TAX AVOIDANCE

[Mr. M. GOVINDARAJAN]

In respect of tax avoidance we may refer the dictum laid down by the House of Lords in England in the case of IRC Versus Duke of Webminster (1936) AC 1 (754 of 263 ITR).  In that case it was held that every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be.   If he succeeds in ordering them so as to secure this result, then, however, unappreciative the Commissioners of Inland Revenue or his fellow tax payers may be of his ingenuity, he cannot be compelled to pay an increased tax.

The said was quoted by the Supreme Court of India in the case of 'Commissioner of Income Tax Versus A. Raman and Co., 1967 -TMI - 5051 - (SUPREME Court) and Madhuram Agarwal Versus State of Madhya Pradesh (1999) 8 SCC 667 decided by a Constitution Bench.

In 'A. Raman and Co.,' case (supra) the Supreme Court held that avoidance of tax liability is distributed is not prohibited.  A tax payer may resort to a devise to divert the income before it accrues or arises to him.   Effectiveness of the device depends not upon considerations of morality, but on the operation of the Income Tax Act.   Legislative injunction in taxing statutes may not, except on peril of penalty, be violated, but it may lawfully be circumvented.

In 'Macdowell's' case (1985) 154 ITR 148 the Court does not endorse the views expressed in Webminster and Raman case but expressed a different but concurring opinion.  However the Supreme Court in 'Union of India V. Azadi Bachao Andolan' 2003 -TMI - 6130 - (SUPREME Court) reiterated the observations made in the Duke of Webminster. 

The Supreme Court in 'LRC V. Fisher's Executors' (1926) AC 395 held that the higher authorities always recognized that the subject is entitled so to arrange his affairs as not to attract taxes imposed by the Crown, so far as he can do so within the law, and that he may legimately claim the advantage of any expressed terms or of any omissions that he can find in his favor in taxing Acts.

A Division Bench of Gujarat High Court in 'Commissioner of Income Tax V. Sakarlal Balabhai' - 1968 -TMI - 7120 - (GUJARAT High Court) observed - "Tax avoidance postulates that the assessee is in receipt of amount which is really and in truth his income liable to tax but on which he avoids payment of tax by some artifice or device.   Such artifice or device may apparently show the income as accruing to another person, at the same time making it available for use and enjoyment to the assessee in a case falling within Section 44D or mask the true character of the income by disguising it as a capital receipt as in a case falling within section 44E or assume diverse other forms.  But there must be some artifice or device enabling assessee to avoid payment of tax on what is really and in truth his income.   If the assessee parts with his income producing asset, so that the right to receive income arising from the asset which theretofore belonged to the assessee is transferred to and vested in some other person, there is no avoidance of tax liability; no part of the income from the asset goes into the hands of the assessee in the shape of income or under any guise.

In respect of Advance Ruling Section 245R (2) (iii) provides that the Authority shall not allow application where the question raised in the application relates to a transaction or issue which is designed prima facie for the avoidance of income tax.   The expression 'transaction designed for the avoidance of income tax' cannot be understood to mean that in the course of entering into a transaction, the taxpayer is precluded from taking into account the tax implications involved and to minimize its tax burden.   It is within the legitimate freedom of the contracting parties to enter into a transaction, which has the effect of extending to the party the benefit of exemption under the taxation statute. The contracting party is not bound to enter into a transaction in such a way that it results in tax liability while forgoing the benefit of exemption under law.  A design to avoid the tax within the meaning of clause (iii) of the proviso to Section 245R(2) apparently covers such of the transactions which are sham or nominal or which would lead to the inescapable inference of a contrived device solely with a view to avoid the tax.  The corollary thereto is that there is no real and genuine business purpose other than tax avoidance behind such transaction.

In 'Wood Polymer Ltd., In re (1977) 109 ITR 177 the Gujarat High Court furnishes a typical illustration of a deliberate design aimed only at tax avoidance by taking recourse to amalgamation.  The sanction to a scheme of amalgamation was refused by the Court exercising the jurisdiction under Section 391(2) of the Companies Act on the ground that the judicial process was sought to be used to escape from the tax net by adopting a dubious device or subterfuge and that the scheme was plainly opposed to public interest.  If the only purpose discernible behind the amalgamation is defeating certain tax and prior to the amalgamation, a situation was brought about by creating a paper company and transferring an asset to such company which can without further consequence be amalgamated to another company to whom the capital asset was to be transferred so that on amalgamation it can pass on to the amalgamated company, it would distinctly appear that the provision for such a scheme of amalgamation was utilized for the avowed object of defeating tax.

It is open to a party to so arrange its affairs so as to reduce its tax liability.   The assessee or party can arrange its affairs so that he or it may not incur any tax liability.  But it must be within the power of the party to arrange its affairs.   If the party seeks the assistance of the court only to reduce tax liability, the court should be the last instrument to grant such assistance or judicial process to defeat a tax liability, or even to avoid tax liability.   If the party has so arranged its affairs, as to reduce or even avoid tax liability and the taxing authority disputes it, and the matter is brought before the court, the court would adjudicate upon the dispute between the Revenue and the assessee on the rival contentions.

In 'Commissioner of Income Tax V. Punjab State Electricity Board' - 2009 -TMI - 34200 - PUNJAB AND HARYANA HIGH COURT a State Electricity Board sold some of its assets to a financier and took them back on lease by way of a sale and lease back transaction, enabling the financier-lessor to claim depreciation on the assets, while getting the right to deduction of the lease rent.   Such a mode of financing had become once popular because of tax advantage to the borrower as well as the financier securing for him a specific security.  The tax advantage for the financier stood forfeited by the amendment brought by the Finance Act,1996 with effect from 01.10.1996 requiring the substitution of written down value of the seller-lessee as the actual cost of the buyer-lessor for purpose of depreciation.   Prior to the amendment, such transactions were sought to be dismissed as a colorable device, so as to justify the Department to ignore the transaction at its face value.  The Court held that such transaction could not be dismissed as sham.   It has legal effect.  The fact that it reduces the tax burden cannot by itself justify the inference that is a colorable device.  It is not every case of tax planning, that is illegal/illegitimate.   It should be treated as a decision taken on the basis of business expediency.

Thus tax avoidance is not impermissible.