The Telangana High Court, in its landmark ruling upheld the General Anti-Avoidance Rules ( GAAR ) action on Bonus stripping transactions on shares by the revenue. The court has dismissed a writ petition filed by a taxpayer seeking a mandamus to declare the initiation of GAAR proceedings under section 144BA of the Income-tax Act, 1961, as lacking jurisdiction.
The bench of Justices P Sam Koshy and Laxmi Narayana Alisetty observed that “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.”
The Petitioner, Ayodhya Rami Reddy Alla filed the writ petition seeking issuance of writ of mandamus declaring the initiation and continuation of proceedings by the respondent No.1/Principal Commissioner of Income Tax for the assessment year 2019-2020, under Section 144BA of the Income Tax Act and all consequent proceedings thereto as illegal, arbitrary, ultra vires the Income Tax Act, lacking in subject jurisdiction and to set aside the same and further direct the respondents not to take any coercive steps or action against the petitioner.
The court heard Mr. S. Ganesh, Senior Counsel for the petitioner, and Mr. N. Venkataraman, Additional Solicitor General of India, for the respondent department.
The issue concerns the issuance of bonus shares to Ramky Estate and Farms Limited (REFL). The petitioner sold REFL shares to Advisory Services Pvt. Ltd (ADR). Before this sale, REFL issued bonus shares at a 5:1 ratio, reducing the face value of each share to 1/6th. This sale resulted in a short-term capital loss for the petitioner.
The petitioner set off this short-term capital loss against long-term gains from the sale of shares in Ramky Enviro Engineers Limited (REEL). For the assessment year 2019-2020, the petitioner reported income under ‘Capital Gains’ from the REEL share sale, adjusted for the REFL share sale loss, and paid the required income tax.
According to the Senior Counsel for the petitioner, the transactions were covered by Section 94(8) of the Income Tax Act, meant to prevent tax avoidance. However, during the assessment for 2019-2020, respondent No.2 treated these transactions as impermissible avoidance arrangements under the General Anti-Avoidance Rules (GAAR) in Chapter X-A of the Act. A reference notice under Rule 10UB(1) was issued on 02.08.2022, calling for objections from the petitioner.
The Senior Counsel contended that Chapter X-A, containing GAAR, provides general provisions for identifying and taxing avoidance arrangements. Since the transactions fall under Chapter X (SAAR), GAAR should not apply. The issuance of the notice under Section 144BA invoking Chapter X-A was, therefore, legally erroneous.
According to the Senior Counsel for the petitioner, Section 94(8) is designed to curb tax avoidance related to bonus stripping of mutual fund units, not shares or securities. The counsel argued that the Parliament did not intend to include shares within the scope of this section.
The petitioner contended that the transactions involved the subscription and sale of shares, not mutual fund units, and thus Section 94(8) does not apply. As a result, the petitioner claimed the right to set off short-term capital loss from the sale of shares against long-term capital gains. The respondent’s application of GAAR provisions under Section 96, instead of the specific provisions of Section 94(8), was argued to be an improper expansion of the scope of the law.
The petitioner also referenced guidelines from the 2012 Shom Committee on GAAR, which recommended that GAAR should not be invoked when SAAR applies. This recommendation was largely accepted by the government, implying that Chapter X (SAAR) provisions exclude the applicability of Chapter X-A (GAAR).
The Additional Solicitor General (ASG) of India, representing the respondent-Department, argued that the writ petition challenging the show cause notice is not maintainable as writ jurisdiction should not be used to challenge such notices unless there is a patent illegality on jurisdictional grounds. The petitioner should appear before the authorities and raise their objections, which will be duly considered.
The ASG highlighted suspicious financial manoeuvres by the petitioner, including:
It is in this context that the ASG appearing for the respondent-Department submitted that in the given factual backdrop, the proceedings had to be initiated under Chapter X-A of the Act.
The Court observed that SAAR under Chapter X of the Act, which the taxpayer relied on, existed before the GAAR provisions were inserted under Chapter X-A. Historically, courts, including the Supreme Court of India, have held that when a special provision of law is enacted, general provisions of the Act cannot be invoked. However, this principle cannot be applied here, as GAAR was enacted after the specific provisions. Notably, Chapter X-A of the Act begins with a non-obstante clause, giving it an overriding effect over all other provisions of the Act.
Further stated that the taxpayer argued that SAAR, as per Section 94(8) of the Act, should take precedence over GAAR. However, this argument was deemed fundamentally flawed and lacking merit, as the taxpayer also contended that Section 94(8) does not apply to the case’s facts, since the transaction involved shares, not units as required by the said section.
The taxpayer’s reliance on the Shome committee report was found to be misplaced. The committee’s stance that SAAR should generally supersede GAAR pertains to international agreements, not domestic cases, as confirmed by the Finance Minister. The Finance Bill, 2013, incorporated only some of the expert committee recommendations and clarified that both GAAR and SAAR could be applied on a case-by-case basis, noted the bench.
The High Court stated that “Section 144AB outlines the procedure for applying the rules in Chapter X-A. This section ensures that transactions are thoroughly evaluated at multiple levels and from various perspectives before determining any connected outcomes. This involves a comprehensive examination of all the elements of the transaction, upholding the principles of fairness at each step. It ensures that the process is thorough, fair, and just. However, the Petitioner has chosen to seek this court’s intervention instead of following the process set out under Section 144AB. This circumvention of the process raises questions about the Petitioner’s motives.”
The bench noted that the The current arrangement is being scrutinised as it is considered
devoid of commercial substance as per Section 97. It is perceived as a deliberate misuse of the Act’s provisions, going beyond the intended use of the law, and manipulating it to one’s advantage. This manipulation violates fair dealing principles, making it an impermissible avoidance agreement under Section 96. As a result, the arrangement falls under Chapter X-A, prompting the application of its rules and regulations.
The Vodafone judgment highlights that business intent can indicate a transaction isn’t deceptive, placing the burden on Revenue to prove fiscal misconduct. However, Section 96(2) shifts this burden to the taxpayer, who must disprove the presumption of tax avoidance. In this case, clear evidence shows the arrangement was designed to evade tax, and the Petitioner failed to provide convincing proof to counter this claim, noted the bench.
The Telangana High Court has affirmed that the Revenue has convincingly demonstrated that the transactions in question do not qualify as permissible tax avoidance arrangements under the law.
Accordingly, the writ petitions were dismissed citing lack of merits as they failed to substantiate their case regarding the application of Chapter X-A to the facts of this case. The respondents are allowed to proceed further with the process under Section 144AB.
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