2025 (8) TMI 1178 - AT - Income Tax

Short-term capital loss from mutual fund redemption allowed; Section 94(7) analysis rejects sham allegations, loss sustained

Deputy Commissioner of Income Tax Versus CMS Computers Limited CMS Lake Centre Kaycee IND Compound, 2015 Grover Family Trust, Mumbai

Deputy Commissioner of Income Tax Versus CMS Computers Limited CMS Lake Centre Kaycee IND Compound, 2015 Grover Family Trust, Mumbai - TMI 1. ISSUES PRESENTED AND CONSIDERED * Whether short-term capital loss claimed on redemption of units of an open-ended mutual fund is disallowable as resulting from a colourable device/sham where dividend was distributed shortly after subscription and the Assessing Officer relies on survey findings alleging manipulation of distributable surplus by the fund house. * Whether the provisions of section 94(7) apply to disallow the short-term capital loss claimed, and if not, whether the loss can nonetheless be held non-genuine on the basis of SEBI circulars and investigation/survey statements without a SEBI adjudicatory action. * What is the burden and quantum of evidence required to characterise a transaction as colourable/without commercial substance for tax disallowance when the transaction is otherwise reflected in bank records, folio statements and regular books of account. 2. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Allowability of short-term capital loss where dividend was received and AO alleges scheme was structured to generate tax-free dividend and artificial losses Legal framework: Capital gains computation governed by section 48; exemption of certain dividend income governed by section 10(35) (as applied); anti-abuse provision in specific circumstances is section 94(7) which disallows loss to the extent of exempt dividend if securities/units bought within 3 months prior to record date and sold within specified period; general tax law principle that transactions otherwise in accordance with law cannot be disregarded unless devoid of commercial purpose. Precedent treatment: Reliance placed by authorities on Supreme Court authority in Walfort Share & Stock Brokers and on coordinate bench decisions (Goldiam, Rajesh Manhar Bhansali) and Calcutta High Court (Eveready). The Tribunal follows Walfort (and subsequent clarifications) and coordinate bench rulings which hold that fall in NAV after dividend is inherent and, absent specific statutory applicability (s.94(7)) or cogent evidence of sham, loss is allowable. Interpretation and reasoning: The Tribunal examined documentary evidence (bank statements, mutual fund folio, books) showing actual purchase consideration, dividend receipts and redemption proceeds; AO did not dispute amounts. The computation of capital loss complied with section 48. The Tribunal found the transactions carried out through proper banking channels, on open-ended SEBI-approved scheme, and the assessee to be a regular investor in securities/mutual funds. Survey statements and investigation reports describing a general modus operandi of the fund house were not shown to establish a direct live link between the fund's alleged internal accounting/IER manipulations and the specific investors' transactions. No SEBI inquiry or order contra was brought on record. Where AO's case rests on suspicion and general investigative observations rather than direct, cogent corroborative evidence tying the assessee to a pre-planned sham, disallowance is not sustainable. Ratio vs. Obiter: Ratio - where purchase, dividend receipt and redemption are evidenced and section 94(7) is not applicable, and absent direct cogent evidence that the particular investor participated in a sham, short-term capital loss is allowable; suspicion from fund-level survey findings alone is insufficient. Obiter - observations on general safeguards in mutual fund regulation and market behaviour reinforcing that NAV fall post-dividend is expected. Conclusion: Short-term capital loss held allowable; AO's disallowance on ground of colourable device/sham set aside. Issue 2 - Applicability and effect of section 94(7) and SEBI circulars on the allowability of loss Legal framework: Section 94(7) prescribes automatic ignoring of loss to extent of exempt dividend where specified temporal conditions around record date are satisfied. SEBI circular (Unit Premium Reserve treatment) regulates fund accounting practices but does not itself directly displace tax consequences unless regulator's findings/penal action or evidence of misuse is established. Precedent treatment: Courts/Tribunals have held that simply obtaining tax advantage does not render transaction abusive (Walfort; Eveready); applicability of s.94(7) is a condition precedent for statutory disallowance; SEBI circular non-compliance at fund level requires concrete regulatory findings to impugn investors' bona fides. Interpretation and reasoning: The Tribunal noted AO did not invoke or establish applicability of section 94(7) against the assessee; even where SEBI circular provides accounting prohibition, a mere allegation of contravention based on survey reports without a SEBI adjudication or specific evidence linking the investor to the contravention cannot convert a transaction into a sham for income-tax purposes. The Tribunal emphasised distinction between regulatory non-compliance at fund house level and proof that an investor was party to or benefited from an engineered return of capital in a manner rendering the loss fictitious. Ratio vs. Obiter: Ratio - failure of AO to demonstrate either statutory disqualification under s.94(7) or cogent evidence of fund-level manipulation affecting the assessee means SEBI circular allegations alone cannot support disallowance. Obiter - comments that SEBI action would be material but was absent. Conclusion: Section 94(7) not shown applicable; reliance on SEBI circular without regulatory finding inadequate to disallow loss. Issue 3 - Evidentiary burden to establish colourable device/sham and evaluation of survey statements and investigation reports Legal framework: Fundamental tax principle that burden lies on Revenue to prove colourable device/sham with direct, cogent and corroborative evidence; mere suspicion or generalized investigative report insufficient; decisions emphasise need for 'live link' between alleged scheme and taxpayer's transactions. Precedent treatment: Tribunal and higher courts (Walfort, Rajesh Manhar Bhansali, Goldiam, Eveready) require concrete evidence connecting taxpayer to sham, and hold that documented market notices, folio and bank records, and routine investment advice are consistent with bona fide investment. Interpretation and reasoning: The Tribunal examined statements relied upon by AO (employees of fund house, assessee's employee) and found they did not admit manipulation aimed at conferring tax benefit to the assessee; no statement from key managerial person or SEBI action was produced; assessee's statement established investment on advice of wealth manager and routine commercial purpose. The Tribunal concluded AO failed to discharge evidentiary burden; transaction authenticity supported by contemporaneous documentary record and investor's pattern of similar market activity. Ratio vs. Obiter: Ratio - Revenue must produce cogent, direct evidence linking taxpayer to sham; survey/investigation findings not tied to taxpayer are insufficient. Obiter - endorsement of prudential commercial practice of obtaining professional advice and expectations from open-ended funds. Conclusion: Evidentiary burden not met; survey statements and investigation reports do not justify treating transactions as colourable. Final Disposition (as to legal conclusions) * The Tribunal affirms that, on the material before it, the short-term capital losses were computed in accordance with section 48 and supported by bank and folio records; section 94(7) was not shown applicable; therefore losses are allowable. * Allegations of fund-level manipulation and SEBI circular violation, unsupported by SEBI action or direct evidence linking the assessee to a pre-planned scheme, cannot convert otherwise documented commercial transactions into sham transactions. * Where transactions are lawful, commercially explicable, and properly recorded, mere tax advantage or contemporaneous awareness of NAV behaviour post-dividend does not suffice to disallow claimed losses; the Revenue bears the onus to prove colourable device by cogent evidence.