Clause 175 Avoidance of tax by certain transactions in securities.

Income Tax Bill, 2025

Introduction

Clause 175 of the Income Tax Bill, 2025, and Section 94 of the Income-tax Act, 1961, are pivotal anti-avoidance provisions targeting tax benefits derived from certain transactions in securities. Both provisions seek to counteract tax avoidance schemes, particularly those involving the transfer, reacquisition, or similar dealings in securities that result in the shifting or deferral of taxable income, or the artificial creation of tax losses. These provisions are crucial in preserving the integrity of the tax base, especially in the context of sophisticated financial markets where taxpayers may structure transactions to exploit timing mismatches, exemptions, or loopholes. While Clause 175 is a proposed re-enactment and modernization in the Income Tax Bill, 2025, Section 94 has been operative since the inception of the 1961 Act, undergoing various amendments to address evolving tax planning strategies. This commentary provides an in-depth analysis of Clause 175, its objectives, detailed provisions, practical implications, and a comparative analysis with Section 94, highlighting continuities, departures, and potential issues.

Objective and Purpose

The primary objective of both Clause 175 and Section 94 is to prevent the avoidance of tax through certain transactions in securities that, in substance, do not alter the economic ownership or beneficial enjoyment of income but are structured to obtain tax advantages. The legislative intent is to ensure that income from securities (including dividends and interest) is taxed in the hands of the true economic owner, and that artificial losses or deferrals arising from short-term transfers or "dividend stripping"/ "bonus stripping" are disregarded for tax purposes. Historically, these provisions were introduced to counteract strategies such as: - Transferring securities shortly before the record date to a person in a lower tax bracket or exempt entity, who receives tax-free income (dividend/interest), and then transferring them back, thus avoiding tax on income that would otherwise accrue to the original owner. - Creating artificial losses through purchase and sale of securities or units around record dates, especially when the income is exempt, to set off against other taxable income. The provisions aim to ensure that tax liability aligns with economic reality and to safeguard the revenue against sophisticated tax avoidance devices.

Detailed Analysis of Clause 175 of the Income Tax Bill, 2025

Clause 175 is structured into eleven sub-sections, each addressing different facets of avoidance through securities transactions. A clause-wise analysis is provided below:

Sub-section (1): Deeming Provision for Income from Securities

Clause 175(1) provides that if the owner of securities sells or transfers them and subsequently buys back or acquires similar securities, any interest (including dividend) that becomes payable in respect of such securities and is received by someone other than the owner, shall, for all purposes of the Act, be deemed to be the income of the owner and not the recipient. This applies irrespective of whether such income would otherwise be chargeable to tax. The core principle is to look through the legal form to the substance: where the economic benefit of the income remains with the owner, tax shall be levied on the owner, not the nominal recipient.

Sub-section (2): Limitation of Liability in Case of Similar Securities

Where the owner acquires similar (not identical) securities, the provision ensures that the owner is not subjected to a greater tax liability than if the original securities had been reacquired. This prevents overreach and maintains fairness, recognizing that similar securities may have different market values or terms.

Sub-section (3): Deeming Income for Beneficial Interest Holders

Clause 175(3) targets cases where a person had a beneficial interest in securities at any time during a tax year, and as a result of transactions, receives no income or less than what would have accrued if income had been apportioned on a daily basis. In such cases, the income from those securities for the year is deemed to be the income of that person. This anti-avoidance rule prevents timing-based avoidance, ensuring that the economic owner cannot escape tax merely by holding securities for a period that excludes the income accrual date.

Sub-section (4): Exceptions - Burden of Proof on Taxpayer

The deeming provisions in Clause 175(1) to (3) do not apply if the taxpayer proves to the Assessing Officer that: - There was no avoidance of income-tax; or - The avoidance was exceptional and not systematic, and no similar avoidance occurred in the preceding three years. This introduces a safeguard for genuine transactions, shifting the onus onto the taxpayer to demonstrate the bona fides of the transaction.

Sub-section (5): Non-Recognition of Certain Business Transactions

For persons dealing in securities as a business, if interest received is not deemed to be their income due to sub-section (1), no account is to be taken of such transactions in computing business profits or losses for tax purposes. This prevents the double benefit of both escaping tax on income and recognizing losses.

Sub-section (6): Extension to Similar Securities

This extends Sub Clause (5) to cases where similar securities are sold or transferred, not just identical ones, ensuring comprehensive coverage.

Sub-section (7): Power to Call for Information

Empowers the Assessing Officer to require any person to furnish details of securities owned or in which the person had a beneficial interest during a specified period, with a minimum notice period of 28 days. This facilitates effective administration and enforcement.

Sub-section (8): Disallowance of Losses - Dividend Stripping

If a person acquires securities or units within three months before the record date and sells them within three months (securities) or nine months (units) after the record date, and the dividend/income is exempt, any loss on such transactions (to the extent it does not exceed the exempt income) is ignored for tax computation. This targets "dividend stripping" - buying securities to receive tax-free dividends and selling at a loss to claim a tax deduction.

Sub-section (9): Disallowance of Losses - Bonus Stripping

If a person acquires securities/units within three months before the record date, is allotted additional securities/units without payment (bonus), and sells the original securities/units within nine months while retaining the bonus, any loss on such sale is ignored for tax purposes. This targets "bonus stripping" - buying securities to obtain bonus allotment, selling the original at a loss, and retaining the bonus units, thereby creating an artificial loss.

Sub-section (10): Cost Adjustment for Disallowed Losses

Any loss ignored under sub Clause (9) is deemed to be the cost of acquisition of the additional securities/units retained, overriding other provisions. This ensures that the disallowed loss is not permanently lost but is deferred until the sale of the bonus units.

Sub-section (11): Definitions

Defines key terms:

- "Interest" includes dividend.

- "Record date" is as fixed by the company, mutual fund, business trust, or AIF.

- "Securities" includes stocks and shares.

- "Similar securities" are those with identical rights, regardless of nominal value or form.

- "Unit" includes units of business trusts, specified funds, and AIFs, and includes shares or partnership interests.

Practical Implications

The practical effect of Clause 175 is significant for various stakeholders:

• Investors
  • Individuals and entities must be cautious in structuring transactions in securities around record dates, as artificial losses or shifting of income will be disregarded.
  • Taxpayers must maintain documentation to prove the bona fides of transactions if challenged.
• Businesses/Dealers in Securities: Dealers cannot claim tax benefits arising from such transactions both in terms of income and business profits/losses.
• Assessing Officers: Given the power to call for detailed information, tax authorities are better equipped to detect and counteract avoidance schemes.
• Mutual Funds, Business Trusts, AIFs: As vehicles often used in such strategies, these entities must ensure compliance and educate investors regarding the tax implications.

Procedurally, the provision requires vigilance in tax reporting, increased documentation, and may lead to more scrutiny of transactions near record dates.

Comparative Analysis: Clause 175 vs. Section 94

A close comparison of Clause 175 and Section 94 reveals that Clause 175 is essentially a re-enactment, with minor modifications and language modernization, of Section 94. The structure, definitions, and anti-avoidance mechanisms are largely retained, but certain clarifications and expansions are evident.

Structural and Substantive Similarities

• Core Anti-Avoidance Mechanisms: Both provisions establish a regime for deeming income from securities to the true owner or beneficial owner where transactions are structured to shift income for tax advantage.
• Dividend and Bonus Stripping: The rules for disregarding losses arising from dividend stripping and bonus stripping are present in both, with similar thresholds for acquisition and sale around the record date.
• Exceptions for Genuine Transactions: Both allow the taxpayer to demonstrate the absence of tax avoidance or that any avoidance was not systematic, providing relief for bona fide transactions.
• Definitions: The definitions of "interest," "record date," "securities," "similar securities," and "unit" are substantially aligned, reflecting legislative continuity and adaptation to regulatory changes (e.g., SEBI regulations).

Key Differences and Evolution

• Language and Modernization: Clause 175 uses more contemporary language and structure, reflecting legislative drafting trends and the evolution of the securities market, including references to new types of investment vehicles (e.g., Alternative Investment Funds).
• Explicit Inclusion of Similar Securities: While Section 94 includes an explanation for similar securities, Clause 175 integrates this concept more directly into the operative provisions, reducing ambiguity.
• Scope of Application: The expanded definitions and references in Clause 175 ensure the provision applies to a broader range of investment products and market participants, including modern collective investment vehicles.
• Procedural Clarity: Clause 175(7) sets a clear minimum period for the notice to furnish information, enhancing procedural fairness.
• Cost of Acquisition Rule: Clause 175 separates the deemed cost of acquisition for bonus units into a distinct sub-section (10), whereas Section 94 combines it within sub-section (8).

Ambiguities and Potential Issues in Interpretation

Despite the clarity of the drafting, certain issues may arise:

• Definition of "similar securities": While the provision defines similar securities as those with identical rights, practical determination may be complex, especially with hybrid instruments or complex financial products.
• Proof of bona fide transactions: The burden on the taxpayer to prove absence of avoidance can be onerous, especially where transactions are part of regular portfolio management.
• Overlap with General Anti-Avoidance Rule (GAAR): The specific anti-avoidance rule in Clause 175 may overlap with the general anti-avoidance provisions, leading to potential double exposure or interpretational conflicts.
• Application to new financial products: As financial innovation continues, the provision may need further updates to address new forms of securities or derivatives.

Comparative Perspective: International and Indian Context

Similar anti-avoidance provisions exist in other jurisdictions, notably the UK's rules on "bed and breakfasting" and the US "wash sale" rules. The Indian approach is broad, covering both interest and dividend stripping, and applies to a wide range of securities and units, including those of mutual funds, business trusts, and AIFs. The integration of bonus stripping rules and the adjustment of cost basis aligns with international best practices.

Practical Compliance and Procedural Impact

The provisions require taxpayers to:

• Maintain detailed records of securities transactions, especially around record dates.
• Disclose information as required by the Assessing Officer.
• Ensure that tax positions on losses and income from securities comply with the anti-avoidance rules.
• Seek professional advice in structuring transactions involving securities, particularly for large or institutional investors.

Non-compliance or aggressive tax positions may result in litigation, denial of losses, or reassessment of income.

Conclusion

Clause 175 of the Income Tax Bill, 2025, represents a comprehensive and modernized anti-avoidance provision, closely modeled on Section 94 of the Income-tax Act, 1961. While the substantive mechanism remains unchanged, the clarity, expanded definitions, and alignment with contemporary financial instruments reflect legislative responsiveness to evolving tax planning strategies. The provision balances the need to counteract tax avoidance with safeguards for genuine transactions, placing the burden of proof on the taxpayer but allowing exceptions for bona fide cases. Its practical impact will be significant for investors, businesses, and tax authorities, necessitating careful compliance and ongoing vigilance. As financial markets evolve, continued monitoring and potential refinement of the provision may be necessary to address new avoidance schemes and ensure alignment with global best practices.

Full Text:

Clause 175 Avoidance of tax by certain transactions in securities.