Wednesday, May 19, 2010

Bombay HC on the Binding Nature of AAR Ruling

(The following post has been contributed by Ravichandra S. Hegde of J. Sagar Associates)

The Bombay High Court on April 29, 2010, while allowing a Writ Petition against the Income Tax Department has ruled on the binding nature of the decision rendered by the Authority for Advance Rulings (“AAR”). The Court has clarified that the decision given by the AAR would be binding on the applicant, the Commissioner and the Income Tax authorities subordinate to him in respect of the applicant’s transactions.

The Petition was filed by the Prudential Assurance Company Ltd, a registered sub-account of a Foreign Institutional Investor (“FII”) against the Director of Income Tax (International Taxation) (“DIT”) being aggrieved by the notice issued by the Commissioner. The matter pertains to the year 2001 when AAR was called upon to determine the incidence of taxation for the purchase and sale of shares by the Petitioner in its ordinary course of business. In April 2001, the AAR had decided that the purchase and sale of shares by the Petitioner was in the ordinary course of its business and the income which resulted from such transactions would constitute business profits and not capital gains. It was also held that the gains arising from the realization of portfolio investments in India would also be treated as part of the company’s business profits. The AAR had made it clear that the amount receivable by the Petitioner from share transactions in India would not be taxable in India as the Petitioner did not have a permanent establishment in India. The Petitioner relied upon this ruling of the AAR in all its assessments till 2008. 

The dispute arose between the parties when DIT purported to set aside the earlier assessments of the Petitioner by issuing a notice to the Petitioner inter alia calling upon the former to show cause as to why the previous assessments should not be set aside as erroneous and prejudicial to the interest of the revenue. The basis for such a notice was that the AAR, in its ruling in the case of Fidelity Northstar Fund (AAR No. 678/ 2006) held that the profits derived on account of purchase and sale of equities would constitute capital gains and would be chargeable to tax accordingly.

The Court interpreted the provisions of Section 245S of the Income Tax Act, 1961 and observed that the ruling pronounced by the AAR shall be binding on the Applicant who had sought it and on the Commissioner along with his subordinates only in relation to the transaction which is the subject matter of the said Application. The Court further stated that the ruling shall not be binding if there is a change in law or facts on the basis of which the ruling was pronounced by the AAR. Once a ruling has been pronounced by the authority, the binding effect of the ruling can only be displaced in accordance with the procedure which is stipulated under law. It was in this backdrop that the High Court came to a conclusion that the subsequent ruling of the AAR which clarified the position on the subject as to the taxability issue would not amount to a “change in law” to erode the binding effect of the ruling given earlier in similar case. The High Court hence held that the Commissioner had exceeded his jurisdiction in relying upon the ruling of AAR in Fidelity Northstar Fund as a ruling which would apply to the Petitioner.  

As a matter of fact, there has been no conclusive ruling on this issue. In my earlier post I had written on the taxation of derivative transactions by FII, where AAR in the case of Royal Bank of Canada had granted the benefit of exemption from taxation to the FII stating that the profits derived from the derivative transactions would amount to business income and not capital gains. While deciding such issue, the AAR had referred to its earlier decisions in the matter of Morgan Stanley and Co and Fidelity North Star Fund, though some reservations over the decisions were expressed by the Chairman. Now pursuant to the decision of the High Court it can be said that till the decision of the AAR is not set aside as provided in the statute, the ruling will be a law for the subject transactions and binding on the Commissioners for all further assessments years.

- Ravichandra S. Hegde

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