The applicable section in respect of income stripping
is given below with analysis.
Avoidance of tax by certain
transactions in securities.
3294. (1) Where
the owner of any securities (in this sub-section and in sub-section (2)
referred to as “the owner”) sells or transfers those securities, and buys back
or reacquires the securities, then, if the result of the transaction is that
any interest becoming payable in respect of the securities is receivable
otherwise than by the owner, the interest payable as aforesaid shall, whether
it would or would not have been chargeable to income-tax apart from the
provisions of this sub-section, be deemed, for all the purposes of this Act, to
be the income of the owner and not to be the income of any other person.
(2) Where any person has had at any
time during any previous year any beneficial interest in any securities, and
the result of any transaction relating to such securities or the income thereof
is that, in respect of such securities within such year, either no income is
received by him or the income received by him is less than the sum to which the
income would have amounted if the income from such securities had accrued from
day to day and been apportioned accordingly, then the income from such
securities for such year shall be deemed to be the income of such person.
(3) The provisions of sub-section
(1) or sub-section (2) shall not apply if the owner, or the person who has had
a beneficial interest in the securities, as the case may be, proves to the
satisfaction of the 33[Assessing]
Officer—
(a) that
there has been no avoidance of income-tax, or
(b) that
the avoidance of income-tax was exceptional and not systematic and that there
was not in his case in any of the three preceding years any avoidance of
income-tax by a transaction of the nature referred to in sub-section (1) or
sub-section (2).
(4) Where
any person carrying on a business which consists wholly or partly in dealing in
securities, buys or acquires any securities and sells back or retransfers the
securities, then, if the result of the transaction is that interest becoming
payable in respect of the securities is receivable by him but is not deemed to
be his income by reason of the provisions contained in sub-section (1), no
account shall be taken of the transaction in computing for any of the purposes
of this Act the profits arising from or loss sustained in the business.
(5) Sub-section (4) shall have
effect, subject to any necessary modifications, as if references to selling
back or retransferring the securities included references to selling or
transferring similar securities.
(6) The 34[Assessing]
Officer may, by notice in writing, require any person to furnish him within
such time as he may direct (not being less than twenty-eight days), in respect
of all securities of which such person was the owner or in which he had a
beneficial interest at any time during the period specified in the notice, such
particulars as he considers necessary for the purposes of this section and for
the purpose of discovering whether income-tax has been borne in respect of the
interest on all those securities.
35[(7) Where—
(a) any
person buys or acquires any securities or unit within a period of three months
prior to the record date;
36[(b) such person sells or transfers—
(i) such securities within a period of three
months after such date; or
(ii) such unit within a period of nine months after
such date;]
(c) the
dividend or income on such securities or unit received or receivable by such
person is exempt,
then, the loss, if any, arising to
him on account of such purchase and sale of securities or unit, to the extent
such loss does not exceed the amount of dividend or income received or
receivable on such securities or unit, shall be ignored for the purposes of
computing his income chargeable to tax.]
37[(8)
Where—
(a) any person buys or acquires any units within a
period of three months prior to the record date;
(b) such person is allotted additional units
without any payment on the basis of holding of such units on such date;
(c) such person sells or transfers all or any of
the units referred to in clause (a) within a period of nine months after
such date, while continuing to hold all or any of the additional units referred
to in clause (b),
then, the loss, if any, arising to him on account of
such purchase and sale of all or any of such units shall be ignored for the
purposes of computing his income chargeable to tax and notwithstanding anything
contained in any other provision of this Act, the amount of loss so ignored
shall be deemed to be the cost of purchase or acquisition of such additional
units referred to in clause (b) as are held by him on the date
of such sale or transfer.]
Explanation.—For the
purposes of this section,—
(a) “interest”
includes a dividend ;
38[(aa) “record date” means such date as may be fixed
by—
(i) a company for the purposes of entitlement of
the holder of the securities to receive dividend; or
(ii) a Mutual Fund or the Administrator of the
specified undertaking or the specified company as referred to in the Explanation
to clause (35) of section 10, for the
purposes of entitlement of the holder of the units to receive income, or
additional unit without any consideration, as the case may be;]
(b) “securities”
includes stocks and shares ;
(c) securities
shall be deemed to be similar if they entitle their holders to the same rights
against the same persons as to capital and interest and the same remedies for
the enforcement of those rights, notwithstanding any difference in the total
nominal amounts of the respective securities or in the form in which they are
held or in the manner in which they can be transferred;
39[(d) “unit”
shall have the meaning assigned to it in clause (b) of the Explanation
to section
115AB.]
Analysis
of section:
1. Issue for consideration :
1.1 S. 94(7), introduced w.e.f.
1-4-2002, provides that the loss, if any, arising to an assessee on account of
purchase and sale of units, within the prescribed period, shall be allowed to
be set off against other income, to the extent of the amount of income received
on such units. This provision is applicable for A.Y. 2002-03 and onwards.
1.2 No specific provisions existed,
prior to insertion of S. 94(7), in the Income-tax Act, 1961 to disallow the
claim for set-off of such losses arising on purchase or sale of units within a
short period. In the circumstances, such short-term losses were eligible for
set-off against other income and the consequent income received on the
intervening record date was eligible for exemption from tax u/s.10 of
Income-tax Act.
1.3 The above-mentioned position in
law used to provide tax shelter to the persons undertaking such transactions,
popularly known as ‘dividend stripping’, at a marginal monetary loss. With the
emergence of numerous transaction of such nature, the Revenue authorities were
prompted to resist the claim for such set-off, on the ground that the
transactions were unreal and were carried out without any economic
consideration. This conflict between the Revenue and taxpayers appeared to be
resolved, for the time being, by the decision of the decisions of Special Bench
of ITAT in the case of Wallfort Shares & Stock Brokers Ltd., 96 ITD 1
(Mum.) (SB), as far as it pertained so A.Y. 2001-02 and earlier assessment
years.
1.4 The Finance Act, 2001 with
introduction of S. 94(7), sought to put an end to the controversy by
introduction of S. 94(7), prospectively w.e.f. A.Y. 2007-08, by providing that
losses incurred on transactions carried out within the prescribed period shall
be ignored to the extent of exempt income received as a result of such
transactions.
1.5 The issue under consideration
continues to be debated even in respect of the period prior to the insertion of
S. 94(7) due to the conflicting decisions of High Court and also of the
Tribunal, delivered after the said Special Bench decision in Wallfort’s case (supra).
The issue assumes relevance even for the post-introduction period, inasmuch as
the revenue authorities regularly deny the claim for setoff of losses in cases
where transactions are admittedly outside the period prescribed by S. 94(7), on
the ground that such transactions are colourable transactions, entered into
with the sole motive of avoiding taxes.
1.6 The Punjab & Haryana High
Court, in a case pertaining to A.Y. 2001-02 involving the issue under
consideration, held that the loss resulting on such transactions was not
eligible for set-off. As against that, the Delhi High Court in two cases
pertaining to the said assessment year held that such a loss, in the absence of
any provisions similar to S. 94(7), was allowable for set-off against other
income.
2. Vaneet Jain’s case :
2.1 The issue came up for
consideration in the case of Vaneet Jain & Anr. v. CIT, 205 CTR 92
before the Punjab & Haryana High Court. In this case, the assessee
purchased units of the JM Mutual Fund on 7th February 2001 and on 9th February
2001, i.e., one day before the record date, worth about Rs.1 crore. The
units were purchased along with right to receive income (dividend). On 10th
February 2001 (the record date), the assessee received income (dividend) of
Rs.29,03,225 and sold the said units on 11th February 2001 for Rs.68,25,806 for
a loss. The investment of the assessee was only Rs.5 lakh and the balance was
met out of the finance facility.
2.2 The AO, the CIT(A) as well as the
Tribunal held that the investment in units was merely to get benefit of tax
exemption on the income u/s.10(33) of the Income-tax Act, 1961 by projecting
that the loss was incurred in purchasing the said units at a higher price and
selling the same at lower price after it became ex-income (dividend).
2.3 It was noted that the persons in
such trade know in advance that prices of units or shares were highest before
the record date because of right to receive dividend and they plunge to the
lowest after declaration of dividend. It further noted that Kotak Mahindra
Finance Ltd. were the financier and broker in mutual fund units and, therefore
were in a position to offer a package deal to its customers for earning
tax-free dividend income; that on overall consideration of all the facts, it
was clear that there was no intention to earn profits on sale of such units,
particularly when such units were intended to be sold immediately after
declaration of income; that the intention to trade was lacking in the said
transactions, as there was no possibility of getting higher price on sale of
units after declaration of dividend; that no prudent businessman would purchase
anything with intention to sell at a loss; that the result of a single
transaction was that the assessee by investing merely a sum of Rs.5 lakh for
five days, enjoyed a tax-free income of Rs.29,02,226 (by way of dividend
declared by JM Mutual Fund) and further claimed a sum of Rs.31,94,194 as
business loss on account of loss on sale of units; that such manipulations were
not permissible under the law.
2.4 Accordingly, it was held that
purchase and sale of units did not constitute an adventure in the nature of
trade. Since essential feature of trade has been found to be lacking, the other
factors pointed out by the assessee’s counsel were not considered.
3. Vikram Aditya’s case :
3.1 Recently, the issue arose in the
case of The CIT v. Vikram Aditya & Associates (P) Ltd., 287 ITR 268
(Del.). The assessee in this case, purchased units of mutual funds on 9th
February , 2001 and sold them on 11th February 2001. Although a dividend
(income) of Rs.43,54,838 was received, yet an overall loss was suffered. The
assessee adjusted its shortterm capital loss against the long-term capital
gains. The claim for set-off of such loss was accepted by the AO while passing
an order u/s.143(3) of the Income-tax Act, 1961.
3.2 The CIT, in exercise of powers
u/s.263 of the Act, revised the assessment on the ground that the assessee had
resorted to a colourable device to evade tax, as the assessee knew fully well
that it was going to incur a loss on sale of the units of the mutual funds. In
the revision order dated 15th March 2005, the CIT described the transaction of
the assessee as ‘dividend stripping’; a transaction in which an investor bought
stocks or units of mutual funds before the record date of dividend, where units
were held only long enough to receive the dividend and to sell them
subsequently.
3.3 The assessee preferred an appeal
to the Tribunal which held in favour of the assessee by observing that the
transaction entered into by the assessee was not prohibited by law; the
assessee was entitled to take advantage of the tax-free dividend; the
genuineness of the transaction was not doubted by the AO, and finally, there
could be two opinions on the issue whether the assessee had resorted to a
colourable device or not; the AO had taken the view that it was not a
colourable device and that was a plausible view; it may be that the CIT had a
different view, but that did not mean that the view of the AO was wrong or that
it deserved to be set aside.
3.4 The Delhi High Court observed
that there was no doubt that insofar as the present case was concerned, the AO
took a particular view which was not unreasonable or irrational. The Court
observed that in that sense, it could be said that the view of the AO was not
erroneous, although it may be prejudicial to the Revenue. The Court took a
particular note of the fact that the disallowance of a loss u/s.94(7) of the
Act in respect of such a transaction was provided for only from the A.Y.
2002-03, while the Court was concerned with the A.Y. 2001-02. It observed that
there was, therefore, a gap in the law, which appeared to have been exploited
by the assessee; that the Legislature appeared to have recognised the lacuna
and had taken steps to rectify it, but that did not mean that the decision of
the AO based on the law as it was could be said to be erroneous; that merely
because the assessee had taken the benefit of the lacuna, it would not raise a
substantial question of law for the consideration of the Court; that it was
also worth noting that it was nobody’s case that the sale and purchase of the
mutual funds were not at the market price.
3.5 The Delhi High Court accordingly
upheld the action of the AO and quashed the order of the CIT.
4. Observations :
4.1 The transactions, in nutshell,
involve purchase of units after the declaration of income (dividend) by a
mutual fund but before the record date and selling such units after the record
date. The purchaser in the intervening period receives the income on
declaration of income on such units on the record date. Normally, a loss is
incurred as a result of these transactions, which is claimed for setoff against
other income and the income (dividend) received is claimed exempt from tax.
4.2 Recently, the Delhi High Court in
the case of CIT v. Vimgi Investments (P) Ltd., 290 ITR 505, again was
required to consider an identical issue for the A.Y. 2001-02. In that case, the
loss claimed on account of the transactions of purchase and sale of units was
allowed to be set off against other income by the AO under an assessment order
passed u/s.143(3). The order of the AO was sought to be revised by the CIT
u/s.263. The Tribunal quashed the order of the CIT and the High Court upheld
the orders of the AO and that of the Tribunal in an appeal by the Income-tax
Department to the Court. In deciding the issue on hand, the Delhi High Court
took note of insertion of S. 94(7), w.e.f. A.Y. 2002- 03, and held that the
said provision was not applicable to A.Y. 2001-02 and further held that in the
absence of the provisions of S. 94(7), the only view that was possible to be
taken by the AO was to allow the losses relating to such transactions in units
for the year under consideration.
4.3 The said decision of the Punjab
and Haryana High Court in Vaneet Jain’s (supra) case, prompted the
Mumbai Tribunal in the case of Omprakash Agarwal, ITA No. 7895/Mum./2004 to not
follow its own decision in the Wallfort’s (supra) case. The Tribunal in
Omprakash Agarwal’s case held that the transactions resulting into short-term
capital loss were sham and the resulting short-term capital loss was not
eligible for set-off against other income for A.Y. 2001-02.
4.4 The series of decisions delivered
after the said Omprakash Agarwal’s decision, however chose to allow the claim
for set-off of losses by relying on the above-mentioned Delhi High Court
decisions in the cases of Vikram Aditya & Associates (supra) and
Vimgi Investments (P) Ltd. and following the decision of the Special Bench in
Wallfort’s case (supra).
4.5 It is evident from the reading of
the decision of the Punjab and Haryana High Court in Vaneet Jain’s case, that
the High Court had not taken cognisance of the insertion of S. 94(7) at all,
perhaps for the reason that the said insertion by the Finance Act, 2001 was not
brought to the notice of the Court. We are sure that the insertion of the said
provision with prospective effect would have led the Court to decide otherwise,
had the same been brought to the notice of the Court. The fact that the
Legislature sought to prospectively monitor such transaction conveys that it
did not intend to thwart the claim for set-off of losses pertaining to such
transactions for and up to A.Y. 2001-02.
4.6 The decision of the Special Bench
in Wallfort’s case (supra) is a comprehensive decision which has taken
into consideration all facets of the issue under consideration, including the
issue of genuineness of the transaction to hold that such transactions were not
sham but were real and the losses arising therefrom were eligible for set-off
against other income in absence of specific provision in law prohibiting such a
set-off.
4.7 The position in law post
insertion of S. 94(7) is clear and the losses pertaining to the transactions
executed within the prescribed period shall not be allowed to be set off to the
extent of the exempt income. At the same time, the Income-tax Department should
not under any circumstances deny the claim for set-off on the pretext of
colourable transactions, where it is established that the transactions are
executed outside the prescribed prohibited period. In such circumstances, no
allegation of colourable transaction should survive inasmuch as the Legislature
in its wisdom has provided a time-bound test for deciding the allowability or
otherwise of such losses. Where the minimum time gap between the transactions
of purchase and sale exceed the gap desired by the Legislature u/s.94(7), the
loss pertaining to such transactions shall qualify for the set-off against
other income without any suspicion by the Income tax Department.
4.8 The time gap prescribed by the
legislature, now, vide insertion of S. 94(7) w.e.f. 1-4-2005, is so wide that
it is impossible to label such transactions as colourable transactions.
Now
let us discuss few latest case laws to have better understanding of the
section.
·
The assessee was engaged in activities
of sale and buyback of units of U.T.I., and claimed that such buybacks did not
attract provisions of s. 94 as the units are not ‘security’ within the meaning
of s. 94. The Tribunal rejected the claim of the assessee. On appeal, held,
dismissing the appeal: The question whether U.T.I. units are ‘security’ or not
was not pressed by the assessee in the hearing,and therefore, no opinion was
expressed on that question. Refer, Peerless General Finance and Investment Co
v. CIT, 217 Taxman 251.
·
Assessee purchased mutual fund units on
20-10-2005. The Record date in respect of mutual fund units was 20-1-2006. The
assessee sold said mutual fund units at a loss on 6-2-2006. It was held that
since units had been purchased within a period of three months prior to record
date and, thereupon, their sale was made within a period of nine months from
record date, relevant conditions mentioned in section 94(7) were cumulatively
satisfied and, thus, revenue authorities were justified in disallowing
short-term capital loss suffered by assessee. Matter decided in against the
assessee. Refer, Krupeshbhai N. Patel v. Dy. CIT, 140 ITD 176.
·
The court held that ultimately the
intention and the circumstances alone have to have a bearing on the question as
to whether the transaction is only of investment or in the nature of trade.
Disallowance of a claim on the ground that the transactions were for tax
avoidance or evasion, could be considered only after the in-depth investigation
and proper recording and marshalling of all relevant facts, so as to establish
the motive of tax avoidance. Matter remanded for reconsideration. Refer, CIT v.
Allu Arvind Babu, 350 ITR 387.
·
The assessee had purchased units of
mutual funds on 26-12-20003. On the very
same date , the assessee received the dividend . On 29-03-2004 , the assessee
redeemed the units and claimed shorter capital loss. The Assessing Officer
opined that the cheque for the purchase of units was actually realized on
30-12-2003 and therefore , the period of holding before the sale was only 88
days i.e. less than 3 months, therefore provision of section 94(7) of the Act
held applicable. He denied the set off
short term capital loss claimed by
assessee. On appeal the claim of loss was allowed by Commissioner (Appeals) by
observing that if date of tender of cheque for purchase of share is considered as the date of
purchase , then the sale was not within three
months of purchase and provision of section 94(7) held not applicable.
On appeal by revenue the Tribunal confirmed the view of Commissioner (Appeals)
and dismissed the appeal of revenue. (A.Y.2004-05)(ITA no 4285/Mum/2009 dated
6-6-2012.Bench ‘F’). Refer, ITO v. Vasudeo
Pandurang Ginde, BCAJ –July –P.57(Mum.)(Trib.)
·
Assessee had purchased certain units of
UTI from P on 29‐5‐1989 at rate of Rs
14.75 per unit, at the same time assessee entered in to an irrecoverable
commitment to sell back those units to P at rate of Rs 13 per unit on 31‐7‐1989. The assessee
received dividend at the rate of 18 percent on those units. The assessee
incurred loss. The assessing officer disallowed the loss holding that the same
was predetermined. The High court held that even if it was assumed that
transaction was a pre planned one, there was nothing to impeach genuineness of
transaction and therefore, assessee was entitled to claim the loss on said
transaction. Refer, Evereaday Industries Ltd v CIT, 201 Taxman 278.
·
Entries and treatment in the assessee’s
books of account is not relevant. Loss on valuation has no place in section 94
(7).Amendment in section 94 (7) , brought by the Finance Act , 2004 should be
applied prospectively is not sustainable. Refer, Ashok Kumar Damani v Addl CIT,
138 TTJ 45.
·
When units have been redeemed by
assessee, same would constitute transfer for the purpose of section 94(7) and
short term capital loss to the extent of dividend is not allowable. CIT(A) was
justified in applying the provisions of section 94(7) and setting off dividend
income of Rs. 97,90 628 of Asst Year 2002-03 against the short term capital
loss of Rs. 1,06,03,428 of the Asst. Year 2003-04. Refer, Administrator of
Estate of Late E. F. Dinshaw vs. ITO, 52 DTR 23.
·
Units Purchased on record date falls
very much within period of three months as prescibed u/s 94(7). Refer, ITO v
Midas Powertech (P) Limited, 9 Taxmann.com 301.
·
Section 94(7) does not provide time
limit of 90 days & it provides time limit for 3 Months. Refer, ITO v Ashish
Navnitlal Shah, 9 Taxmann.com 181.
·
Section 94(7) Deals with only loss on
account of purchase & sale of units and is not concerned with entries or
trearment of same in books of accounts of assessee. Refer, Ashok Kumar Damani v
Add CIT, 9 Taxmann.com 69.
·
Pre S. 94(7) dividend stripping loss
cannot be disallowed. Transaction cannot be ignored on ground that it is for
tax-planning. Refer, CIT vs. Walfort Share & Stock Brokers (SC), 326 ITR 1.
·
The conditions spelt out in clauses(a),
(b) and (c) are cumulative and not alternative. Purchase of units within a
period of less than three months from the record date, but sale beyond a period
of three months loss cannot be ignored.
Refer, CIT vs. Alka Bhosle (Smt.), (2010) July BCAJ 49 ITA No. 2656 of
2009 dt. 9-6-2010
·
For the purpose of invoking the
provisions of s. 94(7) of the Act and to disallow the loss on sale of units,
condition laid down in clauses (a), (b) and (c) of s. 94(7) are to be
cumulatively satisfied. Thus, while the
units of mutual funds were purchased by the assessee within the statutory
period of three months, the sale of said units which is made beyond the statutory
period of three months from the record date the provisions of s. 94(7) are not
attracted and the loss on sale of such units cannot be disallowed. Refer, Shambhu
Mercantile Ltd. 25 DTR 164
·
Once the transaction is genuine merely
because it has been entered into with a motive to avoid tax, it would not
become a colourable devise and consequently earn any disqualification. Loss
incurred on purchase . Refer, Porrits and Spencer (Asia) Ltd. vs. CIT, 231 CTR
294.
·
Hope the above small summary on section 94 will help you in getting some relief from the
hardship from the ITD. In case you have any further clarification please mail
me at taxbymanish@yahoo.com.
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