indisputably, a mandatory presumption is required to be raised in terms of Section 118(b) and Section 139 of the Act. Section 13(1) of the Act defines negotiable instrument to mean a promissory note, bill of exchange or cheque payable either to order or to bearer. Section 138 of the Act has three ingredients, viz.: (i) that there is a legally enforceable debt; (ii) that the cheque was drawn from the account of bank for discharge in whole or in part of any debt or other liability which pre- supposes a legally enforceable debt; and (iii) that the cheque so issued had been returned due to insufficiency of funds. The proviso appended to the said section provides for compliance of legal requirements before a complaint petition can be acted upon by a court of law. Section 139 of the Act merely raises a presumption in regard to the second aspect of the matter. Existence of legally recoverable debt is not a matter of presumption under Section 139 of the Act. It merely raises a presumption in favour of a holder of the cheque that the same has been issued for discharge of any debt or other liability…”

These observations could perhaps be taken to imply that in prosecutions for violation of Section 138 of the Act, the complainant would have to prove the existence of a legally enforceable debt, only after which the presumption u/s 139 would operate to the extent that the Court shall presume that the cheque was issued in relation to that debt. The larger Bench in Rangappa has clarified that this would not be the correct position, “In light of these extracts, we are in agreement with the respondent-claimant that the presumption mandated by Section 139 of the Act does indeed include the existence of a legally enforceable debt or liability. To that extent, the impugned observations in Krishna Janardhan Bhat (supra) may not be correct…”

The 'Single Meaning Rule' and Malicious Falsehood

Ajinomoto Sweeteners Europe SAS v. ASDA Stores Ltd., [2010] EWCA Civ 609, presented an opportunity for the Court of Appeal to clarify some aspects of the law relating to the economic tort of malicious falsehood. In particular, the question was whether the ‘single meaning rule’ applied to malicious falsehood.

The single meaning rule developed in common law in relation to defamation cases. The classis statement of the rule is found in a passage in Slim v. Daily Telegraph, [1968] 2 QB 157, where Lord Justice Diplock expressed the rule in a clear statement:

“…Where, as in the present case, words are published to the millions of readers of a popular newspaper, the chances are that if the words are reasonably capable of being understood as bearing more than one meaning, some readers will have understood them as bearing one of those meanings and some will have understood them as bearing others of those meanings. But none of this matters. What does matter is what the adjudicator at the trial thinks is the one and only meaning that the readers as reasonable men should have collectively understood the words to bear. That is 'the natural and ordinary meaning' of words in an action for libel. Juries, in theory, must be unanimous upon every issue on which they have to adjudicate; and since the damages that they award must depend upon the defamatory meaning that they attribute to the words, they must all agree upon a single meaning as being the 'right' meaning. And so the unexpressed major premise, that any particular combination of words can bear but a single 'natural and ordinary meaning' which is 'right,' survived the transfer from judge to jury of the function of adjudicating upon the meaning of words in civil actions for libel…”

Essentially, the rule says that where two reasonable interpretations are possible, whether defamation has taken place or not must be ascertained by giving the words a single meaning. Thus, it is not sufficient to show that the words used by a defendant in a defamation case are possible to be interpreted in a defamatory manner. Instead, the words used must first be interpreted to mean one single thing (they must be given one single meaning) and then it must be seen whether that meaning is defamatory. In other words, it is not enough to show that a meaning of the words used is defamatory – it must be shown that the meaning of the words used is defamatory. The question before the Court of Appeal was whether this single meaning rule applied to cases of malicious falsehood also; and the judgment may have an important bearing in cases where a claim arises in tort on grounds of alleged commercial disparagement.

The plaintiff in the case was one of the world’s leading manufacturers and suppliers of aspartame (a sugar substitute). The defendant was a seller of health foods. One of its products carried a tag, “No hidden nasties... No artificial colours of flavours and no aspartame’. The plaintiff contended that this implied that the defendant was claiming ‘here is a risk that aspartame is harmful or unhealthy’. The defendant contended that the words simply meant that its product was intended for customers who found aspartame objectionable. The plaintiff argued that the single meaning rule did not apply to malicious falsehoods – it was enough if one of the reasonable meanings of the words used was objectionable. The defendant claimed that the single meaning rule was applicable; and that its preferred meaning was that single meaning.

The Court held in favour of the plaintiff, that the single meaning rule did not apply to malicious falsehood. Lord Justice Sedley concluded (Sir Scott Baker concurring), “On the judge's unchallenged findings, the meanings which reasonable consumers might put on Asda's health-food packaging include both the damaging and the innocuous. Why should the law not move on to proof of malice in relation to the damaging meaning and (if malice is proved) the consequential damage without artificially pruning the facts so as to presume the very thing – a single meaning - that the judge has found not to be the case? I do not accept that doing this will make trials of malicious falsehood claims unwieldy or over-complex. This is not because these claims are always tried by a judge alone: the experience of common law judges is that juries are on the whole very good at assimilating and applying sometimes complicated directions. It is because it makes the trial of the issues fairer and more realistic. Instead of (as here) denying any remedy to a claimant whose business has been injured in the eyes of some consumers on the illogical ground that it has not been injured in the eyes of others, or alternatively (and Mr Caldecott's case necessarily involves this) giving such a claimant a clear run to judgment when in the eyes of many customers the words have done it no harm, trial of plural meanings permits the damaging effect of the words to be put in perspective and both malice and (if it comes to it) damage to be more realistically gauged. For these reasons I would hold that the single meaning rule is not to be imported into the tort of malicious falsehood.” Additional reasons were provided by Lord Justice Rimer, “If the case were allowed to go to trial and the claimant were able to prove that such meaning was false, uttered with malice and calculated to damage it, why should it not be entitled to damages for the injury which the falsehood will have caused it? More importantly – and this is the primary remedy the claimant wants – why, if it can prove its case, should it not be entitled to have the defendant restrained by injunction from doing that which it wants to do, namely (presumably for its own commercial benefit) to continue to publish a falsehood that will continue to damage the claimant in the eyes of a substantial body of consumers? The result, however, of the application by the judge of the single meaning rule is that that body of consumers is removed from the court's radar. The court instead satisfies itself with the fiction, contrary to its own finding, that the entire consuming public will interpret the defendant's packaging as bearing a single innocuous meaning.”

Consequently, the single meaning rule has no application in the case of malicious falsehood. A reading of the judgment indicates that in cases of commercial disparagement, the single meaning rule from the law of defamation would have no application. Consequently, a cause of action would arise in a case of disparagement on showing that a reasonable meaning – as opposed to the meaning – of the defendant’s words is disparaging.

Decision on Existence of a PE: Airline Rotables v. JDIT

A decision of the Mumbai Bench of the Income tax Appellate Tribunal, Airline Rotables v. JDIT, discusses the law on the existence of a permanent establishment. It can be downloaded here, and a summary is available at the same link. I will put up a note on the same shortly. The Tribunal reaffirms that for a PE under the basic rule [Article 5(1)] to exist, it is essential that (a) there is a physical location (physical criterion), (b) the assessee has a legal right to use that place (subjective criterion), and (c) there is actual carrying out of the assessee's business through that place (functionality rule). The Bench elaborated on the tests laid down in a decision of a Special Bench in Motorola Inc. v. DCIT, 95 ITD 269 (SB). Besides the basic rule PE, the decision in Airline Rotables also discusses the conceptual basis for the law on 'dependent agent PE'.

Guest Article: Minority Shareholders Buying Out Majority Shareholders (Part II)

(This is a continuation of Part I of a guest article by M. Rishi Kumar Dugar, which can be accessed here)

In the case of Dale and Carrington Investment (P) Ltd. vs. P.K.Prathapan AIR 2005 SC 1624 : (2005) 1 SCC 212, the Supreme Court reiterated the principles laid down in Needle Industries.  In this case the CLB provided for purchase of shares, but this time of the minority shareholders by the majority shareholders, even after holding that the allotment of shares in question was an act of oppression.  The High Court  and the Supreme Court set aside the allotment of shares and applied the principle that a wrong doer/ oppressor cannot be allowed to take further advantage of his/ their own wrong and that the oppressor cannot be permitted to buy out the oppressed.

Similar observations can be seen in Sangramsinh P. Gaekwad and Ors. v. Shantadevi P.Gaekwad (Dead) through Lrs. and Ors AIR 2005 SC 809:[2005] 11 SCC 314, in which case the dispute was regarding issue of additional shares and issues concerning fiduciary duties of directors.  While interpreting Section 397 read with Section 402 the Act and the jurisdiction of the court, it was observed that there are wide powers to the court while exercising jurisdiction under Section 402, but it is not in all cases that relief can be provided. Relief must be provided depending upon the exigencies of the situation and a decision can be arrived at only on analyzing the materials. It was further observed that the jurisdiction of the court to grant appropriate relief under Section 397 is indisputably of wide amplitude. It is also beyond any controversy that the court while exercising its discretion is not bound by the terms contained in Section 402, if in a particular situation a further relief or relief’s, as the court may deem fit and proper, are warranted.  The same principles were reiterated in a recent decision of the Supreme Court in M.S.D.C. Radharamanan v. M.S.D. Chandrasekara Raja and Anr AIR 2008 SC 1738.

In some of the recent decisions of the CLB, where the minority shareholders were wholly in charge of the management and day to day affairs of the company, the CLB has ordered the majority to exit the company, to protect the interest of the company as the minority would have the expertise to run the company.  In Shri Gurmit Singh vs. Polymer Papers Ltd. [2005] 123 Comp Cas 486 (CLB), and in Chander Mohan Jain vs. CRM Digital Synergies P. Ltd. (2008) 142 Com Cas 658, while laying down the principle that in unusual circumstances the majority may be directed to sell its shares to the minority, it’s interesting that, it also observed that the majority should never be directed to sell its shares to the minority.  In view of the facts of the matter, since the majority did not participate in the affairs of the company and acted completely detrimental to the interest of the company and since interest of the company is the paramount rule of company law, the minority were directed to buyout the majority.

The Madras High Court and the Karnataka High Court in, Probir Kumar Misra vs. Ramani Ramaswamy and Ors. MANU/TN/2194/2009 and Namtech Consultants Pvt. Ltd. vs. GE Termometrics India Pvt. Ltd. ILR 2008 Kar 1187, have also gone to the extent of directing the purchase of shares by one among the warring group of shareholders, through determining the value of shares by an independent expert valuer and by way of competitive bidding respectively, not taking into consideration whether it was majority or minority shareholders.

To conclude, the concept of minority shareholders buying out the majority shareholders though not new, in view of the decision in Needle Industries, is also an evolving phenomenon in Indian company law decisions as can be seen from the trend followed by Indian courts and tribunal.  The duty of the court / CLB under Sections 397/398 read with Section 402 of the Act, is to primarily protect the interest of the company.  It is the duty of the court / CLB to see that the company does not suffer due to the various altercations / disputes between the shareholders.  Hence, while exercising its powers under the aforesaid provisions and providing relief of ordering/ directing the exit of a certain group of shareholders, the court / CLB has to always keep in mind the paramount rule of company law, which is that the interest of the company should always prevail and must be protected and that there are no more conflicts among the shareholders in order for the company to function efficiently and profitably.

(By M. Rishi Kumar Dugar, Advocate, Madras High Court; forthcoming in the National Law School of India Review. The author is thankful for the valuable inputs provided by Mr. P. Giridharan Advocate, Madras High Court)

Guest Article: Minority Shareholders Buying Out Majority Shareholders (Part I)

Mr. M. Rishi Kumar Dugar, Advocate, Madras High Court has very kindly allowed me to publish the following guest post. This will appear as an article in Volume 22, Issue 2 of the National Law School of India Review. Mr. Dugar writes about the legal aspects of minority shareholders buying out the majority in the context of oppression and mismanagement under Sections 397 and 398 of the Companies Act, 1956, discussing the case-law in this regard.

Corporate world continues to suffer from the much prevalent disputes between shareholders. It definitely is not a phenomenon specific to India but is and has always been a universal problem. Allegations by the minority shareholders against the majority reverberate in courtrooms throughout the world. Indian law provides for various reliefs for oppression and mismanagement but how effective they are is a point of debate. This article would highlight one of such reliefs being, as the title suggests – Minority shareholders buying out the Majority shareholders. To aid understanding this right under Indian law, various decisions are analysed on this point while highlighting the principles of substantive law relating to oppression and mismanagement.

The case of Needle Industries (India) vs. Needle Industries Newey (India) Holding Ltd. AIR 1981 SC 1298 is a landmark case on this subject and the Supreme Court’s decision in this matter continues to be an authority on the subject. In this case, the foreign majority alleged oppression by the Indian minority shareholders as the minority appointed additional directors and issued further shares.  The Company Law Board (“CLB”) and the High Court held such acts of the minority shareholder as oppressive. In an appeal, however, the Supreme Court observed that even if a case of oppression fails, the court has power to do substantial justice in the matter and therefore on the facts and circumstance of the case, the Supreme Court while rejecting the plea of oppression, directed the minority Indian shareholders to purchase shares held by the majority foreign shareholders.

Despite the aforesaid Supreme Court judgment, traditionally in matters under Sections 397 / 398 (which sections deal with oppression and mismanagement under company law in India which have been touched upon later in the article) of the Companies Act, 1956 (the “Act”), the CLB has ordered exit of the minority shareholders, as it has been perceived that if the minority shareholders exit, no disputes would arise in running the day to day affairs of the company and the company can be run by the majority efficiently and as the majority may please. In Yashovardhan Saboo vs. Groz-Beckert Saboo Ltd (1995) 83 Com Cas 371, the CLB went on to hold that even if a case of oppression is not established, to provide a relief to do substantial justice between the parties, whose relationship has reached a stage where reconciliation was difficult, it is the majority which has the right to purchase the shares of the minority. It was also held that the majority should never be forced to sell its shares to a minority.

As can be seen from the above, majority rule is the hallmark of democracy. This equally applies to corporate democracy. The majority rule however, is not free from misuse or abuse. Corporate democracy is more vulnerable to such misuse because it is reckoned with the number of shares that a shareholder holds and not with the number of individuals involved. Sections 397 to 409 of the Act are specifically devoted to the subject of prevention of oppression and mismanagement.

The chapter on Prevention of Oppression and Mismanagement in the Act is a self contained code. When the courts used to have jurisdiction, a composite petition under Sections 397/398 read with Section 433(f) was allowed to be filed. The jurisdiction thereafter got transferred from the courts to the CLB and currently the jurisdiction under Sections 397/398 resides with the CLB. However, the jurisdiction under Section 433(f) continues to remain with the court. CLB has wide powers under Section 402. There is a proposed amendment to transfer the powers of the CLB and the court to a Tribunal, but this is yet to come into effect.

Very briefly, let’s understand what the terms ‘oppression’ and ‘mismanagement’ mean under Indian law. The term ‘oppression’ is not defined under the Act. It has been understood as an act or omission on the part of the management (which obviously implies majority, inasmuch as it is the majority which holds or controls the management).  It is needless to state here that though the ownership and management are distinct in the eyes of law, in reality the majority ownership and management are synonymous.

Some of the principles evolved over the years and instances considered by the courts as ‘oppression’ are briefly:

- the act / omission should not only be prejudicial but also unfair, harsh and burdensome to the minority shareholders;

- it is not unfair prejudice to the minority if it is equal prejudice to all members of the company;

- there has to be an advantage to one at the cost of the other for being unfair prejudice;

- there should be lack of probity and good faith;

- the act which otherwise in accordance with the law and procedure but mala fide with intent to deny legitimate expectations of minority is oppression; and

- mere technical irregularity or illegality would not by itself amount to oppression.

Courts while exercising their powers to prevent oppression have also applied principles of quasi partnership and equity to uphold legitimate expectations of the parties concerned looking beyond the memorandum and articles and even provisions of the Act in some instances.

‘Mismanagement’ is neither defined nor is really required to be defined, as the meaning is quite obvious.  However, the said expression is used only in the headings in the said chapter of the Act and not in the body of the sections.  Some of the instances or situations held as ‘mismanagement’ are:

- absence of basic records;

- failure to hold general meetings for adoption of accounts;

- failure to finalize / get the accounts audited; and

- failure to file documents with the Registrar of Companies. 

Providing remedy against the acts of oppression is a very difficult exercise of balancing.  It is necessary that such acts should constitute a ground for winding up the company and should be a just and equitable ground. At the same time winding up should be unfairly prejudicial to the members.  In many cases, any amount of judicial intervention cannot meet the minds of the parties.  It is in situations like these that the courts have been constrained to oust one of the warring groups from the company with typically, compensation being offered to the other group. It is pertinent to note that the requirement of winding up is not applicable in case of remedy on the ground of mismanagement alone. 

Additionally, these applications under Sections 397/398 of the Act before the CLB are not like a suit before the civil court which can be compromised or withdrawn.  This application is representative in nature.  Once the CLB ascertains that there is oppression or mismanagement, it has powers to remedy the situation and the petitioner is not permitted to compromise unless the respondents have remedied the situation alleged against.

The specific provision of the Act dealing with relief’s in these cases and relevant in the context of this article is Section 402.  This section provides for specific kinds of orders that can be passed by the CLB, such as:

- regulation of conduct of affairs;

- purchase of shares of member by other members or even by the company;

- consequential reduction in capital;

- termination / modification of contract with managing director, manager or director;

- terminations of any contract / arrangement with other parties;

- setting aside of any transfer of goods or payment made within 3 months immediately prior to filing an application; and

- any other order on a just and equitable ground.

It is well known that the conventional way of interpreting a statute is to seek the intention of its makers. If a statutory provision is open to more than one interpretation then the court has to choose that interpretation which represents the true intention of the legislature. This task often is not an easy one and several difficulties arise on account of variety of reasons, but at the same time, it must be borne in mind that it is impossible even for the most imaginative legislature to forestall exhaustively all situations and circumstances that may emerge after enacting a statute, where its application may be called for. It is in such situations that the court's duty to expound arises with caution and that the court should not try to legislate.

In majority of the cases filed for oppression and mismanagement, there is hostility between the groups and it is difficult to make them work together by orders and hence purchase of shares by one group is provided for.  Let’s analyze some of the judicial pronouncements in particular dealing with minority shareholders buying out majority shareholders.

(... continued in part II)

Representative Assessees and the Scope of Section 163 of the Income Tax Act

In Hindalco Industries v. DCIT, the Mumbai Bench of the Tribunal examined the relationship between Sections 163 and 195 of the Income Tax Act. ITAT Online summarizes the principles from the case stating, “… the fact that the Agent has deducted tax u/s 195 is not a bar to treat him as an Agent u/s 163… the law does not contemplate any time limit for initiating proceedings u/s 163… However, while the department has the option u/s 166 to assess either the non-resident principal or the representative assessee, once the choice is made and the income is brought to tax in the hands of the principal, the same income cannot be again assessed in the hands of a representative assessee (Saipem UK 298 ITR (AT) 113 (Mum) followed)…”

The case is perhaps a good instance of highlighting the difficulties of the literal interpretation of Section 163 of the Act. Representative assessee is defined under Section 160 of the Act, and in the relevant part reads:

“(1) For the purposes of this Act, “representative assessee” means— (i)   in respect of the income of a non-resident specified in sub-section (1) of section 9, the agent of the non-resident, including a person who is treated as an agent under section 163…”

Section 163 (1) reads:

“Who may be regarded as agent.

163. (1) For the purposes of this Act, “agent”, in relation to a non-resident, includes any person in India—

 (a)   who is employed by or on behalf of the non-resident; or

 (b)   who has any business connection with the non-resident; or

 (c)   from or through whom the non-resident is in receipt of any income, whether directly or indirectly; or

 (d)   who is the trustee of the non-resident;

and includes also any other person who, whether a resident or non-resident, has acquired by means of a transfer, a capital asset in India :

Provided that a broker in India who, in respect of any transactions, does not deal directly with or on behalf of a non-resident principal but deals with or through a non-resident broker shall not be deemed to be an agent under this section in respect of such transactions, if the following conditions are fulfilled, namely:—

 (i)   the transactions are carried on in the ordinary course of business through the first-mentioned broker; and

 (ii)   the non-resident broker is carrying on such transactions in the ordinary course of his business and not as a principal.

Explanation.—For the purposes of this sub-section, the expression “business connection” shall have the meaning assigned to it in Explanation 2 to clause (i) of sub-section (1) of section 9 of this Act.”

From a plain reading of the two sections, it appears that there is no requirement between the agency relationship and the income. In other words, one a person is a statutory agent, he is liable for payment of all the income of the non-resident assessee including the income which arises outside the agency relationship. The inequity of the provision is apparent from an example given to me by Shantanu Naravane, “Assuming that there is a non-resident “A” who has a statutory agent “B” for the purpose of the purchase and export of certain goods, any income which arises from this agency will be taxable on “B”. But, assuming that “A” directly sells a large tract of land in another part of the country of residence of “B”, can “B” be taxed in respect of the income arising from that transfer? In addition, assuming it is not a one-off sale, but “A” is carrying on a real-estate business directly from the other country. In that situation, can “B” be consistently taxed for the income from that parallel business?” On a literal reading, it appears that there is no requirement of any nexus between the income and the agency relationship. Of course, there is no equity about a charging provision – this is however a machinery provision; and some relief may however be available to representative assessees from the decision of the Bombay High Court it CIT v. Ramnarayan Rajmal, 24 ITR 442. The Court had observed in that case, “in order that the agent should become liable to pay tax he should be an agent qua the particular head … in respect of which the non-resident is liable to tax; or in other words, income liable to tax … must be connected with the agency in respect of which the assessee is the agent…” This was followed by the Madras High Court in P. Subramania Chetty v. CIT, 46 ITR 724, which laid down the law as being that “an agent of a non-resident is liable to be charged only on income accruing to the non-resident through details with him and not in respect of all income earned by the non-resident under the various heads… with which he, as an agent, has no concern at all…”

On this basis, holding Hindalco an agent under Section 163(1)(b) would be inappropriate; and the agency relationship would extend if at all only under Section 163(1)(c). Only business income through the agency would be relevant insofar as treating a resident as a representative assessee under Section 163(1)(b). The question in Hindalco was in relation to capital gains. While the CIT in the case had treated Hindalco as a representative assessee under both Sections 163(1)(b) and (c), the Tribunal proceeds solely on the basis of Section 163(1)(c) of the Act. The scope of Section 163 will be further discussed in another post. 

Royal Bank of Canada v. DIT: Derivative Transactions and Characterization of Income

The Authority for Advance Rulings had occasion to consider three important questions of law in a recent ruling in Royal Bank of Canada v. DIT (International Taxation). The three questions were:

1. Whether the profits/losses from futures and options contracts (derivative transactions) carried out on the Indian Stock exchanges are in the nature of "Business income" in the hands of the applicant under the provisions of the Act read with the Agreement for Avoidance of Double Taxation between India and Canada (Treaty)?

2. Whether profits/losses from transactions relating to purchase and sale of equity shares or other tradable securities on the Indian stock exchanges are in the nature of "Business Income" in the hands of the applicant under the provisions of the Act read with the Treaty?

3. Since the applicant does not have a permanent establishment (PE) in India as per Article 5 of the Treaty, whether "Business income" of the applicant (referred to in the question 1 and 2 above) will not be taxable in India under Article 7(1) of the treaty?

The Tribunal refused to answer the second question on the grounds that answering the question depended on “assessment of certain crucial facts, the actual pattern of dealings or the modus operandi of the transactions” and it would not be appropriate to answer the question in relation to whether the trading of shares was in the nature of business income or not. (In a decision in Management Structure & Systems, the Mumbai Bench of the ITAT has summarised the principles to be used in determining whether sale of shares would result in business income or in capital gains. A discussion is available here.) The tribunal answered the first and the third question in favour of the applicant; and the decision insofar as it relates to the first question is discussed below.

The relevant facts were that the applicant was engaged in the banking business; and also trades in securities (including derivatives). As noted in the ruling, “Derivatives are financial contracts which derive their value from the price of underlying instruments such as equity shares, treasury bills, commodities, foreign exchange etc. There are two types of exchange traded derivatives - futures and options. In a futures contract, parties agree to undertake to trade (buy or sell) securities at a stated price and quantity by using standardized contracts on a stock exchange. At the time of entering into contract, no money changes hand. The Exchange may however insist on some margin money to be retained by the brokers of contracting parties. These contracts can be squared up anytime before the expiry date and it is at the time of squaring up the sum equal to profit (or loss) is received (or paid) through Stock Exchange. Mostly, the applicant has been trading in futures. 'Options', on the other hand, are contracts which give the right but not obligation to buy or sell the underlying assets at a stated date and at a stated price. A buyer of the option pays premium to buy the right to exercise his option. The seller (writer) of the option is the one who receives the option premium and is therefore obliged to sell or buy the asset if the buyer exercises his option.”

The applicant was registered as a Foreign Institutional Investor (FII) with the Securities and Exchange Board of India ((SEBI). The books of accounts of the applicant were maintained in accordance with standard accounting principles. Profit/loss from dealing in futures and options was to be reflected as business profits in the books of accounts. Accordingly, the contention of the applicant was that the derivative transactions were part of the trading activity of the applicant, and capable of giving rise to business income and not to capital gains. In the absence of a permanent establishment in India, the same could not be taxed in India by virtue of the provisions of Article 7 of the Indo-Canada DTAA. The Revenue’s case was essentially that “under SEBI and FEMA Regulations, the applicant is only allowed to make 'investments' in the capital market in India; that the trading of derivatives on stock exchanges would also amount to an investment activity and the income earned from such an activity would not be business income but capital gains…”

In its analysis, the AAR relied essentially on its prior ruling in Morgan Stanley, 271 ITR 416, and on observations of the Supreme Court in Raja Bahadur Visveshar Singh v. CIT, 41 ITR 685 to the effect that the relevant considerations are, “the substantial nature of the transactions, the manner in which the books had been maintained, the magnitude of the shares purchased and sold and the ratio between the purchases and sales and the holdings.” The AAR also noted the judgment of the Supreme Court in CIT v. Holck Larsen, 160 ITR 67, where the Supreme Court approved of certain observations of Lord Reid in J.P. Harrison, 40 TC 281, “The real question as Lord Reid said was not whether the transaction of buying and selling the shares lacks the element of trading, but whether the later stages of the whole operation show that the first step - the purchase of the shares - was not taken as, or in the course of, a trading transaction.”

Reference was made to the decision of the AAR in Fidelity North Star, which interpreted the SEBI (FII Regulations, 1995), as not permitting trading activity in securities. In that case, the Authority had observed, “A close reading of the regulations, quoted above, particularly the portions underlined therein, on which reliance is placed by Mr. Desai, do not give any scope for reading in them the permission for training in securities. The expression "or otherwise deal in" in regulation 3(1) means other than buying and selling, e.g. lending/borrowing permitted under regulation 15(8) of the SEBI Regulations. It cannot be understood to mean doing business in securities because trading itself involves buying and selling and if it construed to mean trading as urged by Mr. Desai, the expression will become otiose…” From this, the Authority in Fidelity went on to conclude, “In our view it will be preposterous to impute an intention to FIIs, who responded to the offer of investment in securities in response to the guidelines, got themselves registered under the SEBI Regulations and undertook to abide by those regulations that they would, in the very first step itself, have intended to violate all the legislative requirements which provided them the opportunity to enter the capital marketing India…” As such, the very first step of the transaction showed that the transaction was intended to be on the capital account; resulting in capital gains and not in business profits.

In Royal Bank of Canada, the AAR distinguished this, on the grounds that in Fidelity, the question was not in relation to derivatives. Indeed, a passage in Fidelity itself supports this, “It may be apposite to point out here that Regulation 5(6) of the FEM Regulations (Security), 2000, specifically provides that a FII having approval under the FERA and the FEMA may trade in all exchange traded derivative contracts approved by SEBI. Further Regulation 3 of the FEM Regulations (Derivative) 2000, prohibits that no person in India shall enter into a foreign exchange derivative contract without the prior permission of the Reserve Bank and accordingly the exchange traded derivative is specifically permitted. In contrast there is no provision in the aforementioned Acts, Regulations or Guidelines of the Government of India, permitting trading in other securities. The obvious inference is that trading in other securities is not permitted; in other words trading in securities other than exchange traded derivatives is prohibited.”

Furthermore, the AAR in Royal Bank of Canada pointed out “The Revenue's counsel has contended that under SEBI Regulations, only investments can be done and purchases of shares can only be on capital/investment account. Hence, irrespective of frequency and volume of the transactions and the expression 'trade' employed in, Regulation No. 5(6) of the FEM (Transfer of issue of Security by a nonresident) Regulations, 2000, the word 'trade' is used in a generic sense and it shall be confined only to investment. We do not see any warrant to place such restriction on an expression of wide import especially in the context in which it is used…”

It is submitted that while on the face of it, the AAR in Royal Bank of Canada distinguished Fidelity, this may be just judicial gloss on an effective overruling of the underlying judicial approach. In Fidelity, as seen above, a major factor which influenced the AAR holding that profits from sale of shares were capital gains was that the SEBI rules did not allow for trading activity, but only allowed for investment activity in shares by FIIs. In dealing with the SEBI (FII Regulations), 1995, the AAR in Royal Bank of Canada held that while the regulations allow only ‘investment’ in derivates, the word ‘investment’ has to be understood contextually and cannot be read as necessarily excluding trading transactions. Furthermore, and perhaps more importantly, “We do not think that giving an undertaking in terms of SEBI Regulations would amount to an admission that the applicant is precluded from trading in Derivatives, as contended by the Revenue's counsel. Such undertaking to abide by Rules and Regulations have no bearing on the characterization of income.” This effectively puts an end to arguments based on SEBI/FEMA regulations in determining whether income is to be characterized as business income or not. If that is the case, then at least part of the reasoning of Fidelity is now open to question. 

In conclusion, the AAR answered the first question in favour of the applicant; holding that the income was in the nature of business income, and could not be taxed under Article 7 of the Indo-Canada DTAA. This decision of the AAR has also been analysed by Ravichandra Hegde of J. Sagar Associates in a post on Indian Corporate Law, which may be accessed here. BMR Advisors have discussed the decision in an update, available here.  Ankit Mishra’s post discussing both Fidelity and Royal Bank of Canada on the Indian Legal Space blog is available here.