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?
2. Whether the transactions of purchase and sale of units were not bona fide and were entered into with a motive to avoid tax liability?

Contentions of the appellant [Taxpayer]

• In view of the decision of the Supreme Court in the case of Apollo Tyres Ltd 255 ITR 273 (2002), buying and selling of units issued by UTI cannot be treated as speculative business and Explanation to section 73 does not apply.
• Such transactions are legally recognised by insertion of section 94(7) by the Finance Act 2001, with effect from 1 April 2002.
• If such transactions are otherwise valid in law and result in tax reduction, the same cannot be ignored on the ground that the underlying motive of entering into such transactions was to reduce taxpayer^?s tax liability. The motive of the transaction is not a relevant consideration. Even if the intention is to avoid tax and the transaction is within the four corners of law, the benefit of the transaction cannot be refused merely because it would result into avoidance of tax liability artificially.
• The taxpayer relied upon the decision of the Supreme Court in the case of Azadi Bachao Andolan 263 ITR 706 (2003).

Contentions of the respondent [Revenue]

• Transaction is not bona fide as the underlying intention is to avoid payment of taxes. Such tax planning cannot be approved if it is aimed to prejudice the tax effect, which is impermissible in law. The revenue relied upon the Supreme Court decision in case of McDowell and Co. Ltd 154 ITR 148 (1985), to support its contention that even if the transaction is genuine and entered into with the intention of tax avoidance, it would constitute a colour able device.

Observations and Ruling of High Court

• The High Court held that the transaction of sale and purchase of such units is not a speculative transaction.
• The High Court observed that the basic objective of purchasing the units by the taxpayer was to earn dividend income, which is tax free under section 80M of the Act and to sell such units by suffering losses. It cannot be concluded that the taxpayer used any colour able device, particularly when such transactions have been recognised in the Act by inserting section 94(7) in the Act with effect from 1 April 2002.
• Once the transaction is genuine, merely because it has been entered into with a motive to avoid tax it would not become a colour able device and consequently earn any disqualification.
• The Supreme Court judgement in the case of McDowell and Co. was later on explained in detail by the Supreme Court in the case of Azadi Bachao Andolan and the later judgement is binding on the High Court.

Key takeaways

Loss on purchase and sale of units issued by the UTI is not a speculative loss. Such transaction is not a colour able device even if it is entered into with a motive to avoid taxes.

Source: Porrits & Spencers (Asia) Limited Vs CIT, ITA No. 10 of 2004 (High Court of Punjab and Haryana), Decision dated 31 March 2010.

NF