Business Laws

Legitimate tax planning not taboo

Shailesh Kumar /Love Gupta October 18 | Updated on October 18, 2021

The Supreme Court, in a landmark judgment in the 1985 case of CTO Vs McDowell and Co Ltd, declared that “it is the obligation of every citizen to pay the taxes honestly without resorting to subterfuges”   -  REUTERS

Officials often disregard transactions, terming them as tax evasion in the guise of tax planning

Tax planning and tax avoidance have always been a matter of debate between the tax authorities and taxpayers for over decades. Tax authorities always seek to disregard transactions, terming it to be planned for tax avoidance/ tax evasion in the disguise of tax planning.

On the other hand, taxpayers always claim transactions or structures to be for legitimate tax planning permissible under law. The House of Lords England had addressed the issue of tax planning its orders pronounced in the case of Fisher’s Executors and Duke Westminster, wherein it was held that “a taxpayer is entitled to manage his affairs within law, so as to pay minimum taxes”. This is commonly known as the Westminster’s principle.

The first landmark judgment on difference between ‘tax planning’ and ‘tax avoidance’ was delivered in India in the year 1985, when the Supreme Court while delivering its judgment in the case of CTO Vs McDowell and Co Ltd held that, “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.”

Colourable device

Even though the case adopted the principles of Westminster, it had created certain ambiguity regarding, what would be considered as ‘colourable device’ and what is permissible and what is not.

The issue was again addressed by the Apex Court in the case of Union of India Vs Azadi Bachao Andolan wherein it was stated that, “Not only is the principle in Duke of Westminster alive and kicking in England, but it also seems to have acquired judicial benediction of the Constitutional Bench in India, notwithstanding the temporary turbulence created in the wake of McDowell & Co case.”

Reference was also made to the judgment of Madras High Court in MV Valliappan Vs CIT which has rightly concluded that the decision in McDowell & Co case 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.

It was again reiterated by the Supreme Court in the case of Vodafone International Holdings BV VsUOI, that every taxpayer is entitled to arrange his affairs so that his taxes are as low as possible and is not bound to choose that pattern which will replenish the treasury.

Recently, a similar dispute came for consideration before Mumbai bench of Income Tax Appellate Tribunal, where tax authorities denied taxpayer’s claim of set-off of capital loss incurred by taxpayer on sale of almost worthless shares of an Indian company against capital gains earned by taxpayer from sale of residential house property.

This was case of Michael E Desa, a non-resident Indian, now domiciled in United states, the Assessee while filing its return of income had claimed set off of long-term capital loss from sale of shares of a closely held company against the long-term capital gain from sale of immovable property.

The Assessing Officer (‘AO’) contended such loss claimed by the Assessee to be fictitious and premeditated only to avoid tax liability on sale of immovable property. The AO stated that transaction was not genuine but simply a sham and make-belief story contending that the net worth of the company; the shares of which were sold was completely eroded. The shares were not acquired by the buyer with an intention to actually continue the business, even though the method of share valuation presumes continuity of business of the company.

Further, the AO had also stated that the buyer of the shares was not only know to the assessee but was also a director in the company. Hence, the AO held that the transaction was preconceived, preordained and fabricated for commercial considerations.

The Mumbai ITAT on perusal of the facts of the case, disagreed with contentions of the AO. The Tribunal held that even where the net worth of the company was worthless, what actually had to be seen was whether the transaction is factual and in legal effect. It was not for the AO to take a call on how should the assessee organise his fiscal affairs.

Relying on the judgement of the Apex Court in McDowell & Co and Vodafone International Holdings BV, it was held that the timing of booking of the loss is not germane in this case. As long as the assessee has been able to substantiate that the sale was actually effected, the consideration was received by the buyer and the shares were actually transferred on the name of the buyer, the AO cannot actually question the commercial decision of the transaction and its timing.

ITAT conclusion

It was concluded by the ITAT that minimisation of tax liability as long as it is through the legitimate tax planning and without using any colourable device, is not illegal. Further, it is not even immoral as it is everybody’s duty to himself manage his affairs properly within the framework.

The legitimacy of tax planning has been re-emphasised by the Mumbai-ITAT through this judgment aiming to give a fresh insight to this classic old debate. However, it is important to note that conclusion in every case and applicability of these principles depends on facts of every case and small factual difference may swing the balance either in favour of taxpayer or the tax department.

(The authors are Partner and Manager, respectively, at Nangia Andersen, a law firm)

Published on October 18, 2021

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