Wrong approach of tax authorities to brand transactions resulting into loss as bogus or device to avoid tax.

[C.A. DEV KUMAR KOTHARI]

Relevant links and references:  

Commissioner of Income Tax Versus M/s Pivet Finance Ltd. 2010 -TMI - 77068 - PUNJAB & HARYANA HIGH COURT

Union of India v. Ajadi Bachao Andolan (2003 -TMI - 6130 - SUPREME Court)

McDowell & Company Ltd. v. CTO (1985 -TMI - 40038 - SUPREME Court).

M/s Porrits & Spencer (Asia) Ltd v. The Commissioner of Income Tax, Faridabad (ITA No.10 of 2004 decided on 31.3.2010).  

Financial or business planning resulting into tax reduction in permissible. 

Financial and business planning:

Financial and business planning is important from the initial stage of setting up of business and then at all stages of operation. One of important aspect of financial planning is tax impact according to nature of transaction or the way in which it is implemented. As tax on transactions (like VAT, Service Tax, security Transaction Tax etc.) and tax on resultant income determine the ultimate result by way of profit after tax, it is very important to consider the tax aspect. Depending on tax aspect, a transaction may be viable or unviable. 

Therefore, financial planning or business planning should not be considered as tax planning. However, unfortunately, tax authorities consider it as their right to regard most of business decision which has one of consequence as reduced tax liability as a device to reduce tax or bogus transaction.    

Tax incentives and business decisions:

Many decisions are dependent on tax and other incentives provided by governments in respect of location or nature of business. Some incentives are given to promote industry in particular area or to promote particular industry. For example, if one individual makes deposit in PPF on last day and claim deduction u/s 80C, it cannot be regarded as a device to reduce tax liability.

Business transactions and tax advantages:

If an assessee sells some stock or investments say in last week of previous year, it should not be regarded as means of tax avoidance. Similarly if depreciable assets is purchased and put to use say during last week of previous year, it should not be regarded as a device to avoid tax. However, many times the Assessing officers disallow loss suffered in genuine transactions alleging that no prudent person shall do so and that the sale is simply to reduce tax.

Many times decisions are taken for the purpose of business aspects, financial aspects, etc. however, whenever there is loss , some officers have prejudice in mind that the transaction is  entered into only to book loss or to claim deduction to reduce tax liability.  

Wrong attitude of AO:

Many  Assessing officers are making additions and disallowances entirely with a prejudiced mind. They willingly accept transactions resulting into profit and by deliberately disregarding facts disallow loss suffered in similar transactions and while doing so, they pass very objectionable remarks like ‘ the loss is bogus’, ‘the transaction is entered into to defraud the revenue’ , the transaction is not real and similar remarks.

Recently author came across an assessment order in which assessee has sold many items of paintings in a public auction. Assessee is auctioneer as well as trader of paintings and other items of collection. The participants in auction are registered customers and others. The auction was advertised very widely and participated by main dealers and investors in such items. One of participant was also another trader and investor who was related to the assessee by means of some common directors and shareholders. In the auction the related party has purchased many items as a highest bidder. In many items sold to that related party assessee made  substantial profit of about Rs.3 crores. There were some other items which had fallen in valuation and were placed for sale. As highest bidders some of such items were also sold to the related party.  In such transactions assessee suffered loss of about Rs.1.5 crore. The net result in respect of items sold to related party was a profit of Rs.1.5 crores which was included in income by assessee. 

The learned AO held that the sale of items which resulted a loss were not genuine and the auction was just a make belief affair. He has taken profit made on sale of various items to related parties and other parties as income but disallowed the loss of Rs.1.5 crores. Thus the AO accepted auction as real for all other transactions in which assessee made profit and disbelieved auction of items in which loss was suffered.

It was explained to the AO that it was not necessary to sale those items simply to book loss, as alleged by the AO because assessee could have valued stock-in-trade of those paintings at cost or market value whichever is less, assessee could also defer sale of items on which profit was expected, however, the AO made a disallowance of loss and raised huge demand.   

We find many such instances.This is because many of the officers are not aware of ground realities of business (and many times they disregard the realities deliberately). They have belief that business is mostly  at profit and all losses are just shown by some or other means. They consider the business like their own occupation, in which there is no scope of any loss ( except chances of  loss of job which is also vey rare).

Recently reported  judgment:

Judgment in case of CIT Versus M/s Pivet Finance Ltd. 2010 -TMI - 77068 – (P&H) dated - 23 April 2010 the matter came about allegation of tax evasion versus tax planning. Revenue disallowed loss as shown through colorable devise to reduce tax. As per assessee loss was suffered in genuine business transactions of transfer of shares to sister concern. 

Court held that once the transaction has been found to be genuine by the Tribunal then it cannot be dubbed as colourable device.  

When the transaction was otherwise valid in, it may be a part of tax planning then merely because it has resulted in reduction of tax it cannot be ignored on the ground that the underlying motive of entering into such a transaction by the assessee was to reduce its tax liability to the State. 

The evasion of tax is substantially different than the planning concerning tax. 

The Assessing Officer did not dispute the amount of consideration of sale received by the assessee from the buyer. Therefore, the Court held that there was no reason to accept that the shares were sold only for the purpose of reducing the tax liability and therefore, loss was disallowable. 

This ruling came when the Revenue preferred an appeal under Section 260A of the Income Tax Act, 1961. ('the Act') to challenge the orders passed by the Income Tax Appellate Tribunal, Amritsar Bench, Amritsar (ITAT). The Revenue has claimed various questions of law. However, an all pervasive question which has been raised is whether the assessee-respondent has been consistently resorting to colourable device with the object of reducing the tax liability by transferring shares to another group of companies with a view to reduce the taxable income.

The Tribunal has recorded categorical finding concerning genuineness of the transaction in as much as the transaction was at the then prevailing market rate. The Assessing Officer did not dispute the amount of consideration of sale received by the assessee-respondent from the buyer. Therefore, it has been concluded that there was no reason to accept that the shares were sold only for the purpose of reducing the tax liability.

The Tribunal has placed reliance on the judgement of Hon'ble the Supreme Court rendered in the case of Union of India v. Ajadi Bachao Andolan (2003) 263 ITR 706 which has explained in detail its earlier judgement in the case of McDowell & Company Ltd. v. CTO (1985) 154 ITR 148.

Similar issue was considered by a Division Bench of the same Court in the case of M/s Porrits & Spencer (Asia) Ltd v. The Commissioner of Income Tax, Faridabad (ITA No.10 of 2004 decided on 31.3.2010). In that conclusions drawn were as follows:

1. that once the transaction has been found to be genuine by the Tribunal then it cannot be dubbed as colourable device.
2. When the transaction was otherwise valid in law and a part of tax planning then merely because it has resulted in reduction of tax it cannot be ignored on the ground that the underlying motive of entering into such a transaction by the assessee was to reduce its tax liability to the State.
3.    The evasion of tax is substantially different than the planning concerning tax.
4.    A tax payer will be within his right to resort to a device to divert the income before it arrives to him and effectiveness of such a device would not depend upon consideration of morality.

 Applying the decision and conclusions arrived at in the case of M/s Porrits & Spencer (Asia) Ltd.'s case (supra), judges held that “we are not inclined to admit these appeals as no question of law would arise for determination of this Court. The other questions claimed by the revenue are consequential.”

Therefore court held that all these appeals fail and the same are dismissed. 

Conclusions:

A transaction should be looked at on totality of facts, business and financial consideration. Merely because a transaction is with a related party should not be ground or reason to doubt its genuineness. 

A genuine transaction may result into profit or loss depending on facts and circumstances. 

A transaction of sale may result into loss. The reason of loss is not necessarily the transaction of sale, it is many times due to wrong decision of buying at wrong time or at higher cost or wrong item bought.

A transaction may be entered into with a view to raise money, reduce borrowings, reduce further loss etc. merely because a transaction results into some tax advantages to the assessee, it cannot be regarded as a subterfuge or device to reduce tax liability. 

Tax liability or reduction of tax liability is a consequence of business or other transaction. If the transaction is genuine, bonafide, and result of business considerations then resultant loss should be accepted.