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Ruling
on legality of "Dividend Stripping" Transactions
The
Income Tax Appellate Tribunal ("ITAT"), Mumbai, in a recent
ruling in the case of Wallfort Shares & Stock Brokers Ltd. v.
Income Tax Officer (for assessment years 2001-02 and 2000-01),
held that mere knowledge of "dividend stripping" in a transaction
does not render it to be a tax avoidance strategy, so long as
the transactions between the parties take place at arm's length
and the parties act in the ordinary course of their business.
Further, the ITAT upheld the tax payer's right to set off losses
from such transactions against income chargeable to tax.
In
this case, the taxpayer company, (i.e., assessee), was a member
of Mumbai Stock Exchange and traded in shares. The assessee claimed
that it had incurred loss in the aforesaid transaction in the
normal course of its business and, therefore, the loss should
be treated as "business loss" and should be set off against income
chargeable to tax.
The
tax officer held that this transaction was a "dividend stripping"
transaction wherein, shares were purchased cum - dividend, and
after dividend was received, shares were sold ex-dividend. In
the instant case, resultant loss was set off against other taxable
income. The assessing officer further held that the assessee had
entered into a pre-meditated arrangement with the mutual fund
with the sole purpose of avoidance of tax and there was no commercial
purpose whatsoever and hence, it cannot be treated as "business
loss".
The
assessee filed an appeal before the CIT (Appeals) who also held
that the loss claimed by the assessee should be ignored as there
was no commercial purpose involved in the transaction and the
motive or intention of the assessee for entering into the transaction
in question was tax avoidance. When the matter came up before
the ITAT (Mumbai), the following three questions emanating from
the dispute were considered - (a) Whether the transaction was
a business transaction, (b) Whether the loss incurred by the assessee
on purchase and sale of units of mutual fund is allowable, and
(c) Whether the provisions of section 94(7) of the Income Tax
Act, 1961 ("ITA"), can be interpreted as retrospective
in operation and if so, its effect?
With regard
to the first issue, the ITAT observed that the parties to the
transaction knew that this transaction in the units of the mutual
fund scheme would serve as a tool for dividend stripping by
interested parties. Nonetheless the transactions between the
mutual fund and the assessee were at arm's length and none of
these mutual funds acted in any manner different from what they
were normally doing in the ordinary course of their business.
The mere knowledge of the mutual fund that their units may be
purchased and redeemed by dividend-strippers does not cloth
the mutual fund as a party to tax avoidance. With regard
to the second issue, the ITAT, referring to the case of Azadi
Bachao Andolan ruled that it is not every device resorted to
by a taxpayer to reduce his tax liability that can be disregarded
irrespective of the legitimacy or genuineness of the act. Further,
the ITAT emphasized that exemption under the provisions of section
10(33) of the ITA, to the income distributed by mutual funds
has continued all these years and so long as the tax payers
act in their ordinary course of business, not adopting any colorable
devices, they are entitled to have the loss arising from such
transactions set off against their income from any other transactions
or source. With regard
to the third issue, the ITAT held that the provisions of section
94(7) were introduced through the Finance Act, 2001, effective
from April 1, 2002, which provide that the losses arising from
the sale of securities or units (in respect of which dividend
or income on such securities or units is exempt to tax) would
be disallowed, if such securities or units have been purchased
upto 3 months prior to the record date and have been sold within
3 months after such date. The ITAT referring to the CBDT Circular
No.14 of 2001, held that this section cannot have a retrospective
effect and prior to the assessment year 2002-03, it was legally
permissible to claim the losses. Further, section 94(7) does
not block "dividend strippers". It merely lays down a minimum
holding period and is not against claiming of loss against the
other income of the tax payer.
This
ruling will give relief to several tax payers who were wrongfully
denied losses arising from "dividend stripping" even prior to
the year in which the provisions were amended to provide for a
minimum holding period, under the guise of 'tax avoidance'.
Source:
I.T.A.No.2307 (Mum) / 2004.
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