TMI Blog2008 (8) TMI 222X X X X Extracts X X X X X X X X Extracts X X X X ..... Income-tax Appellate Tribunal, Special Bench, Mumbai, dated July 15, 2005 in Income-tax Appeal No. 2307/Mum/04. Basically, two questions of law are raised by the Revenue in this appeal, namely :- "(i) Whether, on the facts and in the circumstances of the case, the Income-tax Appellate Tribunal was justified in holding that the transaction of purchase and sale of the units of Chola Freedom Technology Fund 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 th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... see claimed that the loss of Rs. 2,09,44,793 was a business loss liable to be set off against other income of the assessee. 8. The Assessing Officer in his assessment order dated March 21, 2003, accepted that the dividend income was exempt under section 10(33) of the Act. However, the assessing officer disallowed the loss claimed by the assessee, inter alia on the ground that there was no commercial purpose involved 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 (Appea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t be allowed as business expenditure. In this connection, he relied upon the principles laid down by the Madras High Court in the case of M. V. Valliappan v. ITO reported in [1988] 170 ITR.238. 13. Mr. Srivastav further submitted that the concept of business or trade necessarily connotes an activity for earning profit though in the process it may incur loss as well. But where the motive is not to earn profit but only 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt in technology stocks, the real motive was to create an artificial loss. The modus operandi of the transaction was that the Mutual Fund would purport to sell the units at a high premium to the tax payer and repurchase the said units immediately after distribution of the dividend at a much lower price. As a result, the loss arising on sale of units was only on paper, because, in reality, the amount of loss was virtually returned to the 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... esponded to the scheme of tax avoidance. Thus, in effect, the mutual fund returned to the tax payer their own money within a span of a day or two in two different nomenclatures, namely dividend and sale proceeds. Nothing materially had happened to alter the financial position of the tax payer except to the extent of entry/exit load paid to the mutual funds. 18. Mr.Srivastav further submitted that it is not the business of the mutual fund 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 o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the mere presence of that structure which by itself could fairly be described as trading will not cast the cloak of trade over the whole structure. 21 . As an alternative argument, Mr. Srivastav submitted that the artificial loss incurred by the assessee would constitute expenditure incurred for earning the tax free dividend income and hence disallowable under section 14A of the Act. Even though the assessee had not claimed any expenditure for earning the tax free 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 hav ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... broker. No financial institution would return the entire amount received from a transaction, because, the Mutual Fund is required to pay 1% fee to the asset management company and incur other administrative expenses and, therefore, in the ordinary course of business the mutual fund cannot afford to return the entire 2% entry load to the assessee through the broker. Similarly, the letter addressed by the broker to the assessee on 19/4/2000, shows that the amount was paid towards 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the order of the Tribunal being contrary to law and passed contrary to the facts on record, is liable to be quashed and set aside and the substantial questions framed above be answered in favour of the Revenue. 27. Mr. Dastur, learned senior advocate appearing for the respondents on the other hand submitted that the transaction of purchase and sale of the units of Chola Mutual Fund by the assessee were two independent transactions. He submitted that the assessee purchased the units with 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and, therefore, the Tribunal was justified in holding that the transaction was a genuine transaction and the assessee was entitled to set off of the business loss. 32. Relying upon the decision of the apex court in the case of Vijaya Bank Ltd. v. CIT reported in [1991] 187 ITR 541, Mr. Dastur submitted that the amount paid to purchase the unit of a mutual fund is based on the net asset value (NAV) and it has nothing to do with the dividend declared by the mutual fund. Therefore, the amount paid to 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, there ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eceived from the units of a mutual fund was tax free. However, there was neither any provision under the Act requiring the unit purchasers to hold the units for any particular period before selling the units nor was there any provision to disallow the loss arising from the transaction. Taking advantage of this lacuna, the taxpayers resorted to purchasing the dividend bearing units and selling the same at a loss immediately after receiving the dividend income. The effect of the transaction was that the amount 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 lo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... were satisfied and, therefore, the loss arising from the transaction in question was liable to be disallowed. 40. We find it difficult to accept the above contention of the Revenue. It is true that without any profit motive, no prudent businessman would enter into any business transaction. However, in the transaction in question, there is, both income as well as loss. Dividend is admittedly received which is the income and there is loss because the amount received on sale of the units is less than the amount 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... easures to curb creation of short-term losses by certain transactions in securities and units.- Under the existing provision contained in section 94, transactions of sale and purchase of securities which result in the interest or dividend in respect of such securities being received by a person not being the owner of the securities, are to be ignored and the interest or dividend from such securities is required to be included in the total income of the owner. It has been pointed out that the purchase and resale 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 sel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le to tax of such person." 46. From the aforesaid CBDT circular, it is clear that the necessity to introduce section 94(7) was that the taxpayers were entering into the transaction in question as a tax avoidance device, because the dividend income received from the transaction was tax free and in the absence of any provision in the Act, the loss arising from the transaction was liable to be set off against other taxable income of the taxpayers. As a result, the taxable income of the taxpayer from other 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 C ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... res the Assessing Officers to disallow the loss only if it is established after detailed investigation that the motive of the transaction was primarily to incur loss and thereby avoid payment of tax due to the Revenue. Therefore, in the light of the CBDT Circular No.14 of 2001 which is binding on the Revenue, it is not open to the Revenue to contend that the loss arising from the transactions in question prior to 1-4-2002, could be disallowed on the ground that the transaction was not a business transaction or that 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 we ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... neral advertisement intended to attract the attention of all the taxpayers and it was not restricted to any particular taxpayer or a group of taxpayers. Neither the advertisement issued by the mutual fund required the unit purchasers to redeem the units immediately after receiving the dividend units nor there is any material on record to suggest any such understanding between the parties. On the contrary, it was specifically stated in the advertisement that the unit purchasers would have to pay 2% exit load if the units 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 pa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le consideration. In that context, it was held that the transaction was a colourable device. In the present case, none of the transactions are found to violate any of the legal provisions. Therefore, the decision of the apex court in the case of McDowell and Co. [1985] 154 ITR 148 does not support the case of the Revenue. 54. It is pertinent to note that the apex court in the case of Azadi Bachao Andolan [2003] 263 ITR 706 has held that every transaction or arrangement which is perfectly permissible in law, but has 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it is contended by the Revenue that the transaction is a colourable transaction. Thus, the decision of the Karnataka High Court does not support the case of the Revenue. 57. The alternative argument of the Revenue is that the loss arising from the transaction in question is liable to be treated as an expenditure incurred for earning the tax free income and hence disallowable under section 14A of the Act. There is no merit in this contention. Section 14A deals with the expenditure incurred for earning tax free income. Admittedly, no expenditure is incurred in purchasing the dividend bearing units. It is only because the units are sold at a loss immediately after receiving the dividend income, the Revenue wants to treat the loss as a deemed expenditure incurred for earning tax free dividend income. What section 14A contemplates is the expenditure actually incurred for earning tax free income and not assumed expenditure or deemed expenditure. In these circumstances, the decision of the Tribunal in rejecting the alternate argument of the Revenue cannot be faulted. 58. Reliance was placed by the counsel for the Revenue on the decisions of the apex court in the case of Calcutta C ..... X X X X Extracts X X X X X X X X Extracts X X X X
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