In pulling off stunning profits in a short spell, Jane Street has challenged several principles and left multiple fingerprints for the income tax (I-T) authorities in India.
An artful use of its arms in different jurisdictions to carry out diverse trades and escape tax will, in all likelihood, come under the scrutiny of the I-T department.
In the taxman's parlance, the Jane group's elaborate mechanism for alleged market manipulation would go down, besides other violations, as "impermissible avoidance arrangement". This, according to the General Anti-Avoidance Rule (GAAR) in the I-T Act, is an arrangement that is put in place to simply dodge tax or is executed in a manner "which are not ordinarily employed for bona fide purposes".
Jane used its outfits in India to take positions in cash and stock futures markets while its Singapore and Hong Kong entities, which are Sebi-registered foreign portfolio investors (FPIs), took large positions in equity options, a large liquid market that has grown dramatically in the past few years.
The bulk of the profit was booked in the Singapore FPI which paid no tax on the earnings from equity derivatives (futures and options trades) by virtue of the India-Singapore tax treaty, which is very similar to the one India has with Mauritius. The Indian entities (JSI Investments and JSI2 Investments) took intra-day positions - buying in the morning and selling before the market closing - to influence prices, while the two FPIs (often taking opposite positions) made a killing. The profits of the two offshore FPIs - Jane Street Singapore and Jane Street Asia Trading, Hong Kong - far exceeded the possible losses of the two onshore entities.
Thus the entities, which recorded either a loss or smaller profits - and therefore paid little or no tax - were incorporated in India which imposes full income tax (varying from 30% to over 40%) on profits from equity derivative trades. But the Singapore FPI, which is the key piece in the entire arrangement and made the most money, paid no tax on options profits as it was housed in a tax-exempt country. Even though there is no similar tax benefit available for the Hong Kong FPI, the vehicle may have been used when the Singapore FPI had used up its margins and internal exposure limits for the group.
MIRROR TRADES?
Now, the Indian entities had to be used for two reasons: first, FPIs cannot take intra-day cash positions; second, an FPI (or two FPIs belonging to the same group) taking contra positions would have immediately raised red flags for Sebi.
Under the circumstances, the I-T department may have enough grounds to question Jane Street, said tax circles and senior practitioners. "Since Indian entities were used to execute trades to bypass the restrictions on FPIs on intra-day cash equity trades, it may trigger a GAAR scrutiny if the I-T sees it as an artificial arrangement to sidestep FPI rules. Also, should the profits be taxed as capital gains or business income or unexplained income which still attracts a penal rate? The question crops up on the back of Sebi's allegations that profits rose from manipulative trades and not genuine market activity," said Girish Vanvari, founder of Transaction Square, a regulatory and business advisory firm.
Sharing the view, Harshal Bhuta, partner at the CA firm PR Bhuta & Co, said, "Given the interim order's observation regarding the admission by Jane Street Group that all its entities operating in Indian markets act collectively, if it is suspected that the trades have been carried out in a manner that results in skewed profitability in entities which enjoy treaty benefits, GAAR could be invoked to reallocate profits to entities subject to Indian tax. Furthermore, the principal purpose test under the India-Singapore DTAA could also be invoked to deny the treaty exemption on gains arising from trades in 'index options'."
As per the Sebi order, the Jane Group had allegedly run a system of coordinated trade across onshore and offshore entities that was managed centrally. If these allegations are substantiated, the Indian subsidiaries may be seen as "functional dependent agents".
"This then could result in income attribution to India and higher tax exposure for offshore arms," said Vanvari.
What could instantly appeal to the taxman is the provision of GAAR. This comes in handy when tax officials choose to deny treaty benefits when they suspect that a vehicle lacks 'commercial substance' - a shell entity that is floated to simply route trades and claim tax benefit. But, there is no evidence that the Jane Singapore vehicle lacked substance or was just a paper company. However, the way it had cut the deals - which, as per the Sebi order, appear as mirror trades with allegedly close links between the different arms - could well raise many eyebrows in the tax office.
An artful use of its arms in different jurisdictions to carry out diverse trades and escape tax will, in all likelihood, come under the scrutiny of the I-T department.
In the taxman's parlance, the Jane group's elaborate mechanism for alleged market manipulation would go down, besides other violations, as "impermissible avoidance arrangement". This, according to the General Anti-Avoidance Rule (GAAR) in the I-T Act, is an arrangement that is put in place to simply dodge tax or is executed in a manner "which are not ordinarily employed for bona fide purposes".
Jane used its outfits in India to take positions in cash and stock futures markets while its Singapore and Hong Kong entities, which are Sebi-registered foreign portfolio investors (FPIs), took large positions in equity options, a large liquid market that has grown dramatically in the past few years.
The bulk of the profit was booked in the Singapore FPI which paid no tax on the earnings from equity derivatives (futures and options trades) by virtue of the India-Singapore tax treaty, which is very similar to the one India has with Mauritius. The Indian entities (JSI Investments and JSI2 Investments) took intra-day positions - buying in the morning and selling before the market closing - to influence prices, while the two FPIs (often taking opposite positions) made a killing. The profits of the two offshore FPIs - Jane Street Singapore and Jane Street Asia Trading, Hong Kong - far exceeded the possible losses of the two onshore entities.
Thus the entities, which recorded either a loss or smaller profits - and therefore paid little or no tax - were incorporated in India which imposes full income tax (varying from 30% to over 40%) on profits from equity derivative trades. But the Singapore FPI, which is the key piece in the entire arrangement and made the most money, paid no tax on options profits as it was housed in a tax-exempt country. Even though there is no similar tax benefit available for the Hong Kong FPI, the vehicle may have been used when the Singapore FPI had used up its margins and internal exposure limits for the group.
MIRROR TRADES?
Now, the Indian entities had to be used for two reasons: first, FPIs cannot take intra-day cash positions; second, an FPI (or two FPIs belonging to the same group) taking contra positions would have immediately raised red flags for Sebi.
Under the circumstances, the I-T department may have enough grounds to question Jane Street, said tax circles and senior practitioners. "Since Indian entities were used to execute trades to bypass the restrictions on FPIs on intra-day cash equity trades, it may trigger a GAAR scrutiny if the I-T sees it as an artificial arrangement to sidestep FPI rules. Also, should the profits be taxed as capital gains or business income or unexplained income which still attracts a penal rate? The question crops up on the back of Sebi's allegations that profits rose from manipulative trades and not genuine market activity," said Girish Vanvari, founder of Transaction Square, a regulatory and business advisory firm.
Sharing the view, Harshal Bhuta, partner at the CA firm PR Bhuta & Co, said, "Given the interim order's observation regarding the admission by Jane Street Group that all its entities operating in Indian markets act collectively, if it is suspected that the trades have been carried out in a manner that results in skewed profitability in entities which enjoy treaty benefits, GAAR could be invoked to reallocate profits to entities subject to Indian tax. Furthermore, the principal purpose test under the India-Singapore DTAA could also be invoked to deny the treaty exemption on gains arising from trades in 'index options'."
As per the Sebi order, the Jane Group had allegedly run a system of coordinated trade across onshore and offshore entities that was managed centrally. If these allegations are substantiated, the Indian subsidiaries may be seen as "functional dependent agents".
"This then could result in income attribution to India and higher tax exposure for offshore arms," said Vanvari.
What could instantly appeal to the taxman is the provision of GAAR. This comes in handy when tax officials choose to deny treaty benefits when they suspect that a vehicle lacks 'commercial substance' - a shell entity that is floated to simply route trades and claim tax benefit. But, there is no evidence that the Jane Singapore vehicle lacked substance or was just a paper company. However, the way it had cut the deals - which, as per the Sebi order, appear as mirror trades with allegedly close links between the different arms - could well raise many eyebrows in the tax office.
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