|V. S. Sirpurkar J
|Business profits, capital gains, shares
|January 19, 2016 (Date of pronouncement)
|January 26, 2016 (Date of publication)
|Click here to download the file in pdf format
|Amount received by a FII under a settlement for giving up right to sue is not assessable as either capital gains or as business profits. In principle, a FII is an "investor" and not a "trader" in stocks. On facts, applying Circular No. 4 of 2007, Aberdeen is an investor in shares
(i) In this case it is to be considered whether right to sue is property and a capital asset as defined u/s 2(14) of the Act and whether it is chargeable to tax. Section 2(14) defines Capital Asset to mean “property of any kind held by an assessee, whether or not connected with his business or profession”. Section 6 of the Transfer of Property Act states that “property of any kind may be transferred, except as otherwise provided by this Act or by any other law for the time being in force.” Section 6 (e) notes that “a mere right to sue cannot be transferred”. Therefore, a ‘right to sue’ is property and thus Capital Asset as defined under section 2(14) of the Act but is not transferable. There cannot be any transfer of a right to sue under Indian law and any capital receipt arising from a right to sue cannot thus be considered capital gains under section 45. While examining the treatment of capital receipt from settlement and extinguishment of right to sue as Capital gains the Gujarat High Court in Baroda Cement and Chemicals v. CIT (158 ITR 636) held as under:
“The amendment of clause (e) of section 6 by the deletion of the italicized words has brought into sharp focus the distinction between property and a mere right to sue. Before the amendment, only the right to sue for damages arising out of a tortuous act fell within the ambit of the said clause. The right to sue arising ex-contractual, therefore, did not fall within the mischief of the clause even if it were a mere right to sue. After the amendment a mere right to sue, whether arising out of tortuous act or ex- contractual is not transferable.”
(Application No. 1060 & 1070 of 2010 relating to taxability of Settlement amount received from Satyam and PwC in similar circumstances, i.e., receipt of settlement amount as a result of settlement agreement and approval by the US Court after the complaints were filed in respect of fraud committed by Satyam/PwC followed).
(ii) The Revenue has also argued that the settlement amount received by the applicants is a part of their business receipt because these applicants are representing mutual funds which invest their funds after careful research of the market on the basis of expectation of potential upside in the market price of share and unlike an investment, mutual funds book their profits frequently and sometimes prefer even booking loses. According to the Revenue these are characteristics of a trader and not of an investor. As regards the treatment of income of such mutual funds as FIIs as capital gains the revenue has submitted that the Government has done so in order to attract investors but that does not alter the basic character of the activities of FII and it only changes the manner of taxability. The Revenue has relied on the principle of surrogatum saying that the settlement amount has been received for the future profits surrendered. The issues raised as above by the Revenue have to be examined first against the factual position in this case and then in the light of legal position. There is no doubt that according to the surrogatum principle the character of receipt of an award of damages or of an amount received in settlement of a claim as capital or revenue depends on what such amount was intended to replace. If the replaced amount would not have been otherwise taxable, the settlement amount may also be not taxable. However, the surrogatum principle does not apply to amounts received pursuant to a fraud. Further, in this case two important facts are noted. One, there is no dispute that at the time of the investments in the shares of Satyam, Aberdeen investors were registered as FIIs under FII regulations with the securities Exchange Board of India (SEBI). FIIs are not carrying out any trade in securities and this position was settled by this authority in the case Fidelity Northstar fund, 2007 288 ITR 641. Therefore, the settled legal position is that FIIs are not engaged in trading business. The facts of the present three cases also show that the shares were purchased as investors and not as traders. In their books of accounts also they have treated this as capital investment.
(iii) The Circular No.4 of 2007 issued by the CBDT quotes three principles laid down by this Authority in the case of Fidelity Group 288 ITR 641 in order to determine whether shares held are investment or stock-in-trade. First principle is how the shares were valued in the books of accounts, i.e., whether they were valued as stock-in-trade or held as investment. In this case the books of accounts show that the shares were held as investment. The second principle is to verify whether there are substantial transactions, their magnitude etc, maintenance of books of accounts and finding the ratio between purchases and sales. In this case the shares of Satyam were purchased, held as investment and sold only after the fraud became public. The third principle suggests that ordinarily purchases and sales of shares with the motive of realizing profit would lead to inference of trade/adventure in the nature of trade; where the object of the investment in shares of companies is to derive income by way of dividends etc, the transactions of purchases and sales of share would yield capital gains and not business profits. This principle also suggests that in this case the object of the investment is not to have business profit because the shares of Satyam were not being purchased and sold at regular interval. In the light of this even CBDT Circular No.4 of 2007 does not support the stand of Revenue that Aberdeen investors were engaged in trading business.
(iv) The next point to be considered is whether the settlement amount was received to compensate part of the business receipt as claimed by the Revenue or it was received because a fraud was committed by Satyam and PwC as a result of which the claims in deceit and fraudulent misrepresentation in respect of losses suffered by the Aberdeen investors in relation to Satyam shares was received. There is no doubt that the settlement amount is relatable to Satyam shares, i.e., if shares would not have been purchased the question of class action or right to sue would not have arisen. However, this does not mean that the settlement arrived with the approval of the US Court is to compensate business receipt of Aberdeen investors. The fact remains that the Aberdeen investors entered into a settlement agreement with Satyam considering the time, effort and costs involved in litigation and the agreement provided for a full, final and complete resolution of all claims asserted or which could have been asserted with respect to the released claims. The Aberdeen investors fully, finally and forever waived, released, discharged and dismissed each and every of their legal claims against Satyam and PwC. This was also agreed vice versa. It is clear, therefore, that the settlement amounts have been received not as part of business profit or to compensate the future income but as a result of surrender of the claim against Satyam and PwC. Surely, even in accordance with the principle of surrogatum such amount is not assessable as income because it does not replace any business income.
(v) In the light of above it is concluded that the settlement amount received by Aberdeen investors is not taxable under the provisions of the Income-tax Act and question No.1 of all three applications is answered accordingly.