Loss on purchase and sale of units issued by UTI not a speculative loss and not a colourable device even if entered into with a motive to avoid taxes

The taxpayer, Porrits & Spencers (Asia) Limited, is a public limited company incorporated under the Companies Act, 1956. It is in the business of manufacturing of engineered fabrics and industrial textiles. During the financial year 1990-91 it purchased, on credit, 2.5 million units of US64 (the units) of Unit Trust of India (UTI) on 21 May 1990 at the prevailing market rate of Rs. 15 per unit. As per the certificate issued by UTI, such units were transferred to the taxpayer on 30 May 1990. The taxpayer received a dividend of Rs. 4.5 million on the said units on 6 July 1990.

The taxpayer sold all the 2.5 million units at the prevailing rate of Rs.13.01 per unit on 21 July.1990 and incurred a net short term capital loss of Rs. 5.1 million. The taxpayer claimed set-off of such loss against its business income, offered the dividend income of Rs. 4.5 million to income tax and claimed deduction under section 80M of the Income Tax Act (^„the Act^?) against such dividend income. While making the assessment, the Assessing Officer çAO^?) did not allow the deduction claimed by the taxpayer on account of such short term capital loss. The AO held that such transaction is speculative in nature within the meaning of Explanation to section 73 of the Act and thus the loss cannot be set off against the profit of the business of the taxpayer. AO further held that the transactions of purchase and sale of units were not genuine transactions and were a device for tax avoidance. The decision of the AO on such transactions was upheld by the Commissioner of Income Tax (Appeals). On appeal, the Income Tax Appellate Tribunal (^„ITAT^?) held that the loss on such transaction was in the nature of speculative business loss. It was further held by ITAT that such transactions were not bona fide as these were entered into with a motive to reduce the tax liability.

Issues before the High Court

1. Whether the loss of Rs. 5,161,875 on account of purchase and sale of units was speculative loss under section 73 of the Act and the taxpayer was not entitled to set off such losses accordingly?

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