HCL Technologies
Is this for real? One would wonder. The draft offer document for HCL Technologies' forthcoming IPO carries several blank spaces. Not only is one hard put to find the date when the directors signed the document, one would also not be able to locate the date on which the board resolution approving the offer document was passed. The date on which the board resolution pertaining to the authorisation of the registrars of the issue to act on behalf of the company on stockinvests was passed is also missing.Not just that, the company has failed to provide the quantum of funds that it requires. No estimate of the issue expenses has been provided. The company is coming out with an IPO for 1,42,00,000 equity shares of Rs 4 paid up. The issue opens on December 10. At least that's one date that its application form / draft offer document has not omitted. That leaves just three days before the company's designated banks begin to get the filled-in forms from investors.
Investors would have expected better from the likes of Kotak Mahindra, ICICI Securities, JM Morgan Stanley and DSP Merrill Lynch. However, given the demand for infotech stocks, it is unlikely that the faux pas will dampen the sentiments for the issue.
Derivatives
With the acceptance of the LC Gupta committee report, derivatives (at least futures trading in the Index) will be a reality in India. A paper presented by Shefali Goradia of Nishith Desai Associates at the fifth conference on International Tax Planning organised by the Bombay Management Association provided insights into the tax implications and the legal issues that are likely to arise.
The first issue that arises is whether a derivative transaction can be treated as a wager and is hence void in accordance with the provisions of the Indian Contract Act, 1872. The answer will depend on the specific facts and circumstances of each case. If the sole/primary object is speculation, it is a wager and hence it is void. The determining factor (as regards wager) is the intention of parties. If the end result is the net difference being collected/paid, it may be treated as speculative.
The Derivatives Bill tabled in Parliament will provide answers to some of the questions. The other important question is what will be the preference for payments on initiation of insolvency proceedings. Also, whether payment made or security delivered after the insolvency proceedings have been initiated is valid? Unless such payments are fraudulent payments made to defeat valid claims under insolvency proceedings, they are valid. A creditor claiming to prove debt against an insolvent company in liquidation is entitled to set it off its related claims. Even cross claims arising out of two separate contracts can be set off, if the two contracts are sufficiently connected and form part of the same transaction.
Tax Issues
According to the comparative study of Derivatives Taxation covering 29 countries conducted by International Fiscal Association (IFA), there are three basic approaches to the taxation of derivatives:
Decomposition Principle: every derivative transaction is analysed into a number of cash flows, each of which can be separately valued and taxed
Separate Transaction Principle
Linked approach: related transactions are clubbed together to analyse the overall profit of the entire transaction
The general acceptance seems to be that the taxation of derivative financial instruments (DFI) is not to be determined by reference to the tax treatment of the underlying instrument to which the derivative relates. The second method seems to be more acceptable to most countries.Key issues
Characterisation of income-business income or interest
Determination of income-timing and cash flow
TDS (withholding tax) implications
Paragraph 21.1 of OECD Commentary on Article 11 (Taxation of New Financial Instruments) makes it clear that in the absence of underlying debt (DFI do not involve a return on initial investment), the payment for a financial instrument will not be regarded as `interest.' If a derivative transaction is entered into the ordinary course of business, it should be considered as `business income' otherwise, it should be `other income'.In a cross border transaction where a tax treaty applies, subject to the existence of Permanent Establishment (PE), the income from the derivative transaction should be be exempt from tax in the source country. When to tax the cash flows may to some extent depend upon the method of accounting adopted by the assessee.
Taxation of Derivatives in India
Tax implications are still to be tested in India and no direct precedence is available. Sec 9 of the I-T Act lists the situations under which income can be ``deemed to accrue or arise in India.'' Whether payments under derivative transactions would constitute `income deemed to accrue or arise in India' will depend on the facts of each case.
The issue is not specifically dealt with in the Act nor there is any direct judgment on the issue. However, case laws are available on the taxability of profits/losses arising due to appreciation/depreciation in the value of foreign currency (FC) held by the assessee. If the FC is held in revenue account or as trading asset or as part of circulating capital, such profit/loss would ordinarily be trading profit/loss (116 ITR 1). If held as capital asset or as fixed capital, it would be capital in nature (158 ITR 102).
TDS implications
The Indian position is different from most of the countries. Under Sec 195(1), TDS is to be deducted by the payer on certain payments made to foreign recipient. The SC has held in Transmission Corporation of AP Ltd (239 ITR 587) that Sec 195 applies even to the gross amount, the whole of which may not be income or profit of the recipient. Thus payment made by an Indian party to an overseas entity under a derivative transaction will generally be liable to TDS.
Emcee (with contributions from Urmik Chhaya)
Copyright © 1999 Indian Express Newspapers (Bombay) Ltd.