2008 (8) TMI 222 - HC - Income Tax

Revenue appeal dismissed; pre-1-4-2002 mutual fund purchase and post-record sale losses allowable under section 94(7) prospectively

HC dismissed the Revenue's appeal and upheld the Tribunal's finding that losses on purchase and post-record-date sale of dividend-bearing mutual fund ... Transaction of purchase and sale of the units of Chola Freedom Technology Fund - bona fide commercial transaction Or a colourable device for tax avoidance - artificial loss arising from the transaction - expenditure for earning tax-free dividend under section 14A - dividend bearing units of a mutual fund are purchased on or before the record date and redeemed at a loss immediately after the record date - Assessee is a member of the Bombay Stock Exchange - earns income from brokerage and trading in shares of various companies on its own account or on behalf of its clients. HELD THAT:- As the units were sold immediately after receiving the dividend income it is contended by the Revenue that the only motive of the transaction was to earn loss and hence the loss is not allowable. It is true that section 94(7) operates prospectively. However, in respect of the transactions taking place prior to 1-4-2002, the Revenue cannot take a stand which renders section 94(7) redundant or nugatory. As noted earlier, section 94(7) was enacted to curb creation of losses by executing the transactions in question which were liable to be set off against other taxable income. If such loss could be disallowed on the ground that the loss was artificial loss then there was no need to insert section 94(7). It is only because such losses were allowable and it resulted in revenue loss, section 94(7) has been enacted. Therefore, the argument of the Revenue that the loss arising from the transactions in question taking place prior to 1-4-2002, could be disallowed on the ground that the loss was artificial cannot be accepted. From the CBDT Circular No.14 of 2001, it is clear that the necessity to introduce section 94(7) was that the taxpayers were entering into the transaction in question as a tax avoidance device, because the dividend income received from the transaction was tax free and in the absence of any provision in the Act, the loss arising from the transaction was liable to be set off against other taxable income of the taxpayers. As a result, the taxable income of the taxpayer from other transactions/sources stood decreased and consequently tax payable thereon also was reduced. Thus, the CBDT Circular No.14 of 2001, makes it abundantly clear that the loss arising from the transaction in question were liable to be set off against other taxable income of the assessee and since such set off resulted in revenue loss, section 94(7) has been inserted. It is well established in law and in fact the apex court in the case of CST v. Indra Industries [2000 (1) TMI 44 - SUPREME COURT] and this court in the case of Unit Trust of India v. P. K. Unny [2001 (4) TMI 77 - BOMBAY HIGH COURT] have held that CBDT circulars are binding on the Revenue and it is not open to the Revenue to argue contrary to the CBDT Circulars. Therefore, in the light of the CBDT Circular No.14 of 2001 which is binding on the Revenue, it is not open to the Revenue to contend that the loss arising from the transactions in question prior to 1-4-2002, could be disallowed on the ground that the transaction was not a business transaction or that the loss was artificial loss and not actual loss. The fact that the unit purchasers have exercised their discretion to sell the units after receiving the dividend income would not make the two independent transactions into one composite transaction. There is nothing on record to suggest that the assessee was aware as to what would be the redemption price of the units immediately after distribution of the dividend. Therefore, in the absence of any material on record it cannot be said that the purchase and sale transactions were one composite transaction and that the transactions were executed with an intention to earn loss. The Tribunal was justified in holding that the loss arising from the transaction in question was liable to be set off against the other taxable income of the assessee. In the result, both the questions are answered in the affirmative, i.e., in favour of the assessee and against the Revenue. Appeal is dismissed Issues Involved:1. Whether the transaction of purchase and sale of units of Chola Freedom Technology Fund was a bona fide commercial transaction or a colourable device for tax avoidance.2. Whether the artificial loss from the transaction could be considered as an expenditure for earning tax-free dividend under section 14A of the Income-Tax Act, 1961.Issue-wise Analysis:1. Bona Fide Commercial Transaction or Colourable Device:Arguments by the Revenue:- The Revenue contended that the transaction was a composite one executed solely to create an artificial loss to avoid tax.- The Revenue argued that the transaction lacked any commercial purpose and was designed to avoid tax on other taxable income.- The Revenue relied on the principle that a transaction, though legal, if executed with an intention to avoid tax, constitutes a colourable device.- The Revenue cited various judgments to support their claim that the transaction was not genuine and was aimed at tax avoidance.Arguments by the Assessee:- The assessee argued that the transactions of purchase and sale were independent and commercially motivated.- The assessee purchased the units to earn a 40% dividend and sold them immediately after receiving the dividend to avoid potential price drops.- The assessee claimed that the loss incurred was a business loss and should be set off against other taxable income.Court's Analysis:- The court noted that prior to the insertion of section 94(7), there was no provision to disallow such losses.- The court observed that the transactions were executed at arm's length and there was no evidence of complicity between the mutual fund and the assessee.- The court held that the transactions were genuine and commercially motivated, and the loss incurred was a business loss.- The court rejected the Revenue's argument that the transaction was a colourable device, noting that the transactions were within the legal framework and there was no evidence of prearrangement.Conclusion:- The court concluded that the transaction was a bona fide commercial transaction and not a colourable device for tax avoidance.- The loss incurred from the transaction was allowed to be set off against other taxable income.2. Artificial Loss as Expenditure under Section 14A:Arguments by the Revenue:- The Revenue argued that the artificial loss should be considered as an expenditure incurred for earning tax-free dividend income and disallowed under section 14A.- The Revenue contended that the differential amount between the purchase and sale price of the units constituted expenditure for earning the tax-free dividend.Arguments by the Assessee:- The assessee argued that the amount paid to purchase the units was based on the net asset value and not related to the dividend.- The assessee claimed that the loss incurred on the sale of units was not an expenditure for earning the dividend and hence not disallowable under section 14A.Court's Analysis:- The court observed that section 14A deals with actual expenditure incurred for earning tax-free income, not assumed or deemed expenditure.- The court noted that no expenditure was incurred in purchasing the dividend-bearing units.- The court held that the loss incurred on the sale of units could not be considered as expenditure for earning tax-free dividend income.Conclusion:- The court rejected the Revenue's argument and held that the loss was not disallowable under section 14A.- The court affirmed that the loss arising from the transaction was a business loss and could be set off against other taxable income.Final Judgment:- The court answered both questions in favor of the assessee and against the Revenue.- The appeal was dismissed with no order as to costs.