Telangana High Court upholds GAAR invocation, dismisses petition on Bonus stripping scheme

Introduction

The Telangana High Court (‘HC’), in a landmark decision, has upheld the invocation of General Anti-Avoidance Rules (‘GAAR’) in a case revolving around bonus stripping.  This significant ruling was made in the case of Ayodhya Rami Reddy Alla¹ (‘Assessee’) against its Writ Petitions 46510 and 46467 of 2022. The HC decision dismisses the Assessee’s petition that sought to challenge the application of GAAR, highlighting the judiciary’s stance on curbing tax avoidance practices through stringent regulatory measures. This verdict underscores the importance of adhering to legislative intent and substance-over-form principles in tax planning, emphasizing compliance with anti-avoidance provisions to ensure fair and transparent tax practices.

Facts of the case

• During its AGM on 27 February 2019, Ramky Estate and Farms Limited (‘REFL’) issued 7,64,40,100 shares to the Assessee and 5,56,52,175 shares to M/s. Oxford Ayyapa Consulting Services Private Limited (‘OACSPL’) on a private placement basis.
• Subsequently on 27 February 2019, the Assessee purchased the aforementioned 5,56,52,175 shares of REFL from OACSPL.
• On 4 March 2019, REFL issued bonus shares at a ratio of 1:5, thereby reducing the value of each share from INR 115 to INR 19.20.
• On 14 March 2019, the Assessee sold 5,56,521 shares to a related party, Advisory Services Pvt. Ltd (‘ADR’), at INR 19.20 per share, resulting in a short-term capital loss (STCL) of approximately INR 462 Crores. Additionally, ADR had insufficient funds to purchase REFL shares, and the transaction was funded by OACSPL.
• The Assessee used the entire STCL to offset long-term capital gains (LTCG) arising from the sale of shares in Ramky Enviro Engineers Limited (REEL).
• The Revenue authorities initiated proceedings under the Act to potentially categorize these transactions as an impermissible avoidance arrangement under the GAAR provisions.
• The Assessee challenged these proceedings by filing the instant writ petition in the Telangana HC.

Assessee’s Contention

• The Assessee contends that the instant case pertains to Section 94(8) of the Act, which addresses tax avoidance related to bonus stripping, invoking Specific Anti-Avoidance Rules (‘SAAR’) provisions.
• The Assessee further argues that Section 94(8) of the Act pertains specifically to the acquisition of mutual fund units and does not extend to shares. The Parliament while enacting the said section, did not intend for shares to fall under bonus stripping provisions. Therefore, SAAR shall not apply to the Assessee in this context.
• Additional reference is made to guidelines issued by the Shome Committee, recommending that if SAAR applies to a transaction, GAAR should not be invoked to scrutinize that element.
• Consequently, the Assessee insists on scrutiny within SAAR provisions alone, precluding the invocation of GAAR in this case.

Revenue’s Contention

• The Revenue contends that the funds in the instant case were cyclically circulated within the same group through transfers among related entities, suggesting a round-tripping of funds.
• Furthermore, the Revenue asserts that the transaction was undertaken primarily for the purpose of evading taxes, lacking any economic, rational, or commercial basis.
• Therefore, the entire sequence of transactions should be classified as an impermissible avoidance arrangement under the GAAR provisions of the Act.
• Additionally, the Revenue contends that Section 95(1) of the Act, which governs the applicability of GAAR, includes a non-obstante clause. This grants GAAR overriding authority over other existing provisions of the law.

References made:

• Union of India v. Shiv Dayal Soin & Sons (P) Ltd.
• Commercial Tax Officer, Rajasthan vs. Binami Cements Limited
• S. Raghunath vs. State of Karnataka
• The Commissioner of Income-Tax (Central), New Delhi vs. M/s. S. Zoraster and Company
• McDowell & Co. Ltd. v. CTO
• Shome Committee Report (expert committee on GAAR)

Issues raised before the HC

1. Whether bonus stripping provisions apply to shares?
2. Whether GAAR provisions would apply in the instant case?
3. Whether GAAR provisions can override SAAR provisions under the Act?

Decision of the HC

1. Whether bonus stripping provisions apply to shares?
2. The HC observed that Section 94 of the Act addresses tax avoidance through specific transactions in securities, including shares, mutual funds, and derivatives from unrecognized stock exchanges.
3. Additionally, the HC emphasized that bonus stripping provisions include definitions for key terms such as ‘securities’ and ‘units’, where securities include stocks and shares.
4. Consequently, the HC concluded that the bonus stripping provisions cover the issuance of bonus shares as well.

1. Whether GAAR provisions would apply in the instant case?
2. The HC observed that the sequence of transactions in the instant case, including the issuance and subsequent sale of bonus shares, lacked genuine business intent.
3. The HC perceives Assessee’s actions as a deliberate misuse of the Act’s provisions, going beyond the intended use of the law, and manipulating it to one’s advantage. It creates extraordinary rights and obligations that seem to be conducted not in good faith.
4. These unusual rights and obligations are not in line with the general principles of fair dealing, leading to the conclusion that it is an impermissible avoidance agreement under GAAR provisions.
5. Accordingly, the HC viewed this arrangement as a deliberate strategy aimed at artificially creating losses and avoiding tax liabilities. As a result, GAAR provisions were deemed applicable in the instant case.

1. Whether GAAR provisions can override SAAR provisions under the Act?
2. GAAR provisions, starting with a non-obstante clause, require that if a taxpayer’s arrangement is deemed impermissible, the Assessing Authority must assess tax consequences under GAAR, overriding other conflicting provisions in the Act.
3. Referring to the Shome Committee report, it was noted that the Committee’s recommendation that SAAR generally supersedes GAAR pertains mainly to international agreements, not domestic cases like this one. This stance is supported by the Finance Minister’s statement on January 14, 2013, indicating that the applicability of GAAR or SAAR depends on specific circumstances.
4. The HC specifically ruled that tax assessments resulting from impermissible arrangements must strictly follow GAAR provisions, ensuring consistent application and enforcement under the Act.
5. Therefore, based on the above observations, the HC concluded that GAAR’s non-obstante clause gives it precedence over other laws, allowing comprehensive application of GAAR principles, including potential override of SAAR provisions.

Conclusion

In this landmark ruling, the HC reaffirmed the critical role of SAAR and GAAR in curtailing tax avoidance strategies stating that the taxpayers cannot rely solely on SAAR provisions to protect impermissible avoidance arrangements from GAAR scrutiny. The HC upheld the rigorous enforcement of these rules to prevent taxpayers from exploiting tax loopholes through artificial transactions. The HC reiterated that tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges. This underscores the necessity of genuine commercial intent in investment activities and strengthens the regulatory framework’s commitment to ensuring fairness and integrity in taxation.