IN THE INCOME TAX APPELLATE TRIBUNALSPECIAL BENCH, MUMBAI

I.T.A.No. 8020(Mum)/2003Assessment year : 2001-2002

WALLFORT SHARES & STOCK BROKERS LTD205, Gundecha Chambers,

Nagindas Master Road, FortMumbai-400 001.

Vs

INCOME TAX OFFICERWard 4(2)(1), Aaykar Bhawan,

Mumbai

I.T.A.No. 2307(Mum)/2004Assessment year : 2000-2001

WALLFORT SHARES & STOCK BROKERS LTD205, Gundecha Chambers,

Nagindas Master Road, FortMumbai-400 001.

Vs

ADDL. COMMISSIONER OF INCOME TAX-205, Range 4(2), Aaykar Bhawan, Mumbai

Dated: July 15, 2005

BEFORE SHRI VIMAL GANDHI, HON'BLE PRESIDENT,SHRI J.P. BENGRA, VICE-PRESIDENT,SHRI S.C. TIWARI, ACCOUNTANT MEMBER,SHRI N. BHARATHVAJA SANKAR, ACCOUNTANT MEMBER, &SHRI T.K. SHARMA, JUDICIAL MEMBER

Appellant by : Mr. Soli Dastur & Sh. R. Muralidhar

Respondent by : Mr. S.D. Kapila, Spl. Counsel Mr. V.S. Singh & Mr. Mahesh Kumar

ORDER

PER S.C. TIWARI, A.M. :

These two appeals have been filed by the assessee on 17.12.2003 and 6.4.2004 against the orders of the learned CIT (Appeals)-IV, Mumbai dated 7.11.2003 and 12.12.2003 in the case of the assessee in relation to assessment orders u/s 143(3) for assessment years 2001-2002 and 2000-2001 respectively. These appeals have been referred to us as a Special Bench to decide the following issues:-

1. “Whether on the facts and in the circumstances of the case, the loss incurred by the assessee on purchase and sale of units of Mutual Funds is allowable or not?

2. Whether the provisions of section 94(7) of the Income-tax Act, 1961 can be interpreted as retrospective in operation and if so, its effect?”

2. The facts of the case relevant to the questions referred to us, briefly, are that the assessee company filed return of income for assessment year 2001-2002 disclosing total income at Rs. 57,31,610/- on 29th October, 2001. The Assessing Officer completed assessment u/s 143(3) on 31.3.2003 at total income of Rs. 2,58,46,553/-. During the year the assessee was a member of Mumbai Stock Exchange and traded shares on own account as well as on behalf of its clients. In addition, the assessee purchased on 18.12.2000 and sold on 21.12.2000 units of Sun F&C Mutual Fund. The learned CIT(A) has enumerated the assessee’s claim of loss on this transaction in tabular form in para 2 of the impugned order in the following manner:-

Particulars          Purchase         Sale            Gain/Loss Dividend amount________________________________________________________________

                        Date         Amount        Date       Amount- - - - - -----------------------------------------------------------------

Units of        18.12.00       100,000,000 Sun F &C MutualFund

Less:Incentive              1673563.22                           - - - - - - - --                            98326436.78

Add:Dividend               20114942.53reinvested             - - - - - - - - -                            118441379.31 21.12.00 97,126,436.79 21314942.52 20,114,942.53_________________________________________________________________________

During the course of assessment proceedings the assessee submitted that it had incurred loss in the aforesaid transaction in the normal course of its business of trading in shares and securities and, therefore, the loss amounting to Rs. 21,314,942/- was a business loss. The assessee argued that in purchase and sale of units of a mutual fund, there could be fluctuation in price because the NAV fluctuated from time to time. The assessment of a transaction of this nature had to be uniform where dividend is received and income is earned on sale as well as where dividend is received and loss is incurred on sale. The mere fact that the dividend received by the assessee from the mutual fund was exempt from income-tax in view of the provisions of section 10(33) of the Act could be no ground to disregard or ignore the resultant loss suffered by a person purchasing the units cum- dividend and selling the units ex-dividend, after collecting the dividend from the mutual fund.

3. The learned Assessing Officer held that the assessee had entered into a pre-meditated agreement with the mutual fund with the sole purpose of avoidance of tax. All transactions occurred within two days. The units were purchased just before the book closure of the mutual fund and were redeemed as soon as dividend was paid out. In this process the assessee suffered reduction of 2% entry load charge when the mutual fund redeemed back the units sold. The assessee knew beforehand that the net result of the transaction would be a financial loss or outflow. The only gain was tax free dividend. The details of other share transactions furnished by the assessee did not conform to this pattern. In this transaction what was given back to the

assessee was assessee’s own investment or capital only which was returned to him in the form of dividend and redemption amount.

4. According to the learned Assessing Officer the transaction under consideration had no motive to earn profit. In open end scheme, it was but natural that NAV shall be reduced by the amount of dividend outflow. Looking to the extremely short period for which funds were parked by the assessee, it was crystal clear that the mutual fund had not invested the money deposited by the assessee and dividend had been paid out to the assessee from out of the purchase price of the units. The assessee knew before hand that it would receive dividend out of its own funds and thereafter the difference in purchase and sale price of units would be a certain loss. The assessee intended to gain because it would reduce such loss from its other taxable income, while the dividend would be claimed as exempt u/s 10(33). The mutual fund, on the other hand, would gain by charging the entry load or exit load and in some cases even both.

5. The learned Assessing Officer held that the basic scheme of a mutual fund was either growth or income or both. However, the manner in which the transaction took place, the objective was neither growth nor income. Hence the transaction revealed an unholy nexus between the mutual fund and the tax avoider. The word “business” though of large and indefinite import connoted something which occupied the attention and labour of a person for earning profit. Profit motive was the crucial test for determining whether it was a business activity and, therefore, implied involvement of some risk in the transaction. A business or an adventure in the nature of trade could not include a transaction where loss was inevitable and a foregone conclusion. There could be loss in a business transaction as an incidence but not as certainty. Therefore, the transaction in question was not a business or commercial transaction and could not be regarded as business. Every loss was not deductible unless it was result of a business. If the loss was not incidental to the business, the same could not be allowed as deduction.

6. The Assessing Officer made the following conclusions:-1 “The scheme is a pure tax avoidance scheme without any commercial justification in so far as the making of a profit is concerned.

2 The transactions are self-canceling and are designed to make neither a gain nor a loss. The tax payers would not have entered into the scheme, if a loss would be incurred.

3 The money required for the transaction is provided by a third party solely for the purpose of the scheme and is returned on completion of the scheme (Bank current A/c. overdraft facilities used by the assessee for 3 days transaction).

4 These transactions have no commercial purpose apart from the avoidance of tax liability.

5 In this kind of transaction, both the assessee and mutual funds are making a handsome gain. The mutual funds by charging the entry or exit load and the assessee by claiming a loss.

6 On the one hand, the assessee is showing loss on account of purchase and sale of units of mutual funds and the other hand, he is almost getting a similar amount of dividend which it can claim as exempt from tax under sec. 10(33). The entire transaction is taking place in a pre-ordained manner and it is nothing but a fiscal nullity.”

Relying upon the judgment of Hon'ble Supreme Court in the case of CIT Vs. India Discount Co. Ltd., 75 ITR 191 (SC), the learned Assessing Officer held that dividend received in respect of shares purchased on cum-dividend basis would reduce the cost of acquisition in the hands of the purchaser. Following the ratio of the aforesaid Supreme Court judgment, the learned Assessing Officer calculated the loss arising to the assessee in the following manner:-

Purchase price of share cum dividend                              1,00,000,000/-

Less: Dividend declared                    Rs. 20,114,942/-Incentive received from MF                      1,673,563/-            21,788,505                                                                                    78,211,495

Less: Sale price of Units                Rs. 97,126,436/-Less: Dividend received                  Rs. 20,114,942/-            77,011,494

Actual loss incurred in the units of transaction.                                                               1,200,001                                                                                   - - - - - -

7. Accordingly the learned Assessing Officer allowed the assessee loss of Rs. 12,00,001/- only as against the loss of Rs. 21,314,942/- claimed by the assessee. He found support from the judgment of House of Lords in the case of S.Craven (Inspector of taxes) Vs. White (Stephen), 183 ITR 216 (HL).

8. Aggrieved by the order of assessment, the assessee filed appeal before the learned CIT(Appeals). The assessee submitted that units of mutual funds were regulated by an independent body constituted under the Act of Parliament, viz., SEBI. The assessee had followed the prescribed procedure and the transactions with the mutual funds were at arms length. The assessee argued that the transactions were not pre-ordained because of high volatility in the assessee’s line of trade. Loss had arisen on account of fall in NAV. As the assessee had not adopted any colorable device, the decision of Hon'ble Supreme Court in the case of Mcdowell & Co. Ltd. was not applicable. The learned CIT(Appeals) held that the transaction entered into by the assessee was popularly known as dividend stripping or a bed and breakfast scheme. In such scheme shares were purchased pregnant with dividend, thereafter dividend was received and shares were sold minus dividend. Resultant loss was claimed against other taxable income. The learned CIT(Appeals) referred to the judgment of House of Lords in the case of Griffiths Vs. J.P. Harrison, 58 ITR 328 (P.C) In that case the assessee purchased shares of a company. That company had at that time no business but considerable accumulated profits. After the company declared dividend, the assessee sold the shares minus dividend at loss. In the process there was difference between purchase price and sale price resulting into loss of Pounds 15900. The assessee set off that loss against dividend income of Pounds 15901. At the same time the assessee sought refund of taxes paid by the company in relation to the dividend payments under the provisions of section 341 of the Act. On those facts divergent views were expressed by their Lordships. The learned CIT(Appeals) referred to the minority view in that judgment and extracted at length from the judgment of Lord Denning, who propounded that the motive behind the transaction should also be considered while deciding particular transaction. Learned CIT(A) then referred to another judgment of House of Lords in the case of Finsbury Securities Ltd. Vs. Bishop (Inspector of Taxes) 43 Tax Cases 591 (H.L). In that judgment Lord Morris of Borth-Y-Gest, who had held the transactions as trading transaction in the case of Griffiths Vs. J.P. Harrison (supra) held different view of the matter. He held that the transactions were no more than devices which were planned and contrived to effect the avowed purpose of tax avoidance. He further held that the arrangements under consideration could not be regarded as within the trade of share- dealing. The view of Lord Morris was endorsed fully by other law lords. Thus, there was visible shift in the thinking of House of Lords. Thereafter another path breaking judgment came in the form of Lupton Vs F.A. & A.B. Ltd. 47 Tax cases 580 (HL). The case of Lupton marked a water shed in tax avoidance cases. Their Lordships noted the earlier judgments in the cases of Griffiths Vs. J.P. Harrison Ltd. and Finsbury Securities Ltd. Vs. Inland Revenue Commissioner. It was held that if upon analysis it was found that the greater part of the transaction is explicable only on fiscal grounds, the mere presence of element of trading will not suffice to translate the transaction into the realms of trading. The learned CIT(Appeals) noted that subsequent judgments in the case of Ramsay Ltd. Vs. Inland Revenue Commissioner 1982 A.C. 300 (HL); Inland Revenue Commissioner Vs. Burmah Oil Co. Ltd. 1982 STC 30 (HL) and Furniss Vs. Dawson 1984 1 All England Reporter 530 (HL) added new dimension to the legal interpretation of the tax avoidance transactions. The contents and the nature of the principles established in those three cases were dealt with extensively in the case of Craven Vs. White 183 ITR 216 (H.L). It was

laid down that an artificial avoidance scheme did not alter the incidence of tax. According to the learned CIT(Appeals), the principle of form over substance which was commonly referred to as Westminster principle with reference to the judgment in the case of Duke of Westminster 1936 A.C. 1 (H.L.) was overwhelmed by the judgments in the cases of Ramsay, Burmah Oil and Furniss, which stood by substance. In India also the doctrine of Duke of Westminster was visible from the cases, such as Jiyaji Rao Vs. CIT, 34 ITR 888; CIT Vs. Raman & Co., 67 ITR 11 (SC) and CIT Vs. Kharwar, 72 ITR 693 (SC). However, the doctrine came under full scrutiny of the Full Bench of Supreme Court in the case of Mcdowell & Co. Ltd. Vs. CTO, 154 ITR 148 (SC), which was thereafter followed in the case of Workmen Vs. Associated Rubber Industries, 157 ITR 77 (SC). In that judgment it was observed, “The time has come for us to depart from the Westminster principle as emphatically as the British Courts have done and to disassociate ourselves from the observations of Shah J. and similar observations made elsewhere.” The learned CIT(Appeals) then quoted at length from the judgment in the case of Mcdowell & Co. He also relied upon the judgment of Hon'ble Bombay High Court in the case of Twinstar Holdings Ltd. Vs. Anand Kedia , Dy. CIT, 260 ITR6 (Bom.)

9. According to the learned CIT(Appeals) the argument of the assessee that insertion of the provisions of section 94(7) of the Act was w.e.f. 1.4.2002 only required a careful thought. Merely because the amendment had not been given retrospective effect by the Legislature, the principles laid down by Hon'ble Supreme Court and House of Lords could not be thrown to the winds and colourable transactions could not be given legal sanctity or approval in a similar situation. The learned CIT(Appeals) referred to the judgment of House of Lords in the case of Lupton. In that case forward stripping had been banned by the Finance Act, 1960, but the House of Lords did not think that the subsequent amendment should prejudice or cloud the process of thinking and the objectivity. The transaction had to be viewed as it was, i.e., the colourable device.

10. The learned CIT(Appeals) proceeded to examine the nature of the transaction. The purpose of the transaction was to have double benefit of not only the tax free income but also reduction of incidence of tax on the assessee’s other income chargeable to tax. The mutual fund played the role of facilitator of the scheme of tax avoidance. These mutual funds advertised in the newspapers the record date and the amount of dividend to be declared. Subscribers, financiers, brokers came alive instantly within hours and subscriptions for units running into crores of rupees were made. In such cases there were ready-made and ever willing financiers willing to finance the transaction without any risk as to the money advanced because the money invested in purchase of units was going to be collected from mutual fund directly in a span of a day. In most of the cases, the assessee who neither had money to invest entered into the fray to get the double benefit. In the process everybody involved in the exercise got benefited. The purchaser got the double benefit of tax free dividend and consequential loss. The brokers were paid handsomely for the services by Mutual Funds. Financiers earned fixed interest without much risk and mutual funds collected their fee in the form of entry load or exist load or both. These cases were distinguishable from the case of Griffiths Vs. J.P. Harrison (supra) in the same manner Lord Morris of Borth-Y-Gest distinguished the subsequent cases of Finsbury Securities etc. In the case of the assessee the vendors of the units were interested parties to have the benefit resulting from the scheme. In the Harrison case there was nothing to suggest that the vendor knew of the intention or stood to derive any benefit from the dividend stripping. In the present case Mutual Funds were consciously marketing tax mitigation scheme. The very fact that touts/brokers were engaged by the mutual funds to lure the customers into the various schemes marketed by them showed the deep rooted nexus and also the collusion between mutual funds and other market forces to entrap the customers into the scheme. Thus, the observations of the House of Lords distinguishing their judgment in Harrison case were relevant and applicable on the fact situation in the assessee’s case.

11. The learned CIT(A) found support from the judgment of Hon'ble Bombay High Court in the case of Twinstar Holdings Ltd. He relied also on the observations of Lord Denning in the case of Griffiths Vs. J.P. Harrison. The transaction entered into by the assessee could not qualify to be “commercial” or “business” transaction. The definition of the word “business” in section 2(13) was of wide import, but the underlying idea was the continuous exercise of an activity for profit. Without profit the transaction was no more business as pickle was not candy. Reference was made to the judgment of Hon'ble Gujarat High Court in the case of CIT Vs. Motilal Hirabhai Spinning & Weaving Co. Ltd., 113 ITR 174; of Allahabad High Court

in the case of Senairam Dongarmal Vs. CIT,42 ITR 392 (S.C); of Supreme Court in the case of Mahendra Prasad Vs. ITO, 129 ITR 295 (SC); of Supreme Court again in the case of Sole Trustee Lokashikshana Trust Vs. CIT, 101 ITR 234 (SC) and of Bombay High Court in the case of Provident Investment Co. Ltd. Vs. CIT, 6 ITC 21 (Bom.) in support of the proposition that an activity undertaken without profit motive could not be considered to be business activity. According to the learned CIT(Appeals), the loss claimed must be one which directly sprung from the business of the assessee. In the case of the assessee in question, the loss incurred had not even remotest connection with the business of the assessee, nor it was incidental thereto. Furthermore, another essential feature of business was that there should be a continuous course of activity. That too was missing in the case of the assessee. Hence even though the transaction was not a sham or illusory transaction, the fiscal content or fiscal element needed to be viewed correctly.

12. After holding that the transaction in question could not be considered to be commercial or business transaction, the learned CIT(Appeals) further held that the transaction entered by the assessee was devoid of any trappings of an investment also. The investment in common parlance was understood to be realization of the capital appreciation over a period of time.

13. The learned CIT(A) held that profit motive was common both in a business transaction and an investment. If the assessee had genuinely entered into investment transaction, he would wait for longer time. It was possible to make loss, but the purpose of making the investment had to be realization of capital appreciation. A transaction entered into not with the motive of capital appreciation but erosion of capital could not be regarded as investment.

14. On the basis of these arguments the learned CIT(Appeals) held that the entire loss claimed by the assessee amounting to Rs. 21,314,942/- should be ignored totally. In this regard the learned CIT(Appeals) enhanced the assessment, in as much as, the learned Assessing Officer had held the assessee entitled to claim loss to the extent of Rs. 12,00,001/-.

15. We shall now turn to the orders of the authorities below in relation to Asessment Year 2000 – 01. The assessing officer found that the assessee purchased 45,53,215.709 units at a price of Rs. 17.57 per unit and sold it back to the mutual fund at a price of Rs. 12.97 per unit. The date of purchase of the units was 24.3.2000. That was the very day of book closure of the mutual fund and dividend @ Rs.4/- per unit amounting to Rs. 1,82,12,862.84 was paid out to the assessee on that day. According to the statement issued by Chola Mutual Fund the units were redeemed back by the Mutual Fund on 27.3.2000 at a price of Rs. 12.97 per unit. The total holding period of units was only two days i.e., 25.3.2000 and 26.3.2000 which were Saturday and Sunday. On Monday the units had been redeemed by the mutual fund. There were no actual units but only a holding statement given by the mutual fund. The assessee knew before entering into the transaction that the net result of the transaction will be a financial loss or outflow. The only gain for the assessee was tax free dividend. Hence the entire transction was ab-initio uncommercial and without intention of making a profit.

16. The learned Assessing Officer further found that the face value of the units of Chola Mutual Fund as originally offered on 6.10.1997 was Rs. 10/-. As on 31.3.1999 the unit had NAV of Rs. 11.42 and as on 31.3.2000, it had NAV of Rs. 13.28. There was, thus, only marginal appreciation in Net Asset Value of the unit over the years. It was surprising that on 24.3.2000, the mutual fund distributed dividend of Rs. 4/- per unit to investors whosoever applied. In other words, the mutual funds simply distributed the investment amount received from the applicants as dividend, thus, parting with exempted income at a pre-determined price.

17. On these facts, the learned Assessing Officer issued show cause notice to the assessee to explain why the trading loss that was not part of the normal business activity in view of the extraordinary circumstances of purchase and sale, should not be disallowed. The arguments of the assessee and the reasoning of the learned A.O. thereupon are more or less the same as enumerated by us in relation to assessment order for A.Y. 2001-02 and for brevity not repeated here. The learned Assessing Officer found that the assessee had received an incentive also of Rs. 23,76,778/- from Chola mutual fund. After reducing the same from purchase price of Rs. 8 crores and matching the balance with the sale price of Rs. 5,90,55,207/-, there was

loss of Rs. 1,85,68,015/- if dividend of Rs. 1,82,12,862 not considered. He held that this loss was not allowable to the extent of the dividend received by the assessee.

18. On assessee’s appeal the learned CIT(A) referred to his decision against the assessee in relation to assessment year 2001-2002. For the reasons stated in that order, the learned CIT(a) held that the loss claimed by the assessee amounting to Rs. 1,85,68,014/- should be ignored.

19. At the outset during the course of hearing before us Shri S.D. Kapila, the learned special counsel for the revenue suggested that we may modify the wording of the issues for consideration before us, inasmuch as the expression “the loss incurred” be replaced by the expression “the loss claimed”. Shri Soli Dastur, the learned counsel for the assessee argued that the modification was not necessary. After consideration we held that it was not necessary to formally change the language of the proposition and it would suffice to keep the revenue’s reservation in this respect in view while adjudicating upon the matter.

20. Shri S.E. Dastur, the learned counsel for the assessee opened his argument with the observation that there was no need to constitute the special Bench. There were already Tribunal orders on this subject matter and with some exception the same were in favour of the assessee. He referred to the Tribunal decisions reported in 83 TTJ 758 (Ahd.); 83 TTJ 843 (Bom.) and the decision of Income-tax Appellate Tribunal “D” Bench, Mumbai in ITA No. 1066(Bom.)/95 in the case of M/s Asian Paints (India) Ltd. The learned counsel pointed out that there was a decision of ITAT, Calcutta Bench in the case of Niagra Investment Co. Ltd. in ITA No. 2600(Cal)/97, but that was an old decision delivered on 27.6.2002 i.e., prior to the judgment of Hon'ble Supreme Court in the case of Union of India Vs. Azadi Bachao Andolan (2003) 263 ITR 706 (SC). Subsequently reference was made to two more decisions of the Mumbai Tribunal in the case of Fifty Fifty Finance & Consultants (P) Ltd. , 141 Taxman (ITAT) page 1 (Mum.) and ITA No. 58/Mum/1997 in the case of M/s Mahindra Sintered Products Ltd. At any rate the whole issue stood concluded by the judgment of Hon'ble Supreme Court in the case of Azadi Bachao Andolan (supra). The learned counsel pointed out that in this case the Assessing Officer made the assessments prior to the judgment of the Hon'ble Supreme Court and the impugned orders of the learned CIT(Appeals) were made after one month of the judgmentof Hon'ble Supreme Court but without noticing the judgment. Thus, the impugned orders were passed without having the benefit of and without following and complying with the judgment of Hon'ble Supreme Court in the case of Azadi Bachao Andolan (supra).

21. The learned counsel for the assessee argued that it was not disputed by lower authorities that the transactions entered into by the assessee were perfectly in accordance with law. The main basis of the department’s argument was that there was no commercial purpose involved in the transaction and, therefore, the loss should be ignored. It was held that the motive or intention of the assessee for entering into the transactions in question was tax avoidance. The learned Assessing Officer had argued that there were several judicial pronouncements to support the view that the loss claimed should not be allowed as it was artificially created. The learned CIT(Appeals) had heavily relied upon the judgments of the English courts in W.T. Ramsay Ltd. Vs. IRC 1982 A.C. 300 (House of Lords); IRC Vs. Burmah Oil Co. 1982 STC 30 (House of Lords) and Furniss Vs. Dawson 1984 1 All England Reporter 530 (House of Lords) as also the judgment of Hon'ble Supreme Court in the case of McDowell & Co. Ltd. Vs. CTO, 154 ITR 148 (S.C). The learned counsel argued that the reliance placed by the revenue on these authorities was not correct for two reasons. The first reason was that even by the majority decision in Mcdowell & Co. Ltd. (supra) what was prevented was colourable transactions by way of a device or a subterfuge. It was emphasized in the majority decision, “Tax planning may be legitimate provided it is within the framework of the law.” It was not the revenue’s case that the transactions entered into by the assessee were not in accordance with the framework of the law. The second reason was that after Mcdowell, 154 ITR 148 (SC), a five judge constitution Bench of the Supreme Court had, in Mathuram Agrawal Vs. State of Madhya Pradesh (1999) 8 SCC 667, followed the principle laid down in Duke of Westminster, 1936 A.C. 1 (which according to Chinnappa Readdy J had been buried in the country of its origin) and Bank of Chettinad Ltd. Vs. CIT, 8 ITR 522 (SC) and held that an assessee cannot be taxed on the basis of the so-called substance of the transactions but that one has to go by the plain language of the statute. The same principle had been followed by the Supreme Court in Azadi Bachao Andolan (supra), wherein the decision in Mcdowell & Co. Ltd. was considered in great detail. The learned counsel invited our attention to a large number of

observations made in Azadi Bachao Andolan. The learned counsel argued that the reliance on the English decisions in W.T. Ramsay Limited Vs. IRC 1982 AC 300; IRC Vs. Burmah Oil Co. Ltd. 1982 STC 30 and Furniss Vs. Dawson 1984 1 All ER 530 was not proper because the English Courts had themselves taken a contrary view in Craven Vs. White and MacNiven (Inspector of Taxes) Vs. Westmoreland Investments Ltd. (2001) 1 All England Reporter 865 (HL), as noted by the Supreme Court in Azadi Bachao Andolan at pages 756 and 757 of 263 ITR. The ITAT Special Bench had also accepted that the English courts have taken a different view in Mid East Portfolio, 87 ITD 537 (Mum)SB), paragraph 29. The transactions with the mutual funds were genuine transactions and could not be regarded as a sham, subterfuge or a colourable device as the transactions had actually taken place with an actual flow of funds. It had been consistently held in India and England that motives with which a transaction was entered into were irrelevant and could not in that way affect the legality of the transaction. Even where it was intended to avoid tax, the intention was irrelevant - one had only to see whether on the facts of a case the charge of tax was attracted.

22. The learned counsel argued that in the case of Azadi Bachao Andolan, the principles laid down in the case of Duke of Westminister 19 TC 490 (HL) and in India in the case of CIT Vs. A. Raman & Co., 67 ITR 11 (SC) had been emphasized and the view taken in Ramsay’s case and some other judgments following the same line, as in Ramsay, had been held to be not reflecting correct position in law. At page 760, the Hon'ble Supreme Court held that “words cannot be added to or substituted so as to give a meaning to the statute which will serve the spirit and the intention of the legislature.” It, therefore, followed that in the absence of statutory provision, the legal consequences flowing from a transaction could not be denied on such vague concept as tax avoidance scheme or device. In the present case, the question was, therefore, whether there was a specific tax avoidance provision disallowing the assessee’s claim of loss. Legal effect of the transactions of the assessee could not otherwise be prevented. Law nowhere said that an assessee must pay maximum amount of tax. The learned counsel pointed out that in the case of Azadi Bachao Andolan (supra), the Hon'ble Supreme Court had approved the judgments of Hon'ble Madras High Court in the case of M.V. Valliappan Vs. ITO, 170 ITR 238 (Mad.) and Gujarat High Court in the case of Banyan & Berry Vs. CIT, 222 ITR 831 (Guj.). The Hon'ble Supreme Court had emphasized the earlier judgments of the court also in the case of A.V. Raman & Co. (supra); CWT Vs. Arvind Narottam, 173 ITR 479 (SC) and Mathuram Agrawal Vs State of Madhya Pradesh (supra). All the judgments squarely supported the case of the assessee. In nutshell, the only relevant question was whether it was permissible in law to do what the assessee had done. If that was so, the fact that the assessee paid less tax was of no consequence. There was no statutory provision to hold it otherwise. The provisions of section 94(7) made difference specifically in respect of the kind of transactions under consideration before us, but that was done w.e.f. assessment year 2002-2003 and not before.

23. The learned counsel for the assessee pointed out that the judgment of Hon'ble Supreme Court in the case of Azadi Bachao Andolan had been applied by the High Courts in 265 ITR 626 (Gau.) and 268 ITR 130 (Orr.). The judgment of Hon'ble Supreme Court had been correctly applied by ITAT, “F Bench Mumbai in the case of Premier Consolidated Capital Trust, 83 TTJ (Mum) 843 and by ITAT, Ahmedabad Bench in the case of Kedia Laboritories Ltd., 83 TTJ Ahd. 758, wherein on similar facts the loss claimed by those assessees were allowed as deduction.

24. The learned counsel argued that the provisions of section 94(7) introduced w.e.f. 1.4.2002 could not be said to be clarificatory for the simple reason that a legislative time limit of 3 months had been provided by the amendment. It could not be said that the time limit of three months was clarificatory in nature. There was nothing particular about the period of 3 months, except that the legislature chose to lay down the time limit of 3 months. It could be two months or even six months, as the subsequent amendments showed. It would, therefore, be thoroughly incorrect to say that the provision clarified the existing legal position. The learned counsel further argued that wherever the intention of the legislature was to give retrospective effect to an amendment, it was explicitly stated. For example, insertion of the provisions of section 90(2) by the Finance (No. 2) Act, 1991 with retrospective effect from 1.4.1972; insertion of section 14-A by the Finance Act, 2001 with retrospective effect from 1.4.1962; Explanation to section 36(1)(viii) by Finance Act, 1992 with retrospective effect from 1.4.1987 and so on. If intention of the legislature was to give retrospective effect to the provisions of section 94(7), the same would have been made explicit by the enactment itself.

25. The learned counsel argued that the position relating to section 94(7) had been explained by CBDT itself as per Circular No. 14, 252 ITR (St.) 65. It stated that the dividend was exempt in the earlier period without reference to any time limit. Revenue was not entitled to argue in the present appeals contrary to CBDT circular. With reference to the various English cases on dividend stripping referred to in the impugned order of the learned CIT(Appeals), the learned counsel stated that the Commissioner (Appeals) had relied on the minority decision in Griffths Vs. J.P. Harrison, 58 ITR 328(PC) (the majority decision was in favour of the appellant), Finsbury Securities Limited Vs. Bishop 43 Tax cases 591 (H.L) and Lupton Vs. F.A. & A.B. Limited 47 Tax cases 580 (HL) to support his stand that the loss on the transactions could not be allowed. The learned counsel submitted that the English decisions based on peculiar and particular provisions of English law (Ramsay, Burmah Oil, Furniss etc.) and delivered under circumstances peculiar to that country and on the construction of the provisions which were not in ‘pari materia’ with the provisions of law prevailing in India, did not have any binding force on Indian courts ( CIT Vs. A. Gajapathy Naidu, 53 ITR 114 (SC), 117 and 118). The majority decision in Griffiths Vs. J.P. Harrison, 58 ITR 328(PC) accorded with the provisions in our law and fully supported the case of the assessee. The facts of that case were worth noting, as they were similar to the facts of the assessee.

4th December, 1953: shares purchased for Pounds 16,90026th January, 1954: Dividend declared Pounds 1590126th January, 1954: The assessee resolved to sell the shares.4th June, 1954: The shares were sold for Pounds 1,000Loss of Pounds 15,900 set off against dividend of pounds 15,901.

It was held by the majority that the fact that the fiscal result or ulterior fiscal object was to obtain a rebate of tax on the dividend was irrelevant.

26. The learned counsel for the assessee pointed out that CIT(Appeals) had not followed the aforesaid observations but had relied upon certain observations from the minority dissenting orders of Lord Reid and Lord Denning. It was obvious that the majority view had to be followed and not that of minority. Further, the CIT(A) had made it appear as if in the other decisions in Finsbury Securities Ltd. Vs Bishop, 43 Tax Cases 591 (H.L) and Lupton Vs. F.A. & A.B. Limited 47 Tax Cases 580 (HL), a contrary view was taken. But that was not correct. The Court distinguished the decision of the Privy Council on facts because the nature of the transactions were different. For example, in Finsbury Securities the vendors’ future interests were safeguarded and they were entitled to have all the benefits that would have resulted from their shareholding had there been no scheme. The purchasers were also required to hold the shares for the period covered by the scheme and were not at liberty to deal with the shares in the way they pleased. In fact at page 626-7, Lord Morris of Borth-Y-Gest (who had delivered judgment in Griffiths Vs. J.P. Harrison) distinguished the decision in Griffiths Vs. J.P. Harrison on the basis that the arrangements were essentially different from those which gave rise to the Harrison case.

27. The learned counsel argued that the assessee’s case fell within the ratio laid down by Harrison’s case as against Finsbury because the transaction was demonstrably a unit dealing transaction. Units were brought; a dividend on them was received; later the units were sold. Like in the Harrison case, there could be no room for doubt as to the real and genuine nature of the transaction. There was no scheme or arrangement with the vendor of the units whereby the seller’s financial circumstances were capable of being better or worse. Once the assessee had subscribed to the units of the mutual fund, the mutual fund was not interested in the said units: There was no arrangement between the assessee and the Mutual Fund to share the fiscal gains of the transaction or to protect the unit holder in the event of a loss being suffered. In Lupton Vs. F.A. & A.B. Limited, 47 Tax cases 580 (HL), the facts were different and Lord Morris of Borth-y-Gest (who was party to both Griffiths Vs. J.P. Harrison and Finsbury Vs. Bishop) distinguished the facts in Lupton’s case.

28. Applying the aforesaid principles, the learned counsel contended, the assessee’s transaction of investing and redemption of units was :

i) A simple transaction as in Harrison’s case as compared to the complex ones involved in the case of Finsbury Securities Limited or F.A. & A.B. Limited.

ii) The loss or gain arising out of the transaction was to the account of the assessee and was not effected or shared with anyone else i.e., it was not in the nature of a scheme for the mutual benefit of parties;

iii) This transaction could not be regarded as a dividend stripping transaction as understood by Lord Morris of Borth-Y-Gest in F.A& A.B. limited’s case at page 620.

29. The learned counsel pointed out that in Mrs. Sarojini Rajah Vs. CIT, 71 ITR 504 (Mad), the Madras High Court had referred to with approval the decision in Griffiths Vs. J.P. Harrison, 58 ITR 328(PC). The CIT(A) had quoted extracts from the aforementioned English decisions. If at all those decisions were helpful they supported the assessee’s case and not that of the revenue. Further, those decisions were concerned with legal provisions that were completely different from Indian law. As laid down in CIT Vs. Sun Engineering Works P. Ltd., 198 ITR 297, 320 it was neither desirable nor permissible to pick out a word or sentence from a judgment, divorced from the context of the question under consideration and treat it to be the complete law. A judgment must be read as a whole in the light of the questions that were before the court as a decision of a court took its colour from the questions involved in the case in which it was rendered.

30. Following interveners requested for being allowed to make their submissions during the course of consideration of the issues by us:-

1. Shri S.C. Kapadia, Shri Y.P. Trivedi & Ms. Usha Dalal. ITA No. 2255/M/04 Nachiket Securities Pvt. Ltd. A.Y. 2001-02

2. Shri V.H. Patil & Shri Satish ModiITA No. 5343/M/04 M/s Sodhani Securities Ltd. A.Y. 2001-02

3. Shri K. Shivram ITA No. 7974/M/2004- Mr. Jaykumar K. Pathare & 2001-02

ITA No. 4960/M/2004- Mr. L. Vinay Reddy 2001-02

4. Shri Dilip K. ShethITA No. 7075/M/04- Goldcrest Capital Markets Ltd. 2001-02

5. Shri Prakash Jhotwani ITA No. 7324/M/2003- Ramon Publications Pvt. Ltd. 2001-02

31. These interveners fully supported the various arguments of Shri S.E. Dastur and accepted that there was not much left to be added. Shri Trivedi argued that his assessee was a dealer in shares, who purchased and sold shares and securities on large scale on regular basis. In such situation there were many transactions resulting into profit and there were also many transactions resulting into loss. The loss making transactions could not be segregated as device. As far as dividend exemption was concerned, it was nobody’s case that the same was not earned. It could not be that a part of transaction i.e., dividend should be accepted as genuine and other part of the transaction i.e., loss should be treated as artificial. The learned counsel referred to the judgments of Hon'ble Supreme Court reported in 75 ITR 174 (SC) and 247 ITR 821 (SC) and argued that section 94(7) could be considered as retrospective only when the various criteria enunciated by the courts in that respect were fully satisfied. Shri V.H. Patil appearing for the second intervener argued that in every case, where any part of income was exempt from tax or was taxed at a concessional rate, a prudent businessman would take the benefits thus arising, into consideration. For that reason the businessman could not be said to be adopting a colourable device, nor the transaction could be branded as non-business transaction. As to the judgment of Hon'ble Supreme Court in the case of Mcdowell, the same had been delivered on very different facts. Excise duty always belonged to the manufacturer but in the case of Mcdowell, a third party was being made to pay excise duty. It was, therefore, clear that the transactions

were in the nature of device. Shri K. Shivram, the learned Advocate appeared for interveners No. 3 and 4. He pointed out that his assessees, unlike the assessee in appeal before us, were not businessmen. He argued that not every one incurred trading loss on purchase and sale of units of a mutual fund. His clients had claimed the loss arising as capital loss. He emphasized that there was nothing illegal committed by the assessees. There was nothing on record to question or doubt genuineness of the transactions. In such situation, the assessee could not be held to have employed a colourable device. Appearing for intervener No. 5, Shri Dilip Sheth emphasized that his assessee was a businessman. For taking any business decision, his assessee had always to consider the overall position, including tax implications of the transaction. For that reason the transactions of the assessee could not be said to be non-commercial. Nature of transaction could not go on changing, when it was profit or when it was loss. Shri Prakash Jhotwani appearing for the last intervener named above, argued that there was no basis to state that his client had entered into a pre-meditated and pre-ordained transaction. His client invested in the units of mutual fund in 1999 and sold them in 2001. Yet the loss was disallowed. At any rate, there were no parameters relating to number of days prior to amendment by way of provisions of section 94(7). He argued that in the case of his client there was no borrowing; there was no joint venture and there was no agreement other than the agreement in question with the mutual fund.

32. Shri S.D. Kapila, the learned counsel for the revenue opened the arguments on behalf of the revenue. He pointed out with respect that in the case of Mcdowell & Co. Ltd. (supra), the main judgment was delivered by Ranganath Misra J. (as he then was) on behalf of himself and other three judges including Chief Justice of India. Chinnappa Reddy J. delivered a separate judgment. At the same time in the majority judgment delivered by Ranganath Misra J, the following passage appeared:-

“Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or 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.

On this aspect, one of us, Chinnappa Reddy J. has proposed a separate and detailed opinion with which we agree. “

33. The learned special counsel for the revenue took us closely through the provisions of sections 2(22), 8, 10(23D), 10(33), 56, 115 AB, 115-O and 115R. He argued that from these provisions, it was clear that an income from units of a mutual fund was not “dividend”, as defined in the Income-tax Act or the Companies Act, 1956. In common parlance such income was being called dividend and even mutual funds and departmental authorities in their assessments/appellate orders called income from units of mutual funds as “dividend”, but in the eyes of law, having regard to the various statutory provisions income from units could not be considered as “dividend”. The learned counsel pointed out that the expression “dividend” having been defined in the Act by section 2(22) had to be given the same meaning. Section 2(22) comprised of 5 clauses to indicate what was included in “dividend” and it also comprised of six clauses to indicate what was not included in the term “dividend”. In all these clauses of inclusion as well as exclusion, the reference was to “company”. Only a distribution made by a company could qualify to be considered as dividend. The expression “company” as defined in section 2(17) of the Act, did not include an open ended mutual fund. Provisions of section 8 of the Act dealing with “dividend income” did not refer to an income declared or distributed or paid by a mutual fund. Section 10(33) employed the expression “income received” in respect of the units of a mutual fund. Section 10(23D) also employed expression “income of mutual fund”. The learned special counsel argued that the provisions of section 56(2)(i) would not, therefore, apply to an income received from a mutual fund in relation to any units of a mutual fund held by an assessee. For that reason the provisions of section 94(7) mentioned both the dividend or income on securities or units. Such distinction was also maintained in the provisions of sections 115A, 115-O and 115R. While provisions of section 115-O applied to amount declared, distributed or paid by domestic companies by way of dividend, the provisions of section 115R(2) applied to amount of income distributed by the specified company or a mutual fund to its unit holders.

34. The learned special counsel for the revenue argued that the distinction was not merely of nomenclature. There were weighty considerations calling for the legal distinction between dividend distributed by a domestic company and income from a mutual fund. Such distinguishing features were well recognized by traders/investors of securities. Those were :-

“a) The market value of a company’s share traded in a stock exchange fluctuates from moment to moment with the movement of price depending on factors like demand and supply for the stock. The NAV of the MF is quite immune to `sensex’ around the time of the `record date’ for `dividend’ because of the cushion provided by the inflation in the value of assets in the form of cash received by MF on account of subscription money.

b) Unlike issue of share capital by a company, the MF may issue or redeem units continuously on a daily basis.

c) Subscribed share capital is the liability of a company; whereas subscription money is an asset of an MF which goes into day-to-day valuation of the NAV of the MF.

d) Unlike buy-back of shares by a company, MF is bound by SEBI Regulations to buy back (redeem) units whenever tendered by a Unit holder on the basis of the NAV (Net Asset Value), which is published by the MF on a daily basis.

e) For the purpose of computing NAV, the MF takes into account the net value of assets including the subscription collected by it on issue of units.

f) Whereas dividend u/s 2(22) of the Act must always be assessed as `income from other source’ in view of provisions of section 8 read with 56(iii) of the Act; income from MFs will have to be assessed either under the head “business” or under the head “income from other sources” (S. 2(24) read with sections 28 and 56) depending on the nature of transaction and the character of the holding i.e., whether the units were held as business asset for trading or as capital asset for investment.

g) Dividend is distributed from accumulated profits of a company with reference to its subscribed share capital in accordance with the provisions of Companies Act; whereas MFs distribute income from its `equalization reserve’ comprising profits and premium charged on sale of units as per SEBI regulations.”

35. The learned special counsel explained the mechanics of distribution of the so-called dividend by an MF in the following manner:-

“The MF gives advance publicity of the amount of ‘dividend’ which it will distribute on the ‘Record Date’. For instance, in the assessee’s case for the assessment year 2000-2001 wide publicity was given by the Cholamandalam MF that it would pay Rs. 4 per unit on March 24, 2000. Advertisements to this effect were prominently published in newspapers. Copy of such an advertisement dated 8th March, 2000 in Times of India is specifically brought to the notice of the Hon'ble Bench. From 20th March onwards the cash collection on sale of units MF started swelling due to surge of inflow of money from the quick-in-quick out investors. By 24th March, 2000 the size of Fund swelled to many times the size of the original fund lying invested in equity. Thus, possibility of any sudden downward movement in the market value of the equity held by the MF was easily cushioned without any adverse impact on its NAV. Even a sudden drop of say 20% in the sensex on 24th March would hardly make any difference to the NAV of the MF. 25th March was Saturday and 26th Sunday. The stock markets were closed on those days. On 27th March, i.e., the ex-dividend NAV falls by the amount of ‘dividend’ distributed and the assessee redeems the units, which the MF under law is bound to purchase back on NAV of that day. During a few days following the record date, the ex-dividend of the MF NAV remains stable due to large amount of subscription money still lying with the MF. Charts of the movement of the MFs as compared to movement of sensex during the relevant periods before and after the ‘record date’ is annexed to this synopsis.”

36. The learned special counsel for the revenue referred to pages 33 to 54 of the department’s paper book indicating the financial position of various mutual funds and how the dividends were financed by receiving subscription within a few days prior to the record date for distribution of dividend. He pointed out that during the financial year 1999-2000 Chola Mutual Fund distributed so-called dividend of Rs. 290 crores, as against its annual net income of Rs. 15 lakhs only. That was made possible by transfer of Unit Premium Reserve to the Equivalisation Reserve, which in turn was built up by surge of subscription money during 21st March, 2000 to 24th March, 2000, as was apparent from the chart at page 53 of the paper book. Similar pattern could be seen in the case of other mutual funds.

37. The learned special counsel pointed out that the assessee filed following `Statement of Fact’ before the CIT(Appeals) in relation to assessment year 2000-2001:-

“Re: Loss arising out of dealing in units of Mutual Fund at Rs. 1,85,68,014/-.

Appellant is engaged in a business of dealing in shares and securities. During the course of business it entered into following transactions for purchase and sale of units of Mutual Funds which resulted into loss of Rs. 1,85,68,014/- and appellant earned dividend income at Rs. 1,82,12,862/- which was not taxable in view of section 10(33) of the Income-tax Act.

Particulars         Purchase          Sale          Gain/loss         Dividend                       Date   Amount   Date      Amount      Date     Amount

Units of      24.3.00      80000000CholaM/Fund(Paid bycheque No.191935)- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -                                                                              29.3.00Less             2376778    27.3.00  59055207.75 (18568014.25)   18212862.84 Incentive      77623222 - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -

38. The learned counsel for the revenue argued that dividend of Rs. 4/- was not accounted for by the assessee in the trading account on the ground that dividend was chargeable to tax under the head `Income from other sources’. Such argument was entirely untenable because income from Cholamandalam Mutual Fund was exempt from tax not as `dividend’ but as income from mutual fund under the provisions of section 10(33) of the Act. Such income was not covered by the provisions of section 56 and would have been assessed in the case of the assessee if it were not exempt, under the head “Profits and gains of business or profession”. Just because income from MF was excluded from computation of total income, it did not mean that it was not a trading receipt and should not have been incorporated in the trading account of the assessee. Reference in this respect was made to the judgment of Hon'ble Bombay High Court in the case of Ahmuty & Co. Ltd., 27 ITR 63 (Bom.) to the effect that dividend income received by the assessee, who was a dealer in shares, was income from business. Reference was also made to the judgment in the case of Western States Trading Company (P) Ltd., 80 ITR 21 (SC) that if the shares were held by the assessee as part of its trading assets, dividend on those shares would form part of the income from business. For the same purpose, reference was also made to the judgment of Hon'ble Supreme Court in the case of Chuggan Das, 55 ITR 17 (SC). The learned Special Counsel argued that in the transaction with Cholamandalam Mutual Fund the assessee incurred an expenditure @ Rs. 17.57 per unit on 24.3.2000 to receive dividend of Rs.4/- on the very same day and sale proceeds of Rs. 13/- after two days. The transaction was undertaken by the assessee with full knowledge of the trading results thus ensuing. On

these facts a part of the expenditure was directly related to the earning of the so-called dividend from the mutual fund. There was a clear nexus between the cost of purchase of units and the immediate receipt of so-called dividend. In other words the composite expenditure on purchase of units was relatable not only to the sale proceeds of units, but also to the receipt of income by way of dividend. The expenditure incurred on purchase of units had to be apportioned on a reasonable basis between the receipt by way of ‘dividend’ and receipt on redemption of the units. The learned special counsel referred to the judgments of Hon'ble Supreme Court in Best & Co., 60 ITR 11 (SC) and Continental Construction Co., 195 ITR 81 (SC); Calcutta High Court in the case of Dunlop Rubber Co., 107 ITR 182 (Cal.) and Bombay High Court in the case of Mahendra Sintered Products Ltd. Vs. CIT, 177 ITR 111 ((Bom). He argued that in the case of Best & Co., the Hon'ble Supreme Court had laid down that difficulty in apportionment cannot be ground for rejecting the claim of either assessee or revenue and that apportionment should be made on a reasonable basis. In the case of Continental Construction Co. (supra), Hon'ble Supreme Court observed that receipts and expenses have always been considered apportionable. In view of the above legal position, the business loss arising to the assessee should be computed after crediting the trading account by the income from the mutual fund. That would also be in conformity with the guidelines issued by the Institute of Chartered Accounts in Accounting Standard 13, which read as under:-

“Interest, dividends and rentals receivables in connection with an investment are generally regarded as income, being the return on the investment. However, in some circumstances, such inflows represent recovery of cost and do not form part of income. For example, when unpaid interest has accrued before the acquisition of an interest bearing investment and is, therefore, included in the price paid for the investment, the subsequent receipt of interest is allocated between pre-acquisition and post-acquisition periods; the pre-acquisition portion is deducted from cost. When dividends on equity are declared from pre-acquisition profits, a similar treatment may apply. If it is difficult to make such an allocation except on an arbitrary basis, the cost of investment is normally reduced by dividends receivable only if they clearly represent a recovery of a part of the cost.”

39. The learned special counsel for the revenue argued that the assessee’s reasoning ran like this. Income from mutual fund was exempt u/s 10(33). By operation of the provisions of section 10(33), the same was not to be included in ‘total income’. It meant that while computing the loss on sale of units under the relevant provisions of computation in Income-tax Act, no part of income from mutual fund could be taken into consideration. The learned counsel argued that such logic was clearly negated by the provisions of section 14-A inserted by the Finance Act, 2001 retrospectively w.e.f. 1.4.1962 to take care of such contentions. He pointed out that the scope and ambit of provisions of section 14A had been explored in the following Tribunal decisions:-

1 S.G. Investments & Industries Ltd. (2004) 89 ITD 44(Kol.)2 Assessing Officer Vs. Dakshesh S.Shah (2004) 90 ITD 519 (Mum.) 3 Harish Krishnakant Bhatt (2004) 91 ITD 311 (Ahd.)

The learned counsel argued that once the nexus between a part of the expenditure on purchase of units and the earning of income from those units stood established, the only question was as to how the cost of purchase of units should be apportioned. As held by the Hon'ble Supreme Court in the case of A.R. Krishnamurthy, 176 ITR 417 (SC), best valuation of cost should be made on the basis of credence. Thus, the cost was best represented by the difference between closing NAV cum-dividend and the opening NAV ex-dividend. Daily movement in the NAV of Chola MF as published by it with the movement of sensex would give the required particulars. Similar trend could be seen in respect of Sun F&C Value Fund in the other assessment year. In almost all the cases the dividend stripping showed the fall in NAV cum-dividend and ex-dividend corresponding to the amount of dividend. It was because the NAV remained immune to the movement in sensex for a brief while because colossal amount of money entered and exit in the mutual fund, allowing quick in quick out traders/investors to have their date with the fund without being affected by any possible impact on account of the movement of sensex.

40. The learned spl. counsel for the revenue argued that it was quite clear that the only commercial reason for purchase of units of mutual fund by the assessee before us was to earn tax free dividend and to recover

the balance amount it invested as soon as possible after the record date. In such situation, the expenditure reflected by the cum-dividend and ex-dividend NAV represented the expenditure having a direct nexus with tax free income and it had to be disallowed u/s 14-A of the Act. Thus, the assessee was not correct in law in claiming the entire cost of purchase of units against the sale proceeds of units.

41. The learned counsel referred to the assessee’s overdraft account with Global Trust Bank and pointed out that the assessee purchased on 24.3.2000 the units of Chola MF by drawing cheque on Global Trust Bank for the sum of Rs. 8 crores. The assessee had then a debit balance of Rs. 2,57,89,379.34, which increased to Rs. 10,57,89,379.34 as a result of the cheque drawn in favour of Chola mutual fund. Thereafter the assessee’s account was credited on 28.3.2000 by the sum of Rs. 5,90,55,207.75 being the payment received from Chola mutual fund in the form of sale proceeds. On 29.3.2000 the assessee’s bank account was credited by another sum of Rs. 1,82,12,862.84 being the payment in the form of income made by Chola MF. The learned counsel argued that the assessee did not even have requisite funds to purchase the units. However, as the entire transaction was intended to last a very brief period of three four days only, the assessee borrowed funds temporarily from its overdraft account and financed the transaction. On these facts, the intention of the assessee were quite clear. The entire transaction was entered into with the sole objective of acquiring tax free income. The learned counsel argued that the entire transaction could take place in the manner desired because unlike joint stock companies governed under the provisions of Companies Act, 1956, a Mutual Fund could distribute income from out of the funds received by it, which were essentially in the nature of subscription funds.

42. Referring to the provisions of section 94(7) introduced by the Finance Act, 2001, the learned special counsel argued that initially it laid down the condition of holding of securities three months prior and three months subsequent to the declaration of dividend or, as the case may be income on such securities or units so as to have the benefit of exemption from tax. The holding period of 3 months has been subsequently increased to 9 months by the Finance (No. 2) Act, 2004 w.e.f. 1.4.2005. Assuming that the provisions of section 94(7) were not retrospective and only prospective in effect, those provisions would have no bearing on the assessment years 2000-2001 and 2001-2002 under consideration before us. It was remarkable and significant that the provisions of section 94(7) were inserted by the same Finance Act, 2001 that introduced the provisions of section 14A with retrospective effect from 1.4.1962. The provisions of section 94(7) would, therefore, appear to be mitigating the rigors of the provisions of section 14-A. Thus, the cases where purchase of securities would be in the normal course the provisions of s. 94(7) immunize them from the effects of section 14A. The learned special counsel argued that as the provisions of section 94(7) have not been given retrospective effect, the doctrine of special provision taking over the general provision would not apply in the assessment years before us as well as in the cases of shorter period of holding in the subsequent assessment years.

43. The ld. counsel further argued that the assessee might object to the plea based on section 14A on the ground that no such issue had been raised by the Assessing Officer or the learned CIT(Appeals). The plea taken by the revenue was purely legal one which could be decided on the basis of material already available on record. The subject matter of appeal before the Special Bench was whether the assessee’s claim of loss had been correctly disallowed. The Assessing Officer may have disallowed the claim on a different ground but that did not mean that the revenue could not contend that the order of the Assessing Officer was justified because of applicability of a specific provision in the Act. The revenue as respondent, could take up a new plea with a view to defend the order of the Assessing Officer. The learned counsel relied upon the judgment of Hon'ble Supreme Court in the case of Hukam Chand Mills Ltd. Vs. CIT, 63 ITR 232 (SC). The learned counsel referred to the judgment of Full Bench of Bombay High Court also in the case of Ahmedabad Electricity Co. Ltd. Vs. CIT, 199 ITR 351 (Bom.)(FB). He also placed reliance on the judgment of Hon'ble supreme Court in the case of National Thermal Power Corporation Vs. CIT 229 ITR 383 (SC).

44. The arguments of Shri S.D. Kapila, the learned special counsel were supplemented by Shri V.S. Singh, the learned CIT, D.R. He argued that the judgment of Hon'ble Supreme Court in the case of Union of India Vs. Azadi Bachao Andolan, 263 ITR 706 (SC) did not conclude the matter in favour of the assessee and did not give the tax evaders such azadi as made out by the learned counsel for the assessee. The rule against

colourable device or pre-planned/pre-ordained scheme of tax avoidance was not withdrawn by that judgment. Explaining the rule, sometimes referred to as the Ramsay Principle, the learned CIT, DR argued that where there was a pre-planned or pre-ordained scheme which had no purpose apart from reduction of liability to tax, the series of transactions or steps comprising the scheme, though legally genuine, had to be viewed as part of the composite scheme for the reason that they had been solely entered into for the purpose of producing an end result entirely different from that which would have been achieved by each successive link in the pre-conceived chain if such link was considered in isolation.

45. The learned CIT, DR gave us the photocopy of the advertisement on 8th March, 2000 in Business Times section of Times of India, by Chola Freedom Technology Fund bearing the head “Double Advantage”. The advertisement beseeched people to invest before 24th March, so that they may get 40% tax free dividend. The learned CIT, DR pointed out that by virtue of this advertisement the assessee was assured of a dividend of Rs. 4/- per unit in the event of investment before 24th March, 2000. The assessee became entitled to dividend of Rs. 1,82,12,862.84 on the close of business hours on 24th March, 2000. On 24th March, 2000 NAV of Chola Fund was Rs. 17.23. As a result of dividend pay out NAV of Chola Fund got reduced to Rs. 13.23. The fall in NAV of each unit of Chola Fund was accurately matched by the amount of dividend pay out. The assessee sold all the units purchased on 24th March, 2000 on 27th March, 2000. The learned CIT, DR argued that all that the assessee did was to make a payment to Chola MF for the purpose that the same would be refunded after deducting certain charges to the assessee under two separate nomenclatures. The assessee converted his own cash into two different amounts viz., sale proceeds of units and income received from units. By this transaction nothing material really happened, except that by payment of certain remuneration to the mutual fund the assessee got a document whereby he could convert his own money into tax free income and at the same time claim equivalent of such tax free income plus charges paid to the mutual fund as a business loss against the assessee’s other business income chargeable to tax. These were the transactions patently to avoid tax with the complicity of the mutual fund. The manner in which the mutual fund promised to the whole world payment of 40% tax free dividend irrespective of the quantum of investment and period of investment clearly proved that from the very beginning the intention of the mutual fund was nothing more than to convert the investors’ cash only into pay out of income by the mutual fund. The learned CIT, DR pointed out that the facts of Sun F & C Value Fund were the same. On 18.12.2000 the said fund had NAV of Rs. 17.10. After pay out of dividend @ Rs. 3.50 per unit on 19.12.2000, the NAV of the fund was reduced to Rs. 13.60. In other words by making payment on 18th December, the assessee could get his own fund split into income received from Mutual Fund as well as sale proceeds of units, on payment of certain charges by way of remuneration to Sun F &C Value Fund for its complicity in the scheme of tax avoidance. By way of icing on the cake, the assessee need not have employed his own funds and the entire transaction could smoothly go through by way of overdraft from the banks who knew that the money was going out for two-three days only. In the scheme of things, record date was known; rate of dividend was known; amount of remuneration payable to the mutual fund was known; the transactions were all pre-planned and pre-ordained. Therefore, in the present case the purchase and sale of units could not be treated as transactions of trade as the purchase and sale though ostensibly bearing features of purchase and sale, were not purchase and sale when viewed as part of a composite scheme. The purchase and sale of units was a mere pretence, as the sole objective was only to produce an artificial loss and not to acquire or dispose of the units of the mutual fund. In that view of the matter the loss claimed by the assessee was required to be ignored as not being real or incidental to any source of income. The learned CIT, DR sought to support this contention with various judgments in the United Kingdom relating to dividend stripping. He cited the following passage from the speech of Lord Denning in Griffiths Vs. J.P. Harrison (supra) :

“Put shortly, it comes to this : If the transaction is, in truth, a transaction in the nature of trade it does not cease to be so simply because the trader had in mind a tax advantage. But if it is, in truth, a tax recovery device and nothing else, then it remains a tax-recovery device, notwithstanding that it is clothed in the trapping of a trade.”

46. The learned CIT, DR thereafter proceeded to next proposition in the following manner:-

“Proposition 1(b) : The statutory validity of any allowance sought by a taxpayer depends on the concept of a provision as used in the concerned statute;

If the relevant concept has necessarily to be construed in the commercial sense due to the reason that it has been used as such in the statute and the allowance sought does not conform to the commercial concept of the provisions;

The scheme is liable to be treated as a negation of the provisions of the statute and therefore, nugatory. “

For this proposition the learned CIT (DR) relied upon the following:

MacNiven Vs. Westmoreland Inv. Ltd. (255 ITR 612)( HL)

M.V. Valliappan ( 170 ITR 238 (Mad.) Banyan Vs. Berry (222 ITR 831 )(Guj.) Azadi Bachao Andolan (263 ITR 706 (SC)

47. The learned CIT, DR argued that in the charging sections of Income-tax Act, 1961, the expression “loss” had not been mentioned anywhere. It was regarded as a part of income chargeable to tax. If in the process of making an income chargeable to tax any loss occurred, the same would also fall within the provisions of the Act relating to computation of income chargeable to tax. There was otherwise no independent provision for computation of any loss. In other words, any loss that could not be regarded as incidental to the earning of income chargeable to tax, could not enter into computation of income or assessment of income. The learned CIT, DR argued that for such reasons loss under the Income-tax Act was a commercial concept and was required to be given its natural, ordinary or popular meaning. The loss under the Income-tax Act was not merely arithmetical difference. Mere arithmetical difference could not be claimed as deduction.

48. The learned CIT, DR then made his second proposition in the following words:-

“Proposition II : Courts in India, even prior to Mcdowell case, have held that the nature of a transaction is to be discerned given the facts and the surrounding circumstances of the case and if such examination so warrants, the documents executed and agreements made in the course of transaction and/or the validity of the parties to the transaction can be disregarded as these constitute only a cloak to conceal the real nature of the transaction.”

49. The learned CIT, DR argued that there were a plethora of court pronouncements in support of the above Proposition II. The flaw in the arguments of the learned counsel of the assessee was that according to him, there was only one judgment ruling the field, viz., Duke of Westminster Vs. Commissioner of Inland Revenue, 19 P.C. 490 (HL). Further, the learned counsel for the assessee erroneously interpreted the judgment of Azadi Bachao Andolan (supra) as over-ruling each and every judgment not in strict conformity to the judgment of House of Lords in Westminster case. Fact of the matter was that the judgment in the case of Duke of Westminster proceeded on its own special facts. It was noted by House of Lords that it was nobody’s case that the deed was not genuine. The important question relating to substance of the transaction or mere device/contrivance for tax avoidance did not form part of discussion and consideration in that judgment. In subsequent judgments, such as, W.T. Ramsay Ltd. Vs. Inland Revenue Commissioner, 1 All England Reporter (H.L) 865; Inland Revenue Commissioner Vs. Burmah Oil Co. Ltd. 54 TC 2000 ; Furniss Vs. Dawson ( 1984) AC 474; Craven Vs. White, 183 ITR 216 (H.L) etc., it was recognized that the issues could not be decided on the narrow footing of sham versus real and it was equally important to examine the substance of the transaction and the fact as to whether the transaction was merely a device or contrivance. Apart from English courts, the Hon'ble apex court and various other High Courts in India had since beginning in a plethora of judgments enshrined the significance of substance of the transaction and the question whether the transaction was natural or artificial. In support of the contentions, the learned CIT, DR divided the case laws into three categories. In the first category fell the court pronouncements prior to

the judgment of Hon'ble Supreme Court in the case of Mcdowell & Co. Ltd. The learned CIT, D.R. mentioned the following judgments:-

1. Jiyajeerao Cotton Mills Ltd., 34 ITR 888 (SC);2. Captain (HS) 36 ITR 84 (Bom.)3. Kikabhai Premchand, 24ITR 506 (SC);4. G.Venkatswami Naidu & Co., 35 ITR 594 (SC);5. Shri Meenakshi Mills Ltd., 63 ITR 609(SC);6. Motor & General Stores , 66 ITR 692(SC);7. A.Raman & Co., 67 ITR 11(SC);8. Sakarlal Balabhai, 69 ITR 186 (Guj.) - approved by Supreme Court in 86 ITR 2);9. B.M. Kharwar, 72 ITR 603(SC);10. Juggilal Kamlapat, 73 ITR 702 (SC);11. Durgaprasad More, 82 ITR 540 (SC);12. Panipat Woollen & General Mills. Co. Ltd., 103 ITR 66(SC);13. Gosalia Shipping Pvt. Ltd., 113 ITR 307 (SC);14. Sutlaj Cotton Mills Ltd., 116 ITR 1 (SC).

50. Thereafter the learned CIT, DR referred to the following judgments pronounced after the judgment in the case of Mcdowell & Co., but before the judgment of Hon'ble Supreme Court in the case of Azadi Bachao Andolan :-

i) Workmen Vs. Associated Rubber Industry Ltd., 157 ITR 77 (SC); ii) State Bank of Travancore, 158 ITR 102 (SC);iii) Neroth Oil Mills Co. Ltd., 166 ITR 418 (Ker.);iv) Smt. Minal Rameshchandra, 167 ITR 507( Guj.);v) Valliappan (M.V.), 170 ITR 238 (Mad.);vi) Warasat Hussain, 171 ITR 405 (Pat.);vii) Arvind Narottam, 173 ITR 479 (SC);viii) Playworld Electronics Pvt. Ltd., 184 ITR 308 (SC);ix) Dalmia (L.N), 207 ITR 89 (Cal.);x) Nayantara G. Agrawal, 207 ITR 639(Bom);xi) Kannan (S), 210 ITR 585 (Kar.);xii) Sumati Dayal, 214 ITR 801 (SC);xiii) Banyan and Berry, 222 ITR 831 (Guj.);xiv) Bhagat Construction Co.(P) Ltd., 250 ITR 291(Del);xv) Twinstar Holdings Ltd., 260 ITR 6 (Bom.);xvi) K. Ramaswamy, 261 ITR 358 (Mad.).

51. The learned CIT, DR referred to the following judgments delivered after the judgment of Hon'ble Supreme Court in the case of Azadi Bachao Andolan(supra):-

1. Avasarala Automation Ltd., 266 ITR 178 (Kar.); 2. Kashyap Sweetners (P) Ltd., 91 ITD 603 (ITAT, Indore); 3. Modi Alkalis & Chemicals Ltd. (2004) 7 S.C. 569

52. The learned CIT, D.R. argued that it was not as if the rule against mere device or contrivance for tax avoidance and the principle of substance of transaction or real income principle was imported in India for the first time in the judgment of Hon'ble Supreme Court in the case of Mcdowell & Co. Ltd. For several decades before that, Hon'ble Supreme Court and various High Courts in India were applying the very same principle on their own and sometimes on relying on English cases also. On reading the judgment of Hon'ble Supreme Court in the case of Azadi Bachao Andolan, this aspect was quite clear. The question before us was whether the entirely non-commercial transactions could be regarded within the trade of share dealing merely because the transactions were clothed in the trappings of a trade transaction. The judgment of

Hon'ble Supreme Court in the case of Azadi Bachao Andolan did not say that it was the trapping and not the substance that mattered. There was also no force in the contention of the learned counsel for the assessee that after the judgment of Hon'ble Supreme Court in the case of Azadi Bachao Andolan, a transaction can be disregarded only if expressly prohibited in the statute. The principles of interpretation of a statute dictated that a term in the statute should be understood as used in the statute. It was, therefore, not essential to provide in the statute that colourable devices or transactions shorn of substance should be disregarded.

53. The ld. CIT, DR vehemently argued that it was not correct interpretation that after the judgment of Hon'ble Supreme Court in the case of Azadi Bachao Andolan the revenue must accept every device employed by an assessee to avoid its tax liability and that the only remedy with the revenue in such situation was to seek a specific amendment of law from the parliament to disregard that particular device. The learned CIT, DR pointed out that in the case of Azadi Bachao Andolan Hon'ble Supreme Court was concerned with the validity of a notification issued by Union of India in relation to section 90 of the Income-tax Act pertaining to double tax avoidance agreement. It was argued by the petitioners in the public interest litigation launched by them that the notification encouraged tax avoidance and, therefore, it was contrary to the judgment of Hon'ble Supreme Court in the case of Mcdowell & Co. and various other similar judgments. The court was not concerned with the application of the judgment of Mcdowell & Co. in such cases as in the appeal before us.

54. The learned CIT, DR argued that before the Hon'ble Supreme Court it was argued that “any tax planning” must be struck down by the court. In the ensuing paragraphs in the judgment of Hon'ble Supreme Court the word “any” occurs again and again. The Hon'ble Court were disapproving the interpretation of the judgment of McDowell that “any tax planning”, “any step”, “any device” resulting into reduction of tax had to be disregarded. Hon'ble Supreme Court in the case of Azadi Bachao Andolan denounced indiscriminate application of McDowell principle and it would be a complete mis-reading of the judgment of Hon'ble Supreme Court in the case of Azadi Bachao Andolan that McDowell principle as a whole had been denounced.

55. The learned CIT, DR emphasized that from Azadi Bachao Andolan case it did not follow that McDowell principle could not be applied selectively in cases of an unreal and artificial transaction aimed solely at dodging revenue. The learned CIT, DR pointed out that at page 757 the judgment of House of Lords in the case of MacNiven (H.M .Inspector of Taxes) Vs. Westmoreland Investments Ltd. (2001) 1 All England Reporter 865 (HL) was referred to and the observation of Lord Hoffmann quoted :

“On the other hand, if the legal position is that tax is imposed by reference to a commercial concept, then to have regard to the business `substance’ of the matter is not to ignore the legal position but to give effect to it.”

The learned CIT, DR argued that “dividend” was a commercial concept and, therefore, having regard to the business substance of the matter was not to ignore the legal position but to give effect to it.

56. The learned CIT, DR thereafter referred to the passage from “American Jurisprudence (1973) 2nd edition volume 71”, cited with approval at page 760 and 761 of 263 ITR in the judgment of Azadi Bachao Andolan. The learned CIT DR argued that the passage clearly showed that while taxpayer had right to resort to a legal method available to him to compute tax liability in manner most beneficial to the taxpayer, he was not entitled to resort to a device for the purpose of avoiding taxation that may amount to “a discreditable evasion of the taxing laws”. The learned CIT, DR, thus, vehemently argued that as far as the two principles viz., Duke of Westminster principle and Ramsay principle were concerned, the judgment in the case of Azadi Bachao Andolan could not be considered as denouncing or disapproving either of the two principles.

57. The learned CIT, DR referred to the judgment of Hon'ble Supreme Court in the case of Commissioner of Central Excise, New Delhi Vs. Modi Alkalis & Chemicals Ltd. and others (2004) 7 S.C. 569 and that

this judgment delivered after the judgment in the case of Azadi Bachao Andolan was a clear affirmation of the fact that it was substance of the transaction that mattered.

58. The learned CIT, DR then made, without prejudice, the following proposition:-

“Proposition III: On the application of the principles governing the determination of the nature of a transaction, the purchase and sale of units cannot be viewed as a trading transaction. The difference between the purchase and sale price is in the nature of expenditure incurred for earning dividend. Since the dividend is exempt, such expenditure is not allowable.

A. Whether a particular constitutes business depends on the character of the transaction to be determined not only with reference to the transaction itself but also surrounding circumstances. A business transaction cannot be devoid of profit motive/expectation of commercial benefit/gain. Every gain or loss incurred by a business does not acquire the character of business income or loss unless it arises in the course of carrying on of the business and is incidental to it.

B. There is a clear distinction between a business expenditure and business loss.

C. In determining the allowability of an expenditure, it should be relatable to an item of income/contemplated income. Matching concept of taxation

D. Dividend income is assessable as business income and ”loss” is in the nature of expenditure incurred “exclusively” for earning dividend income. Conversely, if the dividend income is taken as “ income from other sources”, the “loss” is an “expenditure” incurred in earning dividend income. In either case, the dividend income and “loss” i.e., expenditure are intrinsically linked with one another.

E. Such expenditure is expressly disallowable u/s 14A of the Income-tax Act.

·Rajasthan State Warehousing Corpn.(242 ITR 450)(SC) Memorandum Explaining Finance Bill 2001 ·S.G. Investments & Industries Ltd. (89 ITD 44)(Cal.) ·Rati M. Fyzee (82 ITD 548) (Mum.) ·Devendra Prasad Jajodia Vs. ITO (A.Y) 1998-99 ITA No.2420(Kol)/02 ·K.V. Trading Co. Ltd. Vs. DCIT (ITA No. 924(Kol.)/2003 ·Harish Krishna Bhatt (91 ITD 311)(Ahd.)

59. The learned CIT, DR referred to the judgments in the case of CIT Vs. Meenal Rameshchandra, 167 ITR 507 (Guj.); Senairam Doongarmall, 42 ITR 392(SC); Lok Shikshana Trust, 101 ITR 234 (SC); Hindustan Cellulose & Paper Mills Ltd., 50 ITR 303 (Cal.) and G. Venkataswami Naidu & Co., 35 ITR 594 (SC) and argued that whether there was a business loss was a question to be decided on the basis of all the facts and circumstances of the case and the relevant legal principles. A transaction did not become business transaction merely because the purpose ostensibly purported to do business. The learned CIT, D.R. also placed considerable reliance on the judgment of Hon'ble Calcutta High Court in the case of David Mitchell Vs. CIT, 30 ITR 701(Cal.) and argued that deprivation of oneself of a properly by a voluntary act was not loss sustained. One did not sustain a loss unless the loss was caused to or forced upon one by the exigencies of transaction in the course of which one did everything possible to prevent that loss. Thereafter reference was made to the judgment of Hon'ble Jammu & Kashmir High Court in the case of Chenab Forest Co. Vs. CIT, 96 ITR 568 ( J & K).

60. The learned CIT, DR then made, without prejudice, the following proposition:-

“Proposition IV: The payment made by the assessee at the time of purchase is of two assets viz., units and the accrued dividend. What the assessee sold is only one asset i.e. units. Thus in working out the profit/loss

on sale of units, that portion of the purchase price ought to be taken into consideration which is attributable to the units only and not to accrued dividends.

1 India Discount Co. Ltd. (75 ITR 191 )(SC)

2 Accounting Standard 13 issued by the Institute of Chartered Accountants of India 2004 edition.”

61. The learned CIT, DR relied upon the judgment also of Hon'ble Supreme Court in the case of Dhun Dadabhoy Kapadia, 63 ITR 651 (SC) and Tribunal decisions in the cases of Devender Prasad Jajodia, K.V. Trading Co. and Niagra Investment Co. Ltd. placed at pages 539, 574 and 621 of the paper book filed by the department. He argued that as in the case of Dhun Kapadia where cum-right shares were rendered ex-right in the case of the assessee cum- dividend units became ex-dividend. The depreciation in the market value of the units on account of that factor should be treated as cost of acquisition of dividend particularly when the assessee sold all the units at the very next moment. For the purpose of determination of real income it was very important to apply matching principle, that an expenditure should be matched strictly against the income it produced. The learned DR cited the judgment of Hon'ble Supreme Court in the case of Chandulal Keshavlal & Co., 38 ITR 601 (SC) and Travancore Titanium Products Ltd., 60 ITR 277 (SC) in that respect. He argued that it was an issue to be decided, as held by Hon'ble Supreme Court in the light of accepted commercial practice and trading principles.

62. Finally, the learned CIT, DR argued that though the provisions of section 94(7) have been introduced with prospective effect, it did not have any impact either way on the legal position subsisting prior to the provisions of section 94(7). From the amendment it could not be inferred that prior to the provisions of section 94(7) the loss claimed on the particular facts of the assessee before us was to be allowed as loss and not treated in any other manner. He argued that the normal principle of interpretation was to hold that an amendment did not disturb the earlier position. There could be many reasons for an amendment, for instance the amendment may be brought by way of abundant caution; it may be brought to create a legal fiction; it may be brought to substitute burden of proof. The purpose of amendment by way of section 94(7) was to remove the burden of proof of colorable device from the shoulders of the department. It could not, therefore, be said that the department cannot argue on the basis of colourable device during the period prior to the introduction of the provisions of section 94(7). The learned CIT, DR pointed out that the provisions of section 68 of the Income-tax Act, 1961 introduced in the statute a legal position that had been identified and formulated in the judgments of Hon'ble Supreme Court several decades earlier. The learned CIT, DR argued that the provisions of section 94(7), therefore, did not mean that the same principle was not available for application without legal presumption prior to the provisions of section 94(7). The learned CIT, DR cited the example of forward stripping being banned in England from April, 1960 by the Finance Act, 1960. House of Lords in the case of Lupton (Inspector of Taxes) Vs. F.A & A.B Ltd. held that the amendment did not come in the way of the cases relating to prior period being treated as tax recovery device. He referred to the judgments reported in 224 ITR 677 (SC); 246 ITR 439(Bom); 226 ITR 625 (SC) and 242 ITR 124 also.

63. The learned CIT, DR further argued that there was no force in the argument that the mutual funds were independent entities. There was clearly a complicity for reaping benefits by both the unit buyers and the mutual funds. There was also no force in the argument that during the period falling between purchase of units and sale of units unforeseen developments in the stock exchange could have altered NAV in a significant manner. First, in the cases before us that did not happen. The transactions were so crafted as to obliterate that possibility. Secondly, in case the assessee decided not to sell because of change in circumstances on account of unforeseen developments, that only meant the colourable device was derailed. It was not necessary for the device to be infallible so as to be regarded as colourable.

64. In his rejoinder, Shri S.E. Dastur, the learned Sr. Advocate argued that the arguments of the revenue based on absence of profit motive were not correct. The contention of the revenue was that a transaction entered into where the loss was “certain” could never be called a business or a commercial transaction. That argument was not correct for three reasons:

The first was that it could not be said that there was a certainty that loss would be suffered. It was quite possible that the fall in the value of the units as a result of the dividend be absorbed by the appreciation in the NAV. For example, suppose a fund, which had issued units with face value of Rs. 10/- and NAV of Rs. 50/-, declared a dividend of 20% or Rs. 2/- per unit. According to the argument of the revenue, the NAV should fall by Rs. 2/- to Rs. 48/-. However, even a 5% increase in the value of the portfolio would be sufficient to absorb the loss and result in a profit. As far as the stock market was concerned, it was a common knowledge that fluctuation of 5 to 10% even during a short period was a normal phenomenon. During the course of arguments, the learned DR had handed over a newspaper report. The last paragraph of the report showed that a person could become aware of a proposed income distribution three months in advance and could buy units at any time during that period in order to earn tax free income. The same Chola Opportunities Fund had a NAV of Rs. 12.35 on 5.4.2000; Rs.13.74 on 11.4.2000; Rs. 18.30 on 24.2.2000 and Rs. 10.92 on 24.4.2000. These showed that there were steep fluctuations in the NAV and the chance of a profit and loss was always present even if the unit was held for a very short period.

Secondly, the majority decision in the judgment of Griffiths Vs. J.P. Harrison, 58 ITR 328 (PC) fully supported the case of the assessee that the transaction was a business loss even though it might have been motivated by tax consideration.

Thirdly, in determining whether there was a “profit” or not, one had to have regard to the overall transaction. One had also to have regard to the tax savings that the assessee would make from the transaction. For example, an assessee might earn lesser income by setting up an industrial undertaking in a backward rather than a developed area. Tax incentives such as sales-tax, excise and income-tax benefits may make it commercially attractive to set up the undertaking in a backward area. Similarly, the availability of tax incentives may make it attractive to export goods at a low rate of profits or even at a loss. The learned counsel referred to the judgment of Hon'ble Madras High Court in the case of Mrs. Sarojini Rajah Vs. CIT, 71 ITR 504 (Mad.) where the Hon'ble Madras High Court, referred with approval, the decision in the case of Griffiths Vs. J.P. Harrison (supra) in the following words:-

“We think that the presence of commercial motive is a primary legal requisite of trade. Purchase and sale as a business deal in the present context may be another requisite. Intention to make a profit normally inspires trade and commerce, but it seems it may not be the essence of trade.”

65. The learned counsel thereafter addressed us to the question whether income from units of a mutual fund is dividend? The learned counsel argued that while the revenue placed reliance on the judgment of Bombay High Court in Ahmuty’s case that dividend was assessable prior to the insertion of section 56 as business income, the sequitor to that point was not clear. The learned counsel further argued that even though in the provisions of Income-tax Act, the expression “income” and not “dividend” was used in relation to mutual funds, the fact remained that the income distributed by a mutual fund was as much a dividend as by a joint stock company. Reliance in that respect was placed on the dictionary meaning of the term “dividend”. The learned counsel referred to extract from Black’s “Law dictionary” and Oxford dictionary at pages 550 to 555 of the paper book. He argued that the term “dividend” meant any distribution from a common fund. Whether income from mutual fund was chargeable to tax under the head business income or income from other sources, was irrelevant for considering the issue before us in these appeals. The argument was irrelevant also because income from mutual fund units also was exempt u/s 10(33) and 10(35).

66. The learned counsel then addressed us on the question as to whether any cost should be imputed to the earning of the dividend. He referred to the re-constructed trading account furnished to us in the paper book filed by the department. He argued that the submissions of revenue in that respect were directly contrary to the law laid down by the Supreme Court in Vijaya Bank’s case reported in 187 ITR 541 (SC), wherein it was held that as interest accrues on certain specific days, the purchaser is assessable on the whole amount of interest received by him on the due date and he is not entitled to any deduction from the purchase price in respect of the interest taken into account while determining such price. The same principle of law had been laid down in Wigmore Vs. Thomas Summerson, 9 TC 577 at page 581; IR Vs. John 9 TC 582 and CIT Vs. Pilcher 31 TC 314, referred to by the Hon'ble Supreme Court in the case of Vijaya Bank. The

learned counsel pointed out that for banks, securities were stock-in-trade and, therefore, the words “capital outlay” used in Vijaya Bank judgment was only to denote an outlay to acquire an asset.

67. The learned counsel for the assessee argued that the argument that the expenditure incurred in respect of exempt income was not allowable as a deduction u/s 14A of the Act was not correct because, first, there was no expenditure incurred in respect of the income from units, and secondly, the question of a disallowance could only arise if the assessee was claiming a deduction, which was not so in the present case. The revenue could not first raise a claim of deduction on behalf of the assessee and then say it has to be disallowed.

68. The argument that most mutual funds advertised that they had distributed or would distribute dividends and some even invited the public to make investments could not entitle the revenue to suggest that there was a “scheme” or “collusion” between the mutual funds and the investors. There was also no force in the argument that in the case of mutual funds under consideration the current profits and the funds were not adequate for paying out the dividend resulting into a conversion of the investors’ own fund into dividend and redemption proceeds. The fact of the matter was that all dealings of mutual funds were vigorously monitored by SEBI and if SEBI had not found anything adverse or objectionable in the mutual fund dealings, it was not open to the income-tax department to object to the same. Further the advertisement placed by the funds regarding dividend distribution was not a nefarious practice but was one which was necessary having regard to the manner in which mutual funds did business. Moreover that practice was followed even by public sector mutual funds, such as UTI. The argument that the funds did not have profits to distribute the dividends was not correct. A perusal of the paper book showed that the dividends were distributed from funds in the “Equalization Reserve/Premium Reserve” account. This account represented the profits made by the fund by allotting units to investors at the prevailing NAV. Accordingly, it was a misconception to assume that the assessee’s own money was coming back to him. Indeed all unit holders participated in the income distribution. The argument also overlooked the fact that if the law gave a transaction a particular character, the same had to be respected and followed. The learned counsel pointed out that the contention of revenue was contrary to the finding of the CIT(Appeals) at paragraph 38 also, wherein the learned CIT(Appeals) had held that the source from which the payment was made had no bearing on the question.

69. The learned counsel thereafter addressed us on the question whether the loss can be ignored? He argued that law provided that dividend was exempt from tax. The arguments of the revenue were aimed at defeating the legal provision- to make the dividend income chargeable to tax. The learned counsel argued that in a bilateral transaction, if the law characterized a transaction as dividend in the hands of one party, then it could not be given a different character in the hands of the other party. Suppose the dividend stripping transaction had been done in shares i.e., the shares had been bought on the eve of the dividend record date and sold after the record date. The company would have been liable to pay DDT @ 12.5% on the dividend. A purchaser of shares cum dividend (who sells it ex-dividend) would collect the dividend `tax free’ subject to the 12.5% paid by the company. He would benefit to the extent of 21.5% as his marginal rate may be 33%. When the law treats the amount paid as dividend or income distributed and imposes fiscal consequences on it, the same amount cannot be treated as something other than dividend in the hands of the investor. The same principle applies to a debt Mutual Fund that paid DDT. The same principle also applied to an equity MF. The equity MF was merely a vehicle for an investor to invest in shares. The only reason the MF did not pay DDT was because the company distributing the dividend had already paid it. The learned counsel then made arguments as to how dividend cannot be such as a part of the sale proceeds. He argued that a change in the fact-situation relating to the sale price would result in a fundamental change in the characterization of the dividend/income. He submitted that the basic issue was one of classification of the income distribution. Once the income was characterized as falling within the ambit of section 10(33) of the Act, the other consequences would follow. That this was the first step was shown by T.P. Sidhwa, 133 ITR 840 (Bom.). The learned counsel argued that there was a legal purchase of units, a legal distribution of dividend and a legal redemption of units. Legal rights and obligations between the parties were created on that basis.The transaction had legal consequences ( e.g. DDT in the case of shares).There was no legal basis for treating the dividend as sale proceeds. He referred to Mathuram Agarwal (1999) 8 SCC 667, para 12 : The plain, unambiguous language of the provision has to be seen. It is not permissible to assume any

intention. The economic results are irrelevant. Words cannot be added to or substituted so as to give a meaning different from the plain language. The learned counsel then referred to Azadi Bachao Andolan, 263 ITR 706, 762: One has to see whether the intended legal result has been achieved. If so, the legal steps cannot be ignored on a hypothetical assessment of the “real motive”. E.g. the question whether the assessee is a “resident” of the Contracting State has to be determined from the definition of that term in the AADT and not on any other basis. Further, when the Act provided for a determination of the losses and set off of the same, against other income the department could not deny the said loss, without establishing that the appellant entered into no such transaction or that the transaction was to be disregarded as non est or void.

70. The learned counsel referred to the provisions of section 94(7). He argued that the sub-section was inserted with the object of discouraging `bond washing’ or ‘dividend stripping’ transactions. When the Legislature had enacted a certain anti-avoidance provision, then it was not open to the courts to devise their own formula. One had to simply apply the provisions of the statute, if applicable, and determine the tax effect of the transaction. This principle clearly emerged from the judgment of Hon'ble Supreme Court in the case of Azadi Bachao Andolan, 263 ITR 706 (SC) at page 747 where it was held that if it was desired that benefits should be limited, provision was made in the treaty e.g. India-USA treaty.

71. The learned counsel argued that the whole dispute was because dividend was exempt from levy of tax. Assuming that dividend income was chargeable to tax, the revenue would have argued that the dividend was a revenue receipt and it was fully chargeable to tax without any deduction for cost derived from the purchase price of the asset. Revenue would have then argued that the loss suffered on redemption was a capital loss that could not be set off against the dividend income. Mere fact that dividend was not chargeable to tax could not lead to a different conclusion as to the characterization of the dividend.

72. The learned counsel thereafter addressed us to the question whether section 94(7) was retrospective. He argued that section 94(7) inserted with effect from 1.4.2002 laid down a new rule on the basis of the period of holding. It was not retrospective as per its plain language. Moreover it had been clearly stated that the provision was prospective in “Notes on Clauses on the Finance Bill, 2001”, 248 ITR (St.) 134; “Memorandum explaining the provisions of the Finance Bill, 2001” 248 ITR (St.) 183-184 and “Circular explaining the Finance Act, 2001” 252 ITR 65 at pages 108-09. Such view was also accepted in the Tribunal decisions in the cases of Asian Paints, Cadila Laboratories, 83 TTJ 758 (Ahd) and Fifty Fifty Finance & Management Consultants (P) Ltd., 141 Taxman 167 (Mum). The department had also fairly stated that it was not their contention that section 94(7) was retrospective. However, it was argued by the D.R. that section 94(7) was clarificatory of the law and that it was open to the department to invoke the McDowell principle for cases before and even after the insertion of section 94(7). That argument was not correct. The fact that section 94(7) was inserted with prospective effect clearly showed that the legislature was bringing about the change in the law and was not clarifying the law. The learned counsel supported this argument by reference to:

* Manikchand Tanga 190 ITR 336, 341 (Kar.): It was pointed out that Explanation 2A to section 64 was not clarificatory because if it were so, Parliament would not have postponed its operation only from 1st April, 1980. It was explained that Parliament did not intend to affect the legal devices already resorted to by several assessees. In the instant case, section 94(7) had been inserted by the Finance Act, 2001 with effect from the assessment year 2002-2003.

* V.M. Salgaonkar 243 ITR 383, 401 (SC): It was pointed out that if the benefit on account of a concessional loan had amounted to a benefit, there was no need for Parliament to have inserted clause (vi) in section 17(2) of the Act by the Taxation Laws (Amendment) Act, 1984.

73. The learned counsel addressed us on the reliance placed by the department on the judgment of Hon'ble Supreme Court in the case of CIT Vs. India Discount Co. Ltd., 75 ITR 191 (SC). He argued that the department had placed wrong interpretation on the judgment. In the case before the Supreme Court the assessee had agreed to buy the shares with the arrear dividends that had been declared long ago. The price

paid by the assessee was for the shares and the right to receive the already declared dividends. On the facts of that case two distinct assets already in existence were acquired, viz., shares and arrear dividends. In the appeals before us only one asset i.e., units of mutual fund had been acquired. There was only right to participate in future income distribution. There was no dividend already declared. In the case before Hon'ble Supreme Court the dividend was income of the vendor and not that of the assessee. Accordingly the Supreme Court held that the dividends in the hands of the assessee were a capital asset. That was a case of purchase of the right to collect unpaid dividends For that reason the principle in India Discount case could not be applied to the facts of the appeals before us, where there were no arrear of dividend due to be received. The learned counsel also pointed out that even the CIT(Appeals) had found that view irrelevant.

74. During the course of hearing the learned counsel argued also that it was not correct to say that dividend income was exempt from tax. The fact of the matter was that dividends were exempt in the hands of recipient because the company that declared the dividend was liable to pay tax on dividend paid. Mutual Funds did not pay any tax because the income of an equity mutual fund was derived from other company who had already paid taxes on such income. Mutual Fund was merely a pass through conduit. Furthermore, the law was required to be uniform. There could not be two different principles first applicable to one who bought units, earned dividends and continued to hold the units and, second applicable to one who sold the units immediately after collecting the dividends. Similarly the law should remain the same when dividend was chargeable to tax and when it was tax free. The learned counsel pointed out that in past dividend income was met with varying treatments, sometimes subjected to tax and sometimes treated wholly exempt. There was also a question as to what treatment to be given where the unit was sold immediately after collection of dividend, but at a price higher than the purchase price. There was also a question as to what would be the position for ‘debt fund’. He argued that the law had to be uniform and it could not keep on fluctuating with the exigencies of situation from revenue’s point of view. Cost or expenditure of units could not keep on varying subject to its effect on the income or loss declared by the assessee. The application of the legal principle was not the question of any individual or group of individuals. The fact could not be lost sight of that thousands of people buy mutual fund units.

75. The learned counsel argued that income received from a mutual fund was exempt under the provisions of sec. 10(33) of the Act in Chapter III of the Income-tax Act. The heading of Chapter III read “Incomes which do not form part of total income”. The learned counsel referred to 9th edition of the commentary Kanga & Palkhiwala Vyas at page 438 in relation to the nature of the provisions of section 10. Any income covered by any of the provisions of section 10 was not to be taken into computation of income chargeable to tax in any order of assessment under the provisions of the Act. There was no question of disallowance of any expenditure in relation to such income when there was no claim of the assessee seeking deduction of an expenditure. When an assessee bought a unit it was not an expenditure but an investment. The assessee had not claimed deduction of any expenditure relating to the income from mutual fund units. The learned counsel referred to the judgment of Hon'ble Supreme Court reported in 187 ITR 541 (SC) and argued that cost could not be artificially apportioned. He also referred to the argument of the DR relating to matching principle and argued that matching principle would apply if the two items were of the same type. In the case of the assessee the revenue was attempting not matching but splitting of the cost between two unmatchables. Reference was made to the judgment of Hon'ble Bombay High Court in the case of T.P. Sidhwa, 133 ITR 840 (Bom) and the learned counsel argued that as a first step it was necessary to classify the head of income. The income from Mutual Fund unit was exempt u/s 10(33). The same could not be brought to tax by changing its character. In relation to the reliance placed by the revenue on the judgment of Dhun Dadabhoy Kapadia, 53 ITR 651, the learned counsel argued that the facts of the case were entirely distinguishable. In that case the assessee had sold her right to apply for future shares which was a different and distinct right. Hon'ble Supreme Court held that it was a separate right.

76. The learned counsel for the assessee argued that much could not be made of the fact that the judgment in the case of McDowell & Co. was delivered by a bench comprising of five judges. If the judgment of Hon'ble Supreme Court in the case of McDowell & Co. had not been noticed at all in the judgment in the case of Azadi Bachao Andolan, then it could be argued that McDowell should prevail being the judgment of a larger bench. But in the case of Azadi Bachao Andolan the subsequent Bench of Supreme Court had considered the earlier judgment in the case of McDowell & Co. at considerable length. It was, therefore,

not open to argue that the judgment in the case of McDowell should take precedence. The learned counsel pointed out that the petitioners in the case of Azadi Bachao Andolan had also filed a curative petition in relation to the judgment in the case of Azadi Bachao Andolan. That curative petition having been dismissed by a bench comprising of five judges, the judgment in the case of Azadi Bachao Andolan had the seal of five judges.

77. The learned counsel argued that in any case there was no material at all on the basis of which it could be said that the assessee had employed a “colourable” device. The four English cases being relied upon by the revenue were the cases where an individual manufactured losses by a series of transactions. The assessee was not a party to the mutual fund declaring dividend. The decision of the mutual fund was not influenced by the assessee in any manner. Everything that the assessee did was permitted by law and was perfectly legal in the eyes of law. How could the same become a colourable device in the income-tax assessment proceedings? Purchase and sale of mutual fund units was not peculiar to the assessee. Thousands of people bought and sold units of Mutual Funds. The assessee’s case was squarely covered by the judgment in the case of Azadi Bachao Andolan that laid down that merely because of tax incidence or motive to save tax, the transaction could not be disregarded or called colourable device.

78. The learned counsel argued that in the case of Azadi Bachao Andolan the test of legal result had been laid down. In the case of the assessee there was nothing to suggest that legal effect of the transaction had not been achieved. The assessee purchased the units, the assessee received the dividend and finally the assessee sold the units. There was nothing to suggest that legal effect of any of these transactions had not been achieved. It could not, therefore, be said that the assessee had employed any colourable device. After the judgment in the case of Azadi Bachao Andolan the legal position was quite clear. It was the legal effect that was required to be seen and not what the assessee’s alleged motive was.

79. The learned counsel for the assessee contended that the provisions of sec. 14A could not be applied in relation to the two appeals before us in view of the following proviso to section 14-A:-

“Provided that nothing contained in this section shall empower the Assessing Officer either to reassess under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154, for any assessment year beginning on or before the 1st day of April, 2001.”

The learned counsel pointed out that after having enacted section 14-A with retrospective effect from 1.4.1962, the Legislature became alive to the hardships which the retrospection of the provision could cause to the tax payers. Hence the proviso above mentioned was inserted by the Finance Act, 2002 with retrospective effect from 11th May, 2002. It, therefore, meant that an assessment order already made could not be disturbed or interfered with on the ground of the provisions of section 14-A. For that reason the revenue was precluded from taking any plea based on section 14A for the first time before the Tribunal.

80. Both Shri Sharad Kapila, the learned Special counsel for the revenue and Mr. V.S. Singh, the learned CIT, DR requested for being allowed to make some clarifications. The learned special counsel pointed out that the judgment of Hon'ble Supreme Court in the case of Vijaya Bank Ltd., 187 ITR 541 (SC) came to be considered by Hon'ble Bombay High Court in the case of American Express Bank, 258 ITR 601 (Bom). It was noticed that Vijaya Bank was the case of purchase of a capital asset and not stock-in-trade. Furthermore, in the case of the assessee the mutual fund had already made public offer. The assessee who purchased the units on 24th March, was assured of Rs. 4/- dividend per unit on the very next day. It could not, therefore, be said that the purchase price paid by the assessee did not include any consideration for dividend. Referring to the argument that NAV of the Mutual Fund was susceptible to any unforeseen event that could take place after units were purchased by the assessee, the learned counsel stated that the assessee was a businessman and there was no such thing as absolute certainty in business. As a prudent businessman the assessee took steps when he was more than reasonably certain of the outcome of the transaction. Furthermore, there was not much force, after the enactment of the provisions of section 14A, in the argument that the purchase price of the unit was indivisible. Hon'ble Rajasthan High Court in their

judgment reported in 242 ITR 250(Raj) held that it would not be permissible to bifurcate an indivisible cost. If it were divisible then even under the old law the cost of dividend could be disallowed. Provisions of section 14A were brought on the statute book to counter precisely that difficulty. Thereafter the argument that the purchase price was indivisible was not good any more. The provisions of section 14A employed the expression “in relation to” which was much wider than the expression “for the purpose of”. The question, therefore, was whether or not a part of the purchase price paid by the assessee in the present appeals, was an expenditure incurred “in relation to” income declared by the mutual fund.

81. The learned counsel for the revenue argued that proviso to section 14A only barred the Assessing Officer from reopening an assessment that had become final either u/s 147 or u/s 154 of the Act. The retrospection of section 14A did not, therefore, affect the cases where no proceedings were pending. Apart from the fact that it was settled law that finality did not mean non-filing of appeal by either side ( 156 ITR 474 ( SC) and 171 ITR 197(Bom)) in the present case the assessment was lying open in appeal before the Tribunal on which the Tribunal could pass any order deemed fit. In view of the provisions of sec. 14A, it did not matter that section 94(7) was not retrospective. Section 14A brought on the statute book at the same point of time took care of the period prior to the operation of section 94(7). The learned counsel also referred to the judgment reported in 74 ITR 33 in this respect.

82. The learned CIT, DR argued that there was not much force in the contention that the mutual fund was not under the control of the assessee. There was complicity in the sense that both the assessee as well as the mutual fund stood to gain at the expense of revenue. For that reason it could not be said that there was no colourable device. The learned CIT, DR reiterated that it was wrong to say that Income-tax Act is to be applied divorce from commercial principles. In MacNiven case facts were altogether different from Ramsay and for that reason the different conclusion was reached. The learned CIT, DR argued that there was not much force in the contention that the assessee did not claim deduction of any expenditure. What the assessee called claim of loss was in fact claim of expenditure. The learned CIT, DR relied upon the judgment of Hon'ble Supreme Court in the case of Dhun Dadabhoy Kapadia (supra) in that respect.

83. The learned counsel for the assessee in his concluding arguments contended that if dividend was exempt u/s 10 there was no question of assigning any head of income to it. In that event there did not arise any question of computation of profit or loss in relation to dividend income. Moreover dividend was something a person would get every year. How could the cost be apportioned year after year. That showed the fallacy of the arguments of revenue based on section 14A. The reliance placed on the judgment of American Express was totally misplaced. In that case the judgment proceeded from the fact that the department had already assessed broken period interest. Hence that judgment had no application on the facts of the case in the present appeals. In the case of mutual fund no right to income vested in the investor at any time before the expiry of record date. Provisions of law could not be interpreted on the basis of the facts of a particular assessee. If dividends were taxable, would the department give deduction of cost to all assessees? As dividend, in the eyes of law, was income that did not accrue till such time it was declared, the assessee did not purchase two assets and there was only one asset. That asset gave the assessee several rights which were not restricted to dividend only. Apart from right to dividend the assessee also got right to vote, right to bonus shares, right to get surplus on liquidation. Would revenue apportion the cost against all such rights and in what manner it could be done? As to the provisions of section 94(7), CBDT Circular No. 14 of 2001 in paragraph 56 at page 108-109 of 252 ITR (St.) was clear, that the existing provisions did not cover a case where a person bought securities (including units of a mutual fund) shortly before the record date fixed for declaration of dividend and sold the same shortly after the record date. The Circular said, section 94(7) was to plug the loophole. CBDT circular was binding on revenue and it was not open to revenue to argue that during the period prior to section 94(7), the legal position was the same. Referring to the arguments of the DR relating to colourable device, the learned counsel argued that what was complicity; when to purchase or not to purchase was the decision entirely of a buyer. It was important to note that the mutual funds functioned under the supervision of SEBI. As to the commercial principles, the tax provisions were not based on any commercial principles, but from the point of view of generating revenue. If income is computed as per the provisions of the Act and not on the basis of any commercial principles, it would not be fair and correct to bring in the arguments based on commerciality only when it suited revenue. In the appeals before us the assessee had not committed any illegality or fraud. Finally, the

learned counsel stated that the various judgments relied upon by the learned CIT, DR had to be read on the basis of facts of those cases and in the light of the observations of Hon'ble Supreme Court in the case of Azadi Bachao Andolan.

84. After Mr. Dastur concluded his arguments, the learned counsels for various interveners also briefly addressed us. Their arguments were mostly reiteration of the contentions of Mr. Dastur., In some cases some unique features pertaining to their own cases were pointed out with which we are not concerned in the present appeals.

85. We have carefully considered the rival submissions. In our view there are three major questions to be considered, in relation to the dispute before us, that are as follows:

First questionWhether these are business transactions?

Second questionIf the answer to the first question is in the affirmative, what is the net result of the computation?

Third question If the net result of the computation is a loss, whether the assessee is disentitled or disqualified to have it set off against his income from any other transaction or source?

FIRST QUESTION:

WHETHER THESE ARE BUSINESS TRANSACTIONS?

As to the first question the case of the department is that the loss must arise to the assessee in the course of carrying on an activity chargeable to tax or else such loss should be ignored in the computation of the assessee’s income chargeable to tax. The point is well taken. Under he provisions of section 4(1) of the Act charge of income tax is “in respect of the total income of the previous year of every person”. Total income has been defined under the provisions of section 2(45) in the following words :-

“total income” means the total amount of income referred to in section 5, computed in the manner laid down in this Act;”

Under the provisions of section 5 “total income” is subject to the provisions of the Act. The provisions of sections 14 to 59 in chapter IV of the Act are the provisions relating to “COMPUTATION OF TOTAL INCOME”. Neither the BASIS OF CHARGE in chapter II nor the provisions in Chapter IV make any reference to the loss incurred or arisen to an assessee. Provisions of “Set off, or carry forward and set off” comprised in sections 70 to 80 in chapter VI lay down the treatment to be given where “the net result of the computation under any source or head” is a loss. It, therefore, clearly follows that it is only a loss resultant to the computation of income under the provisions of Income-tax Act that can be set off against the assessee’s income chargeable to tax. The learned D.R. therefore, rightly argued before us that the loss claimed by the assessee in order to be set off against other income of the assessee must be the net result of computation of assessee’s income chargeable to tax under any source or head. The assessee is not entitled to claim set off of any other arithmetical loss.

86. The assessee’s claim of loss for both assessment years 2000-2001 & 2001-2002 have been disputed by the Assessing Officer on the ground that the transactions under consideration had no motive to earn profit. The assessee knew beforehand that the transactions would result into a certain loss, yet the assessee carried out the transactions as the motive was tax avoidance. A business or an adventure in the nature of trade cannot include a transaction where loss is inevitable and a foregone conclusion. The learned CIT(Appeals) has also reiterated the same view. He has relied on the observations of Lord Denning in the case of

Griffiths Vs. J.P. Harrison (supra) and argued that the transaction entered into by the assessee could not qualify to be commercial or business transaction. Without profit the transaction was no more business as pickle was not candy. The learned CIT(Appeals) has also relied in this regard on judgments reported in 4 ITR 392 (All.); 6 ITC 21 (Bom.); 101 ITR 234 (SC); 113 ITR 174 (All.) and 129 ITR 295 (SC). To these judgments the learned CIT, D.R. has added some more viz., 167 ITR 507 (Guj.); 50 ITR 303 (Cal.); 35 ITR 594 (SC); 30 ITR 701 (Cal.) and so on. The thrust of the argument is that a transaction where the prescient result is a loss devoid of any commercial risk or venture cannot be seen as a business transaction. It is argued that the loss claimed by the assessee was a voluntary act and not loss suffered. Shri S.E. Dastur, the learned Sr. Advocate disputes the assumption that there was prescient loss. It was quite possible that the fall in the NAV as a result of the dividend be absorbed by the appreciation in the value of equity shares. It was a common knowledge that fluctuation even during a very short period was a normal phenomenon in the stock market. The learned counsel has argued also that the transaction does not cease to be a business transaction even though it may have been motivated by tax consideration. He argues that the tax consideration is as much a business or commercial consideration as any other kind of consideration.

87. We find the English decisions in the cases of Griffiths (Inspector of taxes) Vs. J.P. Harrison Ltd., (supra), Finsbury Securities (supra) and Lupton Vs. F.A. & A.B. Ltd. (supra) to be of considerable interest and importance on the question before us. In the case of J.P. Harrison Ltd., 58 ITR 328 (P.C) in 1952-53 the respondent company sustained in carrying out its mercantile business a loss which was available to be carried forward under section 341 of the Income-tax Act, 1952. In 1953 it added to its objects that of dealing in shares, and then bought for 16900 Pounds all the issued shares in C. Ltd., which had ceased trading but had funds available for distribution as dividends. In January, 1954, C. Ltd. declared a net dividend of 15,901 Pounds 19s. 3 d. which the respondent company received. The respondent company then sold the shares in C. Ltd. for their nominal value of 1,000 Pounds, that being the sole share-dealing transaction carried out by it in 1953-54. It claimed to be entitled to set the loss of 15,900 Pounds against the net dividend of 15,901 Pounds 19s. 3 d. and to rebate of tax on the dividend. Honble Privy Council comprised of Viscount Simonds, Lord Reid, Lord Denning, Lord Morris of Borth-y-Gest and Lord Gust. It was held (Lord Reid and Lord Denning dissenting), that this was a trading transaction carried out by the respondent company in the course of carrying on its trade. In the impugned order the learned CIT(Appeals) has laid considerable emphasis upon the dissenting judgment of Lord Denning. During the course of hearing of these appeals the learned CIT, D.R. also placed considerable emphasis thereupon. Viscount Simonds found that the argument for the Crown rested on the proposition that the essence of a trading transaction is that its object is to make a profit and that the found object of the transaction was the ulterior one of obtaining a dividend against which it could claim to set off its losses. Viscount Simonds then observed:-

“But, my Lords, attractive as this proposition is, and attractively as it was advanced by the then Solicitor-General, it does not convince me. Here was a company whose object it was to deal in shares. It entered into a commercial transaction which, though it might be given an invidious name, contained no element of impropriety, much less of illegality. I can find nothing that enables me to say that it is not a trading transaction and echo the question asked by the majority in the Court of Appeal : “If it is not trade, what is it?”

It is seen that Lord Reid held the question before them was a question of fact, that meant that the decisions of the Commissioners could not be reviewed by the Court. He further held that opinion of the Commissioners, “the company’s transaction was not entered into as part of any trade of dealing in shares and was not an adventure in the nature of trade” was not unreasonable. He accordingly allowed the revenue’s appeal. It is, thus, seen that there is no direct authority in the judgment of Lord Reid to advance the case of the revenue that the transactions of the assessee under consideration before us are not trading transactions. Lord Denning replied the question “if it is not trade, what is it?” He said, “It is dividend stripping and nothing else”. He further said, :

“My Lords, you have indeed here a question of law, if you please to treat it as such. The contention comes to this : You should split the dividend-stripping transaction into two parts. You should look only at one-half of the transaction and turn a blind eye to the other half. You are to look at the purchase and sale of shares,

but not at the repayment of tax. And when you look at the purchase and sale of shares you are not to have regard to the motive behind it. You must disregard the fact that it is done with a view to create a trading loss, and you must treat it as a normal transaction in share dealing.

My Lords, I do not believe there is any rule of law which requires the commissioners to disregard the object of the transaction or its result. There are occasions when a reasonable man may turn a blind eye to the facts, but this is not one of them. To my mind, the commissioners were entitled to see these people as they really are, prospectors digging for wealth in the subterranean passages of the Revenue, searching for tax repayments. They are not simple traders dealing in stocks and shares. I am not prepared to say that the commissioners were unreasonable, so unreasonable that they could not reasonably come to their conclusion.”

Lord Morris of Borth-y-Gest found that it was nobody’s case that the transaction of the company in the shares was a sham transaction. He, therefore, concluded that the transaction was entered into as part of a trade of dealing in shares or was an adventure in the nature of trade. He rejected the argument that because the company embarked upon the dividend-stripping operation, the transaction could not be regarded as a trading transaction but as a fiscal transaction. In his words :

“It is doubtless true to say that in general a trader embarks upon trade with the intention of making a profit : but it cannot be said that if this intention is lacking there is no carrying on of a trade. A trade may be carried on with the knowledge that losses will result. Equally it seems to me that if on any ordinary examination of them certain transactions must be regarded as trading transactions or adventures in the nature of trade they do not cease to be such because those conducting them have embarked upon them with a view to obtaining some fiscal benefit. It was urged in the present case that the transaction in the shares of Claiborne Ltd. ought to fail to be regarded as a trading transaction because in its real nature it was a fiscal transaction. My Lords, I cannot regard these as alternative descriptions. There may be trading transactions which can be the prelude, if the state of the law so allows, to tax-recovery activities. If tax recovery is possible it is as taxpayers and not as traders that the recovery is obtained. The possibility of tax recovery may be a result made possible by the trading activity but I am unable to accept that if a transaction fairly judged has in reality and not fictitiously the features of an adventure in the nature of trade it must be denied any such description if those taking part in it had their eyes fixed upon some fiscal advantage.”

Lord Gust also rejected the argument that there ought to be presence of a profit motive in a trading transaction. An individual or a company can conduct their business in the most extravagant way, they can conduct it with certainty of making a loss. If there are profits or gains and the business is a trade, then income-tax is payable. He says, “No doubt if it is established that a transaction is entered into with the evident intention of making a profit, that may be a strong indication that the company was trading. But the corollary by no means follows that the absence of an intention to make a profit or the intention to make a loss negatives trading.”

88. The learned CIT(Appeals) in the impugned order and the learned CIT, DR in his detailed arguments during the course of hearing before us have argued that it is the minority view in the case of Griffiths Vs. J.P. Harrison Ltd.(supra), that was followed in the subsequent cases of Finsbury Securities Vs. Inland Revenue Commissioner 43 Tax Cases 591 (HL) and Lupton Vs. F.A. & A.B. Ltd. 47 Tax Cases 580 (HL). It has, therefore, been argued on behalf of the revenue that we should following the judgments hold that the transactions under consideration before us are not business transactions at all and, therefore, the loss arising therefrom does not qualify to be set off against the other income chargeable to tax of the assessee. We find that in the case of Finsbury Securities Ltd. (supra), the earlier judgment in the case of Griffiths Vs. J.P. Harrison Ltd. (supra) has been distinguished on facts. Finsbury Securities Ltd. carried on the trade of dealing in shares and securities. One Mr. Leslie Lavy was responsible for the formation of the company and was at all material times the director in control of its activities. During the same period Mr. Lavy also carried on practice as a Chartered Accountant. The only other director was Mr. Lever and the company’s shares were held by these two, either beneficially or as trustees of their respective family settlements. During the year 1958-59 Mr. Lavy was approached by one or two persons who had interests in companies and were anxious to know whether there was some method of avoiding tax in companies’ profits. Mr. Lavy

was at first lukewarm to these approaches, but he came to the conclusion that forward stripping transaction might achieve this object and provide a profit for the company. The result was that during the years 1958, 1959 and 1960 the company entered into 15 of these transactions. The transactions fell into two distinct categories. A typical transaction of the first category involved the transaction by the company of specially created preference shares in a manufacturing company. They carried, in addition to the normal right to a fixed dividend, a special right to dividends for five years which were to absorb the whole of the profits available for distribution after payment of the fixed dividend, provided that the total did not exceed a certain figure. The purchase price was to be determined by reference to the amount of the net dividends received and the amount of the income tax repayment obtained by the Appellant Company. A typical transaction of the second category involved the purchase by the Company of the whole of the share capital of an estate development company. The sale agreement provided that the development company would distribute the whole of its net profits for the following year and that if any of its assets then remained unsold the vendors of the shares would purchase those assets at cost or market value, whichever was the greater. The purchase price for the shares was to be determined by reference to the amounts of the development company’s profits and of any income tax repayment. The Appellant Company claimed adjustment of its tax liability for the year 1959-60 under s. 341, Income-tax Act, 1952, on the basis that it had sustained losses in its trade in respect of the above transactions. On appeal, the Crown contended (1) that the shares in question were capital assets and not stock-in-trade, and (2) that, if they were stock-in-trade, the dividends received must be taken into account in determining whether there was a loss, and if this were done no loss was shown. The Special Commissioners rejected the Crown’s first contention but accepted the second and disallowed the claim. In view of the decision of the House of Lords in F.S. Securities Ltd. Vs. Commissioners of Inland Revenue 41 T.C. 666 ( 1964) 1 W.L. R 742, the Crown did not pursue its other contention in the High Court.”

89. In the case of Finsbury Securities Ltd. the Crown sought to answer the question that was raised in Griffiths Vs. J.P. Harrison (supra), “If not trading, what is it?” There was no answer available to the question in that case, but in the case of Finsbury Securities Ltd., the answer was that it is investment or more akin to investment than to trade. However, the Court of Appeal did not agree. Following Griffiths Vs. Harisson (supra), it was held that the transactions were properly to be regarded as trading transactions. The Crown having appealed against the decision of Court of Appeal, the judgment of House of Lords was pronounced by Lord Morris of Borth-y-Gest, who had himself in the case of Griffiths Vs. Harrison held the transactions to be trading transactions. The other four law Lords concurred with the speech delivered by Lord Morris of Borth-y-Gest. The question was decided differently in the following words :-

“I turn, therefore, to the question whether the various transactions can be held to be within the trade of dealing in shares. I have earlier quoted the words of the Commissioners in recording their finding that the Company acquired the shares with the object of making a profit out of them by the recovery of income-tax. The Commissioners proceeded to consider whether what they called the “forward-stripping” transactions, which were a feature of the arrangements now under review, were so different in their nature from the arrangements in J.P. Harrison (Watford) Ltd. Vs. Griffiths that that case did not apply. They decided that they could not distinguish that case from the present one.

My Lords, I take a different view. In my opinion, the arrangements now under review are essentially different from those which gave rise to the Harrison case. In that case there was a purchase of the shares in a company called Bendit Ltd. (afterwards called Claiborne Ltd.). The vendors of the shares had no interest in the shares thereafter. They had no prospect of receiving any benefit from any tax recovery. After the Harrison company owned the shares in Claiborne Ltd. there was a declaration of dividend on the shares. After that the shares were sold. It was my view in that case that the transaction was demonstrably a share-dealing transaction. Shares were bought; a dividend on them was received; later the shares were sold. There may be occasions when it is helpful to consider the object of a transaction when deciding as to its nature. In the Harrison case my view was that there could be no room for doubt as to the real and genuine nature of the transaction. The fact that the reason why it was entered into was that the provisions of the revenue law gave good ground for thinking that welcome fiscal benefit could follow did not in any way change the character of the transaction. It was not capable of being made better or worse or being altered or made different by the circumstance that the motive that inspired it was plain for all to see. In that case the vendors

of the shares had no further concern once they had sold. The essence of the arrangements now being reviewed was that the future interests of the vendors were being safeguarded. Under the devised scheme they were to have all the benefits that would have resulted from their shareholdings had there been no scheme. In addition, they were to be saved from the full extent of the exactions which taxation imposes. Here also the scheme involved a factor which was entirely absent in the Harrison case. In that case the purchasers could have done what they wished with the shares. Here, on the other hand, it seems to me that it was of the essence of the scheme that the Company should continue to hold the shares during the periods covered by the particular set of transactions. It is clear and not seriously disputed that the Company could not have sold the preferred shares during the current of the agreement without committing a basic breach of it. The Company had to retain the shares so that year by year there would be diminutions in the value of the shares and so that year by year there could be the receipts of dividends from profits to be earned in the future, so that year by year the planned tax recovery could proceed for the mutual benefit of the Company and the vendors.

A consideration of the transactions now under review leads me to the opinion that they were in no way characteristic of nor did they possess the ordinary features of the trade of share dealing. The various shares which were acquired ought not to be regarded as having become part of the stock-in-trade of the Company. They were not acquired for the purpose of dealing with them. In no ordinary sense were they current assets. For the purposes of carrying out the scheme which was devised the shares were to be and had to be retained. The arguments before your Lordships depended mainly upon the submission by the Crown that the shares were acquired for a period of five years as part of the capital structure of the Company, from which an income would be earned, and, on the other hand, upon the submission of the Company that they were acquired as part of their stock-in-trade.

In my opinion neither argument is correct. For the reasons I have already given this transaction on its particular facts was not, within the definition of s. 526 “an adventure or concern in the nature of trade” at all. It was a wholly artificial device remote from trade to secure a tax advantage.”

90. In the case of Lupton (Inspector of taxes) Vs. F.A & A.B Ltd. 47 T.C. 580 (HL) at all relevant times the company was trading as a dealer in stocks and shares. The question arose in regard to 5 particular transactions whether they were dealing in shares in the course of company’s trade. Four of these transactions involved the creation for purchase by the Company of shares with special rights. In one typical transaction, entered into in December 1959, such shares were bought for Pounds 625,000 down with a warranty that a dividend of Pounds 125,000 net would be paid immediately and further dividends amounting to Pounds 500,000 net by December, 1964, and a stakeholder was appointed to hold Pounds 500,000 deposited by the Company and release it to the vendors as and when the dividends were paid. The legal costs and stamp duty borne by the Company amounted to Pounds 3,572, and it sold the shares for Pounds 455,000 after dividends of Pounds 170,000 net had been received.

In the remaining case the Company on 30th March, 1960 bought for some Pounds 700,000 the issued share capital of an investment company with a trading sub-subsidiary. The vendor undertook that the revenue profits of the investment company’s immediate subsidiary were then sufficient to declare a dividend of Pounds 800,000 net and that the Respondent Company would be entitled to recover from the Inland Revenue the tax deducted from any dividends paid to it by the investment company out of that dividend; they further undertook if the Company failed to recover any such tax to pay the difference between half the tax recovered and Pounds 200,000, and the Company undertook to proceed with a repayment claim with due diligence. The vendors deposited Pounds 200,000 with a stakeholder as security for their undertakings, to hold for three years on trust to release to the vendors that sum or half the tax recovered by the Company. The Company did not sell the shares after payment of the relevant dividend, but on a revaluation of the investment company’s assets the transaction showed a loss of Pounds 182,980 after taking account of the net dividends received but not of the claim of repayment of tax or compensation in lieu.

The Company appealed against refusal of claims to relief under s. 341 in respect of trading losses resulting from falls in the value of the shares purchased in the five transactions. The Special Commissioners found

that the 5 transactions had formed part of the trade of the company of dealing in shares. Megarry J. reversed the decision of the Special Commissioners though with some hesitation in regard to one of the 5 transactions mentioned in the foregoing paragraph. The Company did not appeal against the decision of the learned Judge in regard to 4 of the 5 transactions. Their appeal in relation to the fifth was dismissed by the Court of Appeal (Sachs L.J. dissenting). The Company having appealed against the decision of Court of Appeal, the case came before the House of Lords, who unanimously dismissed the Company’s appeal. Before analyzing the 5th transaction in his judgment Lord Morris of Borth-y-Gest summarized the legal position in the following words :-

“The transactions in the Harrison case were solely and unambiguously trading transactions. There was a purchase of shares and after receipt of a dividend a sale of shares. There was no term, express or implied, in any contract or any transaction which in any way introduced any fiscal element. No fiscal consideration or arrangement intruded itself in any way into any bargain that was made. There was merely an acknowledged reason which inspired one party to enter into certain trading transactions. If that party later made some tax claim that claim would be no part of a trading activity. The transactions in the Harrison case not only had all the characteristics of trading; there was no characteristic which was not trading. There was nothing equivocal. There was no problem to be solved as to what acts were done. To the question quid actum est there could be but one answer. The quo animo was irrelevant. As Lord Reid said in giving the judgment of the Board in Iswera Vs. Commissioner of Inland Revenue (1965) 1 W.L.R 663 (P.C.) (at page 668):

“If in order to get what he wants, the taxpayer has to embark on an adventure which has all the characteristics of trading, his purpose or object alone cannot prevail over what he in fact does. But if his acts are equivocal his purpose or object may be a very material factor when weighing the total effects of all the circumstances.”

The somewhat loose phrase “dividend-stripping transactions” has acquired a certain emotive force, but if it is used its meaning must be examined. It has been suggested that the Harrison case decided that a transaction can be a trading transaction even though it is a pure dividend-stripping transaction entered into with the sole object of making a fiscal profit without any view to a commercial profit. Analysis will show that such a suggestion is ill-founded and mis-leading. The word “transaction” generally suggests some arrangement between two or more persons. In the Harrison case there was a purchase of shares from a seller of them. That was a trading transaction. Later there was a sale of the shares to a new purchaser. That was a trading transaction. In between there had been the declaration and receipt of a dividend. But there was no arrangement whatsoever under which the sellers to Harrisons of the shares or the purchasers from them of the shares were concerned as to whether Harrisons would or would not later make some claim which under the law as it then stood they might be able to make. There was, therefore, no dividend-stripping “transaction” in the Harrison case in the sense that any other person had any control or concern or interest as to what Harrisons would do once they had bought the shares. If, therefore, as in my view is clear, the presence of a motive of securing tax recovery does not cause a trading transaction to cease to be one, then reliance on motive must disappear. And if reliance on motive is either voluntarily or reluctantly but compulsively jettisoned it is not saved even if the language of rhetoric is used to characterize it.

It is manifest that some transactions may be so affected or inspired by fiscal considerations that the shape and character of the transaction is no longer that of a trading transaction. The result will be, not that a trading transaction with unusual features is revealed, but that there is an arrangement or scheme which cannot fairly be regarded as being a transaction in the trade of dealing in shares. The transactions which were under review in Finsbury Securities Ltd. Vs. Bishop (1966) 1 W.L.R. 1402 were of this nature. The transactions have only to be looked at for it to be seen that they were wholly and fundamentally different from the transactions in the Harrison case. Whereas in the Harrison case there is not a trace of any fiscal “arrangement”, in the Finsbury case certain fiscal arrangements were inherently and structurally a part of the transactions which it was sought to describe as trading transactions. The Harrison case and the Finsbury case are wholly different from each other. In the Harrison case the transactions contained no fiscal arrangements whatsoever : in the Finsbury case such arrangements were central to and pivotal of the transactions under review.

There are, therefore, cases where, as Megarry J. indicated, the fiscal element has so invaded the transaction itself that it is moulded and shaped by the fiscal elements. This was helpfully expressed by Megarry J. as follows:

“If upon analysis it is found that the greater part of the transaction consists of elements for which there is some trading purpose or explanation (whether ordinary or extraordinary), then the presence of what I may call `fiscal elements’, inserted solely or mainly for the purpose of producing a fiscal benefit, may not suffice to deprive the transaction of its trading status. The question is whether viewed as a whole, the transaction is one which can fairly be regarded as a trading transaction. If it is, then it will not be denatured merely because it was entered into with motives of reaping a fiscal advantage. Neither fiscal elements nor fiscal motives will prevent what in substance is a trading transaction from ranking as such. On the other hand, if the greater part of the transaction is explicable only on fiscal grounds, the mere presence of elements of trading will not suffice to translate the transaction into the realms of trading. In particular, if what is erected is predominantly an artificial structure, remote from trading and fashioned so as to secure a tax advantage, the mere presence in that structure of certain elements which by themselves could fairly be described as trading will not cast the cloak of trade over the whole structure.”

91. We find the legal position spelt out by the trilogy of the judgments in the cases of Griffiths Vs. J.P. Harrison Ltd.; Finsbury Securities Vs. Inland Revenue Commissioner and Lupton Vs. F.A & A.B. Ltd. very relevant to the issue before us. All these three decisions relate to the cases of dividend-stripping and the contentions of the parties in those cases bear considerable similarity to the contentions of the parties before us. The learned CIT(Appeals) in the impugned orders and the learned CIT, D.R. in his arguments have placed considerable reliance on these judgments. According to the learned CIT(Appeals), the minority judgment delivered by Lord Denning in the case of Graffiths Vs. J.P. Harrison Ltd. represented the correct view and that view was finally affirmed in the subsequent two judgments of House of Lords. According to the learned CIT(Appeals), “there was visible shift in the thinking of House of Lords”. The learned CIT(Appeals) calls the judgment in the case of Lupton Vs. F.A & A.B. Ltd. “another path breaking judgment that marked a water shed in tax avoidance case”. It is, thus, made out that a somewhat erroneous view taken by the majority in the case of Griffiths Vs. J.P. Harrison Ltd. was clearly set right in subsequent judgments and finally it was the view of Lord Denning that prevailed. We find that is not the case. Different view of the matter was taken in the subsequent two judgments of Finsbury and Lupton because their Lordships found facts of those two cases to be altogether different from those in Griffiths Vs. J.P. Harrison Ltd. We do not see any dilution of the majority judgment in the case of Griffiths Vs. J.P. Harrison Ltd. in the subsequent two judgments in the cases of Finsbury Securities Ltd. and Lupton. These cases have proceeded on their own specific facts. We have, therefore, to see whether the facts of the case of the assessee before us would fall in the category of J.P. Harrison Ltd. case or in the category of Finsbury Securities/Lupton. There is some attempt on the part of the learned CIT(Appeals) as well as the learned CIT, D.R. to argue that facts of the case of the assessee before us bear close proximity to the facts in the subsequent two judgments rather than J.P. Harrison Ltd. The learned CIT(Appeals) has called the case before us as part of an “organized tax avoidance scheme in India”. Mutual Funds played the role of facilitator of the scheme of tax avoidance. These mutual funds advertised in the newspapers the record date and the amount of dividend to be declared. Subscribers, financiers, brokers came alive instantly within hours and subscriptions running into crores of rupees were made. There were ever ready and ever willing financiers to finance the transaction to be entered into by dividend-strippers. The brokers who were paid handsomely were appointed by the mutual funds. The learned CIT(Appeals), therefore, holds that in the case of the assessee the vendors of the units were interested parties to have the benefit resulting from the scheme. In the Harrison case there was nothing to suggest that the vendor knew of the intention or stood to derive any benefit from the dividend-stripping. In the present case mutual funds were consciously marketing tax mitigation scheme. The learned CIT, D.R. has also argued that in the case before us purchase and sale of units was a mere pretence. The sole objective was only to produce an artificial loss and not to acquire or dispose of the units of the mutual fund. The learned CIT, D.R. also emphasized that mutual funds joined hands with dividend-strippers in their organized loot of money that rightfully belonged to the revenue. The learned counsel for the assessee has vehemently disputed these arguments. The assessee’s case fell within the ratio laid down by Harrison’s case as against Finsbury because the transaction was demonstrably a transaction of dealing in units of mutual fund. There was no scheme or arrangement with

the vendor or purchaser of the units whereby the sellers financial circumstances were capable of being better or worse. There was no arrangement between the assessee and the mutual fund to share the gains of tax saving or to protect the unit holders in the event of tax concession not materializing.

92. On consideration of the matter we find the facts of the case of the assessee before us to be falling in the category of Griffiths Vs. J.P. Harrison Ltd. It may be that mutual funds knew that the scheme being marketed by them would serve as a tool for dividend-stripping by interested parties. Nonetheless the transactions between the mutual funds and the assessee were at arms length. None of these mutual funds acted in any manner different from what they were normally doing in the ordinary course of their business. These mutual funds sold units to buyers and redeemed them in accordance with certain set rules. There is nothing to suggest that as far as mutual funds were concerned, they deviated in any manner from their uniform course of trading in favour of the dividend-strippers. Mutual funds acted the same way, whether the assessee was a dividend-stripper or a serious investor who bought units, earned dividend and continued to hold the units. That being so, the mere knowledge of the mutual fund that their units may be purchased and redeemed by dividend-strippers also does not cloth the mutual fund as a party to tax avoidance. Mutual fund sold the units and had no interest in the units thereafter. They had no prospect of receiving any benefit from any tax saving. As to the buyers of the units, they could have done whatever they wished with the units. The units purchased by them became part of trading stock in the ordinary sense. There was no obligation on the unit holders to sell or not to sell in any pre-determined manner. No doubt the objective of the assessee in purchase of units was to claim a loss that was likely to arise after declaration of tax-exempt dividend, but as held by their Lordships in all the three cases of J.P. Harrison Ltd., Finsbury and Lupton, where the tax payer embarked upon an adventure which has all the characteristics of trading, his purpose or object alone cannot prevail on what he in fact does. Unlike the transactions in Finsbury and Lupton, the acts of the assessee are unequivocal. There was no arrangement whatsoever under which the mutual funds were concerned as to whether the assessee would or would not later make some claim, which under the law, as it then stood, the assessee might be able to make. In other words the shape and character of the transaction did not undergo such change that it may no longer be regarded a trading transaction. There is no artificial structure remote from trading and fashioned so as to secure a tax advantage. It is, therefore, difficult to regard the transactions under consideration by us to be other than trading transactions, even though the transactions were entered into by the assessee with the motive of reaping a fiscal advantage which is there for all to see.

93. We find the case of the assessee before us on this aspect on stronger footing than J.P. Harrison Ltd. The issue in the case of J.P. Harrison Ltd. was whether the transaction of purchase and sale of shares was a trading transaction. The majority view is that it was a trading transaction. The company bought shares, received dividend from those shares and then sold them. What details did it lack that prevents it being an adventure in the nature of trade? In the judgments of Viscount Simonds, Lord Morris of Borth-y-Gest and Lord Gust the argument that the motive of making a profit is essential requirement of a trade has been specifically rejected. In the appeals before us we are concerned with the question as to whether the transactions in question are business transactions. The word “business” has much wider scope and connotation than the word “trade”. In order to determine whether there was a business or not, the issue cannot be decided from the narrow angle as to whether or not the object was to sell the commodity at enhanced price. In a business transaction there could be several considerations. The tax effect is surely one of them and a very important one for that matter. The learned counsel for the assessee has cited example of an industrial undertaking being set up in a backward area with a view to earn tax incentives. These tax incentives have been instrumental in bringing about reduction in the economic and industrial disparity between the developed areas and relatively less developed areas of the country. Another important example is tax incentives and benefits given to the exporters. It was intended that the exporters should even if there was going to be loss, export nonetheless and be compensated by incentives such as duty draw back, import entitlements and exemption from levy of income-tax. In today’s scenario it would be unrealistic to see a business operation from the narrow angle of the difference between the selling price and the purchase price. There may be systematic and prolonged activity of loss making keeping in view the overall business strategy and long-term prospects. This aspect is mentioned in the judgment of Viscount Simonds in the following words:-

“No doubt, many observations that have been made alio intuitu will be found to the effect that trade is carried on with a view to a profit. But this proposition is not universally true, nor can it be tested merely by ascertaining the difference between the purchase price ( or, it may be, the manufacturing cost) of an article and the selling price of that article. For a dealer may seek his profit, if a profit is essential, otherwise than by an enhanced price upon a resale, as by a declaration of dividend, a repayment upon a reduction of capital or upon a liquidation of the company whose shares he has bought.”

94. We shall now turn to the other judgments relied upon on behalf of the revenue to advance their argument that the assessee’s claim of set off of loss should be rejected as the transactions in question are not business transactions at all. These judgments are Senairam Doongarmall Vs. CIT, 42 ITR 392 (SC); David Mitchell Vs. CIT 30 ITR 701 (Cal); Hindustan Cellulose and Paper Mills Ltd. Vs. CIT 50 ITR 303 (Cal.); G. Venkataswamy Naidu & Co. Vs. CIT, 35 ITR 594 (SC); CIT Vs. Motilal Hirabhai Spinning & Weaving Co. Ltd., 113 ITR 174 (Guj.) and CIT Vs. Minal Rameshchandra 167 ITR 507 (Guj.). We find that these judgments have been decided upon their own facts and the issues arising therein are vastly different from the issue before us, viz., the nature of transaction where an assessee accepts loss in trading in pursuit of larger benefit in tax advantage of such trading transaction.

95. In the case of David Mitchell (supra), the assessee was an accountant by profession and a partner in a firm of chartered accountants. As no provision had been made in the accounts of the firm for payment of income-tax on the profits of the previous year or the current year, the assessee transferred a sum of Rs. 1,44,407/- from his accounts to an account called “Taxation reserve account”. On renouncing all claims to this amount against the firm, the assessee claimed that this amount was a capital loss arising from the transfer of capital asset to the firm and should, therefore, be set off against other capital gains. Hon'ble Calcutta High Court held that the transfer of the amount to the taxation reserve account from the other accounts did not involve any transfer of a capital asset and in any view, the assessee had not suffered a capital loss as he had merely foregone his claim voluntarily in favour of the firm. We find these facts entirely different from the facts of the case before us. In the case before us the assessee has not foregone any income voluntarily in favour of the mutual fund or any other party.

96. In the case of G. Venktaswamy Naidu & Co. Vs. CIT (supra), the assessee firm which acted as managing agents of a company purchased 4 contiguous plots of land adjacent to the plots where the mills of the managed company were situate. Later on the assessee firm sold those plots to the managed company at a profit. Hon'ble Supreme Court held that the assessee purchased the four plots of land with the sole intention of selling them to the mills at a profit, which intention raised a strong presumption that the transaction was an adventure in the nature of trade. We do not find facts of this case having much bearing on the facts of the case under consideration before us.

97. In the case of Senairam Doongarmall Vs. CIT (supra), the factory and other buildings called the tea estate owned by the assessee were requisitioned for different purposes by the military authorities. Though the assessee continued to be in possession of the tea garden and tended them to preserve the plants, the manufacturing of tea was stopped completely. The assessee was paid compensation on the basis of out-turn of tea that would have been manufactured by the assessee during that period. On these facts Hon'ble Supreme Court held that the tending of his gardens to preserve the plants was not a continuation of the business of the assessee which had come to an end for the time being, as there was no activity with the object of earning profit. In this context Hon'ble Supreme Court held, “ordinarily profit motive is a normal incident of business activity”. Here again facts of the case are very different.

98. In the case of Lok Shikshana Trust (supra), a trust was founded with the object to educate the people of India in general and of Karnataka in particular. The trust carried on a business of printing and the question was whether the income of the trust, which at the relevant time was publishing newspapers and journals, was exempt from tax u/s 11. Hon'ble Supreme Court held that the publication of newspapers and journals involved the carrying on of an activity for profit and the income of the trust was, therefore, not exempt from tax. Here again the Hon'ble Supreme Court held that profit motive is a normal incident of business activity. It is needless to say that the facts of the case and the issues involved in that case are altogether different.

99. In the case of CIT Vs. Motilal Hirabhai Spinning & Weaving Co. Ltd. (supra), the assessee was originally running a textile mill. Subsequently the textile mill was closed down and thereafter the assessee earned interest on certain advances or deposits made by it. The income was returned and assessed as income from other sources. In a later assessment year, the assessee claimed that the income was assessable as income from business. Hon'ble Gujarat High Court held that the Tribunal rightly applied the relevant tests, namely, volume, frequency, continuity and regularity of the transaction in reaching the conclusion that the activities of the assessee in giving advances constituted business.

100. In the case of CIT Vs. Smt. Minal Rameshchandra (supra), the assessee along with her mother and brother purchased a large plot of land in March, 1962. The land had been converted into town planning scheme land in July, 1959. When the assessee purchased the land the title to the land was in dispute. The land was not yielding any regular income. In April, 1970, the assessee, along with other co-owners, entered into a partnership with 7 other individuals and contributed the land as their capital contribution to the partnership. The other 7 individuals did not contribute any capital. The three partners contributing the land retired from the partnership w.e.f. August 31, 1970. The land was sold in December, 1973 for Rs. 15 lakhs. Hon'ble Gujarat High Court held that where there was a purchase of land if there was no safety of the capital invested and there was no certainty of regular return, it was difficult to see that such a transaction could be said to be in the nature of investment. On the other hand, risk, uncertainty, foresightedness to visualize the imponderable and capacity to overcome the unforeseen hurdles were the essential requisites for business activity. So would be the case with regard to a transaction which was an adventure in the nature of trade. Here again the issues considered are different.

101. In view of the reasons enumerated in the foregoing paras, our answer to the first question is in the affirmative. The transactions of the assessee with which are concerned in these appeals have to be viewed as business transactions.

SECOND QUESTION :

IF THE ANSWER TO THE FIRST QUESTION IS IN THE AFFIRMATIVE, WHAT IS THE NET RESULT OF THE COMPUTATION?

102. To put it simply, the question is whether the net result of the computation for assessment year 2000-01 is a loss of Rs. 1,85,68,014/- as claimed by the assessee or loss of Rs. 27,31,929/- computed by the learned Assessing Officer in the assessment order. We should point out here that there appears to be an error in the working by the Assessing Officer in the assessment order for assessment year 2000-2001, in as much as he has omitted to take into consideration the sum of Rs. 23,76,778/- received by the assessee by way of incentive. At any rate, the reason for the huge difference between the loss as claimed by the assessee and the loss as worked out by the Assessing Officer lies in the fact that while according to the assessee, the dividend income of Rs. 1,82,12,863/- is not liable to be reduced from the purchase cost of units of Chola Mutual Fund or in other words to be reduced from the loss incurred on sale of those units, according to the revenue the correct amount of loss can be arrived at only after further reducing the difference between sale consideration of the units and purchase consideration of the units by the amount of dividend received by the assessee before the units in question were sold. During the course of hearing before us the learned special counsel for the revenue as well as the learned CIT, DR have vehemently argued that the dividend amount of Rs. 1,82,12,863/- should be adjusted for arriving at the net result of the computation in relation to the assessee’s transactions of purchase and sale of units of Chola mutual fund during the previous year relevant to assessment year 2000-2001. Identical plea has been taken by them in relation to assessment year 2001-2002. Various arguments advanced in support of this contention on behalf of the revenue can be put into following three categories:-

A. Income from units of Mutual Fund cannot be included in the expression “dividends” in section 56(2)(i) of the Act. B. As the assessee purchased units of Chola Mutual Fund only after announcement of dividend of Rs. 4/- per unit just before the record date, the purchase price of Rs. 8 crore should be in part attributed to dividend

income. C. In any case, under the provisions of section 14A inserted by the Finance Act, 2001 with retrospective effect from 1.4.1962, a suitable part of the purchase price of Rs.8 crore is required to be apportioned to the income of Rs. 1,82,12,863/-.

103. As to the argument ‘A’ above, the learned special counsel for the revenue pointed out that as far as the provisions of Income-tax Act are concerned, an income from units of mutual fund has been considered to be separate and distinct from dividends on equity shares of a joint stock company. Those arguments are summarized by us in paragraphs 33 and 34 of this order. In his reply the learned counsel for the assessee has argued that even if the expression “ income” has been employed instead of “dividend” in relation to the units of a mutual fund in various provisions of the Act, in essence income received by a unit holder on units of a mutual fund are “dividend” only. The arguments of the learned counsel in this behalf have been summarized by us in paragraph 65 of this order. On consideration of the matter we are of the view that as far as various provisions of Income-tax Act are concerned, income from units of a mutual fund have not been considered “dividend” within the meaning of section 2(22). At all places the expression “dividend” has been avoided in relation to units of a mutual fund. We, therefore, see force in the contention of the learned special counsel for the revenue that income from units of a mutual fund is not covered by the provisions of section 56(2)(i) of the Act. It, therefore, follows that in the case of an assessee holding units of a mutual fund as his stock-in-trade, income distributed by the Mutual Fund would be chargeable to tax under the head “Profits and gains of business or profession”. At the same time we are of the view that this difference in the head of income does not have any material bearing on the question of the net result of the computation of assessee’s income on sale of the units of Chola Mutual Fund for assessment year 2000-2001 and units of Sun F & C Mutual Fund for assessment year 2001-2002. We say so because dividend declared by these mutual funds represent only return on investment and do not amount to either the recovery of purchase cost of the units or realization of sale consideration of the units. This aspect is clear from Accounting Standard 13 issued by the Institute of Chartered Accountants of India and heavily relied upon by both the special counsel for the revenue as well as the learned CIT, D.R. The Accounting Standard declares, “interests, dividends and rentals receivables in connection with an investment are generally regarded as income, being the return on the investment. However, in some circumstances, such inflows represent recovery of cost and do not form part of income.” Thus income pay out as a rule is to be regarded as income or return on the investment and only in special circumstances it may represent recovery of cost and not part of income. Hence, unless special circumstances are shown to exist, dividend/income cannot be adjusted against purchase price of shares/units. The reason for that is not difficult to see. The assessee purchased ‘X’ number of units of Chola mutual fund on 24.3.2000. On declaration of dividend at the rate of Rs.4/- per unit, the assessee continued to own ‘X’ number of units of Chola Mutual Fund. The assessee would have continued to hold ‘X’ number of units of Chola Mutual Fund as long as he wished and it is only on redemption on 27.3.2000 that the assessee ceased to own ‘X’ number of units of Chola Mutual Fund. The declaration of dividend on 24.3.2000 had no bearing at all on the holding of units of Chola Mutual Fund by the assessee and they remained intact. It is for this reason that where historical cost method of accounting is adopted, while working out the value of closing stock dividend or any other returns are not adjusted in the valuation of closing stock as at the end of the year. That would be the position even if the provisions of section 56 (2)(i) are not there and the dividend income as defined u/s 2(22) is chargeable to tax as business income. It is because the historical cost means the sum of the expenditure directly or indirectly incurred in bringing an article to its existing condition and location. This may be expressed shortly as “acquisition and production cost”. That cost can be adjusted only by the realized or realizable value and not by periodic returns, such as interests, dividends, rentals and other receivables.

104. During the course of hearing before us the learned special counsel relied on the judgments of Hon'ble Bombay High Court in the case of Ahmuty & Co., 27 ITR 63 (Bom.); Western States Trading Co. Pvt. Ltd., 80 ITR 21 (SC) and Chuggan Das 55 ITR 70 (S.C.). These judgments do support the contention of the revenue that dividend earned in a case where the shares are held as stock-in-trade would represent business profits and if the provisions of section 56(2)(i) were not there the same would be chargeable to tax under the head “Profits and gains of business or profession”. These judgments nowhere indicate that dividend income would be considered as recovery of cost or reduced expenditure on purchase in the computation of income of the businessman holding shares as a dealer. The other judgments viz., 60 ITR 11 (SC); 195 ITR

81 (SC); 107 ITR 182 (Cal.) and 177 ITR 111 (Bom.) are on the question of difficulty in apportionment and it is held that such difficulties cannot be ground for rejecting the claim of either assessee or revenue. These judgments have nothing to support the proposition that income declared by a mutual fund should be treated as recovery of the cost of acquisition of the units of mutual fund or the purchase cost of units should in part be ascribed to or adjusted against the income declared by the mutual fund.

105. The argument ‘B’ runs that the assessee purchased units of mutual fund during the two assessment years just on the eve of record date when the amount of dividend declared had become a foregone conclusion. It is argued that the assessee bought units cum-dividend and sold units ex-dividend and, therefore, the difference between sale price and purchase price should be treated as cost of earning dividend and not a loss incurred by the assessee on its transactions of purchase and sale of units. Considerably reliance is placed in this respect on the judgment of Hon'ble Supreme Court in the case of CIT Vs. India Discount Co. Ltd., 75 ITR 191 (SC) and Accounting Standard 13 of Institute of Chartered Accountants of India. The learned CIT, D.R. has also relied heavily in this respect on the judgment of Hon'ble Supreme Court in the case of Miss Dhun Dadabhoy Kapadia 63 ITR 651 (SC) and certain Tribunal decisions in the paper book filed by the department. The learned counsel for the assessee has sought to distinguish the case of the assessee before us from the facts in India Discount Co. Ltd. on the ground that in the case of India Discount Co. Ltd., the assessee had purchased shares with arrears of dividend. Thus, the assessee purchased two assets, viz., equity shares of the company and dividend arrears. In the case of the assessee before us the units of mutual fund had been purchased before record date and dividend was yet to be formally announced by the mutual fund. What the assessee before us purchased was a single asset, i.e. units of mutual fund and not distinct and separate assets, as in the case of India Discount Company (supra). The learned counsel for the assessee has sought to receive further support to his case by the judgment of Hon'ble Supreme Court in the case of Vijaya Bank, 187 ITR 541 (SC) and certain English judgments as referred to by us in paragraph 66 of the order.

106. On consideration of the matter we are of the view that this entire debate is much off the mark. We are concerned in these appeals not with the purchase and sale of equity shares but units of mutual funds. There is considerable difference between the equity shares and mutual fund units as has very helpfully been explained by the learned special counsel for the revenue himself and enumerated by us in paragraph 34 of this order. While shares of a company are traded in a stock exchange based on several factors impacting demand and supply for the stock, the units of a mutual fund are traded on the NAV of the mutual fund. When the amount of dividend declared by a company in respect of its equity shares becomes known or reasonably well anticipated, the factum and quantum of dividend is factored in by the market in the price of equity share around that time. The price of the unit of a mutual fund depends on its NAV and not the amount of dividend announced/declared. We, therefore, do not see as to how the amount of dividend announced by the mutual fund affected the price at which the assessee purchased the units. It is another matter that assessee’s sale price was affected because of the out-flow of dividend distributed by the mutual funds resulting into considerable lowering of NAV. Thus, as far as the purchase price paid by the assessee is concerned, it cannot be said that the assessee paid higher price because the units were pregnant with the amount of dividend announced by the mutual fund. At that point of time the assessee would have paid the same price for those units, had there been no announcement of dividend by mutual funds. Therefore, it cannot be said that the assessee paid additional purchase price because of the dividend declared by the mutual funds. We, therefore, hold that the reliance placed by the revenue on the judgment of Hon'ble Supreme Court in the case of India Discount Company (supra) is not of much assistance on account of different price mechanism in the case of units of a mutual fund. As to the judgment of Hon'ble Supreme Court in the case of Ms. Dhun Dadabhoy Kapadia (supra), first and foremost the assessee in that case was not a dealer in shares. The assessee renounced her right to acquire additional shares and the claim was that depression in the value of old shares as a result of issue of new shares should be set off against the consideration received by the assessee on renunciation of her right to acquire new shares. The argument of the revenue is that depression in the value of units should be set off against the amount of dividend received by the assessee. We have earlier seen that dividend as a return of investment is not regarded, as a rule, recovery of purchase price. As a corollary dividend cannot be regarded as erosion of sale price. Unlike renunciation of right to subscribe for new shares in the case of Ms. Dhun Kapadia, the receipt of income on units of mutual funds by the assessee did not represent one fixed time event. What if the assessee had not

sold the units immediately after the record date and retained the units for some more time? What if the assessee had retained the units for sufficiently longer period and sold them at a profit? At any rate, the case of Ms. Dhun Kapadia pertains to equity shares and not units of a mutual fund. We do not see any authority in the judgment in the case of Ms. Dhun Kapadia to reject the time-tested method of computation of the result of a transaction of purchase and sale of an income bearing asset to be computed on the basis of difference between the sale price and purchase price unaffected by the returns on investment received in the mean time.

107. Argument ‘C’ relates to the provisions of section 14A of the Act. These provisions have been inserted by the Finance Act, 2001 with retrospective effect from 1.4.1962. According to the revenue in the transaction with Chola Mutual Fund the assessee incurred an expenditure @ Rs. 17.57 per unit on 24.3.2000 to receive income of Rs. 4/- per unit on the very same day and sale proceeds of Rs. 12.97 per unit after two days. The transaction was undertaken by the assessee with full knowledge of the trading results thus ensuing. On these facts a part of the expenditure was directly related to the earning of the income from the mutual fund. There was a direct nexus between the cost of purchase of units and the immediate receipt of income. In other words the composite expenditure on purchase of units was relatable not only to the sale proceeds of units but also to the receipt of income distributed by mutual fund. According to the learned special counsel for the revenue, the cost incurred by the assessee for earning income was best represented by the difference between closing NAV cum-dividend and opening NAV ex-dividend. Similar trend could be seen in respect of Sun F&C value fund in the other assessment year. It is argued on behalf of the revenue that irrespective of traditional or conservative method of accounting the provisions of sec. 14A of the Act super-impose an obligation for bifurcation or apportionment of the purchase price of the units between the sale consideration and the dividend income. It is pointed out that the expression employed in section 14A is “in relation to” which is of much wider import and connotation than the expression “ in respect of”. The learned counsel for the assessee argued that the arguments of revenue based on the provisions of section 14A are not correct because first, there was no expenditure incurred in respect of the income from units and, secondly, the question of disallowance could only arise if the assessee was claiming a deduction which was not so in the present case. The learned counsel argued that it was not true that dividend income was altogether exempt from tax, in as much as tax on dividend had been paid by the companies who paid dividend to mutual fund. Mutual Fund in this behalf was merely a pass through conduit. Furthermore, the income received from a mutual fund is exempt under the provisions of section 10(33) of the Act in Chapter III. The heading of Chapter III read “ INCOMES WHICH DO NOT FORM PART OF TOTAL INCOME”. Any income, therefore, which fell in the provisions of section 10 was not to enter into the subsequent provisions of the Act relating to computation of income chargeable to tax. The dividend received by the assessee from mutual funds having been excluded from total income by virtue of the provisions of section 10(33) could not, therefore, be caught in the net of tax by operation of the provisions of section 14-A.

108. The main provision of section 14A inserted by the Finance Act, 2001 with retrospective effect from 1.4.1962 read as under:-

“14A For the purposes of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income which does not form part of the total income under this Act:”

On a plain reading of the above quoted provision we find that if any part of the expenditure claimed by the assessee as deduction against his income chargeable to tax is found or determined to have been incurred by the assessee in relation to income received by the assessee from the mutual funds, the expenditure claimed by the assessee as deduction against his income chargeable to tax has to be disallowed to that extent. We do not see much force in the contention of the assessee that while the provisions of section 10(33) exempting the assessee’s income on units of mutual funds fall under Chaper III, the provisions of section 14A have been inserted in Chapter IV only. The import of the words “ income which does not form part of the total income under this Act” unmistakably takes us to Chapter III titled as “ INCOMES WHICH DO NOT FORM PART OF TOTAL INCOME”. One may as well read the provisions of section 14A in the following manner:-

“For the purpose of computing the total income under this Chapter, no deduction shall be allowed in respect of expenditure incurred by the assessee in relation to income excluded from total income under the provisions of Chapter III of the Act.”

It does not appear correct to say that provisions of section 14A impinge on the provisions of section 10(33). These provisions operate in relation to the expenditure an assessee claims in the computation of his income chargeable to tax. Such expenditure if found to have been incurred in relation to income exempt under Chapter III shall be disallowed by virtue of the provisions of section 14A. In the instant case the assessee has claimed expenditure on purchase of the units of Chola Mutual Fund and SUN F & C Fund against subsequent sale of those units. Those sale proceeds are income chargeable to tax under Chapter IV and are not exempt under any provision of Chaper III. Purchase price of units is an expenditure to which disallowance provision of Chapter IV would squarely apply. Reference in this respect may be made to the judgment of Hon'ble Supreme Court in the case of Attar Singh Gurmukh Singh, 191 ITR 667 (SC). We, therefore, do not accept the arguments based on chapter III. We do not see any conflict between chapter III and s. 14A and even if there is one, the meaning of the provisions of section 14A being unmistakably clear the provisions have to be given effect to by way of harmonious construction. Provisions of section14A cannot be considered defunct or redundant for the reason only that these provisions should have been inserted in Chapter III and not Chapter IV. After all both Chapter III and Chapter IV are integral part of the same enactment. We also do not agree with the arguments of the assessee that it amounts to artificial enhancement of sale price by the amount of dividend. The case of revenue is based on disallowance of expenditure (purchase price), not enhancement of sale proceeds. We also do not see proviso to section 14A having any application. It is not the case of reopening any closed matter. It is, therefore, open to us to take note of the retrospect provisions of section 14A.

109. We are, at the same time in substantial agreement with the contention of the learned counsel for the assessee that there is no expenditure incurred in respect of the income from units. To a large extent our reasons are the same as elaborated by us in relation to argument ‘A” and argument ‘B’ above. We find ourselves unable to accept the contention of the revenue that provisions of section 14A being special provisions and the expression being “ in relation to” a different conclusion should be arrived at. We would now elaborate as to why we think so. From time immemorial the periodic returns from investment have been considered as independent items of income bearing no relationship with the cost or value of the investment. That is the firmly established accountancy principle accepted and followed every where, so much so that it appears to have attained the force of law. Assessments of millions of assessees for all these years have been completed on this basis. If the logic behind the revenue’s arguments based on section 14A is accepted, it may have severe unwanted repercussions. To illustrate, in all cases interest is earned, interest income would not be charged to tax at least until such time the entire principal amount lent or deposited on interest is recouped. Or in any case full amount of interest cannot be subjected to tax and certain part of principal amount would have to be estimated as representing cost of earning interest income. The department has never made assessments on that basis, nor is there any indication of department’s intention to do so henceforth. Rental income is assessed under the head “Income from house property” without giving any deduction in relation to cost of acquisition of immovable property to be apportioned as cost of rental income. We do not understand as to why the matters should suddenly change course for the reason only that certain kinds of returns from investment are exempt under the provisions of Chapter III. There is also the question as to how many times cost of acquisition can be attributed. In the case of the assessee units of mutual funds were sold soon after receipt of dividend. There may be cases of the assessees retaining their units of mutual fund on long term basis. Should the cost of acquisition be attributed to the dividend or income received year after year? These are basic substantive questions that cannot be answered by merely saying that there are provisions of section 94(7) to take care of such a situation. The arguments of revenue appear to be self-contradictory. There cannot be one legal principle applicable to income chargeable to tax and entirely different legal principle when income is exempt from charge of tax. We do not find the expression “ in relation to” compelling us to do so. We also do not find the expression reflective of any such legislative intent. In our view, there is nothing in section 14A calling for re-interpretation of the basic principles of accountancy.

110. We, however, hasten to add to be fair, the contentions of the learned special counsel are not based on the provisions of section 14A in isolation. During the course of hearing before us he has emphasized various aspects of the transactions under consideration here and certain perceived facts relating to the declaration of income by the mutual funds. According to his arguments, in substance the loss suffered by the assessee is the price the assessee willingly paid for acquiring the income he could claim exempt under the provisions of section 10(33). In these special circumstances it is desirable and called for to bifurcate the purchase price of units paid by the assessee between the expenditure on income and expenditure on acquisition of units. He further argued that such a bifurcation cannot be prevented on the ground that the purchase price is indivisible. The provisions of section 14A, in the submissions of the learned special counsel for the revenue, effectively deal with the problem of indivisibility and apportionment of the purchase price should be done regardless of the earlier judicial pronouncements in that behalf. The special counsel has further relied on some judicial pronouncements, such as, 60 ITR 11 (SC); 195 ITR 81 (SC); 107 ITR 182(Cal.) and 177 ITR 111 (Bom.) in that respect.

111. Simply put, the argument of the revenue is that we should look at the substance of the transaction as may be gathered on the facts situation prevailing and find answer to legal problem, if any, in the retrospected provisions of section 14A. This brings us very close to the third question and we would deal with this aspect while deciding upon the third question. 112. Before parting from the second question we wish to clarify that we have not dealt with the incentive amounting to Rs. 23,76,778/- of assessment year 2000-01 and Rs. 16,73,563/- of assessment year 2001-02 because no arguments in respect of these two amounts are contained in the orders of authorities below nor any arguments have been addressed to us during the course of hearing. Our observations and findings in this order, therefore, do not pertain to those two amounts.

THIRD QUESTION :

IS THE ASSESSEE DISENTITLED TO SET OFF LOSS FROM THESE TRANSACTIONS AGAINST HIS OTHER INCOME CHARGEABLE TO TAX?

113. The contentions of the revenue on this third question are broadly based on the arguments (a) in revenue matters substance should prevail over form, and (b) rule against tax avoidance devices should be invoked. According to the learned counsel for the assessee, in view of the judgment of the Hon'ble Supreme Court in the case of Azadi Bachao Andolan, the contentions of the revenue based on (a) and (b) above should be rejected. We have enumerated in the earlier part of this order respective arguments of the revenue and the assessee in this regard at considerable length. We find that legal pronouncements relating to this issue have a chequered history. It would be worthwhile to put the issue in its historical perspective for which purpose we endeavor to trace the legal position in English decisions and Indian decisions respectively.

114. In Secretary of State Vs. Scobel (1903) 4TC 618 ( HL), it was held that in revenue matters, what is material is the substance of the transaction and not the form. The same view was taken in Back Vs. Daniels (1925) 9 TC 183. In IRC Vs. Fisher’s (1926) AC 395, Lord Sumner held that if an individual arranges his affairs to mitigate his tax liability, he neither comes under liability nor incurs blame. In I R C Vs. Adam (1928) 14 TC 34 it was remarked, “ a great deal has been said about form and substance. I think that in a question of this sort both form and substance must be considered.” In Re Hinckes (1921) 1 Ch. 475 Lord Warrington said, “It is said we must go behind the form and look at the substance. I do look at the substance, but in order to ascertain substance, I must look at the legal effect of the bargain which the parties have entered into.” Thereafter came in 1936 the decision of House of Lords in the case of Duke of Westminster Vs. IRC (1936) 19 TC 490( HL). This decision sought to explode the theory of substance. Lord Tomlin, in his speech pronounced, “Apart, however, from the question of contract with which I have dealt it is said that in Revenue cases there is a doctrine that the Court may ignore the legal position and regard what is called, “the substance of the matter” and that here the substance of the matter is that the annuitant was serving the Duke for something equal to his former salary or wages and that, therefore, while he is so serving, the annuity must be treated as salary or wages. The supposed doctrine (upon which the Commissioners apparently acted) seems to rest for its support upon a misunderstanding of language used in

some earlier cases. The sooner this misunderstanding is dispelled and the supposed doctrine given its quietus, the better it will be for all concerned, for the doctrine seems to involve substituting “the uncertain and crooked cord of discretion” for the ‘golden and straight mete wand of the law’”

115. Substance principle could not, however, be given a quite burial. In IRC Vs. Wesleyan General Assurance (1948) 30 T.C 11 ( HL), Viscount Simon said, “the name given to a transaction by the parties concerned does not necessarily decide the nature of the transaction. To call a payment a loan, if it is really an annuity, does not assist the tax payer any more than to call an item a capital payment would prevent it from being regarded as an income payment if that is its true nature. The question always is the real character of the payment, not what the parties call it.” In the case of Pott’s Executors Vs. IRC (1951) 32 TC 211, form was instated. In that case Lord Macdermott said, “….It was said for the Crown that it was no straining of language, where A paid a sum to B at C’s request and for C’s benefit, to say that A had paid C. I cannot agree. The person paid is B and no one else, and the consideration that the payment is advantageous to C seems to me beside the point, as far as concerns the construction of the material words.” In Saunders v Pilcher (1949) 2 All ER 1097, the taxpayer who was a fruit grower and salesman bought freehold land comprising, inter alia, a cherry orchard, for Pounds 5,500. The sale was expressed as ‘inclusive of this year’s fruit crop’, and the taxpayer had valued the cherries on the trees at Pounds 2,500. The cherries were subsequently sold by the taxpayer for Pounds 2,903. In computing his profits of trade, the taxpayer sought to deduct the Pounds 2,500 as representing the cost to him of the fruit. It was held that the purchase of the growing crop was part of a transaction for the purchase of a capital asset, the land and the trees, and therefore, the price paid for the crop was not a sum which could be deducted in computing the profits or gains. Singleton, L J, remarked that it was true to say that if arrangements of a different kind had been made, the taxpayer might have been in a better position. If he had bought the growing cherries first and acquired the freehold later, he might not have had so great a liability to tax. Regard, however, must be had to the contract, to the conditions, and to the conveyance.” The approach of the Courts that in fiscal legislation the form or legal effect of a transaction was more important encouraged taxpayers to draw up schemes and arrangements, very often contrived and fanciful the legal effect of which was to avoid the impact of the letter of the taxing statute. These arrangements came to be known as `tax planning’ or `tax avoidance scheme’. Subsequent English decisions sought to remedy the situation. In IRC Vs Plummer 1980 AC 896 and Floor Vs. Davis 1980 AC 695 substance was given weightage. Thereafter came the triology of decisions viz., Ramsay Ltd. Vs. IRC (1981) 1 All ER 865 (HL); IRC Vs. Burmah Oil Co. Ltd. (1982) Simons TC 30 (HL) and Furniss Vs. Dawson (1984) 1 All ER 530(HL). These decisions came down upon what were considered preordained series of transactions that had no commercial purpose apart from avoidance of a liability to tax, which in the absence of those particular transactions would have been payable. In the words of Lord Wilberforce in W.T.Ramsay Ltd:-

“I have a full respect for the principles which have been stated but I do not consider that they should exclude the approach for which the Crown contends. That does not introduce a new principle: it would be to apply to new and sophisticated legal devices the undoubted power and duty of the courts to determine their nature in law and to relate them to existing legislation. While the techniques of tax avoidance progress and are technically improved, the courts are not obliged to stand still. Such immobility must result either in loss of tax to the prejudice of other taxpayers, or to Parliamentary congestion or most likely to both. To force the courts to adopt, in relation to closely integrated situations, a step by step, dissecting approach which the parties themselves may have negated, should be a denial rather than an affirmation of the true judicial process. In each case the facts must be established; and a legal analysis made; legislation cannot be required or even be desirable to enable the court to arrive at a conclusion which corresponds with the parties’ own intentions.”

116. Like Westminster decision or Westminster principle Ramsay principle also could not entrench itself completely in judicial thinking. In Craven Vs. White (1988) 3 All ER 495 (HL) it was held,

“The test of whether a series of transactions which contained a tax saving step was nevertheless liable to tax was whether the transactions were preordained, in the sense that, looking at the transactions as a whole, realistically, they constituted a single and indivisible whole and were to be treated as such, and was not

whether the tax saving step was effected for the purposes of avoiding tax on a contemplated subsequent transaction.”

117. In a recent judgment delivered on February 8, 2000 House of Lords have in Macniven Vs. Westmoreland Investments Ltd. (2002) 255 ITR 612( HL), considered at length Ramsay triology decisions. The decision in Macniven’s case cannot be seen as repudiation of Ramsay principle altogether. Lord Hoffmann explained Ramsay principle in the following words:-

“28. Everyone agrees that Ramsay is a principle of construction. The House of Lords said so in Inland Revenue Commissioners Vs. McGuckian (1997) 1 WLR 991. But what is that principle? Mr. McCall formulated it as follows in his printed case:

“When a court is asked (i) to apply a statutory provision on which a tax-payer relies for the sake of establishing some tax advantage (ii) in circumstances where the transaction said to give rise to the tax advantage is, or forms part of, some pre-ordinained, circular, self-cancelling transaction (iii) which transaction though accepted as perfectly genuine ( i.e., not impeached as a sham) was undertaken for no commercial purpose other than the obtaining of the tax advantage in question then (unless there is something in the statutory provisions concerned to indicate that this rule should not be applied ) there is a rule of construction that the condition laid down in the statute for the obtaining of the tax advantage has not been satisfied.”

29. My Lords, I am bound to say that this does not look to me like a principle of construction at all. There is ultimately only one principle of construction, namely, to ascertain what Parliament meant by using the language of the statute. All other “principles of construction” can be no more than guides which past judges have put forward, some more helpful or insightful than others, to assist in the task of interpretation. But Mr. McCall’s formulation looks like an overriding legal principle, superimposed upon the whole of revenue law without regard to the language or purpose of any particular provision, save for the possibility of rebuttal by language which can be brought within his final parenthesis. This cannot be called a principle of construction except in the sense of some paramount provision subject to which everything else must be read, like section 2(2) of the European Communities Act 1972. But the courts have no constitutional authority to impose such an overlay upon the tax legislation and, as I hope to demonstrate, they have not attempted to do so.”

In his speech Lord Hoffmann further said:

“ My Lords, I venture to suggest that some of the difficulty which may have been felt in reconciling the Ramsay case with the Duke of Westminster’s case arises out of an ambiguity in Lord Tomlin’s statement that the courts cannot ignore “the legal position” and have regard to “the substance of the matter”. If “the legal position” is that the tax is imposed by reference to a legally defined concept, such as stamp duty payable on a document which constitutes a conveyance on sale, the court cannot tax a transaction which uses no such document on the ground that it achieves the same economic effect. On the other hand, if the legal position is that tax is imposed by reference to a commercial concept, then to have regard to the business “substance” of the matter is not to ignore the legal position but to give effect to it.”

118. As in the English decisions, in Indian decisions also we find both Westminster principle as well as Ramsay principle being given effect to depending upon the facts and circumstances of the case. In the case of Gopal Saran Narain Singh Vs. CIT (1935) 3 ITR 237 (PC) it was held, “It is hardly necessary to say that it is the substance of the transactions and not the form which is important. It would be quite possible for the assessee to be given as a matter of form a right of payment by instalments of a capital sum but which nevertheless would in substance be a right to an income.” At the same time the words of Lord Tomlin in Duke of Westminster echoed in the case of CIT Vs. Kamakshya Narain Singh (1940) 8 ITR 563 (Pat.). In Bank of Chettinad Ltd. Vs. CIT (1940) 8 ITR 522 (PC), it was said, “There Lordships think it necessary once more to protest against the suggestion that in revenue cases ‘the substance of the matter’ may be regarded as distinguished from the strict legal position….”. In Kikabhai Premchand Vs. CIT (1953) 24 ITR

506 (SC) it was said, “It is well recognized that in revenue cases regard must be had to the substance rather than to its form”. In CIT Vs. Provident Investment Co. Ltd. (1957) 32 ITR 190 (SC) the department’s plea that the substance of the matter should be looked at and not mere the form was rejected. In Jiyajeerao Cotton Mills Ltd. Vs. CIT (1958) 34 ITR 888 (SC) Hon'ble Supreme Court observed, “ Every person is entitled to so arrange his affairs as to avoid taxation but the arrangement must be real and genuine and not a sham or make-believe.” In the case of CIT Vs. C.M. Kothari (1963) 49 ITR 107 (SC), Hon'ble Supreme Court held, “If the two transfers are inter-connected and are parts of the same transaction in such a way that it can be said that the circuitous method has been adopted as a device to evade implications of this section, the case will fall within the section. In this case, the device is palpable and the two transfers are so intimately connected that they cannot but be regarded as parts of a single transaction.” In the case of CIT Vs. Sri Meenakshi Mills Ltd. 63 ITR 609 (SC), the Tribunal found that the transactions form part of basic arrangement of scheme between the creditors and the debtor that the money should be brought into British India after it was taken by the borrower outside the taxable territory. Hon'ble Supreme Court held, “But in certain exceptional cases the court is entitled to lift the veil of corporate entity and to pay regard to the economic realities behind the legal façade, for example, the court has power to disregard the corporate entity if it is used for tax evasion or circumvent tax obligation.” In the case of CIT Vs. Motors & General stores (P) Ltd. (1967) 66 ITR 692 Hon'ble Supreme Court referred to the judgments of House of Lords in the case of Secretary of State Vs. Scoble (supra); Duke of Westminster Vs. IRC (supra) and IRC Vs. Wesleyan and General Assurance Society (supra) as well the judgment of Privy Council in the case of Bank of Chettinad Vs. CIT (supra). Hon'ble Supreme Court held, “In the absence of any suggestion of bad faith or fraud the true principle is that the taxing statute has to be applied in accordance with the legal rights of the parties to the transaction. When the transaction is embodied in a document the liability to tax depends upon the meaning and content of the language used in accordance with the ordinary rules of construction.” In the case of CIT Vs. A. Raman & Co. (1968) 67 ITR 11 (SC), Hon'ble Supreme Court without reference to Westminster principle reached almost the same conclusion. Hon'ble Supreme Court held:

“Avoidance of tax liability by so arranging commercial affairs that charge of tax is distributed is not prohibited. A taxpayer may resort to a device to divert the income before it accrues or arises to him. Effectiveness of the device depends not upon considerations of morality, but on the operation of the Income-tax Act. Legislative injunction in taxing statutes may not, except on peril of penalty, be violated, but it may lawfully be circumvented.”

In CIT Vs. Kharwar (B.M) (1969) 72 ITR 603 (SC), the observations in Kikabhai case were read not throwing any doubt on the principle that true legal relation arising from a transaction alone determines the taxability of a receipt arising from the transaction. The Court observed,

“It is now well settled that the taxing authorities are not entitled in determining whether a receipt is liable to be taxed to ignore the legal character of the transaction which is the source of the receipt and to proceed on what they regard as the ‘substance of the matter’….The taxing authority is entitled and indeed is bound to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation it is open to the taxing authority to unravel the device and determine the true character of the relationship. But the legal effect of a transaction cannot be displaced by probing into the substance of the transaction.”

119. In Juggilal Kamlapat Vs. CIT (1969) 73 ITR 702 (SC), the compensation ostensibly paid for pre-mature termination of a managing agency was found to be a colourable transaction. The Hon'ble supreme Court held that the income-tax authorities were, in such a case, entitled to pierce the veil of corporate entity. In CIT Vs. Durga Prasad More (1971) 82 ITR 540 (SC), the assessee claimed to have purchased certain house properties acting as a trustee of his wife. The assessee relied upon the deed of trust executed by his wife nearly one year after the conveyance deed of the property. The assessee’s wife was not shown to have any source of income and the assessee was unable to explain the source. The Hon'ble Supreme Court held that where a party relied on self-serving recitals in documents, it was for that party to establish the truth of those recitals. The taxing authorities were not required to put on blinkers while looking at the documents produced before them. They were entitled to look into the surrounding circumstances to find out the reality of the recitals made in the documents.

In the case of CIT Vs. Panipat Woollen And General Mills Co. Ltd. (1976) 103 ITR 66(SC), Hon'ble Supreme Court declared the law in the following words:-

“It is well settled that the court in order to construe an agreement has to look to the substance or the essence of it rather than to its form. A party cannot escape the consequences of law merely by describing an agreement in a particular form though in essence and in substance it may be a different transaction.”

120. In the case of Union of India Vs. Gosalia Shipping P. Ltd. (1978) 113 ITR 307(SC), Hon'ble Supreme Court held,

“It is true that one could not place over-reliance on the form which the parties give to their agreement or on the label which they attach to the payment due from one to the other. One must have regard to the substance of the matter and, if necessary, tear the veil in order to see whether the true character of a payment is something other than what, by a clever devise of drafting, it is made to appear. But in this case the real intention of the parties was not something different from what the words used by them conveyed in their accepted sense.”

121. In CED Vs. Aloke Mitra (1980) 126 ITR 599 (SC) it was held that regard must be had to the substance of the transaction, that is, its true legal effect rather than to the form in which it is carried out. In that case it was held that the name in which the shares were held could not come in the way of levy of estate duty in respect of the shares of which the deceased was the real owner.

122. We have in the foregoing paragraphs briefly referred to a number of judgments delivered in India prior to the judgment of Hon'ble Supreme Court in the case of McDowell & Co. Ltd. (1985) 154 ITR 148 (SC). In our humble opinion it would not be correct to say that in that judgment any new legal principle has been laid down for the first time. The issues related to form of the transaction and substance of the transaction, legal effect of the transaction and motive of the parties, legitimate tax planning and clever devices for avoiding tax liability have engaged the attention of the courts in India from the very beginning. While in some judgments it would appear that Westminster principle has been enshrined, in some judgments it would be seen that Ramsay principle has been the guiding force. The judgment of Hon'ble Supreme Court in the case of McDowell & Co. Ltd., however, introduced a significant change in the legal position. In the earlier judgments it was not stated that Westminster principle was bad law. In the judgment delivered by Justice Chinnappa Reddy the judgment of House of Lords in the case of Duke of Westminster was declared to be bad law. In the case of McDowell & Co. Ltd., Ranganath Mishra J., as he then was, speaking for majority, held as under:-

“Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or 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.”

At about the same time Hon'ble Supreme Court delivered its judgment in the case of McDowell & Co. on April 17, 1985, another bench of Hon'ble Supreme Court comprising of P.N. Bhagwati C.J, R.S. Pathak & A.N. Sen JJ, in their judgment in the case of Sunil Siddharthbhai Vs. CIT, 156 ITR 509 (SC) on September 27, 1985 approved the similar approach without noticing McDowell & Co. judgment. In the penultimate paragraph of the judgment Hon'ble Supreme Court directed:-

“ If the transfer of the personal asset by the assessee to a partnership in which he is or becomes a partner is merely a device or ruse for converting the asset into money which would substantially remain available for his benefit without liability to income-tax on a capital gain, it will be open to the income-tax authorities to go behind the transaction and examine whether the transaction of creating the partnership is a genuine or a sham transaction and, even where the partnership is genuine, the transaction of transferring the personal asset to the partnership firm represents a real attempt to contribute to the share capital of the partnership firm for the purpose of carrying on the partnership business or is nothing but a device or ruse to convert the

personal asset into money substantially for the benefit of the assessee while evading tax on a capital gain. The Income-tax Officer will be entitled to consider all the relevant indicia in this regard, whether the partnership is formed between the assessee and his wife and children or substantially limited to them, whether the personal asset is sold by the partnership firm soon after it is transferred by the assessee to it, whether the partnership firm has no substantial or real business or the record shows that there was no real need for the partnership firm for such capital contribution from the assessee.” (emphasis supplied)

Hon'ble supreme Court soon followed up these judgments by another judgment in the case of Workmen of Associated Rubber Industry Ltd. Vs. Associated Rubber Industry Ltd. (1985) 157 ITR 77(SC). In that case the employer company was required to take into account dividend received from shares by it while distributing profit bonus to its workmen. The employer company transferred all those shares to a wholly owned subsidiary having no other source of income or business. Hon'ble Supreme Court held that dividend received by subsidiary was required to be taken into account for the purpose of working out profit bonus payable to workmen. Reliance was placed on the judgment in the case of CIT Vs. Sri Meenakshi Mills Ltd. (supra) and McDowell & Co. Ltd. Vs. CTO (supra). Reference was made to Ramsay triology of English cases and some other English judgments. In the case of Neroth Oil Mills Co. Ltd. Vs. CIT (1987) 166 ITR 418 (Ker.) Honble Kerala High Court considered the judgment in the case of Duke of Westminster as well as Supreme Court judgment in the case of A.Raman & Co. A host of other judgments, including Ramsay triology cases and McDowell & Co. were also referred to. Hon'ble Kerala High Court held that for understanding the true impact and the legal nature of the transaction embedded in the agreement, the agreement should be examined as a whole with a view to seeking what is the object and the true intention of the parties in entering upon the transaction. The court must look at the whole nature and substance of the transaction and not be bound by the mere use of the words.

123. In the case of CIT Vs. Smt. Minal Rameshchandra (1987) 167 ITR 507 (Guj.) Honble Gujarat High Court followed the judgment of Hon'ble Supreme Court in the case of Sunil Siddharthbhai Vs. CIT (1985) 156 ITR 509 (SC) as well as McDowell & Co. Ltd. (1985) 154 ITR 148(SC). Hon'ble Gujarat High Court held that adopt a device and avoid payment of tax cannot be accorded approval of judicial process. Hon'ble Madras High Court in the case of Valliappan (MV) Vs. ITO(1988) 170 ITR 238 (Mad.) struck a note of caution. Hon'ble High Court closely examined Ramsay triology of English cases as well as judgment of Hon'ble Supreme Court in the case of McDowell & Co. Ltd. Reference was also made to a host of other judgments. The Hon'ble Madras High Court observed:

“We have gone carefully through the judgment in McDowell’s case (1985) 154 ITR 148 (SC). That decision cannot, in our view, be read as laying down that every attempt at tax planning is illegitimate and must be ignored or that every transaction or arrangement which is perfectly permissible under law which has the effect of reducing the tax burden of the assessee, must be looked upon with disfavour. Having regard to the new approach adopted by the English courts in the matter of considering the legitimacy of a scheme of tax planning which has been now adopted by the Supreme Court in McDowell’s case (1985) 154 ITR 148 (SC), only colourable devices adopted for evading a tax liability will have to be ignored by courts. It appears to us on a careful reading of that decision that a legitimate transaction which does not amount to a dubious device is not hit even by the new approach adopted by the English courts and by the Supreme Court.”

Hon'ble Madras High Court closely examined Ramsay triology decisions to find out what kind of cases would be hit by rule against device of tax avoidance. Hon'ble High court observed:

“This decision clearly shows that when courts adopted the approach of looking upon with disfavour the schemes intended at tax avoidance, such an approach did not rule out the permissibility of mitigating the tax burden. What is the nature of such tax avoidance which will attract the progressive approach of the courts made in Burmah Oil Co. Ltd.’s case (1981) 54 TC 200 and Ramsay’s case (1981) 2 WLR 449 (HL) is highlighted in the last paragraph quoted above, when Lord Templeman pointed out that avoidance of tax takes place and tax advantage is derived from an arrangement in which the income of the taxpayer is not reduced nor does he suffer a loss nor incurs any expenditure but yet he obtains a reduction in his tax liability. As observed by Lord Templeman, “the taxpayer engaged in tax avoidance does not reduce his

income or suffer a loss or incur expenditure but nevertheless obtains a reduction in his liability to tax as if he had. This, in our view, is the crux of the new approach adopted by the English Courts and approved by the Supreme Court”

124. In the case of CWT Vs. Arvind Narottam (1988) 173 ITR 479 (SC), three trust deeds were executed by the settler for the benefit of his son, his son’s wife and children. As the son was a bachelor at the relevant time the WTO brought the entire value of the assets of the trust to tax in the son’s hands. Hon'ble Supreme Court held that the respondent was entitled only to the minimum guaranteed to him. As to the reliance placed by revenue on McDowell & Co. Ltd. , Hon'ble Supreme Court held that where the language of the deed of settlement was plain and admitted of no ambiguity, there was no scope for consideration of tax avoidance. 125. In the case of Union of India & Others Vs. Playworld Electronics P. Ltd. and Another (1989) 184 ITR 308 (SC) Hon'ble Supreme Court referred to the judgment in the case of Juggilal Kamlapat (supra); McDowell & Co. Ltd. (supra); Arvind Narottem (supra) and various other judgments. The Hon'ble Supreme Court reiterated:

“While it is true ……… it is up to the court sometimes to take stock to determine the nature of the new and sophisticated legal devices to avoid tax and to expose the devices for what they really are and to refuse to give judicial benediction, it is necessary to remember, as observed by Lord Reid in Greenberg V. IRC (1971) 47 TC 240 (HL) that one must find out the true nature of the transction. It is unsafe to make bad laws out of hard facts and one should avoid subverting the rule of law.”

In the case of Nayantara G. Agrawal Vs. CIT (1994) 207 ITR 639 (Bom.), the assessee entered into partnership with a company. The assessee brought her land valued at Rs. 10 lakhs as her share of capital contribution in partnership. The company did not bring in any capital. No business of sale and purchase of land was conducted by the firm. Assessee retired from the firm within three months of its formation. Firm was dissolved. Land was retained by the company and assessee received Rs. 10 lakh worth of shares. Hon'ble Bombay High Court after considering both CIT Vs. B.M. Kharwar, 72 ITR 603(SC) and McDowell & Co. Ltd. (supra) held that formation of partnership and dissolution of the firm were nothing but a device to avoid capital gains leviable u/s 45 and the Tribunal was right in holding that there was a transfer of capital asset from the assessee to the limited company.

In the case of CIT Vs. S. Kanan (1994) 210 ITR 585 (Kar.), Hon'ble Karnataka High Court quoted at length from the judgment of Chinnappa Reddy J. in the case of McDowell & Co. Ltd. (supra) and applied the same to the facts of the case. Hon'ble Court further held that the observation in the case of Arvind Narottam (supra) that unless waste and ostentation in government spending are avoided no amount of moral sermons would change people’s attitude to tax avoidance represented a view point, which did not and could not affect the ratio of the decision of Supreme Court in the case of McDowell & Co. Ltd.

126. In the case of Banyan & Berry (1996) 222 ITR 831 (Guj.) the Tribunal concluded that the dissolution of the firm was nothing but a device to avoid tax. The firm was dissolved by a deed but in essence it was a device to avoid tax because there was no purpose in dissolving the firm. The reliance was placed on Supreme Court judgment in the case of McDowell & Co., 154 ITR 148 (SC). Hon'ble Gujarat High Court explained the judgment of the Hon'ble Supreme Court in the case of McDowell & Co. as laying down the rule against colourable device or a dubious method or subterfuge for tax avoidance. Hon'ble High Court observed:

“What has been deprecated as tax planning for avoidance of tax are those acts which have doubtful or questionable character as to their bona fide and righteousness. Not all legitimate acts of a taxpayer which n the ordinary course of conducting his affairs a person does and are under law he is entitled to do, can be branded as being of questionable character on the anvil of McDowell’s case ((1985) 154 ITR 148(SC). We are unable to read in the aforesaid decision that any act of an assessee which results in reduction of his tax liability or expectation of tax benefit in future amounts to colourable device, a dubious method or

subterfuge to avoid tax and can be ignored if the acts are unambiguous and bona fide, merely on the ground that treating those as deliberate would result in tax liability in future.”

In the case of Bhagat Construction Co. Ltd. Vs. CIT (2001) 250 ITR 291 (Del), the assessee, a private limited company, received an amount on account of disputed claims and dues in respect of its erstwhile business. The aforesaid contracts were with the Hindustan Steelworks Construction Co. Ltd. The actionable claims against HSCL were transferred to BPL for a sum of Rs. 50,000/- under an instrument of transfer dated December 14,1981. BPL in turn transferred the aforesaid actionable claims to another company DRB which thereafter assigned the claims by way of gift to MEL. In 1992, a substantial sum was determined payable to MEL in respect of actionable claims and this sum was brought to charge under section 28(iv) in the hands of the assessee. The Tribunal found that colourable devices were adopted, that the transactions entered into by the different concerns were not genuine and the income belonged to the assessee. Hon'ble Delhi High Court found from the Tribunal order that the inferences were from factual aspects and in order. In the judgment Hon'ble Delhi High Court described “ a colourable device” in the following words:-

“It may be necessary to deal with the question of “colourable device”. A colourable transaction is one which is seemingly valid, but a feigned or counterfeit transaction entered into for some ulterior purpose. A conclusion about the nature of a transaction, i.e., whether it is colourable or otherwise, if supported by material or evidence is essentially one of fact.”

127. In the case of Twinstar Holdings Ltd. Vs. Anand Kedia, Deputy Commissioner of Income-tax (2003) 260 ITR 6 (Bom.), the petitioner company incorporated in Mauritius acquired shares in three investment companies in India, who in turn held shares in two Indian companies, viz., Sterlite Industries (India) Ltd. and Madras Alluminium Ltd. Subsequently the three investment companies went into liquidation and approval of Reserve Bank of India was obtained for transmission of shares in Indian companies on fully repatriable basis. As a result of search in the case of three investment companies, block assessment orders were made. Prohibitory notices were issued against receiving/delivering shares of three investment companies to any persons whosoever. On assessee’s writ petition the Hon'ble Bombay High Court held that the entire device had been implemented with a view to evade tax. Hon'ble Bombay High Court referred to the judgment in the case of McDowell & Co. in the following words :-

“In conclusion, we may refer to the judgment of the Supreme Court in the case of Mcdowell & Co. Ltd. vs. CTO (1985) 154 ITR 148, in which it has been held that even if the transaction is genuine and even if it is actually acted upon, but if the transaction is entered into with the intention of tax avoidance, then the transaction would constitute a colourable device. That the courts are now concerned, not merely with the genuineness of a transaction, but with the intended effect of the transaction on the fiscal purpose. That, the true principle in case of W.T. Ramsay (1981) 2 WLR 440 (HL) was that one must consider fiscal consequences of a pre-planned series of transactions and one has not to dissect the scheme and consider individual stages separately. This judgment squarely applies to our case.”

128. In the case of K. Ramasamy Vs. CIT, 261 ITR 358 (Mad.) there was a firm composed of four brothers and a company was formed with four brothers as sharesholders. Company took business of firm on lease and paid compensation to four brothers for not engaging in similar business. Following the judgment of Hon'ble Supreme Court in the case of Juggilal Kamlapat Vs. CIT, Hon'ble Madras High Court held that corporate veil should be pierced on the facts of that case. In the case of Mathuram Agrawal Vs. State of Madhya Pradesh (1999) 8 SC Cases 667, Hon'ble Supreme Court found section 127A(2) Proviso of Madhya Pradesh Municipalities Act 1961 contrary to the charging section. The Hon'ble Supreme Court referred to the judgment of Privy Council in the Bank of Chettinad Ltd. Vs. CIT (1940) 8 ITR 522 (PC); IRC Vs. Duke of Westminster 1936 AC 1 and Russell Vs. Scott (1948) 2 AER 1 and held that in a taxing statute it is not possible to assume any intention or governing purpose beyond what is stated in plain language.

129. During the course of hearing before us considerable arguments were made from both sides deriving support from the judgment of Hon'ble Supreme Court in the case of Union of India And Another Vs. Azadi

Bachao Andolan & Another, (2003) 263 ITR 706 (SC). We have, therefore, very carefully perused the entire judgment and more so the discussion under the title “Rule in McDowell”. Hon'ble Supreme Court have set out the objective of discussion in the very beginning :

“Considering the seminal nature of the contention, it is necessary to consider in some detail as to why McDowell’s case (1985) 154 ITR 148 (SC), what it says, and what it does not say.”

The observations of Hon'ble Supreme Court in the case of Azadi Bachao Andolan are, thus, intended at explaining and not over-ruling the earlier judgment of the court in the case of McDowell & Co. Ltd. The Hon'ble Judges have, at the same time found the observations of Chinnappa Reddy J. in relation to the Westminster principle and judgment of J.C. Shah J. in CIT Vs. A. Raman & Co. (supra) as not constituting ratio decidendi of McDowell & Co. Ltd. They found such observations militating against the observations of majority of the judges in McDowell & Co. Ltd. :

“Speaking for the majority, Ranganath Mishara J. ( As he then was) said:

“Tax planning may be legitimate provided it is within the framework of law. Colourable devices cannot be part of tax planning and it is wrong to encourage or 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. (Emphasis supplied)”

This opinion of the majority is a far cry from the extreme view of Chinnappa Reddy J.

Apparently there is no quarrel in the judgment in the case of Azadi Bachao Andolan with the law laid down in the case of McDowell & Co. that colourable devices cannot be part of tax planning. Secondly, Hon'ble judges in Azad Bachao Andolan found that far from being exorcised in the country of its origin, Duke of Westminster’s case continued to be alive and kicking in England. Reference in this respect has been made to Craven Vs. White (1990) 183 ITR 216 (HL) and MacNiven Vs. Westmoreland Investments Ltd. (2002) 255 ITR 612 (HL). Their Lordships found that the situation is no different in United States as reflected from American Jurisprudence’s case (American Jurisprudence (1973) Second Edition, Volume 71). Their lordships found that Westminster’s principle had found whole hearted approval in the judgment of Privy Council in Bank of Chettinad (1940) 8 ITR 522 (PC) and Mathuram Agrawal Vs. State of Madhya Pradesh (1999) 8 SCC 667(SC). As to the right understanding of the judgment of Hon'ble Supreme Court in the case of McDowell & Co., the Hon'ble judges found that the same has been correctly explained in the case of M.V. Valliappan Vs. ITO (1988) 170 ITR 238 (Mad.) and in the judgment of the Hon'ble Gujarat High Court in the case of Banyan & Berry Vs. CIT (1996) 222 ITR 83 (Guj.).

130. Hon'ble Judges in Azadi Bachao Andolan note that while Chinnappa Reddy J. took the view that Ramsay’s case was an authoritative rejection of the principle in the Duke of Westminster’s case, as explained by Lord Hoffmann in MacNiven’s case:

“In the Ramsay case (1982) AC 300 both Lord Wilberforce and Lord Fraser of Tullybelton, who gave the other principal speech, were careful to stress that the House was not departing from the principle in IRC V. Duke of Westminster (1936) AC 1; (1935) All ER Rep. 259. There has nevertheless been a good deal of discussion about how the two cases are to be reconciled.”

In the case of Craven Vs. White (1990) 183 ITR 216, House of Lords were at great pains to explain each of the three judgments in the triology of Ramsay cases. Lord Keith of Kinkel explained Ramsay principle (at page 225 of 183 ITR) in the following words:-

“The most important feature of the principle is that the series of transactions is to be regarded as a whole. In ascertaining the true legal effect of the series it is relevant to take into account, if it be the case, that all the steps in it were contractually agreed in advance or had been determined on in advance by a guiding will

which was in a position, for all practical purposes, to secure that all of them were carried through to completion. It is also relevant to take into account, if it be the case, that one or more of the steps was introduced into the series with no business purpose other than the avoidance of tax.

The principle does not involve, in my opinion, that it is part of the judicial function to treat as nugatory any step whatever which a taxpayer may take with a view to the avoidance or mitigation of tax. It remains true in general that the taxpayer, where he is in a position to carry through a transaction in two alternative ways, one of which will result in liability to tax and the other of which will not, is at liberty to choose the latter……”

Hon'ble judges in Azadi Bachao Andolan, thereafter note that in the case of MacNiven Lord Hoffmann referred to Ramsay case and the Duke of Westminster’s case in the following manner:

“ My Lords, I venture to suggest that some of the difficulty which may have been felt in reconciling the Ramsay case with the Duke of Westminster case arises out of an ambiguity in Lord Tomlin’s statement that the courts cannot ignore `the legal position’ and have regard to `the substance of the matter’. If `the legal position’ is that the tax is imposed by reference to a legally defined concept, such as stamp duty payable on a document which constitutes a conveyance on sale, the court cannot tax a transaction which uses no such document on the ground that it achieves the same economic effect. On the other hand, if the legal position is that tax is imposed by reference to a commercial concept, then to have regard to the business `substance’ of the matter is not to ignore the legal position but to give effect to it.”

Hon'ble judges in Azadi Bachao Andolan, therefore, find themselves unable to agree with the view that Duke of Westminster’s case was dead or that its ghost had been exorcised in England. As to the correct meaning of the judgment of Hon'ble Supreme Court in the case of McDowell & Co., their lordships have approved Hon'ble Madras High Court in M.V. Valliappan Vs. ITO (1988) 170 ITR 238 (Mad.) and Gujarat High Court in Banyan & Berry Ltd. 222 ITR 831 (Guj.). In the former case Hon'ble Madras High Court concluded

“ the decision in McDowell (1985) 154 ITR 148 (SC) cannot be read as laying down that every attempt at tax planning is illegitimate and must be ignored, or that every transaction or arrangement which is perfectly permissible under law, which has the effect of reducing the tax burden of the assessee must be looked upon with disfavour.”

The Hon'ble judges are inclined to agree with this view. In the case of Banyan & Berry Vs. CIT (supra), Hon'ble Gujarat High Court at page 850 of 222 ITR referred to McDowell’s case in the following manner:

“The court 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; an inference which unfortunately, in our opinion, the Tribunal apparently appears to have drawn from the enunciation made in McDowell’s case (1958) 154 ITR 148 (SC). The ratio of any decision has to be understood in the context it has been made. The facts and circumstances which lead to McDowell’s decision leave us in no doubt that the principle enunciated in the above case has not affected the freedom of the citizen to act in a manner according to his requirements, his wishes in the manner of doing any trade, activity or planning his affairs with circumspection, within the framework of law, unless the same fall in the category of colourable device which may properly be called a device or a dubious method or a subterfuge clothed with apparent dignity.”

Hon'ble Judges in Azadi Bachao Andolan have put their seal of approval on the above quoted passage from Banyan & Berry, “This accords with our own view of the matter.” Finally at page 762 the Hon'ble judges in Azadi Bachao Andolan observed,

“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.”

131. On reading the judgment of Hon'ble Supreme Court in the case of Azadi Bachao Andolan as a whole, we find no denunciation whatsoever of the judgment of majority in the case of McDowell & Co. that colourable devices in the name of tax planning and avoidance of the payment of tax by resorting to dubious methods cannot be encouraged or entertained. At the same time Hon'ble Supreme Court have found that IRC Vs. Duke of Westminster has been always a good law in England and so also in India despite the hiccups of McDowell’s case.

As to the judicial pronouncements in India after the Supreme Court judgment in the case of Azadi Bachao Andolan, in the case of CIT Vs. George Williamson ( Assam) Ltd. (2004) 265 ITR 626 (Gauhati) the assessee sold certain plant and machinery and took it back on lease from the respective buyer. The assessee claimed lease rent paid for plant & machinery. On these facts the revenue applied the dictum laid down in McDowell’s case. Hon'ble High Court following Azadi Bachao Andolan held that every attempt at tax planning cannot be ignored and that the right of the taxpayer to arrange his affairs was still there after McDowell & Co. In the case of Avasarala Automation Ltd. Vs. Joint CIT (2004) 266 ITR 178 (Kar.) the Hon'ble Karnataka High Court found that there was no registration of sale, no identification of machinery. The transaction was entered into so that lessor could claim 100% depreciation. On such facts, Hon'ble High Court held that application of ratio in McDowell’s case was justified. In the case of Industrial Development Corporation of Orissa Ltd. Vs. CIT & Others (2004) 268 ITR 130 (Orissa) there was purchase and lease back of assets. Hon'ble High Court found that there was no evidence that the transaction was not genuine. Relying upon the judgment in the case of Azadi Bachao Andolan, Hon'ble Orissa High court held that the lessor was entitled to depreciation.

132. After the judgment in the case of Azadi Bachao Andolan there is recent judgment of Hon'ble Supreme Court having considerable bearing on the questions being considered by us. In the case of Commissioner of Central Excise Vs. Modi Alkalies & Chemicals Ltd. And Others (2004) 7 SCC 569 (SC), there were three companies, viz., M/s Mahabaleshwar Gas & Chemicals P. Ltd.; Sri Chamundi Gas & Chemicals P. Ltd. and M/s Nippon Gas & Chemicals P. Ltd. that were alleged by the Central Excise authorities to be in realty front companies of Modi Alkalies & Chemicals Ltd. CEGAT relied upon the fact that there were separate registration of these three companies, including under the Central Excise, Sales-tax and Income-tax. Besides these three companies had separate corporate existence. CEGAT, therefore, allowed the appeal of Modi Alkalies & Chemicals Ltd. against clubbing with the other units. Hon'ble Supreme Court found that these three companies had share capital of Rs. 200/- each. It was Modi Alkalies & Chemicals Ltd. who advanced heavy amounts to these three companies and also obtained for them financial assistance from other financiers. The assessee obtained cylinders on lease and sub-let them to these three companies. It also sold hydrogen gas to these three companies @ Rs. 0.50 per unit while it was selling to others at a much higher rate of Rs. 5/- per unit. On these facts Hon'ble Supreme Court held:

“The factors which have weighed with CEGAT like registration of the three companies under the Sales Tax and Income Tax authorities have to be considered in the background of the factual position noted above. When the corporate veil is lifted, what comes into focus is only the shadow and not any substance about the existence of the three companies independently.”

The judgment in the case of Modi Alkalies & Chemicals Ltd. is a clear example that on certain facts substance of the matter shall prevail over the legal form e.g. corporate entity.

133. We have in the foregoing paragraphs made our humble attempt to put the issue in historical perspective. We are of the view that there are two aspects of the matter, (i) what is the form and substance of the transaction, and (ii) what is the legitimacy of the tax avoidance device in a given case. The issues arising in relation to these two aspects may often overlap but that is not always the case. It would, therefore, be important to keep the distinction between the two aspects in view. It is seen that as early as in

1903 in the case of Secretary of State Vs. Scoble (1903) 4 TC 618 (HL) it was held that in revenue matters, what is material is the substance of the transaction and not the form. In many judgments thereafter it has been held that both form and substance must be considered. In the case of Duke of Westminster Vs. IRC (1935) 19 TC 490 (HL) it was held that the legal position cannot be ignored in the name of the substance of the matter. In the case of MacNiven Vs. Westmoreland Investments Ltd. (supra), Lord Hoffmann says,:

“If the legal position is that tax is imposed by reference to a commercial concept, then to have regard to the business “substance” of the matter is not to ignore the legal position but to give effect to it.”

134. It, therefore, follows that where the issue is a commercial concept it is the business substance of the matter that should be considered. The nomenclature given by the parties to the transaction can be ignored so also the view taken by them of their transaction. However, the legal effect of the transaction can be ignored only in exceptional cases, such as Modi Alkalis (supra). As to the second aspect, it is not every device resorted to by a taxpayer to reduce his tax liability that can be disregarded irrespective of the legitimacy or genuineness of the act. But if a transaction falls in the category of colourable device or a dubious method or a subterfuge, in such cases McDowell rule can be applied with full justification, as held in the judgments in the cases of M.V. Valliappan (supra), Banyan & Berry (supra) and Azadi Bachao Andolan (supra).

135. During the course of hearing before us the revenue has sought to contest the assessee’s claims of loss on both counts of the substance of the transaction as well as colourable device or dubious method or subterfuge. Considerable arguments have been made in the orders of the authorities below as well as during the course of hearing by us that in substance the loss incurred by the assessee represented a self-inflicted loss suffered by the assessee for earning income exempt u/s 10(33). It is, therefore, argued that to that extent part of the purchase price of mutual fund units should be attributed to income from units and not to units themselves. The assessee purchased Chola Mutual Fund units on the record date i.e., 24.3.2000. On that very date there was book closure and dividend @ Rs. 4/- per unit amounting to Rs. 1,82,12,863/- was paid to the assessee. On 27th March, 2000 the assessee redeemed back mutual fund units. The total period of holding of units was only two days i.e., 25.3.2000 and 26.3.2000 which were Saturday and Sunday. The learned Assessing Officer argued that face value of the units was Rs. 10/-. At no point of time the Mutual Fund had NAV of Rs. 14/- or above. How could the mutual fund distribute dividend of Rs. 4/- per unit. Similar arguments have been raised by the learned special counsel for the revenue that transaction was undertaken by the assessee with full knowledge that overall there would be some loss. The learned special counsel argued that the assessee was reasonably certain that the loss to be incurred by him would be limited to the charges deducted by the mutual fund. Cholamandalam Mutual Fund issued advertisement in the prominent newspapers that it would pay Rs. 4/- per unit on March 24,2000. On or about 24.3.2000 the size of the mutual fund swelled to many times the size of the original fund lying invested in equity due to surge of inflow of money from the quick-in -quick-out investors. The possibility of any sudden slump in the equity market was easily cushioned by this surge of inflow of money many times more than the total equity investments of the mutual fund. Both the learned special counsel for the revenue as well as the learned CIT, DR argued that what the assessee received by way of so-called dividend or income of mutual fund was asessee’s own money. The learned special counsel pointed out that during the financial year 1999-2000 Chola Mutual Fund distributed income of Rs. 290 crores as against its annual net income of Rs. 15 lakh only. The learned CIT, DR laid emphasis that it was a pre-planned or pre-ordained scheme. According to him, by the transactions of the assessee with Chola Mutual Fund or Sun F&C Mutual Fund nothing material really happened, except that by certain payment of remuneration to the mutual funds, the assessee got a document whereby he could convert his own money into tax free income. The learned Special counsel for the revenue argued that in such a scenario provisions of section 14A are attracted and it is necessary to ascribe certain cost to income payments of mutual fund and accordingly the purchase price paid by the assessee for Mutual Funds units should be split and adjusted against both the redemption price of mutual fund units as well as the income payments received from the mutual funds. The learned CIT, DR, on the other hand, invokes the rule against tax avoidance. According to him, both mutual funds and the assessee in complicity with each other devised a novel method to rob revenue of its fair share of taxes. He called the transaction a colourable device or dubious method or subterfuge.

136. The learned counsel for the assessee has vehemently opposed these contentions. In law these contentions of the revenue, according to the learned counsel for the assessee, are untenable in view of the ratio of Hon'ble Supreme Court judgment in the case of Azadi Bachao Andolan. On facts the learned counsel disputes the premise that the transactions were pre-ordained or pre-determined. The assessee purchased units of an equity mutual fund. Such units are susceptible to fluctuations in the stock market. According to him, there was no certainty that loss would be suffered. In the transactions of this nature there could be a profit, there could be a loss less than dividend and there could be loss equal or more than the amount of dividend. The provisions of law cannot fluctuate along with the fluctuation in the stock market. The legal principle to be applied has to be uniform for all situations. Above all, there is no scheme or collusion, as the assessee and the Mutual Funds were not known to each other, they never met and the transactions were entirely in the ordinary course at arms length.

137. On consideration of the matter, we find that various arguments of the revenue in relation to the facts of the case are not supported by any material or evidence. Revenue’s contention that the mutual funds returned the assessee his own money in the wrapping of dividend has not been substantiated. There is no information whatsoever as to the identity of money that went into dividend or income payments made by Chola Mutual Fund as well Sun F&C Mutual Fund. If the current year’s income was not sufficient and the dividend distributed by the Mutual Fund was drawn from the past reserves of the mutual funds, it cannot be said that the assessee received back his own money converted into income distribution. There is nothing on record to suggest the precise source from which income payments were made to the assessee before us in the two assessment years. We have already seen that normal principles of accounting require that the purchase price of an income generating investment be adjusted on the encashment of investment and not against the income from investment. After all the assessee did not acquire a wasting asset but an asset which could in all probability appreciate in value over the period of time. We, therefore, do not see the scope for application of the provisions of section 14A on the basis of any special facts of the case. As to the Ramsay or McDowell principle the same does not apply at all. We have seen that facts of the case of the assessee fall in the category of Griffiths Vs. J.P. Harrison (supra) and they do not fall in the category of the facts of Finsburry Securities Ltd. and Lupton Vs. F.A & A.B Ltd. There is also considerable substance in the contention of the learned counsel for the assessee that there was no scheme or collusion between the assessee before us and the Chola Mutual Fund or Sun F & C Mutual Fund. It is the case of revenue itself that these funds prominently advertised the record date and the amount of dividend. It is nobody’s case that these Mutual Funds consulted the assessee before doing so. It is not shown also that while doing so these two mutual funds violated any regulation. They operated under the regulatory control of SEBI. Income distributed by them was exempt u/s 10(33) by a legislation of Parliament. No instance of any action having been taken against these Mutual Funds by SEBI has been brought on record. Exemption under the provisions of section 10(33) to the income distributed by these Mutual Funds has continued all these years with the modification from and after assessment year 2002-03 in relation to minimum holding period only. During the course of hearing before us the learned counsel for the assessee argued that these Mutual Funds simply acted in the manner the mutual funds do their business. There is no material to hold a contrary view.

138. Above all, we find the provisions of section 94(7) do not lend much support to the contentions of the revenue before us, if not contradict them. According to the arguments of the learned special counsel for revenue, it is significant that both the provisions of section 14A and section 94(7) were introduced by the same Finance Act, 2001. While the provisions of section 14A have been given retrospective effect from 1.4.1962, the provisions of section 94(7) have been introduced prospectively from and after assessment year 2002-2003. According to the learned special counsel it was not considered necessary to retrospect the operation of section 94(7) in view of the provisions of section 14A being made effective from 1.4.1962. On a close examination of the provisions of section 14A and section 94(7) we do not see any connection between the two. Section 14A does not anywhere mention section 94(7) and there is no mention of section 14A anywhere in the provisions of section 94. On a perusal of the provisions of section 94(7) we find that the only consequence of the sub-section is to lay down a minimum holding period. It is not of concern, as far as the provisions of section 94(7) go, that a taxpayer may secure the double advantage of exemption u/s 10(33) as well as set off of loss on sale of mutual fund units against his income from any other transaction or source. He is permitted to do so after holding mutual fund units for the prescribed period which was initially three months and increased to 6 months and 9 months subsequently. Section 94(7) has nothing in it

to attribute or, as the case may, dis-attribute any cost or expenditure against any income declared or distributed by mutual fund. Section 14A, on the other hand, concerns itself with cost/expenditure in relation to an income exempt under Chapter III. No such expenditure should be allowed while computing income under the provisions of Chapter IV and if claimed by the assessee the same should be disallowed on the strength of the provisions of section 14A. Apparently, if the provisions of section 14A apply, there is nothing in section 94(7) to prevent that application. In other words, if we hold that the cost should be apportioned to the income in cases where mutual fund units are purchased with a view to secure double advantage of exemption as well as adjustment of loss, it would apply even to the cases covered by the provisions of section 94(7), i.e., where the mutual fund units are purchased more than 3 months before the record date, or as the case may be, sold more than 3 months after the record date. We, therefore, do not agree with the argument of the revenue that in the period preceding operation of provisions of section 94(7), the provisions of sec. 14A take charge and they do not do so after 1.4.2002 on account of the provisions of sec. 94(7) having become effective. It was argued that provisions of section 94(7) in fact mitigate the rigors of section 14A. We do not find any such thing in section 94(7).

139. In our opinion, it cannot be assumed that once Mutual Fund units are held for the prescribed period, the fall in NAV on account of income pay-out would be neutralized. If, as argued by the learned special counsel before us, there is surge of inflow of money from the dividend-strippers, so much so the size of the mutual fund would on record date swell to many times the size of the original fund lying invested in equity there is no way the ex-dividend NAV returning to NAV on record date till such time a sizeable portion of the new or old money exit the mutual fund after taking a hit on account of ex-dividend NAV. In other words, the provisions of section 94(7) do not block dividend-strippers. It only make them squat for a longer period. It, therefore, appears to us that provisions of section 94(7) are geared towards quick-in-quick-out aspect and not against claim of loss against the other income of the taxpayer.

140. The provisions of section 94(7) have been brought on the statute book by the Finance Act, 2001 w.e.f. 1.4.2002. In other words, the parliament did not deem it fit to intervene in the transactions that had already taken place. It was open to resort to giving retrospective effect to the provisions of section 94(7), but parliament has chosen not to do that. The learned CIT, DR, on the other hand, has argued as if the provisions of section 94(7) are clarificatory. On consideration we do not agree. As stated in the immediately preceding paragraphs s. 94(7) lays down time limit only. The provision does not stipulate any cost in relation to the income pay out by a mutual fund. There is force in the contention of the learned counsel for the assessee that a time limit laid down by statute cannot be clarificatory. The arguments of the revenue are negated by CBDT Circular No. 14 of 2001, 252 ITR (Statute) 354. Paragraphs 56.2 & 56.3 of the circular read as under:-

“56.2 The existing provisions did not cover a case where a person buys securities (including units of a mutual fund) shortly before the record date fixed for declaration of dividends, and sell the same shortly after the record date. Since the cum-dividend price at which the securities are purchased would normally be the higher than the ex-dividend price at which they are sold, such transactions would result in a loss which could be set off against other income of the year. At the same time, the dividends received would be exempt from tax under section 10(33). The net result would be the creation of a tax loss, without any actual outgoings.

56.3 With a view to curb the creation of such short-term losses, the Act has inserted a new sub-section (7) in the section to provide that where any person buys or acquires securities or units within a period of three months prior to the record date fixed for declaration of dividend or distribution of income in respect of the securities or units, and sells or transfers the same within a period of three months after such record date, and the dividend or income received or receivable is exempt, then, the loss, if any, arising from such purchase or sale shall be ignored to the extent such loss does not exceed the amount of such dividend or interest, in the computation of the income chargeable to tax of such persons.

CBDT circular itself states that prior to the promulgation of the provisions of section 94(7) it was legally permissible to claim the losses in the manner the assessee before us has done.

141. During the course of hearing before us reference has been made to the Instruction issued by CBDT from F. No. 178/32/2003-ITA 1 on 23rd February, 2004. This Instruction reads as under:-

“The Finance Act, 2001 introduced inter-alia sub-section (7) of section 94 of the Income-tax Act, w.e.f. 1.4.2002 to curb tax avoidance through dividend stripping. The sub-section provides, inter-alia, that if securities or units of a Mutual Fund are purchased within a period of three months prior to the record date, and are sold within three months after that date, the loss, if any, arising will be ignored to the extent of the exempt dividends received.

It has been brought to the notice of the Board that some Assessing Officers are disallowing losses arising from purchase and sale of securities or units in similar circumstances, even in respect of assessment years prior to assessment year 2002-2003 (when section 94(7) came into effect), on the ground that the relevant transactions have been entered into for the purpose of tax avoidance. In other words, the said section is being applied retrospectively by the Assessing Officers taking the plea of fiscal nullity.

In this regard, I am directed to convey that the Board desires that such disallowances in respect of assessment years prior to assessment year 2002-03, should be made only after in-depth investigation and proper recording and marshalling of all relevant facts, so as to establish the motive of tax avoidance.”

On consideration we do not find any support to the case of the revenue in the appeals before us from the Instructions above quoted. It is clearly mentioned that ordinarily disallowance of loss in similar circumstances in respect of assessment years prior to assessment year 2002-2003 would amount to applying the provisions of section 94(7) retrospectively. The Board, therefore, cautions its officers that such an assessment should be made only after in-depth investigation and proper recording and marshalling of all relevant facts because the provisions of section 94(7) are prospective only.

142. In view of the discussion in the foregoing paragraphs, we find answer to the third question in the negative, i.e., the assessee is not disentitled to have the loss arising from these transactions set off against his income from any other transactions or source.

143. In the result, we direct that the assessee be allowed loss as claimed in the assessment year 2000-2001 and assessment year 2001-2002 in relation to transactions considered by us in these two appeals. These two appeals are accordingly allowed.

(J.P. Bengra) (Vimal Gandhi) (S.C.Tiwari)Vice President / President / Accountant Member

(T.K.Sharma) (N.BharathvajaSankar)Judicial Member Accountant Member