Court Dismisses Challenge to Notice Invoking GAAR

Remarking that colourable devices could not form part of tax planning, the Telangana High Court recently dismissed the petitions challenging the notice invoking the General Anti-Avoidance Rule (GAAR).[1]

This Rule is contained in Chapter X-A of the Income Tax Act, 1961, which was introduced vide the Finance Act, 2013, and came into force in April 2016. Under this Chapter, an arrangement entered into by an assessee qualifies as an impermissible avoidance arrangement if its main purpose is to obtain a tax benefit and it:

  • creates rights, or obligations, which are not ordinarily created between persons dealing at arm’s length;
  • results, directly or indirectly, in the misuse, or abuse, of the provisions of this Act;
  • lacks commercial substance or is deemed to lack commercial substance under Section 97, in whole or in part; or
  • is entered into, or carried out, by means, or in a manner, which are not ordinarily employed for bona fide purposes.

In the instant case, the petitioner purchased the shares of an entity in the year 2019. The face value of these shares declined significantly after the entity issued bonus shares. Shortly thereafter, the petitioner sold the shares and such a sale resulted in a short-term capital loss. This loss was set off against the long-term capital gain made on another transaction of sale of shares. In his IT returns, the petitioner reported the income arising out of this other transaction after adjusting the loss incurred, as capital gains.

These transactions were considered impermissible avoidance arrangements under Chapter X-A of the Act. Accordingly, a notice was issued by the AO under Rule 10UB(1) of the Income Tax Rules, 1962, to the assessee seeking his objections to the applicability of provisions of said Chapter. After the petitioner submitted his reply to said notice, the impugned notice came to be issued under Section 144BA invoking provisions of Chapter X-A.

The Court rejected the petitioner’s contention that the general provisions would not apply in light of the existence of special provisions relating to avoidance of tax under Chapter X of the Act. This was considering that the general provisions were enacted subsequently. It was also stated that on account of the non-obstante clause, the provisions of Chapter X-A had an overriding effect over and above the other provisions. Further, the inconsistency in the petitioner’s argument regarding the applicability of Section 94(8) was pulled up. In the case at hand, in light of the arrangement lacking any “logical or practical justification”, this particular Section was said not to apply.

The Court observed that the Revenue had shown that the transactions were not permissible tax avoidance arrangements. With this, the Court held that the provisions of Chapter X-A were applicable to the instant case and proceeded to dismiss the writ petitions.

[1] Ayodhya Rami Reddy Alla v. Principal Commissioner of Income-tax (Central) [WP Nos. 46510 & 46467 of 2022]