Judicial approach with regard to taxation in cases of tax avoidance schemes. - Income Tax - 1593/CBDT

INSTRUCTION NO. 1593/CBDT Dated: January 8, 1985 Schemes formulated with a view to avoid taxes being within the letter of the law had the judicial approval. In IRC v. Duke of Westminster(1935) All E.R.259 (1936) A.C.I. at p.19, sub nom Duke of Westminster, V.IRC 19 Tax cases 490 at p.520, Lord Tomin had held: "Every man is entitled if he can to order his affairs so as that the tax attaching under the appropriate Acts is less then 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. This so called doctrine of the substance seems to me to be nothing more than an attempt to make a man pay not withstanding that he has so ordered his affairs that the amount of tax sought from him is not legally claimable." 2. Later on the House of Lords in W.R.Ramsay Ltd. Vs. IRC(1982) AC (1981) I |All ER 865(1981) STC 174 HELD THAT WHERE THE COURTS ARE ASKED TO DETERMINE THE LEGAL EFFECT OF A TRANSACTION CARRIED out in steps as part of a pre-arranged scheme the courts are entitled to compare the position after the last step with that before the first and levy tax on that basis the courts are not limited to examining each steps separately. However still the principle was that a transaction could not be disregarded and treated as fiscal nullity if it had enduring legal consequences. 3. The House of Lords in Furniss (Inspector of Taxes) Vs. Dawson and Related Appeals (1984 I ALL ER 530 ) held that this distinction was of no consequence for purposes of taxation. Lord Brightman in his main judgement in this case observed as under : "My Lords in my opinion the rationale of the new approach is this. In a preplanned tax saving scheme no distinction is to be drawn for fiscal purposes because none exists in reality between (i) a series of steps which are followed through by virtue of an arrangement which falls short of a binding contract and (ii) a like series of steps which are followed through because the participants are contractually bound to take each step seriatim. In a contractual case the fiscal consequences will naturally fall to be assessed in the light of the contractually agreed results. For example, equitable interests may pass when the contract for sale is signed. In many cases equity will regard that as done which is contracted to be done. Ramsay says that the fiscal result is to be no different if the several steps are predarned rather than precontracted. For Example in the third instant case tax will on the Ramsay principle fall to be assessed on the basis that there was a triparti contract between the Dawsons, Greenjacket and Wood Bastow under which the Dawsons contracted to transfer their shares in the operating companies to Greenjacket in return for an allotment of shares in Greenjacket and under which the Greenjacket simultaneously contracted to transfer the same shares to woodbastow for a sum in cash. Under such a triparti contract the Dawsons would have clearly disposed of the shares in the operating companies in favour of woodbastow in consideration of sum of money paid by woodbastow with the concurrence of the Dawsons to Greenjacket. Tax would be assessed, and the base value of the Greenjacket shares calculated, accordingly. Ramsay says that this fiscal result cannot be avoided because the preordained series of steps are to be found in an informal arrangement instead of in a binding contract. The day is not saved for the tax payer because the arrangement is unsigned and contains the magic words this is not a binding contract. In this connection reference is also invited to the judgement of the Supreme court in Juggilal Kamalapat Vs. C.I.T.(1969) 73 ITR 702 at page 710. It is true that from juristic point of view the company is a legal personality entirely distinct from its members and the company is capable of enjoying rights and being subjected to duties which are the same as those enjoyed or borne by its members. But in certain exceptional cases the court is entitled to lift the veil of corporate entity and to pay regard to the economic realities behind the legal facade. For example, the court has power to disregard the corporate entiry if it is used for tax evasion or to circumvent tax obligation or to perpetrate fraud. This change in Judicial approach in regard to taxation in cases of tax avoidance schemes may please be circulated among officers working in your charge immediately.