[CIT v. Walfort Share and Stock Brokers P. Ltd.,
(2010) 326 ITR 1 (SC)]
The assessee, a member of the Bombay Stock Exchange, earned
income mainly from share trading and brokerage. During the financial year
1999-2000, relevant to the A.Y. 2000-01, the Chola Freedom Technology Mutual
Fund came out with an advertisement stating that tax-free dividend income of 40%
could be earned if investments were made before the record date, i.e.,
March 24, 2000. The assessee by virtue of its purchase on March 24, 2000 became
entitled to the dividend on the units at the rate of Rs. 4 per unit and earned a
dividend of Rs. 1,82,12,862.80. As a result of the dividend payout, the NAV of
the said mutual fund which was Rs. 17.23 per unit on March 24, 2000, at which
rate it was purchased, stood reduced to Rs. 13.23 per unit on March 27, 2000,
which was the succeeding working day in the stock exchange. This fall in the NAV
was equal to the amount of the dividend payout. The assessee sold all the units
on March 27, 2000 at the NAV of Rs. 13.23 per unit and collected an amount of Rs.
5,90,55,207.75. The assessee also received an incentive of Rs. 23,76,778 in
respect of the said transaction. Thus, the assessee thereby received back Rs.
7,96,44,847 (Rs. 1,82,12,862.80 + Rs. 5,90,55,207.75 + Rs. 23,76,778) against
the initial payout of Rs. 8,00,00,000. For income-tax purposes, the assessee in
its return, claimed the dividend received of Rs. 1,82,12,862.80 as exempt from
tax u/s.10(33) of the Income-tax Act, 1961 (‘the Act’) and also claimed a
set-off of Rs. 2,09,44,793 as loss incurred in the sale of the units, thereby
seeking to reduce its overall tax liability.
The Assessing Officer in his assessment order dated March 21,
2003, accepted that the dividend income amounting to Rs. 1,82,12,862.80 was
exempt u/s.10(33) of the Act. However, the Assessing Officer disallowed the loss
of Rs. 2,09,44,793 claimed by the assessee, inter alia, on the ground
that a dividend stripping transaction was not a business transaction, and since
such a transaction was primarily for the purpose of tax avoidance, the so-called
loss was an artificial loss created by a pre-designed set of transactions.
Accordingly, the Assessing Officer deducted the incentive income of Rs.
23,76,778 received by the assessee + transaction charges from the loss of Rs.
2,09,44,793 and added back the reduced loss of Rs. 1,82,12,862.80 to the
repurchase price/redemption value amounting to Rs. 5,90,55,207.75.
Being aggrieved by the disallowance of the reduced loss of Rs.
1,82,12,862.80, the assessee filed an appeal before the Commissioner of
Income-tax (Appeals), who by his order dated December 12, 2003, confirmed the
order of the Assessing Officer saying that the loss of Rs. 1,82,12,862.80
incurred by the assessee on the sale of units should be totally ignored and that
the same should not be allowed to be set off or carried forward.
The assessee moved the Tribunal against the order dated
December 12, 2003. The disallowance stood deleted by the Special Bench of the
Tribunal vide its impugned order dated July 15, 2005, by holding that the
assessee was entitled to set off the said loss from the impugned transactions
against its other income chargeable to tax. This view of the Tribunal was
affirmed by the High Court.
The Supreme Court formulated three points which it required
to decide and those were as follows :
(i) Whether ‘return of investment’ or ‘cost recovery’
would fall within the expression ‘expenditure incurred’ in S. 14A.
(ii) Impact of S. 94(7) with effect from April 1, 2002 on
the impugned transactions.
(iii) Reconciliation of S. 14A with S. 94(7) of the Act.
According to the Department, the differential amount between
the purchase and sale price of the units constituted ‘expenditure incurred’ by
the assessee for earning tax-free income, hence, liable to be disallowed
u/s.14A. As a result of the dividend payout, according to the Department, the
NAV of the mutual fund, which was Rs. 17.23 per unit on the record date, fell to
Rs. 13.23 on March 27, 2000 (the next trading date) and, thus, Rs. 4 per unit,
according to the Department, constituted ‘expenditure incurred’ in terms of S.
14A of the Act.
The Supreme Court held that, expenditure, return on
investment, return of investment and cost of acquisition were distinct concepts.
Therefore, one needed to read the words ‘expenditure incurred’ in S. 14A in the
context of the scheme of the Act and, if so read, it was clear that it
disallowed certain expenditure incurred to earn exempt income from being
deducted from other income which was includible in the ‘total income’ for the
purpose of chargeability to tax.
According to the Supreme Court, a return of investment cannot
be construed to mean ‘expenditure’ and if it is construed to mean ‘expenditure’
in the sense of physical spending, still the expenditure was not such as could
be claimed as an ‘allowance’ against the profits of the relevant accounting year
u/s.30 to u/s.37 of the Act and, therefore, S. 14A cannot be invoked.
The Supreme Court further held that the real objection of the Department appeared to be that the assessee was getting tax-free dividend; that at the same time, it was claiming loss on the sale of the units; that the assessee had purposely and in a planned manner entered into a pre-meditated transaction of buying and selling units yielding exempted dividends with full knowledge about the fall in the NAV after the record date and the payment of tax-free dividend and, therefore, the loss on sale was not genuine. According to the Supreme Court, there was no merit in the above argument of the Department. The Supreme Court observed that there were two sets of cases before it. The lead matter covered assessment years before insertion of S. 94(7) vide the Finance Act, 2001 with effect from April 1, 2002. With regard to such cases, the Supreme Court stated that on the facts it was established that there was a ‘sale’. The sale price was received by the assessee. That, the assessee did receive dividend. The fact that the dividend received was tax- free was the position recognised u/s.10(33) of the Act. The assessee had made use of the said provision of the Act. That such use cannot be called ‘abuse of law’. Even assuming that the transaction was pre-planned, there was nothing to impeach the genuineness of the transaction. With regard to the ruling in McDowell and Co. Ltd. v. CTO, (1985) 154 ITR 148 (SC), the Supreme Court observed that in its later decision in Union of India v. Azadi Bachao Andolan, (2003) 263 ITR 706, it has been held that a citizen is free to carry on its business within the four corners of the law. That, mere tax planning, without any motive to evade taxes through colourable devices is not frowned upon even by the judgment of this Court in McDowell and Co. Ltd.’s case (supra). Hence, in the cases arising before April 1, 2002, losses pertaining to exempted income could not be disallowed. However, after April 1, 2002, such losses to the extent of dividend received by the assessee could be ignored by the Assessing Officer in view of S. 94(7).
The next question which the Supreme Court needed to decide was about reconciliation of S. 14A and S. 94(7). According to the Supreme Court, the two operated in different fields. S. 14A deals with disallowance of expenditure incurred in earning tax-free income against the profits of the accounting year u/s.30 to u/s.37 of the Act. On the other hand, S. 94(7) refers to disallowance of the loss on the acquisition of an asset which situation is not there in the cases falling u/s.14A. U/s.94(7), the dividend goes to reduce the loss. S. 14A applies to the cases where the assessee incurs expenditure to earn tax-free income, but where there is no acquisition of an asset. In the cases falling u/s.94(7), there is acquisition of an asset and existence of the loss which arises at a profit of time subsequent to the purchase of units and receipt of exempt income. It occurs only when the sale takes place. S. 14A comes in when there is a claim for deduction of expenditure, whereas S. 94(7) comes in when there is a claim for allowance for the business loss. One must keep in mind the conceptual difference between loss, expenditure, cost of acquisition, etc., while interpreting the scheme of the Act.
