The Hindu Business Line : ‘Engineering’ tax evasion

Tax avoidance is legally and morally right. This has been judiciously recognised for decades. Even in the famous McDowell and Co. Ltd. v. CTO (154 I.T.R. 148), the majority view was that tax planning may be legitimate provided it is within the framework of law. 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.

The Supreme Court in Azadi Bachao Andolan (263 I.T.R. 706) held that 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. The Court m ust deal with what is tangible in an objective manner and cannot afford to chase a will-o’-the-wisp.

Leasing transactions

This point was considered by the Karnataka High Court in I.C.D.S. Ltd. v. C.I.T. (291 I.T.R. 18). The facts in this case were that the assessee was a public limited company, engaged inter alia in the business of l easing, financing and hire-purchase. The assessee entered into several ‘leasing’ transactions involving movables with K, M and other educational institutions and trusts. Under the terms of several identical contracts, the assessee purchased assets and leased them to these institutions.

The assessee received refundable security deposits of sums equivalent to the purchase value of the assets. The security deposits were interest-bearing. The lease rental payable by the lessee was equal to the interest payable on the security deposit.

The assessee claimed depreciation in respect of the assets under these transactions. The assessing authority denied it holding that:

The assessee-company and the institution to which the assets were leased, were controlled by common members;

the transaction was a “self-cancelling transaction” — one where the assessee was in a position to use the security deposit to purchase the asset leased and adjust the lease rentals against interest payable on the secu rity deposit;

the educational institutions which were not liable to pay income-tax could not also claim depreciation on any asset purchased by them; and

the net result of the above transactions enabled a taxable entity to claim depreciation on an asset actually purchased with the funds of a non-taxable entity. This assessment order was upheld by the Tribunal.

On a reference, the Karnataka High Court referred to a decision of the Madras High Court in M. V. Valliappan v. I.T.O. (170 I.T.R. 238) which concluded that the decision in the McDowell case cannot be read as lay ing down that every attempt at tax planning is illegal and must be ignored, or that every transaction or arrangement which is perfectly permissible in law and has the effect of reducing the tax burden of the assessee, must be looked upon with disfavour.

Tax planning

The Gujarat High Court in Banyan and Berry v. C.I.T. (222 I.T.R. 831), while referring to McDowell’s case, observed: “The (Supreme) 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;…”

The Karnataka High Court in the I.C.D.S. Ltd. case referred to the Department’s stand that the total quantum of investment by the assessee in the assets was received back from the lessees by way of security deposits. This, coupled with the fact that the interest payable on the deposits was equal to the lease rent receivable from the lessee and that the lessees were educational institutions exempt from paying income-tax, was an uncanny co-incidence that clearly pointed to the transactions having been entered into to claim depreciation in respect of these assets without actually investing any of its funds.

The High Court observed that the assessee acquired the asset in its name and leased it to the educational institution which made an interest-bearing security deposit, equal to the entire value of the asset so leased and the interest on the deposit was to be adjusted entirely towards lease rentals. There was a remote possibility of termination of the lease and refund of the security deposit.

No room for doubt

The assessee claimed depreciation on the asset which the educational institution could not have claimed if it had directly acquired the asset, as it was exempt from payment of income-tax. The fact that the assessee and the lessees were managed by the same group of individuals as directors in the assessee-company and in other capacities, left no room for doubt that the transactions were blatantly geared to evade tax liability. It was extremely naive to accept the transactions as commercially acceptable transactions.

Courts continue to put fetters on transactions which are contrived to result in tax evasion; the term term is wide enough to include claiming of a deduction, benefit or relief in violation of law.

(The author, a Mumbai-based advocate specialising in tax laws, can be contacted at ranina@bom2.vsnl.net.in.)

More Stories on : Taxation | Economic Offences

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page

Stories in this Section
An idea sans vision

Is Indian aviation a flying hazard?

Aztec Software ruling will increase cost of compliance

From islands to walled cities?

Taxing investment gains — Getting the right measure

Service law conundrums

‘Engineering’ tax evasion

Finance Act, 2007 — Nuances of interpretation

BSNL issue

Science or Art?