This article has been published by Taxmann at Important Takeaways from the Judgment of the Telangana High Court on GAAR – Taxmann

Introduction

“The avoidance of taxes is the only intellectual pursuit that still carries any reward” – John Maynard Keynes.

The aforesaid quotation by Keynes highlights the relentless struggle between bona fide tax planning and impermissible tax avoidance. The Income-tax Act, 1961 (“Act”) provides the General Anti-Avoidance Rule (“GAAR”), which applies broadly to arrangements lacking commercial substance. While Chapter X-A of the Act deals with the provisions of GAAR, the procedure regarding its implementation is provided for under section 144BA of the Act. As per the provisions of GAAR, an Impermissible Avoidance Arrangement (“IAA”), refers to a transaction structured to avoid tax liability through arrangements. For example, setting up an entity in a favourable jurisdiction to avail a benefit under the relevant Double Taxation Avoidance Agreement between Indian and that jurisdiction could be considered as an IAA. Its main purpose is to bring under scrutiny those arrangements whose sole purpose is to obtain a tax benefit with minimal or no commercial substance. However, its wide scope may sometimes affect genuine transactions, such as the sale of shares, regular stock market trades, or other activities that result in either short-term or long-term gains or losses.

This article analyses the recent decision passed by the High Court of Telangana (“Court”) in Smt. Anvida Bandi,¹ by which the Court has disapproved the approach taken by the Revenue Authorities in applying GAAR provisions on transactions undertaken on the floor of the stock exchange. This article also analyses the burden of proof requirement that the Revenue Authorities must discharge before embarking upon the exercise of disregarding a tax benefit, which is otherwise available in genuine cases.

Background

In the case before the Court, the taxpayer was engaged in the business of trading in shares and securities. During the relevant year, the taxpayer sold shares of one company held by her as an investment and earned long-term capital gains of INR 44.14 crores thereon. These gains were subsequently utilised to purchase shares of HCL Technologies Pvt. Ltd. Within the same year, the taxpayer sold shares of HCL Technologies and incurred a capital loss of INR 17.65 crores. It is undisputed in the facts before the Court that all the transactions undertaken by the taxpayer were on the floor of the stock exchange. However, the Revenue Authorities considered these transactions to be an IAA, on the ground that the short-term loss was incurred only to set off the same against the long-term capital gains, thereby attracting the provisions of GAAR. It is in this background that the taxpayer filed a writ petition before the Court seeking quashing of the order passed by the Approving Panel under section 144BA(6) of the Act.

Court’s Decision

The Court, whilst applying the statutory conditions prescribed under the Act, has categorically opined that to treat a transaction as an IAA, there must be a pre-arrangement, and such arrangement should satisfy the conditions prescribed under section 96(1) of the Act². Further, the Court held that mere bald statements on the intent behind a transaction/ arrangement were not enough and that the Revenue Authorities ought to substantiate the satisfaction of the conditions laid down under section 96(1) of the Act with concrete evidence. In that manner, the Court observed that the Revenue Authorities failed in establishing that the case of the taxpayer fell within either of the conditions prescribed under section 96(1) of the Act. Additionally, the Court noted that albeit earning capital gains and capital loss during the same financial year, there was no direct nexus between the two sets of transactions. It was also clarified that the purchase and subsequent sale of shares in HCL Technologies were independent investment decisions carried out through stock exchange, which cannot automatically be linked to the gains that arose earlier.

Importantly, the Court made it clear that the time duration of the sale of shares could not, on its own, justify the invocation of GAAR. It was also observed by the Court that mere incurrence of such losses in the same year in which gains were earned could not lead to the conclusion that the transaction/ arrangement was an IAA. The Court also took note of the fact that the taxpayer was an investor and was continuously engaged in the trading of shares and securities. Therefore, it was held that the sale of HCL’s shares through the stock market, which resulted in a loss, could not be viewed in isolation to consider the transaction as being carried out only to obtain a tax benefit.

Analysis

There are two important takeaways from the judgment of the Court. First, the Court observed that the sale and purchase of shares and securities on the floor of the stock exchange and the timing of such transactions would not be questioned under GAAR. While doing so, the Court placed reliance on the Final Report on GAAR published by the Expert Committee in 2012, which, amongst other recommendations, had recommended a negative list of transactions/ arrangements, including transactions that are undertaken on the stock exchange, which could be kept beyond the purview of GAAR. However, it is interesting to note that the exemption in respect of transactions undertaken on the stock exchange never became a part of Rule 10U of the Income-tax Rules, 1962 (“Rules”), which otherwise provides for instances where the codified GAAR would be inapplicable.

Second, the Court took note of section 96(2) of the Act, which otherwise, as per its language, provides for a rebuttable presumption in favour of the Revenue Authority. In this regard, it is relevant to point out that, as originally enacted, section 96(2) created a pure presumption in favour of Revenue³, which was later amended vide Finance Act, 2013. Post amendment, the language of section 96(2) of the Act allows the taxpayer to rebut such a presumption. However, Circular No. 3/2012 dated 12.06.2012 issued by the Central Board of Direct Taxes, containing Supplementary Memorandum explaining the official amendments moved in the Finance Bill, 2012, clarified that the onus of proof is on the Revenue for any action to be initiated under GAAR. Further, Rule 10UBof the Rules itself indicates that the onus would first lie on the Revenue Authorities before initiating GAAR provisions. While there is no reference to the said Circular or Rule 10UB in the decision of the Court, the Court has nevertheless observed that the Revenue Authorities cannot invoke GAAR in the absence of evidence and material which prima facie establish that the subject transaction/ arrangement is an IAA.

Conclusion

GAAR, as a concept, relies purely on subjectivity rather than objectivity. While the scope and ambit of GAAR under the Act are quite wide, it has judiciously been constrained by the statute itself by incorporating necessary procedural checks and balances. Merely because a transaction may appear to be bordering on the tax avoidance threshold, it would not necessarily warrant an application on GAAR thereon. As per the decision of the Court, the Revenue Authorities must have some evidence or material to support their claim that the subject transaction/ arrangement was entered into with the intent of obtaining a tax benefit. This endorsement by the Court is a huge step in ensuring that GAAR provisions are not abused in genuine cases of tax planning. Furthermore, it also seems to be a step in the right direction, as observed by the Court, that transactions occurring on the floor of the stock exchange should not be questioned under GAAR. However, as stated above, such observation has been made on the reading of the Final Report on GAAR published by the Expert Committee in 2012, and may not strictly be considered as an authoritative pronouncement by the Court.