In the matter of Ayodhya Rami Reddy Alla vs. Principal Commissioner of Income tax Central, the taxpayer had challenged the invocation of the General Anti-Avoidance Rule (GAAR) proceedings by the Income tax Department. The matter involved the taxpayer holding shares in an unlisted private company which issued bonus shares in the ratio 5:1 resulting in considerable reduction in the original face value of the shares. Such shares were immediately sold at the reduced face value to another entity resulting in a short-term capital loss to the taxpayer. Such loss was duly reflected by the taxpayer at the time of filing of the income tax return and was utilized to off-set the long-term gains made on another sale transaction of shares within the same year to reduce the overall tax outlay.
The Income Tax Department alleged that the taxpayer resorted to bonus stripping (i.e., issuance of bonus shares to bring down the per share value) to create artificial capital losses, which were then set off against long term capital gains arising to the taxpayer on another transaction and thus invoked the GAAR provisions under chapter X-A starting from section 95-102 of the Income Tax Act, 1961 (ITA) to treat the transactions as impermissible avoidance arrangement.
The taxpayer challenged the invocation of GAAR before the High Court based on the contention the transactions undertaken were covered by section 94(8) of the Income Tax Act, which is a Specific Anti Avoidance Rules (SAAR) under chapter ‘X’ the provisions of the ITA.
The Hon’ble High Court pointed out the peculiar situation where the special provision of law (SAAR) was already there in the ITA and the general provision of law (GAAR) were subsequently enacted through the Finance Act 2013 w.e.f. 01.04.2016. The Hon’ble High Court highlighted that the provisions of GAAR started with a notwithstanding clause and by virtue of the non-obstante clause, the provisions of GAAR in chapter X-A get an overriding effect over and above the other existing provisions of law.
Further, the Court also pointed out the inconsistency in the taxpayer’s argument since the SAAR provisions of section 94(8) of the ITA during the relevant period (wherein the transactions were undertaken) only dealt with only buying and acquiring of units and not did not apply to shares. The Court also touched upon the aspect that prior to codification of GAAR, the Judicial Anti-Avoidance Rules (JAAR) were operational premised on the principle of ‘substance over form’.
Taking into cognizance the events that had transpired within a short span of time in the case, the Court held that the provisions of section 94(8) of ITA, which might otherwise be relevant in a simple isolated case of the issuance of bonus shares with underlying commercial substance, would not apply to the current case wherein the issuance of bonus shares here is evidently an artificial avoidance arrangement that lacks any logical or practical justification.
The Hon’ble Court upheld the applicability of the GAAR provisions under Chapter X-A of the ITA whilst dwelling into various aspect including, inter-alia, Circular 7/2017 clarifying that both SAAR and GAAR would be applied depending on the specifics of each case, crucial role of intention behind the transaction, checks and balances within the provisions of ITA for GAAR invocation.
The judgement will be instrumental in evaluating the applicability and interplay of GAAR and/or SAAR in a transaction and has brought to the forefront the aspect of tax planning within the legal framework, vis-à-vis, tax evasion through dubious transaction devoid of proper commercial rationale.