CIT vs. Walfort Share & Stock Brokers (Supreme Court)

Pre S. 94(7) dividend stripping loss cannot be disallowed. Transaction cannot be ignored on ground that it is for tax-planning

In respect of AY 2000-01, the assessee bought units of a mutual fund on 24.3.2000 (the record date) for Rs. 17.23 each and immediately became entitled to receive dividend of Rs. 4 per unit. After the dividend payout, the NAV of the unit fell by Rs. 4 to Rs. 13.23. The assessee redeemed the units on 27.3.2000 at Rs. 13.23 per unit and claimed a loss of Rs. 4. The dividend of Rs. 4 was claimed exempt u/s 10(33). The AO & CIT (A) rejected the claim of loss on the ground that the loss was “artificial” and could not be allowed. On appeal by the assessee, a Five Member Special Bench of the Tribunal 96 ITD 1 (Mum) (SB) upheld the claim and this was confirmed by the Bombay High Court 310 ITR 421 (Bom). On appeal to the Supreme Court, HELD, dismissing the appeal:

(i) The argument of the department that the loss (the difference between the purchase and sale price of the units) constitutes “expenditure incurred” for earning tax-free income and was liable to be disallowed u/s 14A is not acceptable. The difference arose as a result of the dividend payout. The said “pay-out” is not “expenditure” to fall within s. 14A. For attracting s. 14A, there has to be a proximate cause for disallowance, which is its relationship with the tax exempt income, which is absent in the present case.

(ii) The argument of the department that the transaction was entered into in a pre-meditated manner and that the loss is not genuine is not acceptable because the transaction was a “sale”, the sale-price and dividend was received by the assessee. The assessee made use of the provisions of s. 10(33), which cannot be called an “abuse of law”. Even assuming that the transaction was pre-planned, there is nothing to impeach the genuineness of the transaction. With regard to McDowell & Co 154 ITR 148(SC), in the later decision in Azadi Bachao Andolan 263 ITR 706(SC) it has been held that a citizen is free to carry on its business within the four corners of the law. Mere tax planning, without any motive to evade taxes through colourable devices is not frowned upon even in McDowell & Co. Accordingly, the losses pertaining to exempted income cannot be disallowed prior to s. 94(7).

(iii) S. 94(7) was inserted w.e.f. 1.4.2002 to curb claim of such loss. However, the effect of s. 94(7) is that only losses to extent of dividend have to be ignored by the AO and not the entire loss. Losses over and above the dividend are still allowable even after s. 94(7). This shows that Parliament has not treated the dividend stripping transaction as sham or bogus or the entire loss as a fictitious or fiscal loss. If the argument of the Department is to be accepted, it would mean that before 1.4.2002 the entire loss would be disallowed as not genuine but, after 1.4.2002, a part of it would be allowable u/s 94(7) which can never be the object of s. 94(7).

(iv) As regards the reconciliation of ss. 14A and 94(7), the two operate in different fields. S. 14A deals with disallowance of expenditure incurred in earning tax-free income while S. 94(7) refers to disallowance of loss on acquisition of an asset. S. 14A applies to cases where an assessee incurs expenditure to earn tax free income but where there is no acquisition of an asset. In cases falling u/s 94(7), there is acquisition of an asset and existence of the loss which arises at a point of time subsequent to the purchase of units and receipt of exempt income. It occurs only when the sale takes place. S. 14A comes in when there is claim for deduction of an expenditure whereas s. 94(7) comes in when there is claim for allowance for the business loss. One must keep in mind the conceptual difference between loss, expenditure, cost of acquisition, etc. while interpreting the scheme of the Act. Also, though ss. 14A and 94(7) were inserted by the Finance Act, 2001, s. 14A was inserted w.r.e.f. 1.4.1962 while s. 94(7) was inserted w.e.f. 1.4.2002.

(v) The argument of the department that by virtue of Para 12 of AS 13, the dividend should be regarded as a “return of investment” and go to reduce the cost of the unit is not acceptable. As 13 provides that interest/ dividends received on investments are generally regarded as return on investment and not return of investment and it is only in certain circumstances where the purchase price includes the right to receive crystallized and accrued dividends/ interest, that have already accrued and become due for payment before the date of purchase of the units, that the same has got to be reduced from the purchase cost of the investment. A mere receipt of dividend subsequent to purchase of units, on the basis of a person holding units at the time of declaration of dividend on the record date, cannot go to offset the cost of acquisition of the units. (Reference made to Vijaya Bank 187 ITR 541 (SC) where it was held that where the assessee buys securities at a price determined with reference to their actual value as well as interest accrued thereon till the date of purchase the entire price paid would be in the nature of capital outlay and no part of it can be set off as expenditure against income accruing on those securities).