2008 (8) TMI 222 - HC - Income Tax

Tax avoidance insertion of s.s. (7) in S. 94 - transaction of purchasing dividend bearing units of Mutual Fund and redeeming the same at a loss immediately after receiving the dividend income transaction between mutual fund and assessee were at arm s length moreover, SEBI had not found any illegality in the transaction such loss cannot be treated as expenditure for earning the tax free income - loss arising on sale of the units can be set off against other taxable income of assessee

Summary

Issues Involved:
1. Whether the transaction of purchase and sale of units of Chola Freedom Technology Fund was a bona fide commercial transaction or a colourable device for tax avoidance.
2. Whether the artificial loss from the transaction could be considered as an expenditure for earning tax-free dividend under section 14A of the Income-Tax Act, 1961.

Issue-wise Analysis:

1. Bona Fide Commercial Transaction or Colourable Device:

Arguments by the Revenue:
- The Revenue contended that the transaction was a composite one executed solely to create an artificial loss to avoid tax.
- The Revenue argued that the transaction lacked any commercial purpose and was designed to avoid tax on other taxable income.
- The Revenue relied on the principle that a transaction, though legal, if executed with an intention to avoid tax, constitutes a colourable device.
- The Revenue cited various judgments to support their claim that the transaction was not genuine and was aimed at tax avoidance.

Arguments by the Assessee:
- The assessee argued that the transactions of purchase and sale were independent and commercially motivated.
- The assessee purchased the units to earn a 40% dividend and sold them immediately after receiving the dividend to avoid potential price drops.
- The assessee claimed that the loss incurred was a business loss and should be set off against other taxable income.

Court's Analysis:
- The court noted that prior to the insertion of section 94(7), there was no provision to disallow such losses.
- The court observed that the transactions were executed at arm's length and there was no evidence of complicity between the mutual fund and the assessee.
- The court held that the transactions were genuine and commercially motivated, and the loss incurred was a business loss.
- The court rejected the Revenue's argument that the transaction was a colourable device, noting that the transactions were within the legal framework and there was no evidence of prearrangement.

Conclusion:
- The court concluded that the transaction was a bona fide commercial transaction and not a colourable device for tax avoidance.
- The loss incurred from the transaction was allowed to be set off against other taxable income.

2. Artificial Loss as Expenditure under Section 14A:

Arguments by the Revenue:
- The Revenue argued that the artificial loss should be considered as an expenditure incurred for earning tax-free dividend income and disallowed under section 14A.
- The Revenue contended that the differential amount between the purchase and sale price of the units constituted expenditure for earning the tax-free dividend.

Arguments by the Assessee:
- The assessee argued that the amount paid to purchase the units was based on the net asset value and not related to the dividend.
- The assessee claimed that the loss incurred on the sale of units was not an expenditure for earning the dividend and hence not disallowable under section 14A.

Court's Analysis:
- The court observed that section 14A deals with actual expenditure incurred for earning tax-free income, not assumed or deemed expenditure.
- The court noted that no expenditure was incurred in purchasing the dividend-bearing units.
- The court held that the loss incurred on the sale of units could not be considered as expenditure for earning tax-free dividend income.

Conclusion:
- The court rejected the Revenue's argument and held that the loss was not disallowable under section 14A.
- The court affirmed that the loss arising from the transaction was a business loss and could be set off against other taxable income.

Final Judgment:
- The court answered both questions in favor of the assessee and against the Revenue.
- The appeal was dismissed with no order as to costs.