Controversies and Case Laws relating to Tax Avoidance

Ashish M. Shaji

23 Sep, 2021

Tax Planning, Tax Avoidance and Tax Evasion are separated by minuscule margin. Tax Planning is legal but not tax evasion, and as far as tax avoidance is concerned, it has been a subject prone to litigation. These matters come up before court every now and then, and it has led to lengthy litigation. Lets’ discuss more on it.

Case Law- Controversies related to Tax Avoidance

There has been controversies related to tax avoidance. In a recent case, the Mumbai Tribunal dealt with the case of eligibility of set off or carry forward of long term capital loss under the provisions of the Income Tax Act^[1], due to a sale of shares of an Indian company by a foreign company.

The taxpayer in this case, was a Switzerland based entity and provided re-insurance services to different insurance companies through its branches. This taxpayer acquired shares of about 26% of the total shares of a company in India in tranches under FDI route. During the AY, the taxpayer sold all its shares to an Indian company. Due to this, he incurred long term capital loss of 499.24 million rupees and carry forward of the loss was claimed in the income return.

The controversy arose about the price of shares bought by the taxpayer, and it was alleged to be a sham transaction using colourable device to create artificial loss selling shares below par value. The tribunal held that the choice to invest in shares at high premium is a commercial choice of the taxpayer and doesn’t amount to violation of any rules or regulations, including FEMA regulations. Therefore it was held that the sale and purchase of the shares was within the legal regulations therefore, it cannot be said that the transaction was a sham transaction using colourable device to create artificial loss selling shares below par value.

Judicial Precedents concerning Tax Avoidance

In the case of CIT vs. A Raman Co.

The Supreme Court in this case, held that avoidance of tax liability by arranging commercial affairs that tax charge is distributed is not prohibited. The taxpayer can resort to a device to divert the income before it accrues to him. The effectiveness of the device shall depend upon the operation of the Act.

In the case of McDowell and Co. Ltd vs. CIT

The Supreme Court held in this case that tax planning can be legal if it falls under the legal framework. Thus colourable devices can’t be a part of tax planning, and one cannot carry the notion that they can avoid paying tax by resorting to dubious ways. Every citizen who falls under the criteria of paying taxes is required to pay taxes honestly.

In the case of Vodafone International Holdings BV vs. Union of India

In the year 2012, the Supreme Court gave a landmark judgement in this case which involved taxability of capital gains on transfer of shares between 2 non-residents where the shares were deriving value from its subsidiaries from India. On noting the facts of the case, the apex court stated that the following factors should be kept in mind:

• The concept of participation in the investment;
• The time duration during which the holding structure exists;
• The time of business operations in India;
• The generation of taxable revenues in India;
• The timing of the exit and on such exit the continuity of the business.

There have been different courts/benches that have applied these observations mentioned above to know if the transactions are legit or not.

In the case of CIT vs. High Energy Batteries (India) Ltd.

The Madras HC, in this case, held that transaction of sale and lease back is not a sham transaction, and it observed the decision of the Supreme Court where it stated that to determine the legal nature of a transaction, the courts should look at the transaction at its entirety and not with a dissecting view.

In the case of Consolidated Finvest and holdings Ltd. Vs. Asstt.

In this case, the Delhi Tribunal looked at various transactions between two related entities that caused capital loss to one entity and determined that there was not any tax avoidance. Further, it observed that the officer could not furnish any reasoning or any evidence to prove it to be a sham.

Tackling tax-avoidance transactions

India introduced limitation of benefit clause to tackle tax avoidance transactions. The limitation of Benefit clause provides for granting tax treaty benefits on meeting certain conditions. Further, India also ratified the Multilateral Instrument and included all of its tax treaties as Covered Tax Agreement. India has also adopted Simplified Limitation of Benefits clause in relation to its Covered Tax Agreement. Simplified Limitation of Benefits provides for benefits of tax treaty to be available to qualified persons. India also plans to adopt some other measures to combat tax avoidance strategies.

Conclusion

From the above, we can conclude that just because a transaction ends up into providing a tax benefit, one cannot say that such transaction is a method for tax avoidance. Not every transaction is a sham transaction, every case requires examination based on facts and circumstances and applying the principles laid down by the court of law.

Read our article:The Concept of Tax Evasion and Tax Avoidance: Definition and Differences