Summary: In a recent case, the Telangana High Court has frowned upon the Revenue’s attempt to invoke GAAR in respect of a transaction that was carried out by the taxpayer through the stock exchange. By rejecting the stance adopted by the Revenue, the High Court categorically held that not every tax planning is bad, and it cannot be brought within the purview of GAAR. Only if a taxpayer colludes or connives to bypass statutory provisions, by entering into transactions that defy commercial logic, can it be examined.
The provisions of General Anti-Avoidance Rules (“GAAR”) were introduced into the Income Tax Act, 1961 (“IT Act”), from financial year (“FY”) 17-18 onwards. GAAR equips the revenue with a powerful tool to curb tax avoidance; however, it also poses the potential risk of including legitimate transactions within its scope. The Hon’ble Telangana High Court (“THC”) was faced with one such transaction in a recent case[1]. The THC clarified the limits of GAAR by quashing an order passed by the Indian Revenue Authorities (“IRA”) that had wrongly classified a share sale as an Impermissible Avoidance Arrangement (“IAA”).
Facts of the case
Smt. Anvida Bandi (“Assessee”), a long-time securities investor, realised significant long-term capital gains in FY19-20 by selling unlisted shares of a company. In the same financial year, she purchased shares of M/s. HCL Technologies Ltd. (“HCL”), a listed company, and sold a portion of it in the stock exchange. She suffered a short-term capital loss, which she set off against her long-term capital gains.
The learned Assessing Officer (“AO”) treated the sequence of transactions as an IAA and referred the matter to the approving GAAR panel. The said panel passed an order under Section 144BA(6), holding the transactions to be an IAA because of the correlation between the timing of earning long-term capital gains and suffering short-term capital loss.
Aggrieved, the Assessee filed a writ petition before the THC.
Issue
Whether the shares of HCL bought and sold in the stock exchange can be categorised as an IAA under Section 96(1) of the IT Act?
Contentions of the Assessee and the Revenue
The Assessee argued that Section 96(1) applies only to arrangements lacking arm’s length dealings. In this case, HCL shares were traded electronically on the stock exchange at market value, with no direct interaction between the Assessee and other parties. Therefore, the Assessee received no preferential treatment. GAAR applies only if tax provisions have been misused/ abused, or there is lack of commercial substance or malafide intent. The Assessee argued that since the IRA provided no such evidence of abuse, GAAR should not apply to the present case. The Assessee cited the GAAR expert committee’s report, which clarified that routine stock market transactions are outside GAAR’s scope. The extract is as follows:
“Example -9: Facts: A company sets off losses in the stock market against gains which is aimed at balancing the portfolio.
Interpretation: Sale/purchase through stock market transactions would not come under GAAR provisions. Moreover, timing of a transaction by a taxpayer would not be questioned under GAAR.”
The IRA argued that the timing and sequence of the transactions indicated tax avoidance mechanism, thereby attracting GAAR provisions. The IRA also invoked Section 96(2) to argue that the onus was on the Assessee to prove that the arrangement was not intended to secure a tax benefit.
Decision of the HC
The THC held that for a transaction to constitute an IAA under Section 96(1), there must be an arrangement between parties that either deviate from arm’s-length dealing, result in misuse or abuse of the IT Act, lack (or deemed to lack) commercial substance, or employed for non-bona fide purposes.
Testing the transactions against the touchstone of Section 96(1), the THC held that the transaction does not amount to IAA as all shares were traded through her demat account in the open market, with no known counterparty. The trades were not isolated instances rather routine transactions. The IRA also failed to bring on record any material indicating mala fide intent, apart from timing of trades.
The THC also rejected the IRA’s timing argument, citing Shome committee’s report[2], which clarified that stock exchange trades do not attract GAAR. Accordingly, the THC quashed the GAAR panel’s order under Section 144BA(6).
Significant Takeaways
The THC’s order marks an important development in delineating GAAR’s scope. It affirms that GAAR does not apply to ordinary market transactions merely because of resulting tax benefits. It clarifies that to invoke Section 96(2), there must be an arrangement satisfying one of the conditions of Section 96(1), such as lack of arm’s length dealing or commercial substance, misuse or abuse of the IT Act, non-bona fide purposes, etc.
It is pertinent to note that the case involved bonus stripping, where HCL issued a 1:1 bonus in December 2019, halving its share price. Under Section 55(2)(iiia), bonus shares have zero acquisition cost, while original shares retain their actual cost. Therefore, when the Assessee sold pre-bonus shares post-issuance, a capital loss was incurred, which she applied to offset prior gains. Although Section 94(8), a specific anti-avoidance rule (“SAAR”) for bonus stripping, was initially applicable only to units, it was later extended to shares only from April 1, 2023. Since the transaction occurred in FY19-20, it fell outside SAAR’s scope. The IRA attempted to apply GAAR, but the Court rightly rejected it.
This case lucidly explains that GAAR provisions are not meant for every instance of tax planning. It applies only to genuine attempts by taxpayers to manipulate IT Act provisions. This offers solace to taxpayers and advisors as the THC has set guardrails that provide legroom for implementing innovative tax strategies.
For further information, please contact:
S.R. Patnaik, Partner, Cyril Amarchand Mangaldas
sr.patnaik@cyrilshroff.com
[1] Smt. Anvida Bandi v. DCIT [TS-1110-HC-2025(TEL)]
[2] A Committee was set up by the CBDT under the Chairmanship of Dr. Parthsarathy Shome to study the implications of the GAAR provisions.
