2025 (5) TMI 609 - AT - Income Tax

Denial of exemption of dividend income u/s.10(35) and claim of set off of short term capital loss - assessee s case before us that he is a regular investor in shares and mutual funds and he has made investment in J.M. Financial Asset Management Ltd. and has earned dividend income and the said units were sold for consideration which had resulted into premium capital loss - as argued AO has not invoked the provision of Section 94(7) HELD THAT - Loss incurred on account of issue of dividend has not been considered as non-genuine and the same shall be disallowed only when the record date falls within the period as stipulated u/s.94(7). This proposition has been upheld in the case of Walfort Share Stock Brokers (P) Ltd. 2010 (7) TMI 15 - SUPREME COURT Loss incurred cannot be held to be non-genuine merely because the dividend has been issued by J.M. Financial funds. It is not in dispute that the purchase / investment and sale had duly been recorded and reflected in the bank statement and as per the provision of Section 48 capital gain has to be computed by reducing the cost of acquisition and expenditure incurred on transfer from sale consideration. In absence of applicability of Section 94(7) such short term capital loss is otherwise allowable under the Act. CIT(A) that assessee has also invested in many other mutual funds during the year under consideration for instance assessee has incurred losses in India Bulls Blue Mutual fund and in Franklin India Smaller Company Fund Growth. He has also received dividend from these funds. As a matter of fact appellant has also invested in JM Arbitrage Advantage Fund floated by JM Financial and earned capital gain which has not been doubted by the AO. This shows that the investment in JM Financial Mutual Fund is not an isolated transaction. Nowhere the ld. AO has brought on record any SEBI enquiry in the case of J.M. Financial Asset Management Ltd. to support his finding given by him. His entire order is based on the premise of SEBI Circular which was general and not particularly applicable for J.M. Financial Asset Management Ltd. Nowhere there is any material that assessee was involved in manipulation done by J.M. Financial Asset Management Ltd. CIT (A) has also considered various statements of employees of J.M. Financial Asset Management Ltd. which has been relied upon by the ld. AO however none of the employees were admitted that any manipulation has been done for the purpose of providing tax benefit to the asset in other investors. There is no whisper that J.M. Financial Management Ltd. have provided excess dividend to the assessee nor provided tax benefit. There is no live link nexus between the statement and the assessee. Thus ld. CIT (A) has rightly held that there is no substance in relying upon such statement. There is no SEBI enquiry raised on J.M. Financial Management Ltd. It is a matter of fact that the said fund is still active in the market and has given early return of 11.51% against the benchmark return of 11.33% as reflected in the annual report of J.M. Financial Management Ltd. for A.Y.2014-15. Thus when assessee has made investment in open-ended scheme floated by the Mutual Fund and assessee has made investment as per the price available in the open market and has exited at the time based on market price then it cannot be said that assessee was involved in alleged pre-planned transaction. Thus the finding of the CIT (A) in deleting the disallowance / addition made by the ld. AO is upheld. Otherwise also on the facts as discussed in the impugned orders we do not find that there any sham transaction involved between assessee and J.M. Financial Asset Management Ltd. to hold that dividend income is fictitious or the short term capital loss is also fictitious. Accordingly the claim of the assessee is allowed and the appeal of the Revenue is dismissed.

Summary

The core legal questions considered by the Tribunal in this appeal are:

1. Whether the dividend income of Rs. 1,83,65,846/- claimed as exempt under section 10(35) of the Income Tax Act, 1961, and the set off of short-term capital loss of Rs. 1,99,36,352/- against capital gains can be disallowed on the ground that the transactions were sham and involved colorable devices.

2. Whether the dividend received from the mutual fund represents genuine income or is a return of capital generated through manipulative accounting practices by the mutual fund, thereby disqualifying it from exemption under section 10(35).

3. Whether the survey conducted under section 133A of the Income Tax Act, 1961, revealing alleged manipulation of distributable surplus by the mutual fund, and the SEBI circular prohibiting distribution of dividends from Unit Premium Reserve, justify denial of exemption and disallowance of capital loss claimed by the assessee.

4. Whether the statements of persons managing the mutual fund admitting non-compliance with SEBI guidelines implicate the assessee in any wrongdoing or justify denial of exemption and set off claims.

Issue-wise Detailed Analysis:

1. Legitimacy of Dividend Income and Capital Loss Claimed

Relevant Legal Framework and Precedents: Section 10(35) of the Income Tax Act exempts dividend income received from equity-oriented mutual funds. Section 94(7) restricts set off of capital losses arising from purchase and sale of securities or units within specified periods around the record date when dividend income is exempt. The Supreme Court ruling in Walfort Share & Stock Brokers (P) Ltd. clarifies that losses incurred on sale of units yielding exempt dividend cannot be disallowed unless conditions under section 94(7) are met. Further, the Azadi Bachao Andolan judgment establishes that tax planning within the law is legitimate and not an abuse.

Court's Interpretation and Reasoning: The Tribunal noted that the assessee made bona fide investments in the mutual fund units and declared dividend income accordingly. The short-term capital loss arose from redemption of these units at market prices. The Tribunal emphasized that section 94(7) was not invoked by the Assessing Officer (AO) and was inapplicable as the purchase and sale dates did not fall within the specified window around the record date. The Tribunal relied on the Supreme Court precedent that mere pre-planned transactions to obtain exempt dividends and claim capital loss do not render the transactions sham or fictitious.

Key Evidence and Findings: The assessee's investment and redemption transactions were recorded in bank statements and mutual fund notices. The assessee's overall portfolio included investments in other mutual funds and shares, with dividend income and capital gains consistent with regular investment activity. The Tribunal observed no direct evidence linking the assessee to any manipulation or colorable device.

Application of Law to Facts: The Tribunal applied the statutory framework and judicial precedents to reject the AO's contention that the dividend income was not genuine and the capital loss artificial. The absence of invocation of section 94(7) and the genuineness of transactions supported the assessee's claim.

Treatment of Competing Arguments: The AO relied on survey findings and SEBI circulars alleging manipulation by the mutual fund and argued that dividend was a return of capital and loss was fictitious. The Tribunal found these arguments unsubstantiated as there was no SEBI enquiry implicating the mutual fund or the assessee, and the circular was of general application, not specific to the fund or transactions involved.

Conclusion: The Tribunal held that the dividend income was exempt under section 10(35) and the short-term capital loss was allowable for set off, rejecting the AO's disallowance.

2. Effect of Survey Findings and SEBI Circular on Dividend Exemption and Capital Loss

Relevant Legal Framework and Precedents: SEBI Circular No. SEBI/IMD/CIR No 18/198647/2010 prohibits mutual funds from declaring dividends out of Unit Premium Reserve, restricting dividend declaration to distributable surplus from profits or gains. The AO relied on this circular and survey findings under section 133A alleging manipulation of accounting to inflate distributable surplus artificially.

Court's Interpretation and Reasoning: The Tribunal observed that the AO's reliance on the survey and SEBI circular was not supported by any formal SEBI enquiry or findings against the mutual fund. The Tribunal noted that the mutual fund remained active and reported returns consistent with market benchmarks. The Tribunal further observed that statements of mutual fund employees did not admit manipulation aimed at providing tax benefits to investors. There was no nexus established between the survey findings and the assessee's transactions.

Key Evidence and Findings: The Tribunal noted absence of any SEBI investigation report or formal adverse finding against the mutual fund or the assessee. The mutual fund's public disclosures and performance reports contradicted the AO's allegations of manipulation. The statements relied upon by the AO lacked direct linkage to the assessee.

Application of Law to Facts: The Tribunal held that mere general SEBI circulars and survey findings without concrete evidence or formal enquiry do not justify denial of exemption or disallowance of capital loss. The assessee's transactions were at arm's length and based on publicly available information.

Treatment of Competing Arguments: The AO argued that the mutual fund's accounting manipulation rendered the dividend a return of capital and the loss artificial. The Tribunal rejected this, emphasizing the absence of any direct evidence or formal SEBI action and the assessee's clean investment record.

Conclusion: The Tribunal concluded that the survey and SEBI circular did not warrant denial of exemption or disallowance of capital loss in the assessee's case.

3. Applicability of Section 94(7) and Allegation of Sham Transactions

Relevant Legal Framework and Precedents: Section 94(7) disallows losses on sale of securities or units acquired within three months prior and sold within three or nine months after the record date when the dividend is exempt. The Supreme Court in Walfort Share & Stock Brokers held that losses on units purchased and sold outside this window cannot be disallowed merely due to tax-free dividend receipt. The McDowell and Azadi Bachao Andolan judgments clarify that tax planning without colorable devices is permissible.

Court's Interpretation and Reasoning: The Tribunal found that the assessee's purchase and sale dates did not fall within the section 94(7) window. The Tribunal noted that the transactions were genuine, recorded, and the dividend was declared by the mutual fund as per publicly available notices. The Tribunal rejected the AO's contention that the transactions were sham or colorable devices designed solely for tax benefits.

Key Evidence and Findings: Mutual fund notices specifying record dates and dividend amounts were on record. The assessee's purchase and sale dates were outside the section 94(7) time limits. The Tribunal also noted similar findings in co-ordinate Bench decisions involving the same mutual fund and similar facts.

Application of Law to Facts: The Tribunal applied the statutory provisions and judicial precedents to find no basis for invoking section 94(7) or treating the transactions as sham.

Treatment of Competing Arguments: The AO argued premeditated tax avoidance through colorable devices. The Tribunal held that mere tax planning is not abuse and without evidence of colorable devices, the transactions must be respected.

Conclusion: The Tribunal upheld the exemption of dividend and allowed the capital loss set off, rejecting the sham transaction allegation.

4. Reliance on Statements of Mutual Fund Employees and Absence of SEBI Enquiry

Relevant Legal Framework and Precedents: Evidence must directly implicate the assessee or establish nexus to deny exemption or disallow losses. General statements or admissions by third parties without connection to the assessee are insufficient.

Court's Interpretation and Reasoning: The Tribunal found that statements of mutual fund employees did not admit manipulation for tax benefit purposes or excess dividend payment to the assessee. There was no direct evidence linking the assessee to any wrongdoing. The absence of any SEBI enquiry or adverse finding against the mutual fund further weakened the AO's case.

Key Evidence and Findings: The Tribunal reviewed the statements and found no admission of wrongdoing connected to the assessee. The mutual fund continued operations and reported returns consistent with market benchmarks.

Application of Law to Facts: The Tribunal concluded that reliance on such statements without direct nexus or formal enquiry was misplaced and insufficient to deny exemption or disallow losses.

Treatment of Competing Arguments: The AO sought to rely on these statements to substantiate allegations of manipulation. The Tribunal rejected this approach due to lack of direct evidence or nexus.

Conclusion: The Tribunal held that the statements did not justify denial of exemption or disallowance of capital loss.

Significant Holdings:

"The real objection of the Department appears to be that the assessee is getting tax-free dividend; that at the same time it is claiming loss on the sale of the units; that the assessee had purposely and in a planned manner entered into a pre-meditated transaction of buying and selling units yielding exempted dividends with full knowledge about the fall in the NAV after the record date and the payment of tax-free dividend and, therefore, loss on sale was not genuine. We find no merit in the above argument of the Department."

"Even assuming that the transaction was pre-planned there is nothing to impeach the genuineness of the transaction... mere tax planning, without any motive to evade taxes through colourable devices is not frowned upon even by the judgment of this Court."

"Mere general SEBI circulars and survey findings without concrete evidence or formal enquiry do not justify denial of exemption or disallowance of capital loss."

"There is no whisper that J.M. Financial Management Ltd., have provided excess dividend to the assessee nor provided tax benefit. There is no live link nexus between the statement and the assessee."

"In the case before us, the assessee is entitled to claim loss on the aforesaid transaction... We direct the Assessing Officer to treat the loss arising out of the aforesaid transaction and also to grant benefit of exemption as pointed out by the Supreme Court."

The Tribunal established the core principle that dividend income exempt under section 10(35) and capital loss arising from genuine investment transactions cannot be disallowed merely on suspicion of tax planning or general allegations of manipulation absent direct evidence or formal regulatory findings. The Tribunal emphasized the necessity of nexus and concrete proof before denying statutory exemptions or disallowing losses.

Accordingly, the Tribunal dismissed the Revenue's appeal, upheld the exemption of dividend income, and allowed the set off of short-term capital loss against capital gains for the assessment year 2016-17.