In a recent decision, the Telangana High Court dismissed petitioner’s contention that General Anti-Avoidance Rule (‘GAAR’) cannot be applied by the Income Tax Department since the impugned fact situation is apparently covered by Specific Anti-Avoidance Rule (‘SAAR’). And that the relevant SAAR provision – Section 94(8) – specifically excludes the impugned situation from its purview thereby obviating the need to apply SAAR as well. In my view, the petitioner adopted a far-fetched argument to circumvent the application of GAAR and the High Court correctly acknowledged the feeble nature of petitioner’s arguments and rejected the same. At the same time, in deciding the writ petition, the High Court seems to have arrived at a pre-mature conclusion about the nature of transaction.
This article is an attempt to provide a detailed comment on the case which involves the crucial issue of application of GAAR. At the same time, I try to understand and analyze the relation between GAAR and SAAR provisions, how they interact – or should interact – under the IT Act, 1961.
Petitioner’s Arguments
The petitioner in the impugned case approached the Telangana High Court arguing that provisions relating to GAAR were inapplicable in the impugned case since the facts were within the scope of a Specific Anti-Avoidance Rule (‘SAAR’) provision.
The facts as narrated in the judgment were: In the Annual General Meeting held on 27.02.2019, the share capital of a company, REFL, was increased to its authorized share capital of Rs 1130,00,00,000/- and through private placement, shares were allotted to the petitioner and another company, M/s OACSP. Thereafter, the petitioner purchased the shares from M/s OACSP at a value of Rs 115 per share. On 04.03.2019, the REFL issued bonus shares in the ratio of 1:5 resulting in reduction of share price by 1/5, i.e., Rs 19.20 per share. The petitioner thereafter sold the newly issued shares to one entity via two separate transactions. In the latter transaction, the purchaser did not have funds and was funded by M/s OACSP and an inter-corporate deposit – which was written off – resulting in rotation of funds. The Revenue’s contention was that the entire exercise was carried by the petitioner to evade tax and with no commercial purpose. The short-term capital loss on sale of shares was created to offset the long term capital gains the petitioner had made on sale of shares.
The petitioner’s claim was that its transactions were covered by Section 94(8), IT Act, 1961. Section 94(8) states that:
Where –
- Any person buys or acquires any units within a period of three months prior to the record date;
- Such person is allotted additional units without any payment on the basis of holding of such units on such date;
- Such person sells or transfers all or any of the units referred to in clause (a) within a period of nine months after such date, while continuing to hold all or any of the additional units referred to in clause (b),
Then, the loss, arising to him on account of such purchase and sale of all or any of such units shall be ignored for the purposes of computing his income chargeable to tax and notwithstanding anything contained in any other provision of this Act, the amount of loss so ignored shall be deemed to be the cost of purchase of acquisition of such additional units referred to in clause (b) as are held by him on the date of such sale or transfer.
The term unit has been defined to mean any unit of a mutual fund.
The petitioner’s main argument against applicability of GAAR can be understood as follows: first, the general rule of interpretation is that specific provision overrides a general provision and thus SAAR should override GAAR; second, the relevant provision applying SAAR is Section 94(8) which inter alia tries to address the issue of a person selling additional units received without payment and claiming capital loss on the sale of all or some of those units. But, the petitioner argued that the legislature has deliberately kept securities outside the ambit of Section 94(8) and thus the transaction in question was outside the scope of Section 94(8). Alternatively, the petitioner’s argument can also be phrased as: if SAAR specifically tries to address a fact situation/transaction but fails to do so, then it cannot be curbed by applying GAAR. Or if SAAR specifically excludes a particular transaction from its purview, then the transaction cannot be scrutinized under GAAR. As per the High Court, the petitioner’s argument was:
… what has been specifically excluded from the provisions curbing bonus stripping by way of SAAR cannot be indirectly curbed by applying GAAR. This in the opinion of the learned Senior Counsel was nothing but expansion of the scope of a specific provision in the Income Tax Act which is otherwise impermissible under the law. (para 13)
The questions that arise are: What is the legislative intent driving Section 94(8)? Was Section 94(8) intended to be a catch-all provision to address bonus-stripping? If the answer to the latter is in the affirmative, it would imply that if a particular transaction involving bonus stripping is not addressed by Section 94(8) or is intended to be addressed by Section 94(8) but it fails to address it, then it excludes the applicability of GAAR to that transaction. But, if Section 94(8) is specifically restricted to only units of mutual funds and not securities, then it is tough to argue that it also aimed to apply to securities but fell short in its attempt regulate transactions involving the latter. Or in the alternative, it is also plausible, as argued here, that the entire transaction is much more than bonus stripping and cannot be reasonably said to be within the scope of Section 94(8).
The petitioner also tried to rely on observations of the Expert Committee on GAAR and argued that if SAAR is applicable to a particular transaction, it would exclude the applicability of GAAR. The Expert Committee on GAAR was of the view that where SAAR is applicable to the particular aspect/element, then GAAR shall not be invoked to look into that aspect/element. The Expert Committee observed that:
It is a settled principle that, where a specific rule is available, a general rule will not apply. SAAR normally covers a specific aspect or situation of tax avoidance and provides a specific rule to deal with specific tax avoidance schemes. For instance, transfer pricing regulation in respect of transactions between associated enterprises ensures determination of taxable income based on arm‘s length price of such transactions. Here GAAR cannot be applied if such transactions between associated enterprises are not at arm‘s length even though one of the tainted elements of GAAR refers to dealings not at arm‘s length. (page 49)
While the committee’s opinion cannot be countenanced, the impugned case was different. SAAR was clearly not applicable to the fact situation as Section 94(8) did not include the impugned transaction in its scope. The question before the High Court, which it chose not to answer clearly, was if SAAR was intended to be applicable to the transaction. It is a trickier and more difficult question to answer unless one scrutinises legislative intent and history of the provision.
Revenue’s Arguments
The Revenue Department questioned maintainability of the writ petition on the ground that the petitioner was only issued a showcause notice and the petitioner can appear before the relevant authorities and explain the case. In the absence of any patent illegality in issuance of showcause notice, filing writ petition before the High Court and interference with proceedings was not necessary at this stage.
The Revenue Department also claimed that the series of transactions undertaken by the petitioner amounted to round tripping of funds with no commercial purpose and for a mala fide purpose to avoid payment of tax. Thus, the transaction was an impermissible avoidance arrangement warranting the invocation of GAAR.
High Court’s Observations
The first observation of the Telangana High Court was with regard to applicability of SAAR vis-à-vis GAAR. Noting the legislative history of GAAR, the High Court concluded that:
In the present case, the petitioner puts forth an argument rooted in the belief that the Specific Anti Avoidance Rules (SAAR), particularly Section 94(8), should take precedence over the General Anti Avoidance Rule (GAAR). This contention, however, is fundamentally flawed and lacks consistency .The reason being the Petitioner’s own previous assertion that Section 94(8) is not applicable to shares during the relevant time frame. This inherent contradiction in the Petitioner’s stance significantly weakens the overall credibility of their argument. (para 31)
As is clear, the Telangana High Court only observed that since Section 94(8) was inapplicable to the facts, GAAR would apply. But, it did not engage with the more difficult question: Was Section 94(8) intended to cover the impugned fact situation? In the absence of engaging with this question, the High Court’s observation looks reasonable and defensible. This is not to suggest that deciphering the legislative intent behind Section 94(8) may have provided a different answer, but would have provided a more comprehensive understanding of the interaction of SAAR and GAAR.
The High Court made additional observations that, in my view, were pre-mature given that the petitioner had only been issued a showcause notice and further proceedings under IT Act, 1961 were yet to commence. The High Court noted that the petitioner’s transactions were not in good faith and in violation of general principles of fair dealing. And further commented that:
In this particular case, there is clear and convincing evidence to suggest that the entire arrangement was intricately designed with the sole intent of evading tax. The Petitioner, on their part, hasn’t been able to provide substantial and persuasive proof to counter this claim. (para 37)
Finally, the Telangana High Court invoked the Vodafone and McDowell judgments to hold that tax planning is permissible only if it is within the framework of law and taxpayer cannot resort to colorable devices and subterfuges. The High Court held that the Revenue Department has been able to persuasively and convincingly show that the petitioner’s transactions were not permissible tax arrangements and the GAAR provisions are applicable. Here the High Court tied another knot that may take time to unravel: the relevance and applicability of judicial anti-avoidance rules in tandem with the statutory provisions of SAAR and GAAR. The latter were incorporated in the IT Act, 1961 after the Vodafone and McDowell judgments, and while the non-obstante in Section 95 of IT Act, 1961 ensures that GAAR will override all other provisions in the statute, there is little clarity on the relevance of judicial pronouncements on tax evasion and tax avoidance. Can both be invoked simultaneously against an assessee?
Conclusion
The Telangana High Court’s judgment is of two parts. The first part where the High Court resolved the tension between SAAR provisions and GAAR provisions convincingly and the petitioner’s weak and contradictory arguments were rejected. The second part if where the High Court, in my opinion, pre-maturely concluded that the transactions in question were impermissible avoidance arrangements before the adjudication proceedings under the IT Act, 1961 were concluded. The petitioner had approached the High Court by filing a writ petition on the basis of a showcause notice. Instead of joining the proceedings under the IT Act, 1961 the petitioner chose writ remedy to resist application of GAAR provisions. The High Court’s observations in the second part were on merits of the transaction and perhaps not needed and may have prejudiced the petitioner’s case. As a final note, the High Court left open the question of the relevance of judicial pronouncements on tax evasion despite the incorporation of statutory provisions on the same. The impugned judgments offers some answers, but provides a glimpse of the recurring interpretive issues that may arise from applicability of GAAR, SAAR, and judicial pronouncements on the same.