TaxTMI 
TaxTMI 
2008 (8) TMI 222
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....was a bona fide commercial transaction and not a colourable device adopted with a view to avoid the tax liability and, therefore, the loss arising from the transaction was liable to be set off against the taxable income of the assessee ? (ii) Whether, on the facts and in the circumstances of the case, the Tribunal was justified in holding that the artificial loss arising from the above transaction could not be considered as an expenditure incurred for earning tax free dividend, so as to make disallowance under section 14A of the Income-Tax Act, 1961 ?" 2. The appeal is admitted on the aforesaid questions and taken up for final hearing by consent of both the parties. 3. The assessment year involved herein is assessment Year 2001-01. 4. The assessee is a member of the Bombay Stock Exchange and earns income from brokerage and also from trading in shares of various companies on its own account or on behalf of its clients. 5. In the assessment year in question, apart from the normal business of trading in shares, the assessee had also entered into a transaction of purchasing dividend bearing units of Chola Freedom Technology Fund ("Mutual Fund" for short) and redeeming th....
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....volved in the transaction. The assessing officer held that the transaction being primarily for the purpose of tax avoidance, the artificial loss created by predesigned, preordained set of transactions cannot be taken cognizance of. Accordingly, the Assessing Officer deducted the incentive income of Rs. 23,76,778 received by the assessee from the loss of Rs.2,09,44,793 and added back the balance amount of Rs.1,85,68,015 to the trading income of the assessee. 9. Challenging the disallowance of the loss of Rs.1,85,68,015 the assessee filed an appeal before Commissioner of Income-tax (Appeals), who by his order dated 12-12-2003, dismissed the appeal by following his decision in the case of the assessee for the assessement year 2001-02. The Commissioner of Income-tax (Appeals) held that the loss of Rs.1,85,68,015 incurred on sale of units should be ignored totally and the same should not be allowed to be set off or carried forward. 10. On further appeal filed by the assessee, the matter was referred to a Special Bench and the Special Bench of Income-tax Appellate Tribunal by the impugned judgment and order dated 15/7/2005 deleted the disallowance by holding that the loss claimed b....
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....ly to earn loss, the transaction cannot be termed as business transaction or adventure in the nature of trade. He submitted that the price of the cum dividend units invariably fall after the dividend is distributed. Therefore, where the cum dividend units are purchased and sold immediately after the dividend is distributed, it would be crystal clear that such a transaction is entered into only for creating artificial loss. Where, substance of the transaction is to create artificial loss and by setting off the said loss avoid payment of tax, then, such a transaction cannot be said to be a business transaction. In this connection he relied upon a decision of the Gujarat High Court in the case of Commissioner of Income-Tax v. Smt. Minal Rameshchandra reported in [1987] 167 ITR 507 and two decisions of the apex court in the case of Senairam Doongarmall v. Commissioner of Income- Tax, reported in [1961] 42 ITR 392, Sole Trustee, Loka Shikshana Trust v. Commissioner of Income-Tax, [1975] 101 ITR 234 (SC). 14. Mr.Srivastav further submitted that the transaction in question is a colourable device designed to create artificial loss and thereby evade payment of tax due to the Revenue is a....
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....e assessee by way of dividend/incentive income. In other words, the loss incurred in the transaction in question was an artificial loss, because, in reality the amount invested in the units was virtually returned to the assessee by way of dividend income plus incentive income plus the sale consideration. Thus, in the transaction in question, the loss was only on paper and such an artificial loss cannot be allowed to be set off against the other taxable income of the assessee. 16. Mr.Srivastav further submitted that in the present case, the assessee had invested Rs. 8,00,00,000/ on 24/3/2000. The next two days, namely, 25-3-2000 and 26-3-2000 being Saturday and Sunday the capital markets were closed. On 27/3/2000, the assessee sold the entire units to the Chola Mutual Fund for Rs. 5,90,55,207 after receiving dividend income of Rs. 1,82,12,862.80 and incentive amount of Rs. 23,76,778. Thus, in this transaction which virtually lasted for a day, the assessee has invested Rs. 8,00,00,000 and has in fact received back Rs. 7,96,44,847.80 (Rs. 5,90,55,207 + Rs. 1,82,862.80 + Rs. 23,76,778) and at the same time claims to have incurred loss of Rs. 2,09,44,793 on sale of units (Rs. 8,00,00....
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....to collect funds from the subscriber and to return the same in a day or two in different form. The mutual funds are supposed to invest the funds received from the investors in securities so as to protect their long-term interest and save them from volatility of the stock market. Neither the assessee had money for investment nor the mutual fund had the income or the necessary reserves to pay such huge amount of dividend. The assessee borrowed money from the overdraft account to make the investment and the mutual fund virtually returned the entire investment amount in the form of dividend, incentive and redemption price. Both the mutual fund and the assessee were the gainers in the transaction - the assessee by saving tax on accumulated profits of the year from other transactions and the mutual fund by getting some part of the fee by way of entry load and exit load. The assessee knew before hand that the transaction would result in loss and, therefore, in a preordained transaction which lacked any business or commercial purpose, the artificial loss, if any, cannot be allowed to be set off. Thus, it is evident that the assessee had subscribed to the tax avoidance scheme floated by the....
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....ree dividend income, the substance of the transaction clearly established that for earning tax free dividend the assessee had to purchase units at a higher price and sell at a lower price and, therefore, the differential amount between the purchase price and sale price of the units constituted expenditure incurred by the assessee for earning the tax free dividend income. Such an expenditure incurred in relation to the tax free dividend income which is not includible in the total income of the assessee is liable to be disallowed under section 14A of the Act. He submitted that in any event, the difference between the closing NAV on the record date and the opening NAV on the next working day, i.e. 27th March, 2000, would have been the reasonable amount of expenditure attributable to the earning of dividend income and hence disallowable. He submitted that the Tribunal committed an error in declining to make any disallowance under section 14A of the Act. 22. Mr.Srivastav further submitted that in the present case actually the assessee has not suffered any loss in the commercial sense of the term, but artificial loss was claimed only to gain the tax advantage. In such a case, the arti....
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....ds brokerage at 2% against investment. An investor is not a broker in the transaction. The letter addressed by the broker on 25/4/2000, also indicates that the brokerage was paid not on the sale price of the units but on the original investment of Rs. 8 crores which is a clear evidence of the fact that the units were meant to be sold and that the incentive was not linked to either the purchase or the sale but was linked to the entirely make believe transaction. All these factors clearly establish that the transaction in question was not a genuine business transaction but a colourable device adopted by the Mutual Fund, broker and the taxpayers to evade payment of tax by creating artificial loss and setting off the same against the other taxable income of the taxpayers. 25. Mr.Srivastav further submitted that the fact that SEBI has not taken any action against Chola Mutual Fund for its complicity in the transaction, it does not mean the transaction is not colourable. He submitted that tax avoidance schemes do not break the law but they dodge the law. In the present case, the entire arrangement of purchase and sale was to create tax loss at a cost of less than ½ per cent. of the t....
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....th a view to earn 40% dividend which was more attractive than any other mutual fund. After purchasing the units on 24/3/2000, and after receiving the dividend income, on 27/3/2000, the assessee decided to sell the units, anticipating that the price of the units may drop gradually. The apprehension of the assessee has come true because in fact in the month of March-April, 2000, the unit price of Chola Mutual Fund fell gradually. Thus, in the present case, the decision to sell the units on 27/3/2000, was a wise commercial decision taken by the assessee. The fact that the assessee in its discretion sold the units shortly after the declaration of results, it cannot be inferred that the transaction of purchase and sale of the units of Chola Mutual Fund was a composite transaction. 28. Mr.Dastur further submitted that prior to the insertion of section 94(7) of the Act there was no provision under the Act to disallow the loss arising from the transaction in question. As the legislature has stepped in to curb this lacuna with effect from 1-4-2002, the loss incurred from the aforesaid transactions which took place prior to 1-4-2002, were liable to be allowed to set off against the taxabl....
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....purchase the unit can never be regarded as "expenditure incurred in relation to the dividend" as contemplated under section 14A of the Act. Similarly, sale of the units at a loss after receiving dividend has nothing to do with the purchase of the unit for earning dividend. Therefore, loss incurred on sale of the units cannot be considered as an expenditure incurred for earning the dividend. Consequently, making disallowance under section 14A of the Act does not arise at all. 33. Mr. Dastur submitted that the entire argument of the Revenue rests on the presumption that the incentive paid by the broker to the assessee is "equal" to the brokerage received by the broker and, therefore, this unnatural transaction cannot be considered as genuine business transaction. He submitted that there is no material on record to show what amount of brokerage was paid by the mutual fund to the broker. In any event there cannot be any linkage between the entry and exit load paid by the investor to the mutual fund and the brokerage paid by the mutual fund to the broker. In view of the finding of fact recorded by the Tribunal to the effect that the transactions between the assessee and the mutual fu....
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....unt invested in the units were virtually received back in a day or two in the form of dividend/incentive income and sale proceeds of the units and at the same time, the taxpayers were entitled to set off the loss arising on sale of the units against other taxable income earned by the tax payer during the year. As a result of the set off, other taxable income of the taxpayer became reduced and consequently, the tax liability was reduced. Thus, by executing the transaction in question, on the one hand the taxpayers virtually received back the amount invested in the transaction and on the other hand got the tax liability reduced on other taxable income by setting off the short-term loss arising from the transaction in question. 38. Section 94(7) has been introduced to curb creation of short-term losses by executing the transactions in question. The scope of section 94(7) can be demonstrated by the following illustration. Suppose the record date fixed by a mutual fund for entitlement of the unitholder to receive dividend income was 1/8/2002, and an assessee had purchased the units of a mutual fund worth Rs. 1,000 on 1/8/2002, and after receiving dividend income of Rs. 250 redeemed t....
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....mount at which the units were purchased. It is not in dispute that if the units purchased were held by the assessee for some time and thereafter sold, then the loss arising from the transaction could be set off against other taxable income of the assessee. As the units were sold immediately after receiving the dividend income it is contended by the Revenue that the only motive of the transaction was to earn loss and hence the loss is not allowable. 41. In such cases, since it was difficult to find out the motive of the transaction, the Legislature has inserted section 94(7) in Chapter X of the Act which deals with tax avoidance transactions. Section 94(7) provides that where the units are purchased and sold by a person within the time stipulated therein and the income on those units received or receivable by such person are exempt, then, while computing the taxable income of such person, the loss to the extent of income received or receivable on those units shall be ignored. Thus, by inserting section 94(7) the Legislature has made it clear that the loss arising from the transaction in question was liable to be set off against other taxable income, however, from assessment year ....
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....ale of securities including units of equity oriented mutual funds, is being carried on for the purposes of creating short-term losses. These losses are set off against other incomes and thus an unintended benefit flows to the taxpayer. This practice popularly known as dividend stripping is being widely used to reduce the tax which would have been otherwise payable by the taxpayers. It is proposed to insert a new sub-section (7) in the said section to provide that where any person buys or acquires securities or unit within a period of three months prior to the record date fixed for declaration of dividend or distribution of income in respect of the securities or unit, and sells or transfers the same within a period of three months after such record date, and the dividend or income received or receivable is exempt, then, the loss, if any, arising from such purchase or sale shall be ignored to the extent such loss does not exceed the amount of such dividend or income, in the computation of the income, chargeable to tax, of such person." 45. Moreover, the CBDT has issued a Circular No.14 of 2001 [2001] 252 ITR (St.) 65, 108, in this context, the relevant paras of which read as un....
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....transactions/sources stood decreased and consequently tax payable thereon also was reduced. Thus, the CBDT Circular No.14 of 2001, makes it abundantly clear that the loss arising from the transaction in question were liable to be set off against other taxable income of the assessee and since such set off resulted in revenue loss, section 94(7) has been inserted. It is well established in law and in fact the apex court in the case of CST v. Indra Industries [2001] 248 ITR 338 and this court in the case of Unit Trust of Inida v. P. K. Unny [2001] 249 ITR 612 have held that CBDT circulars are binding on the Revenue and it is not open to the Revenue to argue contrary to the CBDT Circulars. Therefore, in the light of the CBDT circular No.14 of 2001, it is not open to the Revenue to contend that prior to the insertion of section 94(7) the loss arising from the transaction in question could be disallowed on the ground that the transaction was not a business transaction and that the loss was artificial loss. 47. Strong reliance was placed by the counsel for the Revenue on the CBDT instructions dated 23/2/2004 which reads as under: "The Finance Act, 2001 introduced inter alia sub- sec....
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....t the loss was artificial loss and not actual loss. 49. Assuming that the motive of the transaction was relevant, the question to be considered is, whether the Revenue has established that in the present case, the motive of the transaction was to earn loss? The Tribunal has recorded a finding of fact that the transactions between the Mutual Fund and the assessee were at arm's length and that the Mutual Fund had not acted in any manner different from what it was doing in the ordinary course of business. Consistent stand taken by the assessee is that the units were purchased in view of the attractive 40 per cent. dividend declared by the Mutual Fund and that the units were sold immediately after receiving dividend income anticipating fall in the unit prices. The assessee has demonstrated that in fact the unit prices of the Mutual Fund continuously fell during the month of March/April, 2000, and that the commercial decision taken by the assessee to sell the units immediately after receiving the dividend income was a wise decision. In these circumstances, it cannot be said that the motive of the transaction was to earn loss and, therefore, the decision of the Tribunal to allow the l....
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....its were redeemed within the time stipulated therein. In these circumstances, merely because the assessee and also almost all the unit purchasers sought redemption of units immediately after receiving the dividend income, it cannot be inferred that there was complicity between the unit purchasers and the mutual fund. The inference sought to be drawn by the Revenue is based on conjectures and surmises and is not based on facts and hence the argument of the Revenue cannot be accepted. 52. It is strongly urged by the counsel for the Revenue that the mutual fund had no funds to distribute dividend at 40% and by manipulating the price of the units, the mutual fund has paid dividend out of the amount received from the unit purchasers. It is further contended that the fact that the mutual fund has virtually paid the entire amount of exit load as brokerage to the broker and the broker has virtually paid the brokerage amount to the assessee as "incentive" for purchase/sale of the units clearly shows that there was complicity between the mutual fund, taxpayers and the brokers. We do not agree. Neither the SEBI which is the regulatory authority for the mutual funds has found any irregulari....
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....the effect of reducing the tax burden of the assessee cannot be treated as illegitimate and ignored. In the present case, the assessee has demonstrated that the units were purchased for earning dividend income and that the sale of the units immediately after receiving the dividend was a commercial decision taken by the assessee. Even the majority decision in the case of Griffiths [1965] 58 ITR 328 (PC) supports the case of the assessee that the transaction in question was a trading transaction and in the absence of any allegation that it was a sham transaction, the assessee was entitled to claim set off of the loss irrespective of the fiscal impact. The minority view in Griffiths' case [1965] 58 ITR 328 (PC) which was followed in Finsbury Securities Ltd. [1966] 43 TC 591 (HL) and Lupton [1971] 47 TC 580 (HL) would make no difference, because, the facts in those cases are wholly distinguishable. The decision of the apex court in the case of CCE v. Modi Alkalies & Chemicals [2004] 171 ELT 155 is also distinguishable on facts because, in that case, the finding recorded was that both the entities were interdependent and there was common financial management. In the present case, admitt....