Off-market share sale to partnership firm deemed colorable device for tax evasion under Section 10(38)

ITAT Mumbai held that assessee's off-market sale of shares to partnership firm constituted a colorable device for tax evasion. The transaction artificially created long-term capital loss while maintaining effective control over securities and consideration. The arrangement lacked commercial substance and was designed primarily for tax avoidance, allowing assessee to claim exemption under Section 10(38) while creating artificial losses for set-off. ITAT upheld AO's decision, setting aside CIT(A)'s order, following McDowell and Vodafone precedents on impermissible tax avoidance arrangements.

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Issues Involved:
1. Legitimacy of 'off market' sale of shares.
2. Validity of tax planning vs. colorable device.
3. Eligibility for set off and carry forward of long-term capital loss.
4. Applicability of General Anti-Avoidance Rule (GAAR).

Issue-wise Detailed Analysis:

1. Legitimacy of 'off market' sale of shares:
The revenue challenged the decision of the CIT(A) that the loss incurred by the assessee through the 'off market' sale of shares to a partnership firm controlled by the assessee is not a colorable device and is eligible for set off and carry forward. The AO observed that the shares yielding gains were sold on the stock exchange, while those incurring losses were sold off-market to a sister concern, M/s. Everfresh Enterprises LLP, where the assessee holds a 60% share. The AO deemed this transaction as a colorable device aimed at reducing taxable income by creating artificial losses.

2. Validity of tax planning vs. colorable device:
The CIT(A) held that the assessee's transactions were a legitimate exercise of tax planning, relying on the decision in Nomura India Investment Fund Mother Fund v. ADST(ST). However, the tribunal referred to the Supreme Court's judgments in McDowell & Co. Ltd. v. CTO and Vodafone International Holdings BV v. Union of India, emphasizing that while tax planning within the framework of law is legitimate, colorable devices aimed at tax evasion are not permissible. The tribunal concluded that the transactions were designed primarily for tax evasion and lacked commercial substance.

3. Eligibility for set off and carry forward of long-term capital loss:
The AO disallowed the set off and carry forward of the long-term capital loss incurred through the 'off market' sale, viewing it as an artificial transaction. The CIT(A) overturned this decision, but the tribunal reinstated the AO's decision, stating that the transactions were a means to create artificial losses without any effective loss of control over the securities, thus making the assessee eligible for undue tax benefits.

4. Applicability of General Anti-Avoidance Rule (GAAR):
The tribunal noted that although GAAR provisions were applicable from A.Y. 2018-19 onwards, the principles could be inferred in this case. The tribunal observed that the transaction lacked commercial substance and was designed to create artificial rights and obligations, qualifying it as an impermissible avoidance arrangement. The tribunal emphasized the need for statutory provisions to codify the doctrine of "substance over form" to address aggressive tax planning.

Conclusion:
The tribunal upheld the appeal by the revenue, setting aside the order of the CIT(A) and restoring the decision of the AO. The tribunal concluded that the 'off market' sale of shares was a colorable device aimed at tax evasion, and the losses incurred through such transactions were not eligible for set off and carry forward. The decision was pronounced in the open court on 6th August 2024.

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