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The first GAAR case in India - An analysis
By D P Sengupta
Jun 18, 2024

ON the 7th of June, 2024, almost 12 years after the first enactment of the General Anti- Avoidance Rule (GAAR) in India's income tax law, the first case relating to the invocation of GAAR has been decided by the Telangana High Court - (2024-TII-41-HC-TELANGANA-INTL) - (2024-TIOL-1021-HC-TELANGANA-IT). The GAAR in India was enacted for the first time in 2012 along with the much-debated provisions to deal with the phenomenon of indirect transfer of assets. When enacted, it was drubbed as draconian and intense lobbying ensued to dilute its provisions. A Committee headed by the then Advisor to the Finance Minister, Mr.P. Shome, suggested dilution of some of the original provisions and recommended its adoption with some important changes. The subsequent government finally operationalised the provisions in Chapter-X of the Income Tax Act containing sections 95-102 of the Income Tax Act.

The present case involves one Mr. Alla Ayodha Rami Reddy, founder of the Ramky group. Google search tells us that he is one of the richest MPs in India, being a Rajya Sabha member of the YSRCP Congress. According to a Times of India Report of 6th July 2021, the IT department had conducted raids at the premises of the Ramky group to check whether certain losses shown by some companies of the group were genuine or not.

The facts as appear from the order of the High Court in a writ of mandamus filed by the petitioner, meaning Mr. Ayodhya Rami Reddy Alla, are that some bonus shares were issued to him by Ramky Estate and Farms Limited (REFL). The bonus shares were issued by REFL in the ratio of 5:1. Now, when bonus shares are issued, the total number of shares of the issuing company increases but no fresh capital comes in and consequently the face value of each share falls proportionately and since in this case the bonus was issued in the ratio of 5:1, the face value of the shares fell by 1/6th. The taxpayer sold the shares of REFL to another group company called Advisory Services Pvt Ltd (ADR). Since there was a fall in the face value of the shares consequent to the issue of the bonus shares, the taxpayer incurred a short term capital loss in the transaction of sale. The assessment year involved was 2019-20.

Apparently, the taxpayer had undertaken another sale of shares in the same year in another group company, Ramko Enviro Engineers Limited (REEL) and a profit had accrued to him on account of long term capital gains. The taxpayer adjusted the short term capital loss incurred in the first transaction against the long term capital gain incurred in the second transaction and paid the requisite tax on the balance and filed his return of income.

From the narration of events so far, it is assumed that the case must have been centralised for investigation since the respondent in the case is the Principal Commissioner of Income Tax, Central. The news report in Times of India also mentions that a search was undertaken to verify the veracity of the alleged loss in the share transactions. It is not known what the search revealed. Be that as it may, the court order mentions that the Principal CIT issued a notice to the taxpayer to show cause as to why the provisions of the GAAR contained in Chapter X-A should not be invoked against him.

Section 144BA(1) of the ITA lays down an elaborate procedure even for the mere invocation of the GAAR. Currently, it states as follows:

(1) If, the Assessing Officer, at any stage of the assessment or reassessment proceedings before him having regard to the material and evidence available, considers that it is necessary to declare an arrangement as an impermissible avoidance arrangement and to determine the consequence of such an arrangement within the meaning of Chapter X-A, then, he may make a reference to the Principal Commissioner or Commissioner in this regard.

(2) The Principal Commissioner or Commissioner shall, on receipt of a reference under sub-section (1), if he is of the opinion that the provisions of Chapter X-A are required to be invoked, issue a notice to the assessee, setting out the reasons and basis of such opinion, for submitting objections, if any, and providing an opportunity of being heard to the assessee within such period, not exceeding sixty days, as may be specified in the notice.

(3) If the assessee does not furnish any objection to the notice within the time specified in the notice issued under sub-section (2), the Principal Commissioner or Commissioner shall issue such directions as he deems fit in respect of declaration of the arrangement to be an impermissible avoidance arrangement.

(4) In case the assessee objects to the proposed action, and the Principal Commissioner or Commissioner after hearing the assessee in the matter is not satisfied by the explanation of the assessee, then, he shall make a reference in the matter to the Approving Panel for the purpose of declaration of the arrangement as an impermissible avoidance arrangement.

(5) If the Principal Commissioner or Commissioner is satisfied, after having heard the assessee that the provisions of Chapter X-A are not to be invoked, he shall by an order in writing, communicate the same to the Assessing Officer with a copy to the assessee.

(6) The Approving Panel, on receipt of a reference from the Principal Commissioner or Commissioner under sub-section (4), shall issue such directions, as it deems fit, in respect of the declaration of the arrangement as an impermissible avoidance arrangement in accordance with the provisions of Chapter X-A including specifying of the previous year or years to which such declaration of an arrangement as an impermissible avoidance arrangement shall apply.

(7) No direction under sub-section (6) shall be issued unless an opportunity of being heard is given to the assessee and the Assessing Officer on such directions which are prejudicial to the interest of the assessee or the interests of the revenue, as the case may be.

(8) The Approving Panel may, before issuing any direction under sub-section (6),-

(i) if it is of the opinion that any further inquiry in the matter is necessary, direct the Principal Commissioner or Commissioner to make such inquiry or cause the inquiry to be made by any other income-tax authority and furnish a report containing the result of such inquiry to it; or

(ii) call for and examine such records relating to the matter as it deems fit; or

(iii) require the assessee to furnish such documents and evidence as it may direct.

(9) (…)

(10) The Assessing Officer, on receipt of directions of the Principal Commissioner or Commissioner under sub-section (3) or of the Approving Panel under sub-section (6), shall proceed to complete the proceedings referred to in sub-section (1) in accordance with such directions and the provisions of Chapter X-A.

(…) Other provisions in the section are not relevant for the case in hand. In fact, the case did not proceed beyond sub-section 2.

In terms of Rule 10 UB (1), even before the reference to the Principal Commissioner, the assessing officer has to issue a notice to the taxpayer. The said rule states:

(1) For the purposes of sub-section (1) of section 144BA, the Assessing Officer shall, before making a reference to the Commissioner, issue a notice in writing to the assessee seeking objections, if any, to the applicability of provisions of Chapter X-A in his case.

(2) The notice referred to in sub-rule (1) shall contain the following:-

(i) details of the arrangement to which the provisions of Chapter XA are proposed to be applied;

(ii) the tax benefit arising under the arrangement;

(iii) the basis and reason for considering that the main purpose of the identified arrangement is to obtain tax benefit;

(iv) the basis and the reasons why the arrangement satisfies the condition provided in clause (a), (b), (c) or (d) of sub-section (1) of section 96; and

(v) the list of documents and evidence relied upon in respect of (iii) and (iv) above.

(3) (…).

(4) (…)

(5) Before a reference is made by the Commissioner to the Approving Panel under sub-section (4) of section 144BA, he shall record his satisfaction regarding the applicability of the provisions of Chapter X-A in Form No. 3CEI and enclose the same with the reference.

From the order of the High Court, it appears that the Deputy Commissioner of Income Tax (referred to as Respondent no 2) in the court's order had issued a notice on 02.08.2022 as required by Rule 10UA (1) seeking objections from the taxpayer. The taxpayer submitted his response rebutting the allegations raised by the AO. It is thereafter that the Principal Commissioner issued a notice to the taxpayer stating that the transactions qualify as impermissible avoidance agreement and he again called for the objections from the taxpayer. It seems that it is at this stage that the taxpayer straight way filed a writ petition before the High Court challenging the very initiation of the proceedings under Chapter-X-A as illegal and uncalled for.

The High Court dealt with the case in the order in which the arguments were made and it is a pity that the actual facts are not exactly clear and have to be discerned from the order as stated in different places. This may be because of the taxpayer's reliance on the legal position without getting into facts.

From the argument of the Additional Solicitor General who appeared for the tax department that vide order dated 05.02.2019, the Board of Directors (not clear of which company) had sanctioned inter corporate deposit of INR.350 crores to a related entity REFL i.e., the company that had issued the bonus shares.

Further, it seems that the overall case of the department is the writing off of the loan to the extent of 288.50 crores in the ledgers of the group companies involved in the month of March, 2019, that is within one month of the sanction of the alleged loan in February 2019 through the ruse of a set off of an artificially generated capital loss against capital gains. Unfortunately, this part is not very clear from the narration in the order of the High Court- which states: "The mischief played by the petitioner was that all the ledgers reflected the writing of the loan to the tune of Rs.288.50 crores during the month of March, 2019, and further the said amount was claimed as business loss and set off against the capital gains." What follows from the narration of the argument of the ASG seems to be the manner in which the above purpose was achieved.

Apparently, on 27.2.2019 in the AGM of REFL, its authorised share capital was increased and the AGM also decided to allot 7,64,40,100 shares on a private placement basis to the taxpayer and 5,56,52,175 shares to one M/s. Oxford Ayyapa Consulting Services Private Limited.

Immediately thereafter, in a short span of time, Mr Reddy purchased the aforementioned 5,56,52,175 shares of REFL from Oxford. (Money must have been due to or paid to Oxford).

On 04.03.2019, REFL declared bonus shares in the ratio of 1:5 and as a consequence of bonus shares declaration, the value of the shares got declined from INR115 per share previously to INR19.20 per share.

On 14.03.2019, Mr Reddy sold Rs.5,56,52175- shares to the group firm ADR at the rate of INR 19.20 per share, thereby, resulting in a business loss of approximately Rs.462 crores. The tax department alleged that this sale was without any business purpose and that ADR, the alleged purchaser did not even have sufficient sources of funds to buy the shares of REFL and the funds in this regard were provided by Oxford Ayyapa Consulting Services India Private Limited (from whom Mr. Reddy purchased the shares) to ADR.

It was argued that "the money which was funded by M/s. Oxford Ayyapa Consulting Services India Private Limited were returned by way of rotation of funds from within the group itself in the form of transfer from one group concerned to another."

Thus, the overall case of the tax department was that the entire exercise was nothing but round stripping of funds with no commercial substance. Besides, the entire exercise was done only with a mala fide intention of avoiding the payment of tax by creating losses without any economic, rational, and commercial substance.

The taxpayer, on the other hand, wanted to skirt all these inconvenient factual issues and its main argument was that the Act contained a specific anti-avoidance rule in section 94(8) relating to bonus stripping and when there is a special anti-avoidance rule (SAAR), recourse to the GAAR provision is illegal per-se, since in terms of established jurisprudence, a special provision takes precedence over a general provision.

Section 94(8) was introduced by the Finance No2 Act 2004 to prevent the then prevailing practice of rampant bonus stripping in units of Mutual Funds. At that time shares of companies were not covered in its ambit. It was only through Finance Act 2022 that other types of securities including shares were brought within the ambit of s 94(8). The assessment year being 2019-20, section 94(8) would not apply. Strangely, however, the taxpayer argued that since its case was one of bonus stripping and that bonus stripping was not in its ambit at the relevant point of time, the provisions of GAAR would not apply to its case.

The taxpayer also relied on the observation of the Shome Committee that GAAR should not apply when SAAR applies. Many of such Shome Committee's recommendations were inconsistent and I have earlier written extensively about the same. At any event, not all of its recommendations were accepted. But the taxpayer, for some strange reason relied on the same and argued that its case was covered by chapter-X of the ITA and not chapter X-A containing the GAAR and hence the proceedings initiated were contrary to law and had to be set aside.

The tax department, in particular the ASG pointed out the factual aspects of the case as narrated earlier and also submitted that no writ should lie against a mere notice and that the taxpayer could enter appearance and take all the relevant objections in the regular proceedings.

The legal arguments of the taxpayer being very weak, it was not difficult for the Court to demolish the same. The Court rightly pointed out that the GAAR provisions were brought into force by the Finance Act, 2013 effective 1.4.2016 while the special provisions already existed in the Act. The Court observed that here is a situation where a special provision of law relating to bonus stripping was already there in the Act when the general provision of law has been subsequently enacted; that normally it is the vice-versa, i.e., where the general provision of law already being in force, a special provision of law is subsequently enacted and only in this latter situation, a special provision would override the general provision.

Further, section 95 (GAAR provision) starts with a non-obstante clause- 'Notwithstanding anything contained in the Act…'Therefore, the provisions of chapter X-A gets an overriding effect over and above the other existing provisions of law.

The Court rightly pointed out that even before the introduction of GAAR, there was already the Judiciary evolved anti-avoidance rule or JAAR and generally speaking, the judiciary has always tried to uphold the substance over form doctrine, seeking to uncover misleading structures or transactional arrangements that lacked real commercial substance. Besides, the taxpayer's argument that section 94(8) should take precedence over GAAR was contradictory in that as per taxpayer's own submission, at the relevant point of time, it did not apply to transactions in shares.

The Court held that section 100 of chapter -X-A clarifies that it is applicable in addition to or in lieu of any other basis for determination of tax liability. This provision thus emphasizes the legislative intention that the GAAR provisions should act as an all- encompassing safety net. It's designed to capture all illicit arrangements, ensuring that tax on these arrangements is calculated using the provisions of this Chapter.

The Court also agreed with the revenue's contention that Section 94(8) might be relevant in a simple, isolated case of the issuance of bonus shares, provided such issuance has an underlying commercial substance. However, this provision does not apply to the present case, as issuance of bonus shares here is evidently an artificial avoidance arrangement that lacks any logical or practical justification.

As for Shome Committee's recommendations, the Court pointed out that only some of its recommendations were accepted and that in terms of subsequent CBDT clarification, GAAR may apply even when SAAR applies to a particular case depending on the facts and circumstances.

Interestingly, to rebut the taxpayer's argument that facts of the case are irrelevant to determine the application of general law, the Court relied on a decision of the Supreme Court in an old case- Commissioner of Income Tax (Central), New Delhi v S. Zoraster and Company - 2002-TIOL-1331-SC-IT wherein the Court stated that laws must be interpreted based on the specific facts of each case.

According to the court, in terms of the Vodafone judgement of the Supreme Court also, the business intent behind a transaction could serve a strong piece of evidence that a transaction is not deceptive or artificial. But, the burden of proof there is on the revenue. However, section 96(2) of the Act requires the taxpayer to disprove the presumption of tax avoidance.

The court held: "In this particular case, there is clear and convincing evidence to suggest that the entire arrangement was intricately designed with the sole intent of evading tax. The Petitioner, on their part, hasn't been able to provide substantial and persuasive proof to counter this claim."

Referring to the McDowell &Co case, the Court reiterated that tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid payment of tax by resorting to dubious methods. It is obligation of every citizen to pay taxes honestly without resorting to subterfuges.

The Court held that the procedural rules for application of GAAR involve a comprehensive examination of all elements of the transaction upholding the principles of fairness at each step and the circumvention of the process by filing a writ raises questions about the motive of the taxpayer.

The Court finally dismissed the writ petition and allowed the department to proceed with the GAAR process.

Strictly speaking, it is not a case where GAAR has been invoked and order passed after obtaining the approval of the GAAR Panel. The taxpayer tried to stymie the very effort of invoking the GAAR by filing a writ at the level of notice itself. In this case though the court has more or less given a verdict that GAAR is applicable. So, it will be interesting watch the further developments in this case.

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