GAAR v. SAAR on bonus stripping of shares

Taxpayer acquired certain shares of a private limited company. Thereafter, the said private limited company issued bonus shares. Pursuant to the issuance of such bonus shares, the value of each share was reduced to 1/6^th of its original value. Subsequently within a short period of time, the taxpayer transferred the original shares to another company. On account of such transfer, the taxpayer incurred a short-term capital loss as per the provisions of the IT Act.

While filing the return of income, taxpayer had set-off the short-term capital loss incurred on the above transaction against the long-term capital gains realised on another transaction. During the assessment proceedings, the Assessing Officer (AO) was of the view that the transaction of transfer of the original shares which resulted into short-term capital loss was an ‘impermissible avoidance arrangement’ (IAA) as per the provisions of GAAR under Chapter X-A of the IT Act and accordingly, GAAR proceedings were initiated. The PCIT issued a show-cause notice seeking response from the taxpayer on why the taxpayer’s transaction should not be treated as an IAA under Chapter X-A of the IT Act. The taxpayer filed writ petition challenging the said notice.

• The taxpayer argued that the transactions undertaken were covered under Chapter X of the ITA which provides for Specific Anti-Avoidance Rules (SAAR) and the provisions under Chapter X-A dealing with GAAR cannot be invoked. The taxpayer also placed reliance on ‘Shome Committee Report of 2012 on GAAR’ in support of its claim that GAAR cannot be invoked where SAAR is applicable to a particular transaction.
• According to Section 94(8) of the IT Act, any loss arising from transactions involving purchase and sale of units of a mutual fund (within a specified time frame from the issuance of bonus units) must be ignored for computing income chargeable to tax, subject to satisfying the conditions stipulated under the provisions. The scope of the above provision was extended to securities (other than units) vide Finance Act 2022.
• According to the taxpayer, Section 94(8) of the IT Act (falling within Chapter X) is the relevant provision of law for bonus stripping which for the year under consideration (i.e. AY 2019-20) was restricted only to units of mutual funds.
• Also, as per the taxpayer, the Parliament, while enacting section 94(8) of the IT Act, never intended to include shares within the scope of bonus stripping and if the Parliament had intended this, it would have included shares within the rigors of section 94(8) of the IT Act.
• Considering the above, the taxpayer argued that Section 94(8) of the IT Act is not applicable on transfer of shares for the year under consideration and accordingly, what has not been specifically included through SAAR cannot be indirectly included by applying GAAR.

• It was highlighted the series of steps undertaken in quick succession that resulted in a loss – acquisition of shares, declaration of bonus shares and sale of those shares. The entire transaction was undertaken to create loss without rationale and commercial substance which was then adjusted against gains arising from another transaction.
• The Revenue also relied on the fact pattern involving the advancement of funds, write-off of such funds in a short duration, etc and argued that aforesaid transaction is nothing but round tripping of funds with no commercial substance. It was contended that such series of steps were undertaken with mala fide intension of avoiding tax payments. Therefore, this was a fitting case for the invocation of GAAR.

High Court analysed the facts of the case and upheld the action of the Revenue by dismissing the taxpayer’s writ petition. It concluded that the GAAR provisions will apply to the facts of the case on the following grounds:

• The High Court observed that SAAR under Chapter X of the IT Act (as relied upon by the taxpayer) were in existence before the insertion of GAAR provisions under Chapter X-A of the IT Act. Several courts, including the Supreme Court of India, consistently held that when a special provision of law is enacted, general provisions of the Act cannot be invoked. However, the said principle cannot be applied in the instant case, as GAAR was enacted after the specific provisions. Further, the High Court also noted that Chapter X-A of the IT Act begins with a non obstante clause and has an overriding effect on all other provisions of the IT Act. Also, section 100 of the IT Act specifically provides that GAAR provisions are applicable in addition to or as a substitute for any other existing method of determining tax liability.
• The High Court also observed that the taxpayer’s argument that SAAR as per section 94(8) of the IT Act should take precedence over GAAR as invoked by the AO is fundamentally flawed and lacks merit as taxpayer itself also argued that section 94(8) of the IT Act does not apply to the facts of the case, as the transaction was in shares and not units as required by the said section.
• Further, the High Court held that section 94(8) of the IT Act may be relevant in a simple, isolated case of bonus share issue, provided such issuance has an underlying commercial substance. However, this provision did not apply to the case under consideration, as a bonus share issue was evidently an artificial avoidance arrangement lacking any logical or practical justification. The arrangement was primarily designed to sidestep tax obligations, in direct contravention of the principles of the IT Act.
• According to the High Court, the taxpayer’s reliance on the Shome committee report is misplaced as the committee’s stand that SAAR should generally supersede GAAR pertains to international agreements and not domestic cases which has been confirmed by the Finance Minister as Finance Bill, 2013, only incorporated some of the expert committee recommendations and clarified that both GAAR and SAAR can be applied on a case-to-case basis.
• High Court placed reliance on Supreme Court’s ruling in the case of Vodafone International Holdings B.Vwherein it was implied that the business intent behind a transaction could serve as a strong piece of evidence that the transaction isn’t a deceptive or artificial arrangement. The commercial motive behind a transaction often reveals the true nature of the transaction. However, the burden of proof was on the Revenue to prove any fiscal misconduct. In contrast, section 96(2) of the IT Act places this responsibility on the taxpayer and requires the taxpayer to disprove the presumption of a tax avoidance scheme.
• As per the High court, in the case under consideration, there was a clear and convincing evidence to suggest that the entire arrangement was intricately designed with the sole intent of evading tax and the taxpayer not able to provide substantial and persuasive proof to counter the claim.

• This High Court decision on GAAR lays down several findings and observations that could shape the litigation on this issue. This ruling, while dealing with applicability of GAAR vis-à-vis SAAR, has held the following:
  – By virtue of the non obstante clause under section 95(1) of the ITA dealing with the applicability of the GAAR, the provisions of Chapter X-A get overriding effect over and above the other existing provisions of law.
  – The applicability of either GAAR or SAAR would be determined on a case by-case basis.
  – The business intent behind a transaction could serve as strong evidence that the transaction isn’t deceptive or artificial arrangement.
• The High Court decision has again highlighted the importance of maintaining contemporaneous documentation to establish business rationale and commercial substance for undertaking any transaction. A transaction undertaken with a sole intent to evade tax liability may attract applicability of anti-abuse provisions from tax authorities and courts.

We trust you will find this an interesting read. For any queries or comments on this update, please feel free to contact us at insights@elp-in.comor write to our authors:

Mitesh Jain, Partner, Email – miteshjain@elp-in.com

Jishaan Jain, Associate Partner– jishaanjain@elp-in.com

Shruti Desai, Senior Associate– shrutidesai@elp-in.com