IN THE INCOME TAX APPELLATE TRIBUNAL
SPECIAL BENCH, MUMBAI

I.T.A.No. 8020(Mum)/2003
Assessment year : 2001-2002

WALLFORT SHARES & STOCK BROKERS LTD
205, Gundecha Chambers,
Nagindas Master Road, Fort
Mumbai-400 001.

Vs

INCOME TAX OFFICER
Ward 4(2)(1), Aaykar Bhawan,
Mumbai

I.T.A.No. 2307(Mum)/2004
Assessment year : 2000-2001

WALLFORT SHARES & STOCK BROKERS LTD
205, Gundecha Chambers,
Nagindas Master Road, Fort
Mumbai-400 001.

Vs

ADDL. COMMISSIONER OF INCOME TAX-205,
Range 4(2), Aaykar Bhawan, Mumbai

Dated: July 15, 2005

BEFORE SHRI VIMAL GANDHI, HON'BLE PRESIDENT,
SHRI J.P. BENGRA, VICE-PRESIDENT,
SHRI S.C. TIWARI, ACCOUNTANT MEMBER,
SHRI N. BHARATHVAJA SANKAR, ACCOUNTANT MEMBER, &
SHRI T.K. SHARMA, JUDICIAL MEMBER

Appellant by : Mr. Soli Dastur & Sh. R. Muralidhar
Respondent by : Mr. S.D. Kapila, Spl. Counsel Mr. V.S. Singh & Mr. Mahesh Kumar

ORDER

PER S.C. TIWARI, A.M. :

These two appeals have been filed by the assessee on 17.12.2003 and 6.4.2004 against the orders of the learned CIT (Appeals)-IV, Mumbai dated 7.11.2003 and 12.12.2003 in the case of the assessee in relation to assessment orders u/s 143(3) for assessment years 2001-2002 and 2000-2001 respectively. These appeals have been referred to us as a Special Bench to decide the following issues:-

1. “Whether on the facts and in the circumstances of the case, the loss incurred by the assessee on purchase and sale of units of Mutual Funds is allowable or not?

2. Whether the provisions of section 94(7) of the Income-tax Act, 1961 can be interpreted as retrospective in operation and if so, its effect?”
2. The facts of the case relevant to the questions referred to us, briefly, are that the assessee company filed return of income for assessment year 2001-2002 disclosing total income at Rs. 57,31,610/- on 29th October, 2001. The Assessing Officer completed assessment u/s 143(3) on 31.3.2003 at total income of Rs. 2,58,46,553/-. During the year the assessee was a member of Mumbai Stock Exchange and traded shares on own account as well as on behalf of its clients. In addition, the assessee purchased on 18.12.2000 and sold on 21.12.2000 units of Sun F&C Mutual Fund. The learned CIT(A) has enumerated the assessee’s claim of loss on this transaction in tabular form in para 2 of the impugned order in the following manner:-

Particulars Purchase Sale Gain/Loss Dividend amount
______

Date Amount Date Amount
------

Units of 18.12.00 100,000,000
Sun F &
C Mutual
Fund

Less:
Incentive 1673563.22
------
98326436.78

Add:
Dividend 20114942.53
reinvested ------
118441379.31 21.12.00 97,126,436.79 21314942.52 20,114,942.53
______

During the course of assessment proceedings the assessee submitted that it had incurred loss in the aforesaid transaction in the normal course of its business of trading in shares and securities and, therefore, the loss amounting to Rs. 21,314,942/- was a business loss. The assessee argued that in purchase and sale of units of a mutual fund, there could be fluctuation in price because the NAV fluctuated from time to time. The assessment of a transaction of this nature had to be uniform where dividend is received and income is earned on sale as well as where dividend is received and loss is incurred on sale. The mere fact that the dividend received by the assessee from the mutual fund was exempt from income-tax in view of the provisions of section 10(33) of the Act could be no ground to disregard or ignore the resultant loss suffered by a person purchasing the units cum- dividend and selling the units ex-dividend, after collecting the dividend from the mutual fund.

3. The learned Assessing Officer held that the assessee had entered into a pre-meditated agreement with the mutual fund with the sole purpose of avoidance of tax. All transactions occurred within two days. The units were purchased just before the book closure of the mutual fund and were redeemed as soon as dividend was paid out. In this process the assessee suffered reduction of 2% entry load charge when the mutual fund redeemed back the units sold. The assessee knew beforehand that the net result of the transaction would be a financial loss or outflow. The only gain was tax free dividend. The details of other share transactions furnished by the assessee did not conform to this pattern. In this transaction what was given back to the assessee was assessee’s own investment or capital only which was returned to him in the form of dividend and redemption amount.

4. According to the learned Assessing Officer the transaction under consideration had no motive to earn profit. In open end scheme, it was but natural that NAV shall be reduced by the amount of dividend outflow. Looking to the extremely short period for which funds were parked by the assessee, it was crystal clear that the mutual fund had not invested the money deposited by the assessee and dividend had been paid out to the assessee from out of the purchase price of the units. The assessee knew before hand that it would receive dividend out of its own funds and thereafter the difference in purchase and sale price of units would be a certain loss. The assessee intended to gain because it would reduce such loss from its other taxable income, while the dividend would be claimed as exempt u/s 10(33). The mutual fund, on the other hand, would gain by charging the entry load or exit load and in some cases even both.

5. The learned Assessing Officer held that the basic scheme of a mutual fund was either growth or income or both. However, the manner in which the transaction took place, the objective was neither growth nor income. Hence the transaction revealed an unholy nexus between the mutual fund and the tax avoider. The word “business” though of large and indefinite import connoted something which occupied the attention and labour of a person for earning profit. Profit motive was the crucial test for determining whether it was a business activity and, therefore, implied involvement of some risk in the transaction. A business or an adventure in the nature of trade could not include a transaction where loss was inevitable and a foregone conclusion. There could be loss in a business transaction as an incidence but not as certainty. Therefore, the transaction in question was not a business or commercial transaction and could not be regarded as business. Every loss was not deductible unless it was result of a business. If the loss was not incidental to the business, the same could not be allowed as deduction.

6. The Assessing Officer made the following conclusions:-
1 “The scheme is a pure tax avoidance scheme without any commercial justification in so far as the making of a profit is concerned.

2 The transactions are self-canceling and are designed to make neither a gain nor a loss. The tax payers would not have entered into the scheme, if a loss would be incurred.

3 The money required for the transaction is provided by a third party solely for the purpose of the scheme and is returned on completion of the scheme (Bank current A/c. overdraft facilities used by the assessee for 3 days transaction).

4 These transactions have no commercial purpose apart from the avoidance of tax liability.

5 In this kind of transaction, both the assessee and mutual funds are making a handsome gain. The mutual funds by charging the entry or exit load and the assessee by claiming a loss.

6 On the one hand, the assessee is showing loss on account of purchase and sale of units of mutual funds and the other hand, he is almost getting a similar amount of dividend which it can claim as exempt from tax under sec. 10(33). The entire transaction is taking place in a pre-ordained manner and it is nothing but a fiscal nullity.”

Relying upon the judgment of Hon'ble Supreme Court in the case of CIT Vs. India Discount Co. Ltd., 75 ITR 191 (SC), the learned Assessing Officer held that dividend received in respect of shares purchased on cum-dividend basis would reduce the cost of acquisition in the hands of the purchaser. Following the ratio of the aforesaid Supreme Court judgment, the learned Assessing Officer calculated the loss arising to the assessee in the following manner:-

Purchase price of share cum dividend 1,00,000,000/-

Less: Dividend declared Rs. 20,114,942/-
Incentive received from MF 1,673,563/-21,788,505
78,211,495

Less: Sale price of Units Rs. 97,126,436/-
Less: Dividend received Rs. 20,114,942/- 77,011,494

Actual loss incurred in the units
of transaction.1,200,001
------

7. Accordingly the learned Assessing Officer allowed the assessee loss of Rs. 12,00,001/- only as against the loss of Rs. 21,314,942/- claimed by the assessee. He found support from the judgment of House of Lords in the case of S.Craven (Inspector of taxes) Vs. White (Stephen), 183 ITR 216 (HL).

8. Aggrieved by the order of assessment, the assessee filed appeal before the learned CIT(Appeals). The assessee submitted that units of mutual funds were regulated by an independent body constituted under the Act of Parliament, viz., SEBI. The assessee had followed the prescribed procedure and the transactions with the mutual funds were at arms length. The assessee argued that the transactions were not pre-ordained because of high volatility in the assessee’s line of trade. Loss had arisen on account of fall in NAV. As the assessee had not adopted any colorable device, the decision of Hon'ble Supreme Court in the case of Mcdowell & Co. Ltd. was not applicable. The learned CIT(Appeals) held that the transaction entered into by the assessee was popularly known as dividend stripping or a bed and breakfast scheme. In such scheme shares were purchased pregnant with dividend, thereafter dividend was received and shares were sold minus dividend. Resultant loss was claimed against other taxable income. The learned CIT(Appeals) referred to the judgment of House of Lords in the case of Griffiths Vs. J.P. Harrison, 58 ITR 328 (P.C) In that case the assessee purchased shares of a company. That company had at that time no business but considerable accumulated profits. After the company declared dividend, the assessee sold the shares minus dividend at loss. In the process there was difference between purchase price and sale price resulting into loss of Pounds 15900. The assessee set off that loss against dividend income of Pounds 15901. At the same time the assessee sought refund of taxes paid by the company in relation to the dividend payments under the provisions of section 341 of the Act. On those facts divergent views were expressed by their Lordships. The learned CIT(Appeals) referred to the minority view in that judgment and extracted at length from the judgment of Lord Denning, who propounded that the motive behind the transaction should also be considered while deciding particular transaction. Learned CIT(A) then referred to another judgment of House of Lords in the case of Finsbury Securities Ltd. Vs. Bishop (Inspector of Taxes) 43 Tax Cases 591 (H.L). In that judgment Lord Morris of Borth-Y-Gest, who had held the transactions as trading transaction in the case of Griffiths Vs. J.P. Harrison (supra) held different view of the matter. He held that the transactions were no more than devices which were planned and contrived to effect the avowed purpose of tax avoidance. He further held that the arrangements under consideration could not be regarded as within the trade of share- dealing. The view of Lord Morris was endorsed fully by other law lords. Thus, there was visible shift in the thinking of House of Lords. Thereafter another path breaking judgment came in the form of Lupton Vs F.A. & A.B. Ltd. 47 Tax cases 580 (HL). The case of Lupton marked a water shed in tax avoidance cases. Their Lordships noted the earlier judgments in the cases of Griffiths Vs. J.P. Harrison Ltd. and Finsbury Securities Ltd. Vs. Inland Revenue Commissioner. It was held that if upon analysis it was found that the greater part of the transaction is explicable only on fiscal grounds, the mere presence of element of trading will not suffice to translate the transaction into the realms of trading. The learned CIT(Appeals) noted that subsequent judgments in the case of Ramsay Ltd. Vs. Inland Revenue Commissioner 1982 A.C. 300 (HL); Inland Revenue Commissioner Vs. Burmah Oil Co. Ltd. 1982 STC 30 (HL) and Furniss Vs. Dawson 1984 1 All England Reporter 530 (HL) added new dimension to the legal interpretation of the tax avoidance transactions. The contents and the nature of the principles established in those three cases were dealt with extensively in the case of Craven Vs. White 183 ITR 216 (H.L). It was laid down that an artificial avoidance scheme did not alter the incidence of tax. According to the learned CIT(Appeals), the principle of form over substance which was commonly referred to as Westminster principle with reference to the judgment in the case of Duke of Westminster 1936 A.C. 1 (H.L.) was overwhelmed by the judgments in the cases of Ramsay, Burmah Oil and Furniss, which stood by substance. In India also the doctrine of Duke of Westminster was visible from the cases, such as Jiyaji Rao Vs. CIT, 34 ITR 888; CIT Vs. Raman & Co., 67 ITR 11 (SC) and CIT Vs. Kharwar, 72 ITR 693 (SC). However, the doctrine came under full scrutiny of the Full Bench of Supreme Court in the case of Mcdowell & Co. Ltd. Vs. CTO, 154 ITR 148 (SC), which was thereafter followed in the case of Workmen Vs. Associated Rubber Industries, 157 ITR 77 (SC). In that judgment it was observed, “The time has come for us to depart from the Westminster principle as emphatically as the British Courts have done and to disassociate ourselves from the observations of Shah J. and similar observations made elsewhere.” The learned CIT(Appeals) then quoted at length from the judgment in the case of Mcdowell & Co. He also relied upon the judgment of Hon'ble Bombay High Court in the case of Twinstar Holdings Ltd. Vs. Anand Kedia , Dy. CIT, 260 ITR6 (Bom.)

9. According to the learned CIT(Appeals) the argument of the assessee that insertion of the provisions of section 94(7) of the Act was w.e.f. 1.4.2002 only required a careful thought. Merely because the amendment had not been given retrospective effect by the Legislature, the principles laid down by Hon'ble Supreme Court and House of Lords could not be thrown to the winds and colourable transactions could not be given legal sanctity or approval in a similar situation. The learned CIT(Appeals) referred to the judgment of House of Lords in the case of Lupton. In that case forward stripping had been banned by the Finance Act, 1960, but the House of Lords did not think that the subsequent amendment should prejudice or cloud the process of thinking and the objectivity. The transaction had to be viewed as it was, i.e., the colourable device.

10. The learned CIT(Appeals) proceeded to examine the nature of the transaction. The purpose of the transaction was to have double benefit of not only the tax free income but also reduction of incidence of tax on the assessee’s other income chargeable to tax. The mutual fund played the role of facilitator of the scheme of tax avoidance. These mutual funds advertised in the newspapers the record date and the amount of dividend to be declared. Subscribers, financiers, brokers came alive instantly within hours and subscriptions for units running into crores of rupees were made. In such cases there were ready-made and ever willing financiers willing to finance the transaction without any risk as to the money advanced because the money invested in purchase of units was going to be collected from mutual fund directly in a span of a day. In most of the cases, the assessee who neither had money to invest entered into the fray to get the double benefit. In the process everybody involved in the exercise got benefited. The purchaser got the double benefit of tax free dividend and consequential loss. The brokers were paid handsomely for the services by Mutual Funds. Financiers earned fixed interest without much risk and mutual funds collected their fee in the form of entry load or exist load or both. These cases were distinguishable from the case of Griffiths Vs. J.P. Harrison (supra) in the same manner Lord Morris of Borth-Y-Gest distinguished the subsequent cases of Finsbury Securities etc. In the case of the assessee the vendors of the units were interested parties to have the benefit resulting from the scheme. In the Harrison case there was nothing to suggest that the vendor knew of the intention or stood to derive any benefit from the dividend stripping. In the present case Mutual Funds were consciously marketing tax mitigation scheme. The very fact that touts/brokers were engaged by the mutual funds to lure the customers into the various schemes marketed by them showed the deep rooted nexus and also the collusion between mutual funds and other market forces to entrap the customers into the scheme. Thus, the observations of the House of Lords distinguishing their judgment in Harrison case were relevant and applicable on the fact situation in the assessee’s case.

11. The learned CIT(A) found support from the judgment of Hon'ble Bombay High Court in the case of Twinstar Holdings Ltd. He relied also on the observations of Lord Denning in the case of Griffiths Vs. J.P. Harrison. The transaction entered into by the assessee could not qualify to be “commercial” or “business” transaction. The definition of the word “business” in section 2(13) was of wide import, but the underlying idea was the continuous exercise of an activity for profit. Without profit the transaction was no more business as pickle was not candy. Reference was made to the judgment of Hon'ble Gujarat High Court in the case of CIT Vs. Motilal Hirabhai Spinning & Weaving Co. Ltd., 113 ITR 174; of Allahabad High Court in the case of Senairam Dongarmal Vs. CIT,42 ITR 392 (S.C); of Supreme Court in the case of Mahendra Prasad Vs. ITO, 129 ITR 295 (SC); of Supreme Court again in the case of Sole Trustee Lokashikshana Trust Vs. CIT, 101 ITR 234 (SC) and of Bombay High Court in the case of Provident Investment Co. Ltd. Vs. CIT, 6 ITC 21 (Bom.) in support of the proposition that an activity undertaken without profit motive could not be considered to be business activity. According to the learned CIT(Appeals), the loss claimed must be one which directly sprung from the business of the assessee. In the case of the assessee in question, the loss incurred had not even remotest connection with the business of the assessee, nor it was incidental thereto. Furthermore, another essential feature of business was that there should be a continuous course of activity. That too was missing in the case of the assessee. Hence even though the transaction was not a sham or illusory transaction, the fiscal content or fiscal element needed to be viewed correctly.