TaxTMI 
TaxTMI 
2005 (7) TMI 645
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.... units of Mutual Funds is allowable or not ? 2. Whether the provisions of section 94(7) of the Income-tax Act, 1961 can be interpreted as retrospective in operation and if so, its effect ?" 2. The facts of the case relevant to the questions referred to us, briefly, are that the assessee-company filed return of income for assessment year 2001-02 disclosing total income at Rs. 57,31,610 on 29th October, 2001. The Assessing Officer completed assessment under section 143(3) on 31-3-2003 at total income of Rs. 2,58,46,553. During the year the assessee was a member of Mumbai Stock Exchange and traded shares on own account as well as on behalf of its clients. In addition, the assessee purchased on 18-12-2000 and sold on 21-12-2000 units of Sun F&C Mutual Fund. The learned CIT(A) has enumerated the assessee's claim of loss on this transaction in tabular form in para 2 of the impugned order in the following manner :- Particulars Purchase Sale Gain/Loss Dividend amount Date Amount Date Amount Units of Sun F & C Mutual 18-12-2000 10,00,00,000 Fund ....
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....earn profit. In open end scheme, it was but natural that NAV shall be reduced by the amount of dividend outflow. Looking to the extremely short period for which funds were parked by the assessee, it was crystal clear that the mutual fund had not invested the money deposited by the assessee and dividend had been paid out to the assessee from out of the purchase price of the units. The assessee knew beforehand that it would receive dividend out of its own funds and thereafter the difference in purchase and sale price of units would be a certain loss. The assessee intended to gain because it would reduce such loss from its other taxable income, while the dividend would be claimed as exempt under section 10(33). The mutual fund, on the other hand, would gain by charging the entry load or exit load and in some cases even both. 5. The learned Assessing Officer held that the basic scheme of a mutual fund was either growth or income or both. However, the manner in which the transaction took place, the objective was neither growth nor income. Hence the transaction revealed an unholy nexus between the mutual fund and the tax avoider. The word "business" though of large and indefinite impo....
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....Assessing Officer calculated the loss arising to the assessee in the following manner : Purchase price of share-cum-dividend 10,00,00,000 Less : Dividend declared Rs. 2,01,14,942 Incentive received from MF 16,73,563 2,17,88,505 7,82,11,495 Less : Sale price of Units Rs. 9,71,26,436 Less : Dividend received Rs. 2,01,14,942 7,70,11,494 Actual loss incurred in the units of transaction 12,00,001 7. Accordingly the learned Assessing Officer allowed the assessee loss of Rs. 12,00,001 only as against the loss of Rs. 2,13,14,942 claimed by the assessee. He found support from the judgment of House of Lords in the case of Craven (Inspector of taxes) v. White (Stephen) [1990] 183 ITR 2161. 8. Aggrieved by the order of assessment, the assessee filed appeal before the learned CIT(A). The assessee submitted that units of mutual funds were regulated by an independent body constituted under the Act of Parliament, viz., SEBI. The assessee had followed the prescribed procedure and the transactions with the mutual funds were at arms length. The assessee....
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....hinking of House of Lords. Thereafter another path breaking judgment came in the form of Lupton v. F.A. & A.B. Ltd. 47 TC 580 (HL). The case of Lupton marked a water shed in tax avoidance cases. Their Lordships noted the earlier judgments in the cases of Griffiths (Inspector of Taxes) v. J.P. Harrison (Watford) Ltd. [1965] 58 ITR 328 (PC) and Finsbury Securities Ltd. v. IRC. It was held that if upon analysis it was found that the greater part of the transaction is explicable only on fiscal grounds, the mere presence of element of trading will not suffice to translate the transaction into the realms of trading. The learned CIT(Appeals) noted that subsequent judgments in the case of W.T. Ramsay Ltd. v. IRC [1982] AC 300 2 (HL); IRC v. Burmah Oil Co. Ltd. [1982] STC 303 (HL) and Furniss v. Dawson [1984] 1 All ER 5304 (HL) added new dimension to the legal interpretation of the tax avoidance transactions. The contents and the nature of the principles established in those three cases were dealt with extensively in the case of Craven (Inspector of Taxes) v. White (Stephen) [1990] 183 ITR 2165 (HL). It was laid down that an artificial avoidance scheme did not alter the incidence of tax. Ac....
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.... double benefit of not only the tax free income but also reduction of incidence of tax on the assessee's other income chargeable to tax. The mutual fund played the role of facilitator of the scheme of tax avoidance. These mutual funds advertised in the newspapers the record date and the amount of dividend to be declared. Subscribers, financiers, brokers came alive instantly within hours and subscriptions for units running into crores of rupees were made. In such cases there were ready-made and ever willing financiers willing to finance the transaction without any risk as to the money advanced because the money invested in purchase of units was going to be collected from mutual fund directly in a span of a day. In most of the cases, the assessee who neither had money to invest entered into the fray to get the double benefit. In the process everybody involved in the exercise got benefited. The purchaser got the double benefit of tax-free dividend and consequential loss. The brokers were paid handsomely for the services by Mutual Funds. Financiers earned fixed interest without much risk and mutual funds collected their fee in the form of entry load or exit load or both. These cases we....
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....uestion, the loss incurred had not even remotest connection with the business of the assessee, nor it was incidental thereto. Furthermore, another essential feature of business was that there should be a continuous course of activity. That too was missing in the case of the assessee. Hence even though the transaction was not a sham or illusory transaction, the fiscal content or fiscal element needed to be viewed correctly. 12. After holding that the transaction in question could not be considered to be commercial or business transaction, the learned CIT(Appeals) further held that the transaction entered by the assessee was devoid of any trappings of an investment also. The investment in common parlance was understood to be realization of the capital appreciation over a period of time. 13. The learned CIT(A) held that profit motive was common both in a business transaction and an investment. If the assessee had genuinely entered into investment transaction, he would wait for longer time. It was possible to make loss, but the purpose of making the investment had to be realization of capital apprecaition. A transaction entered into not with the motive of capital appreciation but....
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....y in view of the extraordinary circumstances of purchase and sale, should not be disallowed. The arguments of the assessee and the reasoning of the learned Assessing Officer thereupon are more or less the same as enumerated by us in relation to assessment order for assessment year 2001-02 and for brevity not repeated here. The learned Assessing Officer found that the assessee had received an incentive also of Rs. 23,76,778 from Chola Mutual Fund. After reducing the same from purchase price of Rs. 8 crores and matching the balance with the sale price of Rs. 5,90,55,207, there was loss of Rs. 1,85,68,015 if dividend of Rs. 1,82,12,862 not considered. He held that this loss was not allowable to the extent of the dividend received by the assessee. 18. On assessee's appeal the learned CIT(A) referred to his decision against the assessee in relation to assessment year 2001-02. For the reasons stated in that order, the learned CIT(A) held that the loss claimed by the assessee amounting to Rs. 1,85,68,014 should be ignored. 19. At the outset during the course of hearing before us Shri S.D. Kapila, the learned special counsel for the revenue suggested that we may modify the wording of....
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....hat the transactions entered into by the assessee were perfectly in accordance with law. The main basis of the department's argument was that there was no commercial purpose involved in the transaction and, therefore, the loss should be ignored. It was held that the motive or intention of the assessee for entering into the transactions in question was tax avoidance. The learned Assessing Officer had argued that there were several judicial pronouncements to support the view that the loss claimed should not be allowed as it was artificially created. The learned CIT(A) had heavily relied upon the judgments of the English courts in W.T. Ramsay Ltd. v. IRC [1982] AC 3001 (HL); IRC v. Burmah Oil Co. Ltd. 1982 STC 302 (HL) and Furniss v. Dawson [1984] 1 All ER 5303 (HL) as also the judgment of Hon'ble Supreme Court in the case of McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148 4. The learned counsel argued that the reliance placed by the revenue on these authorities was not correct for two reasons. The first reason was that even by the majority decision in McDowell & Co. Ltd.'s case (supra) what was prevented was colourable transactions by way of a device or a subterfuge. It was emphasized ....
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....e charge of tax was attracted. 22. The learned counsel argued that in the case of Azadi Bachao Andolan (supra) the principles laid down in the case of IRC v. Duke of Westminster [1936] 19 TC 4905 (HL) and in India in the case of CIT v. A. Raman & Co. [1968] 67 ITR 11 (SC) had been emphasized and the view taken in W.T. Ramsay Ltd.'s case (supra) and some other judgments following the same line, as in W.T. Ramsay Ltd.'s case (supra), had been held to be not reflecting correct position in law. At page 760, the Hon'ble Supreme Court held that "words cannot be added to or substituted so as to give a meaning to the statute which will serve the spirit and the intention of the Legislature." It, therefore, followed that in the absence of statutory provision, the legal consequences flowing from a transaction could not be denied on such vague concept as tax avoidance scheme or device. In the present case, the question was, therefore, whether there was a specific tax avoidance provision disallowing the assessee's claim of loss. Legal effect of the transactions of the assessee could not otherwise be prevented. Law nowhere said that an assessee must pay maximum amount of tax. The learned coun....
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....ever the intention of the Legialture was to give retrospective effect to an amendment, it was explicitly stated. For example, insertion of the provisions of section 90(2) by the Finance (No. 2) Act, 1991 with retrospective effect from 1-4-1972; insertion of section 14A by the Finance Act, 2001 with retrospective effect from 1-4-1962; Explanation to section 36(1)(viii) by Finance Act, 1992 with retrospective effect from 1-4-1987 and so on. If intention of the Legislature was to give retrospective effect to the provisions of section 94(7), the same would have been made explicit by the enactment itself. 25. The learned counsel argued that the position relating to section 94(7) had been explained by CBDT itself as per Circular No. 14, 252 ITR (St.) 65. It stated that the dividend was exempt in the earlier period without reference to any time limit. Revenue was not entitled to argue in the present appeals contrary to CBDT circular. With reference to the various English cases on dividend stripping referred to in the impugned order of the learned CIT(A), the learned counsel stated that the Commissioner (Appeals) had relied on the minority decision in Griffiths (Inspector of Taxes) v. J....
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.... that would have resulted from their shareholding had there been no scheme. The purchasers were also required to hold the shares for the period covered by the scheme and were not at liberty to deal with the shares in the way they pleased. In fact at page 626-7, Lord Morris of Borth-Y-Gest (who had delivered judgment in Griffiths (Inspector of Taxes) v. J.P. Harrison (Watfords) Ltd. [1965] 58 ITR 328 (PC) distinguished the decision in J.P. Harrison (Watford) Ltd.'s case (supra) on the basis that the arrangements were essentially different from those which gave rise to the Harrison case. 27. The learned counsel argued that the assessee's case fell within the ratio laid down by J.P. Harrison (Watford) Ltd.'s case (supra) as against Finsbury Securities Ltd.'s case (supra) because the transaction was demonstrably a unit dealing transaction. Units were brought; a dividend on them was received; later the units were sold. Like in the J.P. Harrison (Watford) Ltd.'s case (supra), there could be no room for doubt as to the real and genuine nature of the transaction. There was no scheme or arrangement with the vendor of the units whereby the seller's financial circumstances were capable of ....
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....s rendered. 30. Following interveners requested for being allowed to make their submissions during the course of consideration of the issues by us :- 1 . Shri S.C. Kapadia, Shri Y.P. Trivedi & Ms. Usha Dalal . ITA No. 2255/M/04 Nachiket Securities Pvt. Ltd. A.Y. 2001-02 2 . Shri V.H. Patil & Shri Satish Modi ITA No. 5343/M/04 M/s. Sodhani Securities Ltd. A.Y. 2001-02 3 . Shri K. Shivaram ITA No. 7974/M/2004 - Mr. Jaykumar K. Pathare & 2001-02 ITA No. 4960/M/2004 - Mr. L. Vinay Reddy 2001-02 4. Shri Dilip K. Sheth ITA No. 7075/M/04 - Goldcrest Capital Markets Ltd. 2001-02 5 . Shri Prakash Jhotwani ITA No. 7324/M/2003- Ramon Publications Pvt. Ltd. 2001-02 31. These interveners fully supported the various arguments of Shri S.E. Dastur and accepted that there was not much left to be added. Shri Trivedi argued that his assessee was a dealer in shares, who purchased and sold shares and securities on large scale on regular basis. In such situation there were many transactions resulting into profit and there....
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....ng, when it was profit or when it was loss. Shri Prakash Jhotwani appearing for the last intervener named above, argued that there was no basis to state that his client had entered into a pre-meditated and pre-ordained transaction. His client invested in the units of mutual fund in 1999 and sold them in 2001. Yet the loss was disallowed. At any rate, there were no parameters relating to number of days prior to amendment by way of provisions of section 94(7). He argued that in the case of his client there was no borrowing; there was no joint venture and there was no agreement other than the agreement in question with the mutual fund. 32. Shri S.D. Kapila, the learned counsel for the revenue opened the arguments on behalf of the revenue. He pointed out with respect that in the case of McDowell & Co. Ltd. (supra), the main judgment was delivered by Ranganath Misra, J. (as he then was) on behalf of himself and other three judges including Chief Justice of India. Chinnappa Reddy, J, delivered a separate judgment. At the same time in the majority judgment deliverd by Ranganath Misra, J, the following passage appeared "Tax planning may be legitimate provided it is within the f....
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..... While provisions of section 115-O applied to amount declared, distributed or paid by domestic companies by way of dividend, the provisions of section 115R(2) applied to amount of income distributed by the specified company or a mutual fund to its unit holders. 34. The learned special counsel for the revenue argued that the distinction was not merely of nomenclature. There were weighty considerations calling for the legal distinction between dividend distributed by a domestic company and income from a mutual fund. Such distinguishing features were well recognized by traders/investors of securities. Those were :- (a)The market value of a company's share traded in a stock exchange fluctuates from moment to moment with the movement of price depending on factors like demand and supply for the stock. The NAV of the MF is quite immune to 'sensex' around the time of the 'record date' for 'dividend' because of the cushion provided by the inflation in the value of assets in the form of cash received by MF on account of subscription money. (b)Unlike issue of share capital by a company, the MF may issue or redeem units continuously on a daily basis. (c)Subscribe....
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....t any adverse impact on its NAV. Even a sudden drop of say 20% in the sensex on 24th March would hardly make any difference to the NAV of the MF, 25th March was Saturday and 26th Sunday. The stock markets were closed on those days. On 27th March, i.e., the ex-dividend NAV falls by the amount of 'dividend' distributed and the assessee redeems the units, which the MF under law is bound to purchase back on NAV of that day. During a few days following the record date, the ex-dividend of the MF NAV remains stable due to large amount of subscription money still lying with the MF. Charts of the movement of the MFs as compared to movement of sensex during the relevant periods before and after the 'record date' is annexed to this synopsis." 36. The learned special counsel for the revenue referred to pages 33 to 54 of the department's paper book indicating the financial position of various mutual funds and how the dividends were financed by receiving subscription within a few days prior to the record date for distribution of dividend. He pointed out that during the financial year 1999-2000 Chola Mutual Fund distributed so-called dividend of Rs. 290 crores, as against its annual net income....
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....dgment of Hon'ble Bombay High Court in the case of CIT v. Ahmuty & Co. Ltd. [1955] 27 ITR 63 to the effect that dividend income received by the assessee, who was a dealer in shares, was income from business. Reference was also made to the judgment in the case of Western States Trading Co. (P.) Ltd. v. CIT [1971] 80 ITR 21 (SC) that if the shares were held by the assessee as part of its trading assets, dividend on those shares would form part of the income from business. For the same purpose, reference was also made to the judgment of Hon'ble Supreme Court in the case of CIT v. Chugandas & Co. [1965] 55 ITR 17 . The learned Special Counsel argued that in the transaction with Cholamandalam Mutual Fund the assessee incurred an expenditure @ Rs. 17.57 per unit on 23-3-2000 to receive dividend of Rs. 4 on the very same day and sale proceeds of Rs. 13 after two days. The transaction was undertaken by the assessee with full knowledge of the trading results thus ensuing. On these facts a part of the expenditure was directly related to the earning of the so-called dividend from the mutual fund. There was a clear nexus between the cost of purchase of units and the immediate receipt of so-cal....
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....or the revenue argued that the assessee's reasoning ran like this. Income from mutual fund was exempt under section 10(33). By operation of the provisions of section 10(33), the same was not to be included in 'total income'. It meant that while computing the loss on sale of units under the relevant provisions of computation in Income-tax Act, no part of income from mutual fund could be taken into consideration. The learned counsel argued that such logic was clearly negated by the provisions of section 14A inserted by the Finance Act, 2001 retrospectively w.e.f. 1-4-1962 to take care of such contentions. He pointed out that the scope and ambit of provisions of section 14A had been explored in the following Tribunal decisions :- 1.Dy. CIT v. S.G. Investments & Industries Ltd. [2004] 89 ITD 44 (Kol.) 2.Asstt. CIT v. Dakshesh S. Shah [2004] 90 ITD 519 (Mum.) 3.Harish Krishnakant Bhatt v. ITO [2004] 91 ITD 311 (Ahd.). The learned counsel argued that once the nexus between a part of the expenditure on purchase of units and the earning of income from those units stood established, the only question was as to how the cost of purchase of units should be apportioned. As held by t....
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....e units. However, as the entire transaction was intended to last a very brief period of three four days only, the assessee borrowed funds temporarily from its overdraft account and financed the transaction. On these facts, the intention of the assessee were quite clear. The entire transaction was entered into with the sole objective of acquiring tax-free income. The learned counsel argued that the entire transaction could take place in the manner desired because unlike joint stock companies governed under the provisions of Companies Act, 1956, a Mutual Fund could distribute income from out of the funds received by it, which were essentially in the nature of subscription funds. 42. Referring to the provisions of section 94(7) introduced by the Finance Act, 2001, the learned special counsel argued that initially it laid down the condition of holding of securities three months prior and three months subsequent to the declaration of dividend or, as the case may be income on such securities or units so as to have the benefit of exemption from tax. The holding period of 3 months has been subsequently increased to 9 months by the Finance (No. 2) Act, 2004, w.e.f. 1-4-2005. Assuming tha....
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....dgment of Hon'ble Supreme Court in the case of Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706 2 did not conclude the matter in favour of the assessee and did not give the tax evaders such azadi as made out by the learned counsel for the assessee. The rule against colourable device or pre-planned/pre-ordained scheme of tax avoidance was not withdrawn by that judgment. Explaining the rule, sometimes referred to as the Ramsay Principle, the learned CIT, DR argued that where there was a pre- planned or pre-ordained scheme which had no purpose apart from reduction of liability to tax, the series of transactions or steps comprising the scheme, though legally genuine, had to be viewed as part of the composite scheme for the reason that they had been solely entered into for the purpose of producing an end result entirely different from that which would have been achieved by each successive link in the pre-conceived chain if such link was considered in isolation. 45. The learned CIT, DR gave us the photocopy of the advertisement on 8th March, 2000 in Business Times section of Times of India, by Chola Freedom Technology Fund bearing the head "Double Advantage". The advertisemen....
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....e. By way of icing on the cake, the assessee need not have employed his own funds and the entire transaction could smoothly go through by way of overdraft from the banks who knew that the money was going out for two- three days only. In the scheme of things, record date was known; rate of dividend was known; amount of remuneration payable to the mutual fund was known; the transactions were all pre-planned and pre-ordained. Therefore, in the present case the purchase and sale of units could not be treated as transactions of trade as the purchase and sale though ostensibly bearing features of purchase and sale, were not purchase and sale when viewed as part of a composite scheme. The purchase and sale of units was a mere pretence, as the sole objective was only to produce an artificial loss and not to acquire or dispose of the units of the mutual fund. In that view of the matter the loss claimed by the assessee was required to be ignored as not being real or incidental to any source of income. The learned CIT, DR sought to support this contention with various judgments in the United Kingdom relating to dividend stripping. He cited the following passage from the speech of Lord Denning....
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.... "Proposition II : Courts in India, even prior to McDowell case, have held that the nature of a transaction is to be discerned given the facts and the surrounding circumstances of the case and if such examination so warrants, the documents executed and agreements made in the course of transaction and/or the validity of the parties to the transaction can be disregarded as these constitute only a cloak to conceal the real nature of the transaction." 49. The learned CIT, DR argued that there were a plethora of court pronouncements in support of the above Proposition II. The flaw in the arguments of the learned counsel of the assessee was that according to him, there was only one judgment ruling the field, viz., IRC v. Duke of Westminster [1936] 19 TC 4901 (HL). Further, the learned counsel for the assessee erroneously interpreted the judgment of Azadi Bachao Andolan (supra) as overruling each and every judgment not in strict conformity to the judgment of House of Lords in Duke of Westminster's case (supra). Fact of the matter was that the judgment in the case of Duke of Westminster (supra) proceeded on its own special facts. It was noted by House of Lords that it was nobody's cas....
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....o Andolan (supra) :- (i) Workmen, Associated Rubber Industry Ltd. v. Associated Rubber Industry Ltd. [1986] 157 ITR 77 (SC); (ii) State Bank of Travancore v. CIT [1986] 158 ITR 102 1 (SC); (iii) Neorth Oil Mills Co. Ltd. v. CIT [1987] 166 ITR 418 2 (Ker.); (iv) CIT v. Smt. Minal Rameshchandra [1987] 167 ITR 507 3 (Guj.); (v) M.V. Valliappan v. ITO [1988] 170 ITR 238 4 (Mad.); (vi) CIT v. Warasat Hussain [1988] 171 ITR 405 1 (Pat.); (vii) CWT v. Arvind Narottam [1988] 173 ITR 479 2 (SC); (viii) Union of India v. Playworld Electronics (P.) Ltd. [1990] 184 ITR 308 (SC); (ix) CIT v. L.N. Dalmia [1994] 207 ITR 89 (Cal.); (x) Smt. Nayantara G. Agrawal v. CIT [1994] 207 ITR 639 (Bom.); (xi) CIT v. S. Kannan [1994] 210 ITR 585 3 (Kar.); (xii) Sumati Dayal v. CIT [1995] 214 ITR 801 4 (SC); (xiii) Banyan & Berry v. CIT [1996] 222 ITR 831 5 (Guj.); (xiv) Bhagat Construction Co. (P.) Ltd. v. CIT [2001] 250 ITR 291 6 (Delhi); (xv Twinstar Holdings Ltd. v. Anand Kedia, Dy. CIT [2003] 260 ITR 6 7 (Bom.); (xvi) K. Ramasamy v. CIT [2003] 261 ITR 358 8 (Mad.). ....
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....ourt was concerned with the validity of a notification issued by Union of India in relation to section 90 of the Income-tax Act pertaining to double tax avoidance agreement. It was argued by the petitioners in the public interest litigation launched by them that the notification encouraged tax avoidance and, therefore, it was contrary to the judgment of Hon'ble Supreme Court in the case of McDowell & Co. Ltd. (supra) and various other similar judgments. The court was not concerned with the application of the judgment of McDowell & Co. Ltd. (supra) in such cases as in the appeal before us. 54. The learned CIT, DR argued that before the Hon'ble Supreme Court it was argued that "any tax planning" must be struck down by the court. In the ensuing paragraphs in the judgment of Hon'ble Supreme Court the word "any" occurs again and again. The Hon'ble Court were disapproving the interpretation of the judgment of McDowell & Co. Ltd. (supra) that "any tax planning", "any step", "any device" resulting into reduction of tax had to be disregarded. Hon'ble Supreme Court in the case of Azadi Bachao Andolan (supra) denounced indiscriminate application of McDowell principle and it would be a comp....
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....e application of the principles governing the determination of the nature of a transaction, the purchase and sale of units cannot be viewed as a trading transaction. The difference between the purchase and sale price is in the nature of expenditure incurred for earning dividend. Since the dividend is exempt, such expenditure is not allowable. A.Whether a particular constitutes business depends on the character of the transaction to be determined not only with reference to the transaction itself but also surrounding circumstances. A business transaction cannot be devoid of profit motive/expectation of commercial benefit/gain. Every gain or loss incurred by a business does not acquire the character of business income or loss unless it arises in the course of carrying on of the business and is incidental to it. B.There is a clear distinction between a business expenditure and business loss. C.In determining the allowability of an expenditure, it should be relatable to an item of income/contemplated income. Matching concept of taxation. D.Dividend income is assessable as business income and "loss" is in the nature of expenditure incurred "exclusively....
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.... portion of the purchase price ought to be taken into consideration which is attributable to the units only and not to accrued dividends. 1.India Discount Co. Ltd. ( 75 ITR 191 ) (SC) 2.Accounting Standard 13 issued by the Institute of Chartered Accountants of India 2004 edition." 61. The learned CIT, DR relied upon the judgment also of Hon'ble Supreme Court in the case of Miss Dhun Dadabhoy Kapadia v. CIT [1967] 63 ITR 651 and Tribunal decisions in the cases of Devendra Prasad Jajodia v. ITO [IT Appeal No. 2420 (Kol.) of 2002], K.V. Trading Co. Ltd. v. Dy. CIT [IT Appeal No. 924 (Kol.) of 2003] and Niagra Investment Co. Ltd. (supra) placed at pages 539, 574 and 621 of the paper book filed by the department. He argued that as in the case of Miss Dhun Dadabhoy Kapadia (supra) where cum-right shares were rendered ex-right in the case of the assessee cum-dividend units became ex-dividend. The depreciation in the market value of the units on account of that factor should be treated as cost of acquisition of dividend particularly when the assessee sold all the units at the very next moment. For the purpose of determination of real income it was very important to app....
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.... (P.) Ltd. v. CIT [1997] 224 ITR 6771 (SC); CIT v. Kantilal Chhotalal [2000] 246 ITR 439 2 (Bom.); CIT v. Podar Cement (P.) Ltd. [1997] 226 ITR 625 3 (SC) and CIT v. Kavji Shivji & Co. [2000] 242 ITR 1244 (SC) also. 63. The learned CIT, DR further argued that there was no force in the argument that the mutual funds were independent entities. There was clearly a complicity for reaping benefits by both the unit buyers and the mutual funds. There was also no force in the argument that during the period falling between purchase of units and sale of units unforeseen developments in the stock exchange could have altered NAV in a significant manner. First, in the cases before us that did not happen. The transactions were so crafted as to obliterate that possibility. Secondly, in case the assessee decided not to sell because of change in circumstances on account of unforeseen developments, that only meant the colourable device was derailed. It was not necessary for the device to be infallible so as to be regarded as colourable. 64. In his rejoinder, Shri S.E. Dastur, the learned Sr. Advocate argued that the arguments of the revenue based on absence of profit motive were not correct. ....
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....rt goods at a low rate of profits or even at a loss. The learned counsel referred to the judgment of Hon'ble Madras High Court in the case of Mrs. Sarojini Rajah v. CIT [1969] 71 ITR 504 where the Hon'ble Madras High Court, referred with approval, the decision in the case of J.P. Harrison (Watford) Ltd. (supra) in the following words :- "We think that the presence of commercial motive is a primary legal requisite of trade. Purchase and sale as a business deal in the present context may be another requisite. Intention to make a profit normally inspires trade and commerce, but it seems it may not be the essence of trade." 65. The learned counsel thereafter addressed us to the question whether income from units of a mutual fund is dividend? The learned counsel argued that while the revenue placed reliance on the judgment of Bombay High Court in Ahmuty & Co. Ltd.'s case (supra) that dividend was assessable prior to the insertion of section 56 as business income, the sequitor to that point was not clear. The learned counsel further argued that even though in the provisions of Income-tax Act, the expression "income" and not "dividend" was used in relation to mutual funds, the....
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.... a claim of deduction on behalf of the assessee and then say it has to be disallowed. 68. The argument that most mutual funds advertised that they had distributed or would distribute dividends and some even invited the public to make investments could not entitle the revenue to suggest that there was a "scheme" or "collusion" between the mutual funds and the investors. There was also no force in the argument that in the case of mutual funds under consideration the current profits and the funds were not adequate for paying out the dividend resulting into a conversion of the investors' own fund into dividend and redemption proceeds. The fact of the matter was that all dealings of mutual funds were vigorously monitored by SEBI and if SEBI had not found anything adverse or objectionable in the mutual fund dealings, it was not open to the income-tax department to object to the same. Further the advertisement placed by the funds regarding dividend distribution was not a nefarious practice but was one which was necessary having regard to the manner in which mutual funds did business. Moreover that practice was followed even by public sector mutual funds, such as UTI. The argument that ....
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....nd cannot be such as a part of the sale proceeds. He argued that a change in the fact- situation relating to the sale price would result in a fundamental change in the characterization of the dividend/income. He submitted that the basic issue was one of classification of the income distribution. Once the income was characterized as falling within the ambit of section 10(33) of the Act, the other consequences would follow. That this was the first step was shown by CIT v. Smt. T.P. Sidhwa [1982] 133 ITR 840 1 (Bom.). The learned counsel argued that there was a legal purchase of units, a legal distribution of dividend and a legal redemption of units. Legal rights and obligations between the parties were created on that basis. The transaction had legal consequences (e.g., DDT in the case of shares). There was no legal basis for treating the dividend as sale proceeds. He referred to Mathuram Agrawal v. State of Madhya Pradesh [1999] 8 SCC 667, para 12: The plain, unambiguous language of the provision has to be seen. It is not permissible to assume any intention. The economic results are irrelevant. Words cannot be added to or substituted so as to give a meaning different from the plain ....
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..... Moreover it had been clearly stated that the provision was prospective in "Notes on Clauses on the Finance Bill, 2001", 248 ITR (St.) 134; "Memorandum explaining the provisions of the Finance Bill, 2001" 248 ITR (St.) 183 - 184 and "Circular explaining the Finance Act, 2001" 252 ITR (St.) 65 at pages 108-109. Such view was also accepted in the Tribunal decisions in the cases of Asian Paints India Ltd. (supra), Dy. CIT v. Cadila Laboratories Ltd. [2004] 83 TTJ (Ahd.) 7581 and Fifty-Fifty Finance & Management Consultants (P.) Ltd. v. Asstt. CIT [2004] 141 Taxman 1 (Mum.). The department had also fairly stated that it was not their contention that section 94(7) was retrospective. However, it was argued by the D.R. that section 94(7) was clarificatory of the law and that it was open to the department to invoke the MacDowell principle for cases before and even after the insertion of section 94(7). That argument was not correct. The fact that section 94(7) was inserted with prospective effect clearly showed that the Legislature was bringing about the change in the law and was not clarifying the law. The learned counsel supported this argument by reference to : u Dr. Manickchand R. T....
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....ed the dividend was liable to pay tax on dividend paid. Mutual Funds did not pay any tax because the income of an equity mutual fund was derived from other company who had already paid taxes on such income. Mutual Fund was merely a pass through conduit. Furthermore, the law was required to be uniform. There could not be two different principles first applicable to one who bought units, earned dividends and continued to hold the units and, second applicable to one who sold the units immediately after collecting the dividends. Similarly the law should remain the same when dividend was chargeable to tax and when it was tax-free. The learned counsel pointed out that in past dividend income was met with varying treatments, sometimes subjected to tax and sometimes treated wholly exempt. There was also a question as to what treatment to be given where the unit was sold immediately after collection of dividend, but at a price higher than the purchase price. There was also a question as to what would be the position for 'debt fund'. He argued that the law had to be uniform and it could not keep on fluctuating with the exigencies of situation from revenue's point of view. Cost or expenditure....
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....ld that it was a separate right. 76. The learned counsel for the assessee argued that much could not be made of the fact that the judgment in the case of McDowell & Co. Ltd. (supra) was delivered by a bench comprising of five judges. If the judgment of Hon'ble Supreme Court in the case of McDowell & Co. Ltd. (supra) had not been noticed at all in the judgment in the case of Azadi Bachao Andolan (supra), then it could be argued that McDowell should prevail being the judgment of a larger bench. But in the case of Azadi Bachao Andolan (supra) the subsequent Bench of Supreme Court had considered the earlier judgment in the case of McDowell & Co. Ltd. (supra) at considerable length. It was, therefore, not open to argue that the judgment in the case of McDowell & Co. Ltd. (supra) should take precedence. The learned counsel pointed out that the petitioners in the case of Azadi Bachao Andolan (supra) had also filed a curative petition in relation to the judgment in the case of Azadi Bachao Andolan ( supra). That curative petition having been dismissed by a bench comprising of five judges, the judgment in the case of Azadi Bachao Andolan (supra) had the seal of five judges. 77. The le....
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....ective effect from 1-4-1962, the Legislature became alive to the hardships which the retrospection of the provision could cause to the tax payers. Hence the proviso above mentioned was inserted by the Finance Act, 2002 with retrospective effect from 11th May, 2002. It, therefore, meant that an assessment order already made could not be disturbed or interfered with on the ground of the provisions of section 14A. For that reason the revenue was precluded from taking any plea based on section 14A for the first time before the Tribunal. 80. Both Shri Sharad Kapila, the learned Special counsel for the revenue and Mr. V.S. Singh, the learned CIT, DR requested for being allowed to make some clarifications. The learned special counsel pointed out that the judgment of Hon'ble Supreme Court in the case of Vijaya Bank Ltd. v. Addl. CIT [1991] 187 ITR 541 1 came to be considered by Hon'ble Bombay High Court in the case of American Express International Banking Corpn. v. CIT [2002] 258 ITR 6012 . It was noticed that Vijaya Bank Ltd.'s case (supra) was the case of purchase of a capital asset and not stock-in-trade. Furthermore, in the case of the assessee the mutual fund had already made publ....
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.... 14A brought on the statute book at the same point of time took care of the period prior to the operation of section 94(7). The learned counsel also referred to the judgment in Jogendra Nath Naskar v. CIT [1969] 74 ITR 33 (SC) in this respect. 82. The learned CIT, DR argued that there was not much force in the contention that the mutual fund was not under the control of the assessee. There was complicity in the sense that both the assessee as well as the mutual fund stood to gain at the expense of revenue. For that reason it could not be said that there was no colourable device. The learned CIT, DR reiterated that it was wrong to say that Income-tax Act is to be applied divorce from commercial principles. In Macniven H.M. (Inspector of Taxes) case (supra) facts were altogether different from W.T. Ramsay Ltd.'s case (supra) and for that reason the different conclusion was reached. The learned CIT, DR argued that there was not much force in the contention that the assessee did not claim deduction of any expenditure. What the assessee called claim of loss was in fact claim of expenditure. The learned CIT, DR relied upon the judgment of Hon'ble Supreme Court in the case of Miss Dhun....
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....s important to note that the mutual funds functioned under the supervision of SEBI. As to the commercial principles, the tax provisions were not based on any commercial principles, but from the point of view of generating revenue. If income is computed as per the provisions of the Act and not on the basis of any commercial principles, it would not be fair and correct to bring in the arguments based on commerciality only when it suited revenue. In the appeals before us the assessee had not committed any illegality or fraud. Finally, the learned counsel stated that the various judgments relied upon by the learned CIT, DR had to be read on the basis of facts of those cases and in the light of the observations of Hon'ble Supreme Court in the case of Azadi Bachao Andolan ( supra). 84. After Mr. Dastur concluded his arguments, the learned counsels for various interveners also briefly addressed us. Their arguments were mostly reiteration of the contentions of Mr. Dastur. In some cases some unique features pertaining to their own cases were pointed out with which we are not concerned in the present appeals. 85. We have carefully considered the rival submissions. In our view there are....
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....ssessing Officer on the ground that the transactions under consideration had no motive to earn profit. The assessee knew beforehand that the transactions would result into a certain loss, yet the assessee carried out the transactions as the motive was tax avoidance. A business or an adventure in the nature of trade cannot include a transaction where loss is inevitable and a foregone conclusion. The learned CIT(Appeals) has also reiterated the same view. He has relied on the observations of Lord Denning in the case of J.P. Harrison (Watford) Ltd. (supra) and argued that the transaction entered into by the assessee could not qualify to be commercial or business transaction. Without profit the transaction was no more business as pickle was not candy. The learned CIT(Appeals) has also relied in this regard on judgments in Bengal Coal Co. Ltd. v. Janardan Kishore Lal Singh Deo [1936] 4 ITR 392 (Cal.); Provident Investment Co. Ltd. v. CIT 6 ITC 21 (Bom.); Sole Trustee, Loka Shikshana Trust v. CIT [1975] 101 ITR 234 (SC); 113 ITR 174 (All.) (sic) and Barendra Prosad Ray v. ITO [1981] 129 ITR 2951 (SC). To these judgments the learned CIT, D.R. has added some more viz., CIT v. Smt. Minal Ra....
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.... held (Lord Reid and Lord Denning dissenting), that this was a trading transaction carried out by the respondent company in the course of carrying on its trade. In the impugned order the learned CIT(Appeals) has laid considerable emphasis upon the dissenting judgment of Lord Denning. During the course of hearing of these appeals the learned CIT, D.R. also placed considerable emphasis thereupon. Viscount Simonds found that the argument for the Crown rested on the proposition that the essence of a trading transaction is that its object is to make a profit and that the found object of the transaction was the ulterior one of obtaining a dividend against which it could claim to set off its losses. Viscount Simmonds then observed :- "But, my Lords, attractive as this proposition is, and attractively as it was advanced by the then Solicitor-General, it does not convince me. Here was a company whose object it was to deal in shares. It entered into a commercial transaction which, though it might be given an invidious name, contained no element of impropriety, much less of illegality. I can find nothing that enables me to say that it is not a trading transaction and echo the questio....
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....f trade. He rejected the argument that because the company embarked upon the dividend-stripping operation, the transaction could not be regarded as a trading transaction but as a fiscal transaction. In his words : "It is doubtless true to say that in general a trader embarks upon trade with the intention of making a profit: but it cannot be said that if this intention is lacking there is no carrying on of a trade. A trade may be carried on with the knowledge that losses will result. Equally it seems to me that if on any ordinary examination of them certain transactions must be regarded as trading transactions or adventures in the nature of trade they do not cease to be such because those conducting them have embarked upon them with a view to obtaining some fiscal benefit. It was urged in the present case that the transaction in the shares of Claiborne Ltd. ought to fail to be regarded as a trading transaction because in its real nature it was a fiscal transaction. My Lords, I cannot regard these as alternative descriptions. There may be trading transactions which can be the prelude, if the state of the law so allows, to tax recovery activities. If tax recovery is possible ....
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....eneficially or as trustees of their respective family settlements. During the year 1958-59 Mr. Lavy was approached by one or two persons who had interests in companies and were anxious to know whether there was some method of avoiding tax in companies profits. Mr. Lavy was at first lukewarm to these approaches, but he came to the conclusion that forward stripping transaction might achieve this object and provide a profit for the company. The result was that during the years 1958, 1959 and 1960 the company entered into 15 of these transactions. The transactions fell into two distinct categories. A typical transaction of the first category involved the transaction by the company of specially created preference shares in a manufacturing company. They carried, in addition to the normal right to a fixed dividend, a special right to dividends for five years which were to absorb the whole of the profits available for distribution after payment of the fixed dividend, provided that the total did not exceed a certain figure. The purchase price was to be determined by reference to the amount of the net dividends received and the amount of the income-tax repayment obtained by the Appellant Com....
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.... words : "I turn therefore, to the question whether the various transactions can be held to be within the trade of dealing in shares. I have earlier quoted the words of the Commissioners in recording their finding that the company acquired the shares with the object of making a profit out of them by the recovery of income-tax. The Commissioner proceeded to consider whether what they called the 'forward-stripping' transactions, which were a feature of the arrangements now under review, were so different in their nature from the arrangements in J.P. Harrison (Watford) Ltd. v. Griffiths that, that case did not apply. They decided that they could not distinguish that case from the present one. My Lords, I take a different view. In my opinion, the arrangements now under review are essentially different from those which gave rise to the Harrison case. In that case there was a purchase of the shares in a company called Bendit Ltd. (afterwards called Claiborne Ltd.). The vendors of the shares had no interest in the shares thereafter. They had no prospect of receiving any benefit from any tax recovery. After the Harrison company owned the shares in Claiborne Ltd. there was....
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....ares which were acquired ought not to be regarded as having become part of the stock-in-trade of the company.They were not acquired for the purpose of dealing with them. In no ordinary sense were they current assets.For the purposes of carrying out the scheme which was devised the shares were to be and had to be retained. The arguments before your Lordships depended mainly upon the submission by the Crown that the shares were acquired for a period of five years as part of the capital structure of the company, from which an income would be earned, and, on the other hand, upon the submission of the company that they were acquired as part of their stock-in-trade. In my opinion neither argument is correct. For the reasons I have already given this transaction on its particular facts was not, within the definition of section 526 'an adventure or concern in the nature of trade' at all. It was a wholly artificial device remote from trade to secure a tax advantage." 90. In the case of Lupton v. F.A & A.B Ltd. 47 TC 580 (HL) at all relevant times the company was trading as a dealer in stocks and shares. The question arose in regard to 5 particular transactions whether they were dealin....
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....nsactions mentioned in the foregoing paragraph. The company did not appeal against the decision of the learned Judge in regard to 4 of the 5 transactions. Their appeal in relation to the fifth was dismissed by the Court of Appeal (Sachs L.J. dissenting). The company having appealed against the decision of Court of Appeal, the case came before the House of Lords, who unanimously dismissed the company's appeal. Before analyzing the 5th transaction in his judgment Lord Morris of Borth-Y-Gest summarized the legal position in the following words : "The transactions in the Harrison case were solely and unambiguously trading transactions. There was a purchase of shares and after receipt of a dividend a sale of shares. There was no term, express or implied, in any contract or any transaction which in any way introduced any fiscal element. No fiscal consideration or arrangement intruded itself in any way into any bargain that was made. There was merely an acknowledged reason which inspired one party to enter into certain trading transactions. If that party later made some tax claim that claim would be no part of a trading activity. The transactions in the Harrison case not only had....
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....y jettisoned it is not saved even if the language of rhetoric is used to characterize it. It is manifest that some transactions may be so affected or inspired by fiscal considerations that the shape and character of the transaction is no longer that of a trading transaction. The result will be, not that a trading transaction with unusual features is revealed, but that there is an arrangement or scheme which cannot fairly be regarded as being a transaction in the trade of dealing in shares. The transactions which were under review in Finsbury Securities Ltd. v. Bishop (Inspector of Taxes) [1966] 1 WLR 14021 were of this nature. The transactions have only to be looked at for it to be seen that they were wholly and fundamentally different from the transactions in the J.P. Harrison (Watford) Ltd.'s case (supra). Whereas in the J.P. Harrison (Watford) Ltd.'s case (supra) there is not a trace of any fiscal 'arrangement', in the Finsbury Securities Ltd.'s case (supra) certain fiscal arrangements were inherently and structurally a part of the transactions which it was sought to describe as trading transactions. The J.P. Harrison (Watford) Ltd.'s case (supra ) and the Finsbury Securities....
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....iance on these judgments. According to the learned CIT(A), the minority judgment delivered by Lord Denning in the case of J.P. Harrison (Watford) Ltd. (supra) represented the correct view and that view was finally affirmed in the subsequent two judgments of House of Lords. According to the learned CIT(A), 'there was visible shift in the thinking of House of Lords'. The learned CIT(A) calls the judgment in the case of Lupton (supra) 'another path breaking judgment that marked a water shed in tax avoidance case'. It is, thus, made out that a somewhat erroneous view taken by the majority in the case of J.P. Harrison (Watford) Ltd. (supra) was clearly set right in subsequent judgments and finally it was the view of Lord Denning that prevailed. We find that is not the case. Different view of the matter was taken in the subsequent two judgments of Finsbury Securities Ltd. (supra) and Lupton (supra ) because their Lordships found facts of those two cases to be altogether different from those in J.P. Harrison (Watford) Ltd.'s case (supra). We do not see any dilution of the majority judgment in the case of J.P. Harrison (Watford) Ltd.'s case (supra) in the subsequent two judgments in the ca....
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....t with the vendor or purchaser of the units whereby the sellers financial circumstances were capable of being better or worse. There was no arrangement between the assessee and the mutual fund to share the gains of tax saving or to protect the unit holders in the event of tax concession not materializing. 92. On consideration of the matter we find the facts of the case of the assessee before us to be falling in the category of J.P. Harrison (Watford) Ltd.'s case (supra). It may be that mutual funds knew that the scheme being marketed by them would serve as a tool for dividend-stripping by interested parties. Nonetheless the transactions between the mutual funds and the assessee were at arms length. None of these mutual funds acted in any manner different from what they were normally doing in the ordinary course of their business. These mutual funds sold units to buyers and redeemed them in accordance with certain set rules. There is nothing to suggest that as far as mutual funds were concerned, they deviated in any manner from their uniform course of trading in favour of the dividend-strippers. Mutual funds acted the same way, whether the assessee was a dividend-stripper or a se....
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....revents it being an adventure in the nature of trade ? In the judgments of Viscount Simonds, Lord Morris of Borth-Y-Gest and Lord Gust the argument that the motive of making a profit is essential requirement of a trade has been specifically rejected. In the appeals before us we are concerned with the question as to whether the transactions in question are business transactions. The word "business" has much wider scope and connotation than the word "trade". In order to determine whether there was a business or not, the issue cannot be decided from the narrow angle as to whether or not the object was to sell the commodity at enhanced price. In a business transaction there could be several considerations. The tax effect is surely one of them and a very important one for that matter. The learned counsel for the assessee has cited example of an industrial undertaking being set up in a backward area with a view to earn tax incentives. These tax incentives have been instrumental in bringing about reduction in the economic and industrial disparity between the developed areas and relatively less developed areas of the country. Another important example is tax incentives and benefits given t....
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....its of the previous year or the current year, the assessee transferred a sum of Rs. 1,44,407 from his accounts to an account called "Taxation reserve account". On renouncing all claims to this amount against the firm, the assessee claimed that this amount was a capital loss arising from the transfer of capital asset to the firm and should, therefore, be set off against other capital gains. Hon'ble Calcutta High Court held that the transfer of the amount to the taxation reserve account from the other accounts did not involve any transfer of a capital asset and in any view, the assessee had not suffered a capital loss as he had merely foregone his claim voluntarily in favour of the firm. We find these facts entirely different from the facts of the case before us. In the case before us the assessee has not foregone any income voluntarily in favour of the mutual fund or any other party. 96. In the case of G. Venktaswamy Naidu & Co. (supra), the assessee firm which acted as managing agents of a company purchased 4 contiguous plots of land adjacent to the plots where the mills of the managed company were situate. Later on the assessee firm sold those plots to the managed company at a ....
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....sessment year, the assessee claimed that the income was assessable as income from business. Hon'ble Gujarat High Court held that the Tribunal rightly applied the relevant tests, namely, volume, frequency, continuity and regularity of the transaction in reaching the conclusion that the activities of the assessee in giving advances constituted business. 100. In the case of Smt. Minal Rameshchandra (supra), the assessee along with her mother and brother purchased a large plot of land in March, 1962. The land had been converted into town planning scheme and in July, 1959. When the assessee purchased the land the title to the land was in dispute. The land was not yielding any regular income. In April, 1970, the assessee, along with other co-owners, entered into a partnership with 7 other individuals and contributed the land as their capital contribution to the partnership. The other 7 individuals did not contribute any capital. The three partners contributing the land retired from the partnership w.e.f. August 31, 1970. The land was sold in December, 1973 for Rs. 15 lakhs. Hon'ble Gujarat High Court held that where there was a purchase of land if there was no safety of the capital in....
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....la mutual fund during the previous year relevant to assessment year 2000-01. Identical plea has been taken by them in relation to assessment year 2001-02. Various arguments advanced in support of this contention on behalf of revenue can be put into following three categories:- A.Income from units of Mutual Fund cannot be included in the expression "dividends" in section 56(2)(i) of the Act. B.As the assessee purchased units of Chola Mutual Fund only after announcement of dividend of Rs. 4 per unit just before the record date, the purchase price of Rs. 8 crores should be in part attributed to dividend income. C.In any case, under the provisions of section 14A inserted by the Finance Act, 2001 with retrospective effect from 1-4-1962, a suitable part of the purchase price of Rs. 8 crores is required to be apportioned to the income of Rs. 1,82,12,863. 103. As to the argument 'A' above, the learned special counsel for the revenue pointed out that as far as the provisions of Income-tax Act are concerned, an income from units of mutual fund has been considered to be separate and distinct from dividends on equity shares of a joint stock company. Those arguments are summarized b....
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....d not part of income. Hence, unless special circumstances are shown to exist, dividend/income cannot be adjusted against purchase price of shares/units. The reason for that is not difficult to see. The assessee purchased 'X' number of units of Chola mutual fund on 24-3-2000. On declaration of dividend at the rate of Rs. 4 per unit, the assessee continued to own 'X' number of units of Chola Mutual Fund. The assessee would have continued to hold 'X' number of units of Chola Mutual Fund as long as he wished and it is only on redemption on 27-3-2000 that the assessee ceased to own 'X' number of units of Chola Mutual Fund. The declaration of dividend on 24-3-2000 had no bearing at all on the holding of units of Chola Mutual Fund by the assessee and they remained intact. It is for this reason that where historical cost method of accounting is adopted, while working out the value of closing stock dividend or any other income returns are not adjusted in the valuation of closing stock as at the end of the year. That would be the position even if the provisions of section 56(2)(i) are not there and the dividend income as defined under section 2(22) is chargeable to tax as business income. It....
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....s transactions of purchase and sale of units. Considerably reliance is placed in this respect on the judgment of Hon'ble Supreme Court in the case of CIT v. India Discount Co. Ltd. [1970] 75 ITR 191 and Accounting Standard 13 of Institute of Chartered Accountants of India. The learned CIT, DR has also relied heavily in this respect on the judgment of Hon'ble Supreme Court in the case of Miss Dhun Dadabhoy Kapadia v. CIT [1967] 63 ITR 651 and certain Tribunal decisions in the paper book filed by the department. The learned counsel for the assessee has sought to distinguish the case of the assessee before us from the facts in India Discount Co. Ltd. on the ground that in the case of India Discount Co. Ltd., the assessee had purchased shares with arrears of dividend. Thus, the assessee purchased two assets, viz., equity shares of the company and dividend arrears. In the case of the assessee before us the units of mutual fund had been purchased before record date and dividend was yet to be formally announced by the mutual fund. What the assessee before us purchased was a single asset, i.e., units of mutual fund and not distinct and separate assets, as in the case of India Discount Co. ....
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....hun Dadabhoy Kapadia (supra), first and foremost the assessee in that case was not a dealer in shares. The assessee renounced her right to acquire additional shares and the claim was that depression in the value of old shares as a result of issue of new shares should be set off against the consideration received by the assessee on renunciation of her right to acquire new shares. The argument of the revenue is that depression in the value of units should be set off against the amount of dividend received by the assessee. We have earlier seen that dividend as a return of investment is not regarded, as a rule, recovery of purchase price. As a corollary dividend cannot be regarded as erosion of sale price. Unlike renunciation of right to subscribe for new shares in the case of Miss Dhun Dadabhoy Kapadia (supra) the receipt of income on units of mutual funds by the assessee did not represent one fixed time event. What if the assessee had not sold the units immediately after the record date and retained the units for some more time? What if the assessee had retained the units for sufficiently longer period and sold them at a profit? At any rate, the case of Miss Dhun Dadabhoy Kapadia (su....
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.... if the assessee was claiming a deduction which was not so in the present case. The learned counsel argued that it was not true that dividend income was altogether exempt from tax, in as much as tax on dividend had been paid by the companies who paid dividend to mutual fund. Mutual Fund in this behalf was merely a pass through conduit. Furthermore, the income received from a mutual fund is exempt under the provisions of section 10(33) of the Act in Chapter III. The heading of Chapter III read "incomes which do not form part of total income". Any income, therefore, which fell in the provisions of section 10 was not to enter into the subsequent provisions of the Act relating to computation of income chargeable to tax. The dividend received by the assessee from mutual funds having been excluded from total income by virtue of the provisions of section 10(33) could not, therefore, be caught in the net of tax by operation of the provisions of section 14A. 108. The main provision of section 14A inserted by the Finance Act, 2001 with retrospective effect from 1-4-1962 read as under :- "14A For the purposes of computing the total income under this Chapter, no deduction shall be ....
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....tion 14A and even if there is one, the meaning of the provisions of section 14A being unmistakably clear the provisions have to be given effect to by way of harmonious construction. Provisions of section 14A cannot be considered defunct or redundant for the reason only that these provisions should have been inserted in Chapter III and not Chapter IV. After all both Chapter III and Chapter IV are integral part of the same enactment. We also do not agree with the arguments of the assessee that it amounts to artificial enhancement of sale price by the amount of dividend. The case of revenue is based on disallowance of expenditure (purchase price), not enhancement of sale proceeds. We also do not see proviso to section 14A having any application. It is not the case of reopening any closed matter. It is, therefore, open to us to take note of the retrospect provisions of section 14A. 109. We are, at the same time in substantial agreement with the contention of the learned counsel for the assessee that there is no expenditure incurred in respect of the income from units. To a large extent our reasons are the same as elaborated by us in relation to argument 'A' and argument 'B' above. W....
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....rm charge of tax. We do not find the expression "in relation to" compelling us to do so. We also do not find the expression reflective of any such legislative intent. In our view, there is nothing in section 14A calling for re-interpretation of the basic principles of accountancy. 110. We, however, hasten to add to be fair, the contentions of the learned special counsel are not based on the provisions of section 14A in isolation. During the course of hearing before us he has emphasized various aspects of the transactions under consideration here and certain perceived facts relating to the declaration of income by the mutual funds. According to his arguments, in substance the loss suffered by the assessee is the price the assessee willingly paid for acquiring the income he could claim exempt under the provisions of section 10(33). In these special circumstances it is desirable and called for to bifurcate the purchase price of units paid by the assessee between the expenditure on income and expenditure on acquisition of units. He further argued that such a bifurcation cannot be prevented on the ground that the purchase price is indivisible. The provisions of section 14A, in the su....
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.... respectively. 114. In Secretary of State in Council of India v. Scobie [1903] 4 TC 618 (HL), it was held that in revenue matters, what is material is the substance of the transaction and not the form. The same view was taken in Back v. Daniels [1925] 9 TC 183. In IRC v. Fisher's Executors [1926] AC 395, Lord Sumner held that if an individual arranges his affairs to mitigate his tax liability, he neither comes under liability nor incurs blame. In IRC v. Adam [1928] 14 TC 34 it was remarked, "a great deal has been said about form and substance. I think that in a question of this sort both form and substance must be considered." In Re Hinckes [1921] 1 Ch. 475 Lord Warrington said, "It is said we must go behind the form and look at the substance. I do look at the substance, but in order to ascertain substance, I must look at the legal effect of the bargain which the parties have entered into." Thereafter came in 1936 the decision of House of Lords in the case of IRC v. Duke of Westminster [1936] 19 TC 4901. This decision sought to explode the theory of substance. Lord Tomlin, in his speech pronounced, "Apart, however, from the question of contract with which I have dealt it is said....
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....t. It was held that the purchase of the growing crop was part of a transaction for the purchase of a capital asset, the land and the trees, and therefore, the price paid for the crop was not a sum which could be deducted in computing the profits or gains. Singleton, L.J., remarked that it was true to say that if arrangements of a different kind had been made, the taxpayer might have been in a better position. If he had bought the growing cherries first and acquired the freehold later, he might not have had so great a liability to tax. Regard, however, must be had to the contract, to the conditions, and to the conveyance." The approach of the Courts that in fiscal legislation the form or legal effect of a transaction was more important encouraged taxpayers to draw up schemes and arrangements, very often contrived and fanciful the legal effect of which was to avoid the impact of the letter of the taxing statute. Such arrangements came to the known as 'tax planning' or 'tax avoidance scheme'. Subsequent English decisions sought to remedy the situation. In IRC v. Plummer [1980] AC 896 and Floor v. Davis [1980] AC 695 substance was given weightage. Thereafter came the triology of decisi....
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....estments Ltd. [2002] 255 ITR 612 (HL), considered at length Ramsay triology decisions. The decision in Macniven's case cannot be seen as repudiation of Ramsay principle altogether. Lord Hoffmann explained Ramsay principle in the following words :- "28. Everyone agrees that Ramsay is a principle of construction. The House of Lords said so in Inland Revenue Commissioners v. McGuckian [1997] 1 WLR 991. But what is that principle? Mr. McCall formulated it as follows in his printed case : 'When a court is asked (i) to apply a statutory provision on which a taxpayer relies for the sake of establishing some tax advantage (ii) in circumstances where the transaction said to give rise to the tax advantage is, or forms part of, some pre-ordained, circular, self-cancelling transaction (iii) which transaction though accepted as perfectly genuine (i.e., not impeached as a sham) was undertaken for no commercial purpose other than the obtaining of the tax advantage in question then (unless there is something in the statutory provisions concerned to indicate that this rule should not be applied) there is a rule of construction that the condition laid down in the statute for ....
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.... and not the form which is important. It would be quite possible for the assessee to be given as a matter of form a right of payment by instalments of a capital sum but which nevertheless would in substance be a right to an income." At the same time the words of Lord Tomlin in Duke of Westminster's case (supra) echoed in the case of CIT v. Kumar Kamaksha Narain Singh, Maharaja of Padma [1940] 8 ITR 563 (Pat.). In Bank of Chettinad Ltd. v. CIT [1940] 8 ITR 522 (PC), it was said, "There Lordships think it necessary once more to protest against the suggestion that in revenue cases 'the substance of the matter' may be regarded as distinguished from the strict legal position....". In Sir Kikabhai Premchand v. CIT [1953] 24 ITR 506 (SC) it was said, "It is well recognized that in revenue cases regard must be had to the substance rather than to its form". In CIT v. Provident Investment Co. Ltd. [1957] 32 ITR 190 (SC) the department's plea that the substance of the matter should be looked at and not mere the form was rejected. In Jiyajeerao Cotton Mills Ltd. v. CIT [1958] 34 ITR 888 (SC) Hon'ble Supreme Court observed, "Every person is entitled to so arrange his affairs as to avoid taxatio....
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....ds not upon considerations of morality, but on the operation of the Income-tax Act. Legislative injunction in taxing statutes may not, except on peril of penalty, be violated, but it may lawfully be circumvented." In CIT v. B.M. Kharwar [1969] 72 ITR 603 (SC), the observations in Sir Kikabhai Premchand's case (supra) were read not throwing any doubt on the principle that true legal relation arising from a transaction alone determines the taxability of a receipt arising from the transaction. The Court observed, "It is now well settled that the taxing authorities are not entitled in determining whether a receipt is liable to be taxed to ignore the legal character of the transaction which is the source of the receipt and to proceed on what they regard as the 'substance of the matter'.... The taxing authority is entitled and indeed is bound to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation it is open to the taxing authority to unravel the device and determine the true character of the relationship. But the legal effect of a transaction cannot be displaced by probing into the substance of t....
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....hat is, its true legal effect rather than to the form in which it is carried out. In that case it was held that the name in which the shares were held could not come in the way of levy of estate duty in respect of the shares of which the deceased was the real owner. 122. We have in the foregoing paragraphs briefly referred to a number of judgments delivered in India prior to the judgment of Hon'ble Supreme Court in the case of McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148 2. In our humble opinion it would not be correct to say that in that judgment any new legal principle has been laid down for the first time. The issues related to form of the transaction and substance of the transaction, legal effect of the transaction and motive of the parties, legitimate tax planning and clever devices for avoiding tax liability have engaged the attention of the courts in India from the very beginning. While in some judgments it would appear that Westminster principle has been enshrined, in some judgments it would be seen that Ramsay principle has been the guiding force. The judgment of Hon'ble Supreme Court in the case of McDowell & Co. Ltd. (supra), however, introduced a significant change ....
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....on after it is transferred by the assessee to it, whether the partnership firm has no substantial or real business or the record shows that there was no real need for the partnership firm for such capital contribution from the assessee." [Emphasis supplied] Hon'ble Supreme Court soon followed up these judgments by another judgment in the case of Workmen, Associated Rubber Industry Ltd. v. Associated Rubber Industry Ltd. [1986] 157 ITR 77. In that case the employer company was required to take into account dividend received from shares by it while distributing profit bonus to its workmen. The employer company transferred all those shares to a wholly owned subsidiary having no other source of income or business. Hon'ble Supreme Court held that dividend received by subsidiary was required to be taken into account for the purpose of working out profit bonus payable to workmen. Reliance was placed on the judgment in the case of Sri Meenakshi Mills Ltd. (supra) and McDowell & Co. Ltd. (supra). Reference was made to Ramsay triology of English cases and some other English judgments. In the case of Neroth Oil Mills Co. Ltd. v. CIT [1987] 166 ITR 418 1 Hon'ble Kerala High Court considered....
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....h Court closely examined Ramsay triology decisions to find out what kind of cases would be hit by rule against device of tax avoidance. Hon'ble High Court observed : "This decision clearly shows that when courts adopted the approach of looking upon with disfavour the schemes intended at tax avoidance, such an approach did not rule out the permissibility of mitigating the tax burden. What is the nature of such tax avoidance which will attract the progressive approach of the courts made in Burmah Oil Co. Ltd.'s case [1981] 54 TC 200 and Ramsay's case [1981] 2 WLR 449 (HL) is highlighted in the last paragraph quoted above, when Lord Templeman pointed out that avoidance of tax takes place and tax advantage is derived from an arrangement in which the income of the taxpayer is not reduced nor does he suffer a loss nor incurs any expenditure but yet he obtains a reduction in his tax liability. As observed by Lord Templeman, 'the taxpayer engaged in tax avoidance does not reduce his income or suffer a loss or incur expenditure but nevertheless obtains a reduction in his liability to tax as if he had. This, in our view, is the crux of the new approach adopted by the English Courts ....
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....ited company. In the case of CIT v. S. Kannan [1994] 210 ITR 585 1, Hon'ble Karnataka High Court quoted at length from the judgment of Chinnappa Reddy J. in the case of McDowell & Co. Ltd. (supra) and applied the same to the facts of the case. Hon'ble Court further held that the observation in the case of Arvind Narottam (supra ) that unless waste and ostentation in government spending are avoided no amount of moral sermons would change people's attitude to tax avoidance represented a view point, which did not and could not affect the ratio of the decision of Supreme Court in the case of McDowell & Co. Ltd. (supra). 126. In the case of Banyan & Berry v. CIT [1996] 222 ITR 831 2 (Guj.) the Tribunal concluded that the dissolution of the firm was nothing but a device to avoid tax. The firm was dissolved by a deed but in essence it was a device to avoid tax because there was no purpose in dissolving the firm. The reliance was placed on Supreme Court judgment in the case of McDowell & Co. Ltd. v. CTO [1985] 154 ITR 1483 . Hon'ble Gujarat High Court explained the judgment of the Hon'ble Supreme Court in the case of McDowell & Co. Ltd. (supra) as laying down the rule against coloura....
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....erial or evidence is essentially one of fact." 127. In the case of Twinstar Holdings Ltd. v. Anand Kedia, Dy. CIT [2003] 260 ITR 62 (Bom.), the petitioner company incorporated in Mauritius acquired shares in three investment companies in India, who in turn held shares in two Indian companies, viz., Sterlite Industries (India) Ltd. and Madras Alluminium Ltd. Subsequently the three investment companies went into liquidation and approval of Reserve Bank of India was obtained for transmission of shares in Indian companies on fully repatriable basis. As a result of search in the case of three investment companies, block assessment orders were made. Prohibitory notices were issued against receiving/delivering shares of three investment companies to any persons whosoever. On assessee's writ petition the Hon'ble Bombay High Court held that the entire device had been implemented with a view to evade tax. Hon'ble Bombay High Court referred to the judgment in the case of McDowell & Co. Ltd. (supra) in the following words :- "In conclusion, we may refer to the judgment of the Supreme Court in the case of McDowell & Co. Ltd. v. CTO [1985] 154 ITR 148 , in which it has been held that....
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....ourt in the case of Azadi Bachao Andolan (supra) are, thus, intended at explaining and not overruling the earlier judgment of the court in the case of McDowell & Co. Ltd. (supra). The Hon'ble Judges have, at the same time found that observations of Chinnappa Reddy, J. in relation to the Westminster principle and judg- ment of J.C. Shah J. in A. Raman & Co. (supra) as not constituting ratio decidendi of McDowell & Co. Ltd.'s case (supra). They found such observations militating against the observations of majority of the judges in McDowell & Co. Ltd.'s case (supra) : "Speaking for the majority, Ranganath Mishra, J. (As he then was) said : 'Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable 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.'" [Emphasis supplied] This opinion of the majority is a far cry from the extreme view of Chinnappa Reddy J. Apparently there is no quarrel in the judgment in the ca....
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....transactions is to be regarded as a whole. In ascertaining the true legal effect of the series it is relevant to take into account, if it be the case, that all the steps in it were contractually agreed in advance or had been determined on in advance by a guiding will which was in a position, for all practical purposes, to secure that all of them were carried through to completion. It is also relevant to take into account, if it be the case, that one or more of the steps was introduced into the series with no business purpose other than the avoidance of tax. The principle does not involve, in my opinion, that it is part of the judicial function to treat as nugatory any step whatever which a taxpayer may take with a view to the avoidance or mitigation of tax. It remains true in general that the taxpayer, where he is in a position to carry through a transaction in two alternative ways, one of which will result in liability to tax and the other of which will not, is at liberty to choose the latter. . . ." Hon'ble judges in Azadi Bachao Andolan's case (supra) thereafter note that in the case of Macniven (supra) Lord Hoffman referred to W.T. Ramsay Ltd.'s case (supra) and the Duke ....
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.... to have drawn from the enunciation made in McDowell's case [1958] 154 ITR 148 (SC). The ratio of any decision has to be understood in the context it has been made. The facts and circumstances which lead to McDowell's decision leave us in no doubt that the principle enunciated in the above case has not affected the freedom of the citizen to act in a manner according to his requirements, his wishes in the manner of doing any trade, activity or planning his affairs with circumspection, within the framework of law, unless the same fall in the category of colourable device which may properly be called a device or a dubious method or a subterfuge clothed with apparent dignity." Hon'ble Judges in Azadi Bachao Andolan's case (supra) have put their seal of approval on the above quoted passage from Banyan & Berry's case (supra); "This accords with our own view of the matter." Finally at page 762 the Hon'ble judges in Azadi Bachao Andolan's case (supra) observed, "If the court finds that notwithstanding a series of legal steps taken by an assessee, the intended legal result has not been achieved, the court might be justified in overlooking the intermediate steps, but it would not....
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....s recent judgment of Hon'ble Supreme Court having considerable bearing on the questions being considered by us. In the case of CCE v. Modi Alkalies & Chemicals Ltd. [2004] 7 SCC 569, there were three companies, viz., M/s. Mahabaleshwar Gas & Chemicals (P.) Ltd.; Sri Chamundi Gas & Chemicals (P.) Ltd. and M/s. Nippon Gas & Chemicals (P.) Ltd. that were alleged by the Central Excise autorities to be in realty front companies of Modi Alkalies & Chemicals Ltd. CEGAT relied upon the fact that there were separate registration of these three companies, including under the Central Excise, Sales-tax and Income-tax. Besides these three companies had separate corporate existence. CEGAT, therefore, allowed the appeal of Modi Alkalies & Chemicals Ltd. against clubbing with the other units. Hon'ble Supreme Court found that these three companies had share capital of Rs. 200 each. It was Modi Alkalies & Chemicals Ltd. who advanced heavy amounts to these three companies and also obtained for them financial assistance from other financiers. The assessee obtained cylinders on lease and sub-let them to these three companies. It also sold hydrogen gas to these three companies @ Rs. 0.50 per unit while ....
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....rted to by a taxpayer to reduce his tax liability that can be disregarded irrespective of the legitimacy or genuineness of the act. But if a transaction falls in the category of colourable device or a dubious method or a subterfuge, in such cases McDowell rule can be applied with full justification, as held in the judgments in the cases of M.V. Valliappan (supra), Banyan & Berry (supra) and Azadi Bachao Andolan (supra). 135. During the course of hearing before us the revenue has sought to contest the assessee's claims of loss on both counts of the substance of the transaction as well as colourable device or dubious method or subterfuge. Considerable arguments have been made in the orders of the authorities below as well as during the course of hearing by us that in substance the loss incurred by the assessee represented a self-inflicted loss suffered by the assessee for earning income exempt under section 10(33). It is, therefore, argued that to that extent part of the purchase price of mutual fund units should be attributed to income from units and not to units themselves. The assessee purchased Chola Mutual Fund units on the record date i.e., 24-3-2000. On that very date there....
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....ts should be split and adjusted against both the redemption price of mutual fund units as well as the income payments received from the mutual funds. The learned CIT, DR, on the other hand, invokes the rule against tax avoidance. According to him, both mutual funds and the assessee in complicity with each other devised a novel method to rob revenue of its fair share of taxes. He called the transaction a colourable device or dubious method or subterfuge. 136. The learned counsel for the assessee has vehemently opposed these contentions. In law these contentions of the revenue, according to the learned counsel for the assessee, are untenable in view of the ratio of Hon'ble Supreme Court judgment in the case of Azadi Bachao Andolan (supra). On facts the learned counsel disputes the premise that the transactions were pre-ordained or pre-determined. The assessee purchased units of an equity mutual fund. Such units are susceptible to fluctuations in the stock market. According to him, there was no certainty that loss would be suffered. In the transactions of this nature, there could be a profit, there could be a loss less than dividend and there could be loss equal or more than the am....
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....hat these Mutual Funds consulted the assessee before doing so. It is not shown also that while doing so these two mutual funds violated any regulation. They operated under the regulatory control of SEBI. Income distributed by them was exempt under section 10(33) by a legislation of Parliament. No instance of any action having been taken against these Mutual Funds by SEBI has been brought on record. Exemption under the provisions of section 10(33) to the income distributed by these Mutual Funds has continued all these years with the modification from and after assessment year 2002-03 in relation to minimum holding period only. During the course of hearing before us the learned counsel for the assessee argued that these Mutual Funds simply acted in the manner the mutual funds do their business. There is no material to hold a contrary view. 138. Above all, we find the provisions of section 94(7) do not lend much support to the contentions of the revenue before us, if not contradict them. According to the arguments of the learned special counsel for revenue, it is significant that both the provisions of section 14A and section 94(7) were introduced by the same Finance Act, 2001. Whi....
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....provisions of section 14A take charge and they do not do so after 1-4-2002 on account of the provisions of section 94(7) having become effective. It was argued that provisions of section 94(7) in fact mitigate the rigors of section 14A. We do not find any such thing in section 94(7). 139. In our opinion, it cannot be assumed that once Mutual Fund units are held for the prescribed period, the fall in NAV on account of income pay-out would be neutralized. If, as argued by the learned special counsel before us, there is surge of inflow of money from the dividend-strippers, so much so the size of the mutual fund would on record date swell to many times the size of the original fund lying invested in equity there is no way the ex-dividend NAV returning to NAV on record date till such time a sizeable portion of the new or old money exit the mutual fund after taking a hit on account of ex-dividend NAV. In other words, the provisions of section 94(7) do not block dividend strippers. It only make them squat for a longer period. It, therefore, appears to us that provisions of section 94(7) are geared towards quick-in-quick-out aspect and not against claim of loss against the other income ....
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....f states that prior to the promulgation of the provisions of section 94(7) it was legally permissible to claim the losses in the manner the assessee before us has done. 141. During the course of hearing before us reference has been made to the Instruction issued by CBDT from F. No. 178/32/2003-ITA 1 on 23rd February, 2004. This Instruction reads as under :- "The Finance Act, 2001 introduced inter alia sub-section (7) of section 94 of the Income-tax Act, w.e.f. 1-4-2002 to curb tax avoidance through dividend stripping. The sub-section provides, inter alia, that if securities or units of a Mutual Fund are purchased within a period of three months prior to the record date, and are sold within three months after that date, the loss, if any, arising will be ignored to the extent of the exempt dividends received. It has been brought to the notice of the Board that some Assessing Officers are disallowing losses arising from purchase and sale of securities or units in similar circumstances, even in respect of assessment years prior to assessment year 2002-03 [when section 94(7) came into effect], on the ground that the relevant transactions have been entered into for the pur....