Every tax advantageous action or inaction cannot be treated as a colourable device

IN THE ITAT KOLKATA BENCH ‘C’

Assistant Director of Income-tax (International Taxation)

versus

Maersk Line UK Ltd.

IT Appeal No. 2150 (Kol.) of 2009

[Assessment year 2006-07]

September 21, 2012

ORDER

Pramod Kumar, Accountant Member  

By way of this appeal, the Assessing Officer has challenged correctness of CIT(A)’s order dated 24th December 2008, in the matter of assessment under section 143(3) of the Income Tax Act, 1961, for the assessment year 2006-07.

2. Ground nos. 1 to 4, which are raised in the form of questions requiring our adjudication and which we will take up together, are as follows:

 1.  On the facts and in the circumstances of the case, whether the learned CIT(A) has erred in law in directing the Assessing Officer to compute the long term capital gains at Rs. 2,58,76,551 instead of Rs. 17,12,57,331 ?

 2.  On the facts and in the circumstances of the case, whether the learned CIT(A) has erred in accepting the valuation per equity share at Rs. 48.56 instead of Rs. 184.25 ?

 3.  On the facts and in the circumstances of the case, whether the learned CIT(A) has erred in not accepting that the payment of dividend to Nedllyod India Pvt Ltd as sham and On the facts and in the circumstances of the case, whether the learned CIT(A) colourable transaction ?

 4.  On the facts and in the circumstances of the case, whether the learned CIT(A) has erred in rejecting (the contention) that the transaction of sale of shares was in violation of guidelines of the RBI ?

3. Ground Nos. 5 and 6 are consequential in nature and no specific arguments are advanced in respect of the same. These two grounds are thus dismissed in limine. We, therefore, restrict our discussion on the main issue referred to in grounds numbers 1 to 4.

4. The issue in appeal lies in a narrow compass of material facts. During the relevant financial period, i.e. 28th March 2006, the assessee sold 10,71,420 equity shares of its wholly owned subsidiary Nedllyod India Pvt Ltd (NIPL, in short) for a consideration of Ra 5,20,28,155 to Maersk India Private Limited. There is also no dispute about the fact that this sale was part of the overall reorganization of business in the sense that, as stated in the notes to the assessee’s financial statements for the relevant period and as reproduced in the assessment order, “effective 11th August 2005, AP Mollar – Maersk Group acquired Royal P&O Nedllyod NV, ultimate holding company” and “subsequently, on 28th March 2006, all shares of NIPL were acquired by Maersk India Pvt Ltd (Maersk India, in short)”. The assessee computed long term capital gains on sale of these shares, which worked out to Rs 2,58,76,351. The trouble, however, arose with regard to distribution of dividends, @ Rs 140 per equity share – aggregating to Rs. 14,99,988,800, by NIPL just before the sale transaction between the assessee and Maersk India took place. While the case of the Assessing Officer is that this distribution of dividend is nothing but a colourable device to deny legitimate share of revenue in capital gains of the assessee, and should, therefore, be ignored in computation of long term capital gains in the hands of the assessee, learned Commissioner (Appeals) does not share that perception. It is an undisputed position that distribution of dividend was authorised in the meeting of the board of directors on 24th March 2006, and the bank account of NIPL evidences the debit for dividend payment on 28th March 2006.

5. In the course of assessment proceedings, the Assessing Officer, in addition of having taken note of the above facts, noted that after distribution of dividends as above, NIPL got the value of its shares determined by two chartered accountant firms, namely BSR & Co, and CBG & Co. Both of these firms have relied upon audited accounts of NILP as on 31st March 2005 and certain adjustments in respect of period after that date. The dates of these valuation reports, as noted by the Assessing Officer, are 27th March 2006 and 29th March 2006. The Assessing Officer also noted that “as per RBI circular no. 16 of 2004, containing the relevant guidelines for valuation of shares, in the case of shares not listed in any stock exchange, valuation will be at a price which is not lower of the two independent valuation of such shares – one is to be conducted by the statutory auditor of the company, and the other by a chartered accountant or a merchant banker in category-1 registered with SEBI”. It was also noted that the TDS certificate indicating payment of sale consideration of shares and deduction of tax therefrom shows the date of payment as “March 2006” and that the date of deposit of tax with the Government, as also the date of certificate itself, was 28th March 2006. The Assessing Officer also noted that the remittance of sale consideration, net of taxes, was on the basis of a chartered accountant’s certificate and that no order under section 195(2) was obtained from the department. He also noted that both the valuation report noted that in view of declaration of dividend to the extent of Rs 17.10 crores, the net worth of NILP has been deleted to that extent, and, accordingly, the net asset value of the shares was determined at Rs 48.56 per share.

6. On these facts, the Assessing Officer was of the opinion that the since AP Mollar – Maersk Group had already acquired Royal P&O Nedllyod NV, ultimate holding company, on 11th August 2005, it was just a matter of time before merger and acquisition of other group companies takes place. He noted that the NIPL, being a domestic company, its dividends, subject to payment of dividend distribution tax by the company, were tax exempt under section 10(34) in the hands of the shareholders, including the assessee before us. The Assessing Officer was of the view that “just prior to furnishing of the valuation report of NAV per equity shares of the company, and most likely after such assignment for valuation was given to the chartered accountant firms, a board meeting was hastily conducted ………… (which) declared an interim dividend of Rs 140 per equity share on the basis of unaudited financial results for the period ended 28.2.2006″. The Assessing Officer was also of the view that the whole process of declaration, distribution and payment of dividend was completed within six days (including weekend) and that “the urgency shown in the process of declaration and payment of dividend at a certain rate is considered to be strange and a clear deviation from normal behaviour”. He further observed that “the sale of shares, payment of consideration, tax deduction and deposit to Government even before obtaining the valuation report from the second independent valuer, M/s CBG Associates, was in clear violation of RBI guidelines, since it is lower of the two prices determined which was to be followed, though incidentally the value determined by the two was the same. With this analysis, the Assessing Officer concluded that “the payment of dividend was nothing but a sham and colourable transaction” and that “even if the payment of dividend distribution tax to the tune of Rs. 2.10 crores is taken into consideration, the net tax evasion was Rs. 94 lakhs”. Referring to Hon’ble Delhi High Court’s judgment in the case of Azadi Bachao Andolan v. Union of India 256 ITR 563, he concluded as follows:

Hon’ble Delhi High Court, in the case of Azadi Bachao Andolan had held inter alia that Having regard to the law laid down by the Supreme Court in McDowell & Co Ltd. v. CTO [1985] 154 ITR 148, it is open to the income tax officer, in a given case, to lift the corporate veil for finding out whether the purpose of corporate veil is avoidance of tax or not. It is one of the functions of the Assessing Officer to ensure that there is no conscious avoidance of tax by the assessee, and such function, being quasi judicial in nature, cannot be interfered or prohibited.

To quote the lines of the learned Judges of Supreme Court in McDowell :

“Tax Planning may be legitimate provided it is within framework of law. Colourable devices cannot be part of tax planning and it is wrong to entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods. It is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges”

In the present case, the Nedllyod Group resorted to dubious method of declaration and payment of dividend to avoid payment of tax on LTCG by the assessee. Though the decision to sale out was taken much earlier, the blue print of tax avoidance was chalked out only towards the fag end of the financial year 2005-06. The two companies involved in the process did not even hesitate to violate the RBI norms. The whole process was completed even before the valuation report was obtained from the second valuer viz. CBG & Associates. It goes on to show the culpable state of mind of the persons involved in the transaction.

The payment of dividend in the present case, being a colourable transaction as established above, it cannot be considered as a part of assesee’s tax planning and it clearly amounts to tax evasion. Hence, deduction is denied for the dividend paid for determination of NAV per equity share.

7. Accordingly, the Assessing Officer recomputed long term capital gain by adopting NAV @ Rs. 184.25 per share and substituting the sale consideration of Rs. 5,20,28,1555 by Rs. 19,74,09,135. The LTCG was computed at Rs. 17,12,57,331 as against LTCG returned at Rs. 2,58,76,351. Aggrieved, assessee carried the matter in appeal before the CIT(A). Learned CIT(A) was of the view that “the Assessing Officer was not justified in holding that the declaration and payment of dividend by NIPL to the appellant was a sham and colourable transaction”. He noted that NIPL was having substantial amounts of reserves and surplus, that the dividends were declared in accordance with the law, that dividend distribution tax was duly paid by NIPL, and that the AO has failed to prove that action of the NIPL, in distributing the dividends shortly before the sale, was outside the framework of law. It was finally concluded that “the AO is not justified in adopting the FMV per equity share of NIPL at Rs. 184.25” , and, accordingly, the Assessing Officer was directed to “compute the LTCG by adopting the FMV per share at Rs. 48.56 and total sale consideration received by the appellant amounting to Rs. 5,20,28,155”. The Assessing Officer is not satisfied by the relief so granted by the CIT(A) and is in appeal before us.

8. We have heard the rival contentions, perused the material on record and duly considered factual matrix of the case as also the applicable legal position.

9. There is no dispute that distribution of dividend by NIPL prior to its sale by the assessee, even after the payment of dividend distribution taxes, has resulted in tax advantage of Rs 94 lakhs, but the fundamental question that we really need to decide is whether this declaration of dividend by NIPL, just before sale of its shares to Maersk India, could be treated as a colourable device and part of impermissible tax avoidance scheme. One of the allegations in the assessment order, as indeed in the grounds of appeal before us, is that the sale of shares is contrary to the RBI guidelines but the learned Departmental Representative could not really demonstrate so. The circular no 16 of 2004, issued by the Reserve Bank of India under the Foreign Exchange Management Act, deals with the issues regarding remittances of proceeds to the non resident, and it is not even the case of the revenue that the price at which the shares are sold by the assessee are lower than the prices determined under the aforesaid circular. As a matter of fact, the price at which shares are sold are arrived at in accordance with the above circular, and even the Assessing Officer does not dispute that fact. The only controversy is that, as per the Assessing Officer, the sale of shares took place before the second valuation report, as required under this circular, was obtained, i.e. one day after the sale took place, but then this fact does not lead to the conclusion that actual sales price of share can be ignored. The fact observed by the Assessing Officer, even if correct, has no cause and effect relationship with the course adopted by the Assessing Officer. Coming back to the core issue whether declaration of dividends just prior to sale of NIPL shares can be considered colourable device or not, we find guidance from the following observations made by Hon’ble Supreme Court in the case of Union of India v. Azadi Bachao Andolan 263 ITR 706 wherein Their Lordships have, inter alia, observed as follows:

115. Though the words ‘sham’, and ‘device’ were loosely used ……….., we deem it fit to enter a caveat here. These words are not intended to be used as magic mantras or catchall phrases to defeat or nullify the effect of a legal situation. As Lord Atkin pointed out in Duke of Westminster (supra) :

“I do not use the word device in any sinister sense; for it has to be recognised that the subject, whether poor and humble or wealthy and noble, has the legal right so to dispose of his capital and income so as to attract upon himself the least amount of tax. The only function of a Court of law is to determine the legal result of his dispositions so far as they affect tax.”

“There may, of course, be cases where documents are not bona fide nor intended to be acted upon, but are only used as a cloak to conceal a different transaction.”

116. In Snook v. London and West Riding Investments Ltd. [1967] All ER 518 at 528 Lord Diplock L.J., explained the use of the word ‘sham’ as a legal concept in the following words:

“it is, I think, necessary to consider what, if any, legal concept is involved in the use of this popular and pejorative word. I apprehend that, if it has any meaning in law, it means acts done or documents executed by the parties to the ‘sham’ which are intended by them to give to third parties or to the Court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create. One thing I think, however, is clear in legal principle, morality and the authorities [see Yorkshire Railway Wagon Contracting State v. Maclure [1882] 21 Ch.D.309; Stoneleigh Finance Ltd. v. Phillips [1965] 1 All ER 513] that for acts or documents to be a “sham”, with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating. No unexpressed intentions of a “shammer” affect the rights of a party whom he deceived.”

117. In Waman Rao & Ors. v. Union of India & Ors. [1981] 2 SCC 362 at para 45 and Minerva Mills Ltd. & Ors. v. Union of India & Ors. [1980] 3 SCC 625 this Court considered the import of the word ‘device’ with reference to art. 31B which provided that the Acts and Regulations specified in Ninth Schedule shall not be deemed to be void or even to have become void on the ground that they are inconsistent with the Fundamental Rights. The use of the word ‘device’ here was not pejorative, but to describe a provision of law intended to produce a certain legal result.

118. If the Court finds that notwithstanding a series of legal steps taken by an assessee, the intended legal result has not been achieved, the Court might be justified in overlooking the intermediate steps, but it would not be permissible for the Court to treat the intervening legal steps as non est based upon some hypothetical assessment of the ‘real motive’ of the assessee. In our view, the Court must deal with what is tangible in an objective manner and cannot afford to chase a will-o’-the-wisp

10. It is important to bear in mind uncontroverted claim of the assessee that there were sufficient reserves and surplus, which were eligible for distribution as ‘dividend’, and the NIPL had sufficient cash balances as well. The nature of amounts distributed as dividend has not been altered as a result of, what the revenue authorities describe as, colourable device to evade taxes. It is difficult to comprehend the rationale in revenue’s approach. Here is a company which has amounts available, in accordance with the law, for distribution of dividends, and when this company is in the process of changing ownership, it declares all, or most of, such available funds, as ‘dividends’ to the existing shareholders. There is nothing wrong in this approach on the first principles. If the amounts available for distribution of dividends are distributed, even if in entirety, before entire shareholding is to change hands – and particularly when surplus cash funds are available, this is what ought to have been done anyway. The deferment of distribution of dividends can be justified when the funds are required for business purposes, but then, right now, we are dealing with a situation in which entire shareholdings is to be change hands, and, if dividends are not distributed, what is in the nature of undistributed profits to the shareholders will change the character as of capital appreciation on value of share. There is also no dispute that the distribution of dividend has been implemented, as evident from the fact, as recorded in the assessment order itself, that bank debit for dividend is reflected on 28th March 2006. The decision to distribute dividends, on these facts, cannot be termed as a ‘dubious’ method to evade taxes; it is not a case where dividend distribution exercise is not a bonafide exercise, is not intended to be acted upon and is used as a cloak to conceal a different transaction. The fact that this distribution of dividend also ends up saving taxes on sale of NIPL shares cannot end up negating the effect of the lawful and legitimate action of distribution of dividend by NIPL. We have also noted that the NIPL has duly paid dividend distribution tax and the same has been duly accepted in its assessment. Once the taxes on distribution of dividend have been duly accepted, the character of such dividend payments in the hands of the assessee cannot be recharacterized just because by such characterization of receipt, revenue ends up getting higher taxes. As observed by Hon’ble Gujarat High Court in Banyan & Berry v. CIT 222 ITR 831, which is approved by Hon’ble Supreme Court in Azadi Bachao Andolan’s case (supra), Hon’ble Supreme Court has “nowhere said that every action or inaction on the part of the taxpayer which results in reduction of tax liability to which he may be subjected in future, is to be viewed with suspicion and be treated as a device for avoidance of tax irrespective of legitimacy or genuineness of the act”. Undoubtedly, the course adopted by the assessee was tax advantageous inasmuch as if NIPL, assessee’s wholly owned subsidiary, was not to distribute dividend and sell the shares without this exercise, the tax outgo would have been Rs 94 lakhs more than under the present arrangement, but then every tax advantageous action or inaction cannot be treated as a colourable device unless such an action or inaction is not bonafide, it conceals the true nature of transaction or is an exercise without any commercial justification. In view of these discussions, and bearing in mind entirety of the case, we are of the considered view that on the facts and in the circumstances of this case, distribution of dividend by NIPL, prior to sale of its shares by the assessee, even though tax advantageous cannot be termed as a colourable device or sham transaction and the receipt of these dividends cannot be recharacterized as sale consideration of shares in the hands of the assessee. We, therefore, approve and uphold the conclusions arrived at by the CIT(A) and decline to interfere in the matter.

11. In the result, the appeal is dismissed.