Indian tax laws contain a mechanism whereby an FII can obtain an advance ruling which would, considering the facts and circumstances, lay down the basis of taxation on its income in India. The primary purpose of this mechanism is to provide certainty to the FIIs about tax costs before they decide to do business in India, and to avoid unnecessary, unproductive and expensive litigation.

In a landmark decision, the Bombay High Court has decided on some key aspects of taxation of FIIs and the advance ruling mechanism. The issue came up as a result of a writ petition filed by Prudential Assurance Company Ltd, a UK-based company. Prudential is registered as a sub-account of an FII with Sebi. As part of its insurance business, Prudential buys and sells Indian-listed securities on the stock exchange. It obtained an advance ruling in 2001 from the Authority of Advance Rulings (AAR), which held that the income earned by it from the purchase and sale of Indian shares and securities constituted ?business income? and not ?capital gains?. AAR held that as Prudential did not have a permanent establishment in India, the said business profits were not assessable to tax in India in terms of the India-UK Double Taxation Avoidance Agreement.

Accordingly, the assessing officer (AO) completed the assessment for several years up to 2005-06 based on the said ruling. In March 2010, the commissioner of income tax proposed to revise/ set aside the assessment orders passed by the AO for 2004-05 and 2005-06 by referring to the ruling of the AAR issued in 2007 in the case of Fidelity Northstar Fund in which it had been held that profits derived by an FII on account of purchase and sale of equities were taxable as capital gains. Prudential objected to the commissioner?s proposed revision on the grounds that the ruling obtained by it was binding and that a following ruling obtained by another taxpayer would defeat the very purpose of obtaining an advance ruling.

The high court decision would bring major relief to FIIs who have obtained a ruling or propose to obtain a ruling from the AAR.

The author is executive director, PwC