Direct Tax Updates & Legal Developments - Q4 2023

Himanshu SinhaPartner

Aditi GoyalPartner

Paras AroraAssociate

Key Developments

• Telangana High Court upholds applicability of General Anti-Avoidance Rule over Specific Anti-Avoidance Rule

  The Telangana High Court recently delivered the first ever decision interpreting the General Anti-Avoidance Rule (GAAR) provisions under the Income Tax Act, 1961 (ITA) and their interplay with Specific Anti-Avoidance Rule (SAAR) provisions.¹ This decision is expected to have a far-reaching impact on transaction structuring.

  The Court upheld the applicability of the GAAR provisions on the basis that SAAR provisions (relating to bonus stripping) under the ITA did not apply to shares during the relevant assessment year. It held that the doctrine of ‘specific provisions prevail over general provisions’ would not apply in the facts of the case and GAAR provisions were introduced in the ITA with a non-obstante clause, after the SAAR provisions, and would have an overriding effect.

  The case revolves around a series of transactions undertaken by the petitioner, Ayodhya Rami Reddy Alla (Petitioner), involving the receipt of bonus shares and set-off of capital gains. Ramky Estate and Farms Limited (REFL) allotted shares to the Petitioner and M/s Oxford Ayyapa Consulting Services Private Limited (Oxford) on a private placement basis. Within a short period, the Petitioner acquired shares of REFL from Oxford. Thereafter, REFL issued bonus shares in the ratio of 5:1. As a result, the value of each REFL share was reduced to 1/6th of its original value. The Petitioner then sold the shares of REFL to its related entity, Advisory Services Private Limited (ADR). ADR did not have sufficient funds to acquire REFL’s shares from the Petitioner and therefore, funds for the acquisition were provided by Oxford. Given the fall in value of the shares due to the bonus issue, the Petitioner incurred a short-term capital loss on the sale of the shares to ADR. The Petitioner proceeded to offset the loss against long-term capital gains earned from another transaction involving the sale of shares in Ramky Enviro Engineers Limited.

  The Petitioner contended that its case would fall under the SAAR provision on bonus stripping as provided in section 94(8) of the ITA.² Contrary to the contention that the case fell under the SAAR provision under section 94(8) of the ITA, the Petitioner also submitted that for the subject year, section 94(8) of the ITA only applied to bonus stripping in the case of units of specified mutual fund or Unit Trust of India and did not include bonus stripping on shares in its scope. The Petitioner highlighted that the Parliament, while enacting section 94(8) of the ITA, did not intend to include shares within the scope of the bonus stripping provision. Therefore, what was specifically excluded from the provisions curbing bonus stripping by way of SAAR could not be indirectly covered by applying GAAR. Section 94(8) being a special provision aimed at preventing tax avoidance, would prevail over GAAR. In this context, the Petitioner also relied on the Shome Committee’s Report on GAAR which recommended that where SAAR applies to a particular transaction, GAAR should not be invoked.

  The Court noted that the transaction under consideration was devoid of commercial substance and was primarily designed to sidestep tax obligations and held that such arrangement would fall within the purview of GAAR provisions citing the following reasons:

  • GAAR provisions were introduced after the SAAR provision referred to in section 94(8) of the ITA and begin with a non-obstante clause. Thus, GAAR provisions have an overriding effect on section 94(8).
  • Section 94(8) may be relevant in a single, isolated case of bonus issuance provided such issuance has commercial substance. However, section 94(8) did not apply to the Petitioner’s case since the issuance of bonus shares was an artificial avoidance arrangement lacking any logical or practical justification. In cases of impermissible avoidance arrangements, GAAR provisions override SAAR.
  • The Petitioner’s contention that SAAR should prevail over GAAR was flawed and lacked consistency since section 94(8) did not apply to shares for the subject year.
  • The Petitioner’s reliance on the Shome Committee Report was misplaced and misconstrued. The Committee’s stance that SAAR should generally supersede GAAR was mainly for international agreements and not domestic cases. Further, the Court noted that the Finance Minister and the Central Board of Direct Taxes (CBDT) had clarified that the applicability of GAAR and SAAR would be determined on a case-to-case basis. Further, all recommendations of the Shome Committee Report were not incorporated into the GAAR provisions.
  • Before the formal codification of GAAR into the law in 2018, the judicial system had already established its own set of rules known as the Judicial Anti-Avoidance Rules (JAAR). JAAR operated under the principle of ‘substance over form’, essentially seeking to uncover misleading structures or transactional arrangements that lacked real commercial substance. The Court also relied on a landmark decision³ and emphasised that tax planning may be legitimate provided it is within the framework of law.

  The ITA outlines the procedure for invoking GAAR provisions (including reference to the Principal Commissioner or Commissioner, notice to the taxpayer setting out reasons and seeking objections, reference to approving panel in certain situations, etc.). This process ensures that transactions are evaluated from multiple perspectives before any outcomes are determined. However, the Petitioner filed a writ petition before the Court prior to the completion of this due process and the Court has also seemingly upheld the applicability of the GAAR provisions. As a result, even though the Court dismissed the writ petition, allowing the tax authorities (i.e., the respondents) to continue with the prescribed process under the ITA, the GAAR process and its outcome may be reduced to a formality given that the Court has already ruled on the applicability of GAAR.

  This decision has been challenged before the Supreme Court by the Petitioner and the tax authorities have filed a caveat. Given that this decision is the first ever decision on GAAR and its interplay with SAAR provisions, it will be interesting to see how jurisprudence evolves on this front.

More in this issue