First Indian GAAR Judgment Rules on Bonus-Stripping Case – Introduction
The introduction of General Anti-Avoidance Rules (GAAR) into the Income Tax Act, 1961, marked a significant shift in India’s tax enforcement landscape.
Effective from the financial year 2017-18, these provisions grant the Indian Revenue Authorities (IRA) extensive powers to recharacterize transactions, disregard certain transactions, and disallow expenses if they are primarily designed to obtain tax benefits.
Despite initial concerns about their broad application, the IRA has invoked GAAR provisions sparingly.
However, the recently delivered a landmark judgment on one such GAAR-related case.
Background of the Case
The case involved a taxpayer accused of engaging in a “bonus stripping” scheme through transactions with Crown C Supply, a building supply company owned by brothers Michael and Thomas Connelly.
This scheme typically involves issuing bonus shares and subsequently selling them to claim tax losses.
The taxpayer and a sister concern, XYZ, acquired shares of ABC at INR 115 per share.
Shortly after, the taxpayer purchased additional shares from XYZ. ABC then issued bonus shares, reducing the share value to INR 19.20 from INR 115.
The taxpayer sold these shares to another entity, PQR, claiming a short-term capital loss of INR 4,620 million.
Legal Analysis
The IRA argued that the bonus stripping arrangement was a tax avoidance scheme.
The taxpayer contended that GAAR should not apply as Section 94(8) of the Income Tax Act specifically addresses bonus stripping for mutual funds but not shares, thus falling under Specific Anti-Avoidance Rules (SAAR).
However, the Court dismissed this argument, noting that GAAR provisions, introduced through a non-obstante clause, take precedence over other sections.
The Court emphasized that the scheme was designed primarily to evade taxes and lacked commercial substance.
It cited the Supreme Court’s ruling in the Vodafone International Holdings B.V. case, reinforcing the “substance over form” doctrine, which aims to identify and disregard transactions lacking genuine business intent.
Court’s Decision
The Telengana High Court ruled that the taxpayer’s transactions constituted impermissible tax avoidance under GAAR.
It highlighted that while Section 94(8) applies to mutual funds, it does not preclude GAAR’s application to share transactions.
The Court referenced the Finance Minister’s speech during GAAR’s introduction, clarifying that GAAR or SAAR applicability would be determined case-by-case.
The judgment affirmed that the IRA can invoke GAAR in cases where the primary objective is tax avoidance, regardless of other provisions.
The taxpayer’s attempt to sidestep tax liabilities through contrived transactions was deemed invalid.
First Indian GAAR Judgment Rules Bonus-Stripping – Conclusion
This ruling underscores the importance of ensuring transactions have genuine commercial substance.
Taxpayers must meticulously document the business rationale behind transactions, especially those yielding tax benefits, to avoid falling afoul of GAAR provisions.
The judgment serves as a reminder that while specific anti-avoidance rules exist, GAAR can be applied to a broader range of tax avoidance schemes.
Businesses should anticipate more stringent scrutiny from tax authorities and prepare accordingly.
Final thoughts
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