Mere receipt of dividend subsequent to purchase of units in a mutual fund cannot go to offset the cost of acquisition of the units.
Chief Justice Kapadia of the Supreme Court has delivered a remarkable judgment analysing the concept of tax avoidance in dividend-stripping transactions. The court examined the impact of various sections in the Income-Tax Act, 1961 in arriving at the taxable income in the Walfort case.
As per the facts of this case, Walfort Share and Stock Brokers P. Ltd purchased units of Chola Freedom Technology Mutual Fund on March 24, 2000. This was the record date for declaring dividend. The company became entitled to a dividend at Rs 4 per unit and the amount earned was Rs 1,82,12,862. The NAV (net asset value) stood at Rs 17.23 on this date. It fell to Rs 13.23 soon after declaration of the dividend. The company sold all the units on March 27, 2000. It received an incentive of Rs 23,76,778 for the transaction. In its income-tax return, the company claimed exemption of the dividend amount of Rs 1,82,12,862 under Section 10(33) of the I-T Act. It also claimed a set-off of Rs 2,09,44,793 as loss incurred on the sale of units.
The assessing officer (AO) disallowed this loss. He pointed out that this was a dividend stripping transaction and not a business transaction. It was entered into primarily for the purpose of tax avoidance. The loss was artificially created by a pre-designed set of transactions.
Return on investment?
Before the Supreme Court, the Revenue argued that the amount received by the company as dividend constituted a return on investment. It has to be adjusted against the cost of the purchase of the units in such an event, there will be no loss suffered by the company on subsequent redemption.
Alternatively, it was argued, the price of units included the price of dividend embedded there in. Dividend represented a price paid for the units and it is an expenditure incurred for obtaining exempt income which should be disallowed under Section 14A.
"Loss" is a commercial concept and will not take in "tax loss" created or contrived without suffering commercial loss. Section 94(7) is meant to curb tax avoidance involving "dividend stripping transactions".
The court had to decide whether "return on investment" or "cost recovery" would fall within the expression "expenditure incurred" in Section 14A. It had to reconcile the provisions of Section 14A with those of Section 94(7), which was inserted by Finance Act, 2001 w.e.f. April 1, 2002; Section 14A was inserted w.e.f. April 1, 1962.
Section 10(33) recognises receipt of tax-free dividends. This cannot be called "abuse of law".
Even assuming that the transaction was pre-planned, there is nothing to impeach the genuineness of the transaction.
The McDowell case has to read in conjunction with the Azadi case ( 263 ITR 706). A citizen is free to carry on business within the boundaries of the law. Mere tax planning without any motive to evade taxes through colourable devices is not frowned upon. However, after April 1, 2002, losses to the extent of dividend received by the company could be ignored by the department under Section 94(7) which curbs short-term losses.
The loss to be ignored would be only to the extent of dividend received and not the entire loss. Losses over and above the amount of dividend received would still be allowed. Parliament has not treated dividend-stripping transactions as sham or bogus.
If the Revenue's argument is accepted, it would mean that before April 1, 2002, the entire loss will be disallowed as genuine, but after this date only a part of it would be allowable under Section 94(7). This will not be a reasonable interpretation.
Sections 14A and 94(7) operate in different fields. The former deals with disallowance of expenditure incurred in earning tax-free income, while the latter refers to disallowance of loss on the acquisition of an asset which situation is not there in cases falling under Section 14A. Section 94(7) applies to cases where the loss is more than the dividend. Section 14A does not deal with acquisition of an asset. Under Section 94(7), there is acquisition of an asset. Loss arises when sale takes place under Section 94(7). There is a conceptual difference between loss, expenditure, cost of acquisition, and so on, while interpreting the scheme of the Act.
A mere receipt of dividend subsequent to purchase of unit, on the basis of a person holding units at the time of declaration of dividend on the record date, cannot go to offset the cost of acquisition of the units.
Para 12 of the Accounting Standard 13 relied upon by the Revenue will have no application in cases where units are bought at the ruling NAV with a right to receive dividend as and when declared in future and did not carry any vested right to claim dividends which had already accrued prior to the purchase.
There can be no question of AS-13 coming to the aid of the department. The Supreme Court upheld the ruling of the Bombay High Court and dismissed the appeal of the Revenue.(The author is a former Chief Commissioner of Income-Tax.)