Colourable Devices To Evade Tax Can't Be Tax Planning, Rules Telangana High Court
The Telangana High Court has held that tax planning may be legitimate, provided it is within the framework of the law. Colorable devices cannot be part of tax planning, and it is wrong to encourage or entertain the belief that it is honorable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting...
The Telangana High Court has held that tax planning may be legitimate, provided it is within the framework of the law. Colorable devices cannot be part of tax planning, and it is wrong to encourage or entertain the belief that it is honorable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges.
The bench of Justice P.Sam Koshy and Justice Laxmi Narayana Alishetty has relied on the decision of the Apex Court in the case of McDowell & Co. Ltd. v. CTO, in which it was held that the proper way to construe a taxing statute while considering a device to avoid tax is not to ask whether the provisions should be construed literally or liberally, nor whether the transaction is not unreal and not prohibited by the statute, but whether the transaction is a device to avoid tax, and whether the transaction is such that the judicial process may accord its approval to it.
The whole issue revolves around the issuance of bonus shares to the shareholder firm, namely Ramky Estate and Farms Limited (REFL). The petitioner sold the shares of REFL to Advisory Services Pvt. Ltd. (ADR). Prior to the sale of shares to ADR, REFL had issued bonus shares to its shareholders in a ratio of 5:1. Due to the issuance of bonus shares, the face value of each share of REFL was reduced to 1/6th of its value. The sale of REFL shares to ADR resulted in a short-term capital loss to the petitioner.
The petitioner set off the short-term capital loss incurred on the sale of shares of REFL against the long-term gains made on another transaction involving the sale of shares in REEL.
For the assessment year 2019–2020, the petitioner filed his income tax return, reporting the income under the heading 'Capital Gains' arising out of the sale of REEL shares after adjusting the capital loss incurred on the sale of REFL shares and paying the requisite income tax.
The petitioner contended that the transactions were covered by Section 94(8) of the Income Tax Act, which is primarily enacted to prevent the avoidance of tax. However, the respondent department, in the course of the assessment of income for the years 2019–2020, sought to treat the transactions as an impermissible avoidance arrangement as per the General Anti-Avoidance Rules (GAAR) under Chapter X-A, starting from Section 95–102 of the Income Tax Act. In the process, notice was issued by the respondent, i.e., a reference notice under Rule 10UB(1) of the Income Tax Rules, 1962, and objections were sought from the petitioner under Section 144BA(1).
The petitioner argued that the relevant provision of law to be taken note of in the present writ petition is Section 94(8) of the Act, which specifically deals with the buying and acquiring of any units. The explanation to the provision specifically enumerates that units referred to in the section shall have the meaning assigned to them in clause B of the explanation to Section 115AB. Clause B to the explanation of Section 115AB clearly indicates that the Parliament, while enacting the law, meant units to be units of a mutual fund specified under clause 23(D) of Section 10.
The department contended that the petitioner can very well make an appearance before the authorities concerned and take all the relevant objections in support of his contentions. The authorities concerned shall duly consider all the contentions that the petitioner will raise in his response. Thus, no strong case for interfering with the impugned show cause notice at this juncture is made out.
The court noted that the current arrangement is being scrutinized as it is considered devoid of commercial substance as per Section 97. It is perceived as a deliberate misuse of the Act's provisions, going beyond the intended use of the law and manipulating it to one's advantage. It creates extraordinary rights and obligations that seem to be conducted in bad faith. These unusual rights and obligations are not in line with the general principles of fair dealing, leading to the conclusion that it's an impermissible avoidance agreement under Section 96. Consequently, the arrangement falls under the purview of Chapter X-A. The procedures were set in motion to apply the rules and regulations of Chapter X-A to the arrangement.
The court, while dismissing the petition, held that there is clear and convincing evidence to suggest that the entire arrangement was intricately designed with the sole intent of evading tax. The petitioner, on their part, has not been able to provide substantial and persuasive proof to counter the claim.
Counsel For Petitioner: Rubaina S Khatoon
Counsel For Respondent: B Narasimha Sarma
Case Title: Ayodhya Rami Reddy Alla Versus Principal Commissioner of Incometax Central
Case No.: WP 46510/2022