In Killick Nixon v DCIT, decided on 6 March 2012, a Division Bench of the Bombay High Court (Dr DY Chandrachud and MS Sanklecha JJ.) has considered the application of the guidance given by the Supreme Court in Vodafone to a transaction that was found at first instance to constitute a sham.
The attempt by the taxpayer in this case is reminiscent of the tax avoidance transactions that shaped English law in the 80s, and in particular, of the judgment of the House of Lords in IRC v Burmah Oil. The taxpayer had executed a guarantee in favour of Vysya Bank for a loan the bank had advanced to Geekay Exim India Ltd [“GEIL”], a company belonging to the G.K. Rathi Group. When GEIL defaulted, Vysya Bank invoked the guarantee, and the taxpayer sold land that it owned in satisfaction of the claim, and capital gains of Rs. 49.72 crores arose from this transaction. In a period of three days between 28 and 30 March 2000 (perhaps the month is no coincidence), the taxpayer purchased shares in four of its wholly owned subsidiaries for a total of Rs. 48 crores. These shares, with a face value of Rs. 10, were purchased at a premium of Rs. 140, although they were valued at Rs. 23 on price earning capacity and valued at a negative on the net value basis. Two other facts are even more significant: first, the source of the Rs. 48 crores required to purchase these shares was the GK Rathi Group – four group companies made a contribution to the taxpayer of Rs. 48 crores, and secondly, the four subsidiary companies whose shares were purchased transferred the Rs. 48 crores they received to a GK Rathi Group company. The effect of this transaction was that Rs. 48 crores left the GK Rathi group on 28 March (through contributions to the taxpayer) and came back to the GK Rathi group on 31 March (through transfers by the four companies whose shares were purchased at a premium of Rs. 140). The Assessing Officer made the following finding of fact:
The money never existed. Only debit and credit entries were created in Bank by issuing cheques to one party and receiving the same amount through that party by circular transaction. Thus the Bank accounts got squared up showing no negative balance or positive balance at the end of a particular date on account of the activity
These shares, purchased in AY 2000-2001 at Rs. 150 each, were then sold by the taxpayer in AY 2001-’02 for Rs. 5 each to two companies and the taxpayer claimed the resultant capital loss. The Assessing Officer found that the two companies which purchased the shares for Rs. 5 each had received the funds necessary for this purpose from the Chairman of the taxpayer company and from a GK Rathi group company. There were two other claims by the taxpayer in this case that need not be described in detail at this stage (interested readers may refer to para 4(c) and 4(d) of the judgment).
The case for the taxpayer in the Bombay High Court appears to have been argued principally on the basis that the Tribunal erred in relying on a judgment that neither counsel had referred to, in concluding that the test of examining the surrounding circumstances and human probabilities pointed to the conclusion that the taxpayer’s transactions were not genuine. The Court had little difficulty in rejecting this contention, but as a result was not required to examine at length the law on tax avoidance. In principle, there are two bases on which the taxpayer’s claim could have been rejected – the first is the conclusion that these transactions are shams in the sense in which that word is used in English and Indian tax avoidance jurisprudence, and the second is that the claim fails even if the transactions are not shams. A sham, as Lord Wilberforce explained in Ramsay, “means that while professing to be one thing, it is in fact something different”. The important point is that the sham doctrine does not invite any substance over form analysis – as Diplock LJ’s judgment in Snook points out, a document is a sham if the parties give it an appearance is at variance with their own intention. The findings of the Assessing Officer in this case perhaps justify the inference that there was a sham and if so that is the end of the matter.
However, the taxpayer’s case is difficult to sustain even on the alternative hypothesis that this was not a sham. As our readers will recall, the attempt in Burmah Oil was similar: Burmah had sustained a capital loss of around £160 million (in the form of a bad debt owed by its subsidiary, Holdings, to it) that was not allowable under the capital gains legislation in England and wished to “covert” it into a form that was. So it lent a sum of £160 million to MORH, another subsidiary, which in turn lent it to Holdings which paid off the debt of £160 million. Holdings then issued shares worth £160 million to which Burmah subscribed, and Holdings used that money to pay off its debt to MORH, which repaid Burmah. Holdings then went into voluntary liquidation and Burmah claimed the cost of acquisition of its new shares in computing the capital gains on the disposal of its shares in Holdings. Lord Diplock and Lord Fraser of Tullybelton accepted that this was not a sham since the transaction was what it professed to be, but nevertheless held that Burmah suffered “no real loss” since the £160 million which left it in order to provide the funds to repay the debt came back to it when MORH repaid the loan it had been given. Although this is not a subject we can explore in detail here, the conclusion in Burmah Oil, unlike Furniss v Dawson, is unaffected by the subsequent decisions of the English courts.
The Bombay High Court has relied on the observation in the judgment of the Chief Justice in ¶64 of Vodafone that there is no conflict between McDowell and Azadi Bachao Andolan in those cases in which the taxpayer uses “colourable devices”. Sanklecha J. makes the following observations in paragraph 15:
The aforesaid observations of the Supreme Court makes it very clear that a colourable device cannot be a part of tax planning. Therefore where a transaction is sham and not genuine as in the present case then it cannot be considered to be a part of tax planning or legitimate avoidance of tax liability. The Supreme Court in fact concluded that there is no conflict between its decisions in the matter of McDowell (supra), Azadi Bachao (supra) and Mathuram Agarwal (supra). In the present case the purchase and sale of shares, so as to take long term and short term capital loss was found as a matter of fact by all the three authorities to be a sham. Therefore authorities came to a finding that the same was not genuine.
On the facts of this case, the Bombay High Court was therefore not required to consider what the law in India is once the assessing officer finds that a transaction, albeit effected perhaps solely to avoid tax, is not a sham in the Snook sense. As we have pointed out, the Chief Justice’s judgment in Vodafone appears to indicate that Indian law on that question may be narrower than English law.
This was extremely lucidly written.