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Income Tax Appellate Tribunal, MUMBAI BENCH “L”, MUMBAI
Before: SHRI G S PANNU
ORDER �ी अिमत शु�ला, �या स: PER AMIT SHUKLA, JM: The aforesaid appeal and cross objection has been filed by the revenue and assessee against impugned order dated 2 M/s UBS AG CO 210/Mum/2015 31.03.2014, passed by Ld. CIT(Appeals)-11, Mumbai for the quantum of assessment passed under section 144C(3) r.w.s. 143(3) for the assessment year 2009-10. Revenue in its appeal has raised following grounds of appeal:-
“1. Whether on the fact and in the circumstance of the case and in law, the Ld. CIT(A) was right in holding the gain on transfer of debt securities amounting to Rs.100,92,23,761/- is assessable as capital gain and not taxable as business income.
2. Whether on the fact and in the circumstance of the case and in law, the Ld. CIT(A) was right in allowing the interest income earned in respect of debt securities of Rs.28,23,12,500/- under Article 11 of the Treaty instead of under Article 7 of the Treaty as Business income.
3. Whether on the fact and in the circumstance of the case and in law, the Ld. CIT(A) was right in allowing the claim of additional expenses of Rs.2,45,73,373/- as deduction while computing the business income”.
The assessee, UBS AG is tax resident of Switzerland and has been registered as Foreign Institutional Investor (FII) in India with Security Board of Exchange of India (SEBI) from 1996 for the purpose of making investments in Indian securities. During the period relevant to the assessment year 2009-10, the assessee had also opened a branch in Mumbai for carrying out banking business in India. For this purpose approval from RBI and License was obtained on 27th February, 2008. . Thus, the investment in Indian security activities was carried out through FII, which was regulated by SEBI and the Branch was opened to carry out banking business regulated by the RBI under ‘Banking Regulation Act, 1949’. The first issue which has been raised by the revenue is, whether the 3 M/s UBS AG CO 210/Mum/2015 gain earned by assessee as FII on the transfer of debt securities amounting to Rs.100,92,23,761/-, is assessable as ‘capital-gain’ which is exempt under Article 13(6) of India- Swiss DTAA or whether it is assessable as ‘business income’ to be taxed accordingly under Article 7 by treating the Branch as PE of assessee. Since 1996, the activities carried out by the assessee as FII for making investment in Indian securities and any gain arising there from was assessed as ‘capital-gains’ and was claimed as exempt in terms of provisions of Article 13(6) of Indo-Swiss Tax Treaty.
3. Before us, the Ld. Senior Counsel, Shri Arvind Sonde, referred to the history of assessment made in the case of the assessee right from assessment year 2001-02 and pointed out that in all these years, assessee’s stand that gain earned by it as FII is assessable as ‘capital gain’ stood finally accepted up till 2008-09. Not only that, it was also endorsed and upheld by ITAT that capital-gains earned on the transaction of debt securities is not taxable in India in view of Article 13(6) of the DTAA. In fact in AY 2008-09, the AO has treated the income from transaction in debt securities as income from business carried on by the assessee company and, therefore, such an income has to be taxed under Article 7 and not under Article 13(4). This view taken by the AO was rejected by the Ld. CIT(A) holding that transaction in debt securities would be in the nature of capital gains only. This finding of the CIT(A) has been affirmed by the Tribunal in AY 2008-09 vide order dated 17.04.2015 in ITA No.1207/Mum/2013. In this year again, the AO has treated the transaction of debt securities as ‘business income’ to be taxed under Article 7. However, for coming to this view, the AO has first gone by the fact that in this year assessee had opened a branch in India which was authorized to trade in Govt. securities and Treasury bills during the course of its banking business. Not only that, the Branch had requisite infrastructure, experience and skilled employees to undertake 4 M/s UBS AG CO 210/Mum/2015 investment activities. Further, based on the magnitude and volume of transactions undertaken by the FII, AO held that there was a systematic and regular trading activity with the intention to earn profit. Thus on both the counts, he held that all the income including those shown by the assessee in the capacity of FII would be attributable directly or indirectly to the PE of the assessee in India represented by the Branch and accordingly, the same would be taxable under the head “business income” in terms of Article 7 of DTAA. From the perusal of the assessment order, it is seen that, the AO first of all, tried to highlight that the Branch was carrying out a systematic activity of investment in interest bearing debt securities/ instruments which were classified as “held to maturity” and “held for trade” and these investments were acquired with intention for trading purpose. FII activities carried out by assessee in India also involved debt securities which is akin and similar to activities carried out by the Branch, Thus, he held that both the activities were connected with the Branch in India. After coming to this conclusion, he held that the income earned from short-term- capital-gain of Rs.100,92,23,761/- cannot be treated as capital gain so as to give benefit under Article 13(6) but is assessable as a ‘business income’ to be taxed under Article 7. The assessee’s case before the AO apart from distinguishing the different functions carried out by the Branch as well as by the assessee as FII, submitted that, in view of the ‘Protocol’ of the Treaty in respect of Article 7 wherein the phrase “directly or indirectly attributable” has been defined to mean that PE must take active part in negotiating, concluding or fulfilling contracts entered into by the enterprise, which has not been done qua FII activities. The relevant contention of the assessee is reproduced hereunder:-
“In this connection, your goodself’s attention is invited to the Protocol of the Treaty for the meaning of ‘directly and indirectly’ attributable:
5 M/s UBS AG CO 210/Mum/2015 ‘With respect to paragraph 1 of Article 7, it is understood the words “directly or indirectly” mean, for the purposes of this Article, that where a permanent establishment takes an active part in negotiating, concluding or fulfilling contracts entered into by the enterprise, then, notwithstanding that other part of the enterprise have also participated in those transactions, there shall be attributed to the permanent establishment that proportion of profits of the enterprise arising out of those contracts as the contribution of the permanent establishment to those transactions bears to that of the enterprise as a whole. It is also understood that profits shall be regarded as attributable to the permanent establishment to the abovementioned extent, even when the contracts in question are made directly with the head office of the enterprise rather than with the permanent establishment.’ In the present case, it is submitted that the Mumbai Branch is not involved in negotiating, concluding or fulfilling contracts in relation to FII investments. Thus, it is our humble submission that gains on transfer of debt securities cannot be said to be ‘directly or indirectly’ attributable to the PE in India”.
4. However, the AO rejected the assessee’s contention on the ground that investment activities undertaken by the FII or investment activities by Branch are done through stock exchange, hence no negotiation or concluding or fulfilling of contracts in relation to these activities are required. Hence, the assessee’s reliance on the Protocol cannot be sustained. Accordingly, he taxed the entire gain as business income in India in terms of Article 7.
5. Before the CIT(A), the assessee demonstrated that both the activities were entirely different. The FII activities were carried out since last several years and income there from has always been 6 M/s UBS AG CO 210/Mum/2015 treated as capital gains and benefit of Article 13(6) was always given. The registration of FII was renewed from time to time and so also the certificate of registration with the SEBI. Separate and independent approvals under the law have been sought for the FII activity which is only for the purpose of trading in securities. Whereas, banking operations carried out with RBI approval was entirely different a activity altogether. Further, assessee has shown separately the closing stock of FII Division which was valued at Rs.103,49.57 crores, whereas Government securities held by Mumbai Branch reflected in the Balance sheet was at Rs.75.85 crores. Thus, there was not only different division and different operations carried but both had entirely different set of personnel, investment teams and expenditures. The Ld. CIT(A) after considering the entire gamut of facts and contention of the assessee, observed and held as under:-
The AO, in the assessment order, has presumed that the PE of the assessee company in India, represented by the branch, was directly or indirectly engaged in the FII trading in debt securities. No factual basis for coming to such a conclusion has been brought on record by the AO. On the other hand, from the sample email communications available on record, it is seen that the FII division of the assessee company continued to operate from overseas with its own personnel and funds. Instructions to the Indian custodian of the debt securities are being regularly sent from overseas and the requisite funds are provided to the custodian by the FII division from its own bank account held with the HSBC Bank and unrelated to the branch operations in India. On the facts of the present case, it is found that the operations of the FII and the banking operations of the branch are two separate divisions with the no commonality of personnel, infrastructure or funds. While it is true that the incomes attributable to the PE, represented by the assessee company’s branch in India, 7 M/s UBS AG CO 210/Mum/2015 can be taxed under Article 7 of the Treaty, however, as one of the incomes accruing to the FII division of the assessee company are relatable to the banking operations carried on by the PE branch in India, neither directly nor indirectly, the income from investment in debt securities by the FII cannot be taxed as a business income of the PE While coming to his conclusion, the Ld. CIT (A) also relied upon the decision of ITAT Mumbai Bench in the case of LG Asian Plus Ltd. Vs. ADIT, reported in ([2011] TII-85-ITAT-MUM-INTL) and Platinum Investment Management Ltd vs DDIT, reported in 33 Taxmann.com298. The final conclusion of the Ld. CIT(A) reads as under:- “In view of the existence of the FII division of the assessee company prior to and also after the setting up of the branch in India, the separate regulatory regimes governing these two separate activities, the provision of section 115AD of the Act and the provisions of Article 7 and Article 13 of the relevant DTAA as interpreted by the judicial authorities, the AO’s decision to tax the transactions of the FII as income from business is found to be not correct. These gains from the sale of debt securities would constitute to be in the nature of capital gains and would remain exempt from tax in terms of the provisions of Article 13(6) of the relevant DTAA even after the branch operations of the assessee company were set up in India. Appeal filed by the assessee on this ground is accordingly allowed”.
Before us, the Ld. Senior Counsel, Mr. Sonde after explaining entire facts as above, submitted that, here in this case the assessee has checkered history in favour of the assessee and pointed out that in AY 2011-12, the DRP itself has held that gain from transaction of security undertaken by the FII is to be taxed under the head “capital gain”. The Tribunal also in AY 2008-09 8 M/s UBS AG CO 210/Mum/2015 had also held the same thing. Thus, so far as the issue, whether the gain from transactions undertaken by the FIIs on the debt securities is to be treated as income chargeable under the head “capital gain” should be no longer in dispute and principle of consistency should be followed. Once it is held to a capital gain, then admittedly the same is not taxable in view of Article 13(6) Indo-Swiss-DTAA. He submitted that, before the AO the assessee had pointed out the entire difference of activities carried out by the assessee as FII and the Indian Branch undertaking banking activity. The entire process of how FII activities have been carried out had also been explained. Thus, the finding of the CIT(A) is not only in the consonance of the earlier and subsequent years precedence but also on the facts of the present year.
On the other hand, Ld. DR relying upon order of the AO submitted that, the earlier precedence cannot be followed, because this year the assessee admittedly had PE in India and the FII activities can be held to be indirectly attributable to the PE as per the factual analysis done by the AO in the assessment order and accordingly, the gain of Rs.100.92 crores is to be taxed as business income in India under Article 7.
We have heard the rival submissions, perused the relevant finding given in the impugned orders and the relevant material placed before us. As culled out in the foregoing paragraphs, it is an undisputed fact that, firstly, the assessee is tax resident of Switzerland and accordingly, the provisions of India-Swiss DTAA is applicable; secondly¸ since 1996 the assessee has been registered with SEBI as FII in India to make investment in Indian securities, which approval/certificate has been renewed from time to time and applicable in this year also; and lastly, up till AY 2008-09, the assessee’s income / gain from transaction of debt securities which were held as investment had been taxed under the head “capital gains” and accordingly, the treaty benefit under Article 13(6) had 9 M/s UBS AG CO 210/Mum/2015 been given. The AO in the impugned assessment year has tried to deviate from the past precedence, firstly, on the ground that, this year a Branch has been opened in Mumbai (India) for carrying out banking activities which is a similar and akin to activities carried out by the FII, therefore, such activities can be reckoned to be indirectly attributable to the Branch, which constitute a PE of the assessee in India; secondly, he held that transaction of debt securities should be construed as business income, because the assessee had regular and frequent dealing in securities and, therefore, based on the magnitude and the volume of the transaction there is systematic and regular trading activity, therefore, income from such activity is to be treated as business income only. As noted above, the Branch was set-up in the relevant previous year purely for carrying out the banking business for which a separate approval and license has been obtained by the RBI and its entire activities are strongly regulated by the RBI under the Banking Regulation Act, 1949. Thus, to say that FII and the banking activities are one and the same would be incorrect because both the activities are entirely different and governed by different authorities and regulation of laws. It is also not the case of the AO that the Branch was carrying out the FII activity, albeit both the activities banking and investment activities are akin to each other; therefore, same should be construed as one. Before the AO, the assessee had described the process of investment in debt securities in the capacity of FII in the following manner:- Based on in-house research, reports from research houses and commercial parameters, UBS investment team decides on investment/ divestment in a particular debt security. Based on the same, the UBS investment team gives instructions to Indian brokers for executing the transaction i.e. to purchase or sell Indian debt securities.
10 M/s UBS AG CO 210/Mum/2015 The transaction is thereafter executed by the Indian broker on behalf of UBS AG FIl and a confirmation is sent to the Indian custodian and the UBS investment team. The UBS investment team sends a trade confirmation directly to the Indian custodian. Based on the confirmation received from the UBS investment team and the Indian broker, the Indian custodian arranges to settle the trade. Depending on the availability of funds in the Indian bank account, UBS investment team gives instructions for transfer of funds to / from the custodian in relation to the executed transaction. As a part of the settlement process, the Indian custodian makes payment/ receives funds for the transaction and the debt securities are credited to / debited from the custodian account of UBS AG FII in India.
The entities involved in the investment process of UBS AG HI are Indian brokers, Indian custodian and Indian banker.
The names and addresses of some of the brokers through whom the transactions have been executed by UBS AG Fit during the captioned Assessment Year are enclosed herewith as Annexure 5. Further, the custodian and banker of UBS AG Fit for the captioned Assessment Year is The Hong Kong and Shanghai Banking Corporation Limited, Mumbai”.
Similarly, in the banking activity carried out by the Branch, the assessee gave the details of activities carried out by it and also 11 M/s UBS AG CO 210/Mum/2015 highlighted that the personnel, bank accounts, brokers, books of accounts, investment team and heads were entirely different and both have been authorized under different act and authorities for carrying out different permitted activities. AO has not rebutted these specific points brought in by the assessee to distinguish the activities, rather he has gone solely on the presumption that the banking activity also requires dealing in debt securities as has been done by the FII. Even if for the argument sake it is accepted that the activities are common but how an activity of a Branch can be merged with the activity as FII, whose activity is monitored form Switzerland and all the decision of investment are taken there only. The activities of FII are entirely different and are carried out separately right from the earlier years. It is also not the case that bank also can act as FII. Hence, we do not find any reason to sustain the conclusion of the AO. So far as the AO’s allegation that the activity of the FII can be said to be attributable directly or indirectly to the PE cannot be sustained, because ‘Protocol’ of the Treaty for Article 7 clearly specifies and defines the meaning of term “applicable directly or indirectly attributable” which is to be understood, whether the PE takes an active part in negotiating, concluding or fulfilling contracts entered into by the enterprise and if so, then it can be held to be attributable to the PE that proportionate of the profit of the enterprise arising out those contracts as the contribution of the PE to those transactions bears to that enterprise as a whole. Here, as pointed out by the assessee, the brokers, the employees and the activities are entirely different. There is no active part by the Branch in negotiating, concluding or fulfilling the contracts of purchase and sale of securities carried out by the PE. Thus, Mumbai Branch cannot be held to be involved directly or indirectly of the activities carried out by the assessee in India, therefore, the FII activities have to be segregated from the activities carried out by the Branch. Accordingly, we hold that the income of the FII is separate and distinct from the Branch and accordingly, the income has to be separately considered in the 12 M/s UBS AG CO 210/Mum/2015 hands of the assessee as FII. As regards taxability of income of FII as capital gains, we find that, first of all, the gain from the transaction of securities has always been assessed as capital gains in the earlier years and as pointed out by the Ld. Senior Counsel by the DRP in AY 2011-12 also. Not only that, the Ld. CIT(A) has clearly brought out as to why such an activity has to be reckoned as taxable under the head “capital gain” specifically in light of his finding given at paragraph 3.6. Accordingly, we affirmed the order of the CIT (A) and hold that, assessee’s income is chargeable under the head ‘capital gain’ and not business income and consequently, under Article 13(6) such a capital gain is exempt from tax in India. Thus, ground No.1 as raised by the revenue stands dismissed.
Now, we come to the second issue taxability of interest income earned in respect of debt securities of Rs.28,23,12,500/-, whether under Article 11 or under Article 7 as held by the AO by treating it as a business income.
The assessee had shown interest income on debt securities as ‘income from other sources’ and had offered to tax @ 10% in terms of Article 11 of Indo-Swiss DTAA. Since the AO has held that the entire income from transaction of securities and the activities as FII is to treated as income from business directly or indirectly attributable to the PE, therefore, he has taxed the same under Article 7 as business income. The Ld. CIT(A) held that, mere existence of Mumbai Branch of the assessee does not result in automatic establishing a effective connection of such interest received earned in the status of the FII to the banking operations of the PE. Such a finding of the Ld. CIT(A) has to be upheld, because, firstly, we have already held above that income from FII activities and debt securities do not form part of the business asset of the PE and secondly, the Mumbai Branch did not felicitate or participate in any manner in the earning of interest income from debt securities, which is earned by the assessee in the capacity of FII 13 M/s UBS AG CO 210/Mum/2015 only. Accordingly, the order of the CIT(A) on this score is affirmed and the grounds raised by the revenue is dismissed.
The last issue is with regard to allowing of claim of the additional expenses of Rs.2,45,73,373/- as deduction while computing the business income.
The relevant fact are that, the assessee had claimed certain expenditures incurred by its Head Office such as Group IT expenses; ESOP costs; and management fees, which were allocated to the Branch of assessee in India as the same were relatable to the branch operations carried out in India. These expenses were not debited to the profit and loss account but were claimed during the course of the assessment proceedings vide letter dated 28.01.2013. The said note had been reproduced by the AO at page 11 of the assessment order. However, the AO required the assessee to explain whether the TDS has been deducted on such expenses as per the provisions of section 40(a)(i) or not. In response, the assessee submitted that the said expenses have not been paid or credited by UBS AG Mumbai Branch to UBS AG HO; therefore, there is no question of deducting TDS. Reliance was also placed on the decision of ITAT Special Bench in the case of Sumitomo Mitsui Banking Corporation v DDIT, reported in [2012] 136 ITD 66. Apart from that, reliance was also placed on various ITAT decision including that of Bank of America NT & SA v DCIT, reported in 27 SOT 97. The assessee’s submission in this regard has been dealt by the AO from pages 12 to 14 and ultimately he held that, firstly, no TDS has been deducted on such expenses claimed by the Branch and secondly, these expenses have not been reported in Form 3CEB filed along with the return of income, therefore they cannot be allowed. Before the CIT(A), the assessee’s contention had been that, Head office and Branch have to be treated as separate tax entities for the purpose of computing the profit attributable to the PE and further the said expenses claimed were linked to the 14 M/s UBS AG CO 210/Mum/2015 operations of Mumbai Branch and the same had been certified for their quantification and allocation by an independent Auditor. The Ld. CIT (A) after detailed analysis of each and every expenses and also the various judgments, held that so far as ESOP cost is concerned, it being direct expenses would be allowable in its entirety in terms of section 37(1) and no restriction under section 44C would apply. As regards the Information Technology Expenses of Rs.35,74,413/- and the Management Fees of Rs.23,29,962/-, he after detailed discussion held as under:- “In view of the above discussion, ESOP cost being a direct expense would be allowable in its entirety in term of the provisions of section 37(1) of the Act and no restriction under section 44C would apply”. As regards the information technology expenses of Rs.35,74,413 and management fess of Rs.23,29,962/-, no amount out of these two expenses claimed would be allowable as 5% of the adjusted profit of the PE would be nil, there being a loss incurred by the PE during the period under consideration. The AO is hereby directed to modify the allowance for Head Office expenses accordingly. Appeal filed by the assessee company on this ground may be treated as partly allowed”.
Before us, the Ld. DR strongly relied upon the order of the AO, whereas the Ld. Counsel submitted that, so far as expenses on ESOP expenses is concerned same are squarely covered not only by the various decisions of the Tribunal but also by the decision of Calcutta High Court in the case of ABN Amro Bank NV, reported in [2012] 343 ITR 81. The list of decision relied upon before us are as under:-
Case Law Citation 1 ABN Amro Bank NV(2011) 198 Taxman.376(Cal) 2 Sumitomo Mitsui Banking Corpn [2012] 136 ITD 66 Vs DCIT (Mumbai Tribunal) 3 Bank of America NT & SA vs [2005] 27 SOT 97 DCIT Mumbai ITAT) 4 British Bank of Middle East vs [2005] 4 SOT 122 JCIT (Mumbai ITAT) 5 Biocon Limited vs DCIT [2013] 35 taxmann.com 355 (Bang ITAT SB)
15 M/s UBS AG CO 210/Mum/2015 14. After considering the rival submissions and on perusal of the impugned order of the AO as well as CIT(A), we find that the CIT(A) has allowed only ESOP costs incurred by the Head Office for sum of Rs.1,87,25,998/-. The Head Office of the assessee company had granted various employees, stock compensation awards to some of the employees of the Mumbai Branch under various employee share plans, wherein the shares of the assessee company were allotted to the credits of employees. The claim of ESOP cost relatable to the Mumbai Branch was identified and such quantification has also been certified by the independent Accountant which has not been disputed. This being the nature of direct expenses, it has been rightly allowed by the CIT(A) under section 37(1). There is no obligation on the Branch to deduct TDS on such ESOP costs, therefore, qua this expenditure, the finding of the AO is not relevant, however, with regard to other expenses it has been confirmed by the CIT(A) that same has to be computed as per section 44C in view of Article 7(3), the same is not in dispute before us. Accordingly, the order of the CIT(A) is confirmed on this point.
Now, we will come to the Cross Objection No.210 of 2015 of the assessee, which reads as under:-
1. On the facts and in the circumstances of the case and in law, presuming and not admitting that the gains on transfer of debt securities are characterized as business income, such gains cannot be taxed in India under Article 7 of the India- Switzerland Tax Treaty (“the Treaty ) since such gains cannot be said to be attributable to the permanent establishment (PE) of the Respondent in India.
2. On the facts and in the circumstances of the case and in law, and consistent with the position accepted by the tax department in AY 2008-09 and earlier years, interest income 16 M/s UBS AG CO 210/Mum/2015 earned on debt securities should be characterized as ‘Income from other sources’ and taxed under Article 11 of the Treaty.
On the facts and in the circumstances of the case and in law, presuming and not admitting that the interest income of Rs.28,23,12,500/- earned on debt securities is characterized as business income, such interest income cannot be taxed in India under Article 11(5) read with Article 7 of the Treaty since such interest income cannot be said to be ‘effectively connected to the PE of the Respondent in India.
Without prejudice to Ground No.3 on the facts and in the circumstances of the case and in aw, presuming and not admitting that interest income of Rs.28,23,12,500 earned on debt securities is characterized as business income and is effectively connected to the PE in India, such interest income should be taxed at the rate prescribed under section 115D of the Income Tax Act, 1961.
Without prejudice to Ground No. 1 to 4 above, on the facts and in the circumstances of the case and in law, even if the gains on transfer of debt securities and interest income in respect of such securities are held to be taxable under Article 7 of the Treaty, only income attributable to the PE in India on net income basis can be taxed after allowing deduction for expenses”.
In view of our finding given in the Department’s appeal, all the grounds as raised by the assessee already gets subsumed and in view of the finding given therein, these grounds are treated as infructuous.
Thus, the grounds raised by the revenue as well as by the assessee in its cross objections are dismissed.
17 M/s UBS AG CO 210/Mum/2015 18. In the result, revenue’s appeal as well as assessee’s Cross Objections stands dismissed. Order pronounced in the open court on 27th June, 2016.
Sd/- Sd/- (जी एस प�ू) (अिमत शु�ला) लेखा सद�य �याईक सद�य (G S PANNU) (AMIT SHUKLA) ACCOUNTANT MEMBER JUDICIAL MEMBER Mumbai, Date: 27th June, 2016 ��त/Copy to:- 1) अपीलाथ� /The Appellant. 2) ��यथ� /The Respondent. 3) The CIT(A) -11, Mumbai. 4) The CIT-concerned__/DIT(Int. tax.)-I, Mumbai. 5) िवभागीय �ितिनिध “एल”, आयकर अपीलीय अिधकरण, मुंबई/ The D.R. “L” Bench, Mumbai. 6) गाड� फाईल Copy to Guard File. आदेशानुसार/By Order / / True Copy / /