The Telangana High Court has set aside directions invoking the General Anti-Avoidance Rules (GAAR) against share transactions that generated a short-term capital loss of ₹49.33 crore, holding that claiming a legally permitted set-off against long-term capital gains does not, by itself, establish an impermissible tax avoidance arrangement.
The Bench of Acting Chief Justice P. Sam Koshy and Justice Narsing Rao Nandikonda has observed that the taxpayer was entitled to set off the loss against long-term capital gains arising from a slump sale under Section 70(2) of the Income Tax Act, 1961.
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The Court found that the Revenue had failed to establish the existence of an “arrangement” within Section 102(1), demonstrate that obtaining a tax benefit was the main purpose of the transactions, or show misuse of the Act or the adoption of means not ordinarily employed for bona fide purposes.
The dispute concerned assessment year 2018–19 and arose following the transfer of the “Mebaz” apparel business of New Meena Bazar International Private Limited to Vedant Fashions Private Limited.
The business was transferred as a going concern under a Business Transfer Agreement dated June 13, 2017, for approximately ₹210.46 crore. Following successive amalgamations sanctioned by the National Company Law Tribunal, the tax consequences of the transaction came to be examined in the petitioner’s case.
After discharging liabilities of approximately ₹59.40 crore, the business sale left a surplus of ₹151.06 crore. Excluding a deferred tranche of approximately ₹20 crore, about ₹130 crore was available for investment.
According to the taxpayer, neither it nor its promoters had previously managed an investable surplus of that magnitude. It consulted several wealth managers and financial institutions, including ICICI, HDFC, IIFL, Anand Rathi and Kotak, and also engaged an internal consultant.
Pending a final investment decision, the funds were parked in liquid mutual funds. The taxpayer subsequently decided to allocate approximately ₹50 crore to listed equities and ₹80 crore to bonds and debt mutual funds.
The taxpayer submitted that it had been advised that purchasing shares before a bonus issue and selling an equivalent quantity after the allotment could offer short-term arbitrage opportunities.
Acting on that advice, it invested an aggregate of ₹106.31 crore in pre-bonus shares of several large listed companies. It subsequently sold shares worth ₹57.24 crore after the bonus allotments and retained a net investment, at cost, of ₹49.07 crore.
The transactions resulted in a short-term capital loss of ₹49,32,71,673. The taxpayer claimed a set-off of this loss against long-term capital gains of ₹1,75,91,50,508 computed under Section 50B on the slump sale.
Its case was that Section 70(2) expressly permitted the adjustment of short-term capital losses against capital gains arising during the same year, including long-term capital gains.
Revenue Alleged That Transactions Were Designed To Obtain A Tax Benefit
The Income Tax Department conducted a search at the taxpayer’s premises on November 27 and 28, 2018. Proceedings under Section 153A followed.
On April 5, 2021, the Assessing Officer called upon the taxpayer to explain why GAAR should not be invoked in relation to the bonus-share transactions and the resulting loss set-off.
After considering the taxpayer’s objections, the matter proceeded through the statutory reference mechanism to the GAAR Approving Panel. By directions dated February 23, 2022, issued under Section 144BA(6), the panel treated the transactions as an impermissible avoidance arrangement.
The Revenue argued that the taxpayer had structured its transactions so that the statutory treatment of bonus shares and the First-In-First-Out method operated together to generate short-term capital losses. Those losses were then adjusted against the substantial long-term capital gains from the business sale.
According to the Department, this demonstrated that the transactions were undertaken to obtain a tax benefit through misuse or abuse of the Act.
The taxpayer maintained that the trades involved reputed listed companies, were executed at prevailing market prices through recognised stock exchanges, and formed part of a commercially considered investment strategy.
The High Court explained that Section 96(1) required two conditions to be satisfied cumulatively: the main purpose of the arrangement must be to obtain a tax benefit, and the arrangement must also fall within at least one of the descriptions specified in clauses (a) to (d).
Before those conditions could be examined, the Revenue had to establish an “arrangement” within Section 102(1).
Given the serious consequences of GAAR, including the disregard or recharacterisation of transactions, the Bench held that its statutory conditions required strict examination. Suspicion or disagreement with a taxpayer’s commercial choices was insufficient.
The Court found that the Approving Panel had inferred the taxpayer’s purpose from the tax result instead of examining whether the evidence established that obtaining a tax benefit was the dominant purpose of the investments.
A lawful transaction becoming tax-efficient, the Bench held, did not automatically make it impermissible.
Examining the transactions, the Court noted that the taxpayer had purchased and sold shares of large listed companies through recognised stock exchanges at prevailing market rates.
The trades were transparent and at arm’s length. The taxpayer did not know the counterparties, and the prices depended on market movements beyond its control.
Reading the expressions used in Section 102(1) in their statutory context, the Court considered whether there was concert between identifiable parties or a predetermined sequence of steps whose outcome was within the taxpayer’s control. It found no such basis on the facts before it.
The taxpayer’s commercial explanation also remained substantially unaddressed in the impugned directions. The Bench referred to the substantial surplus available after the business sale, the consultations with financial advisers, the diversification strategy and the continued holding of investments worth ₹49.07 crore at cost.
These circumstances supported the taxpayer’s explanation that the share dealings formed part of the deployment of its surplus funds.
The Bench emphasised that income tax is an annual levy on total income, and that adjusting eligible losses against gains forms part of the statutory computation mechanism.
Section 70(2), it observed, permits short-term capital losses to be set off against either short-term or long-term capital gains arising in the same year.
On the facts of this case, the taxpayer had applied that provision to a loss the Court accepted as genuinely and commercially sustained. The Court therefore rejected the Revenue’s attempt to characterise the computation itself as an impermissible tax advantage.
It also held that Section 96(1)(b), concerning misuse or abuse of the Act, was not attracted. The taxpayer had applied the statutory rules governing bonus-share acquisition cost, followed the prescribed FIFO method and computed the slump sale gains under Section 50B.
Using the set-off provision for the purpose for which it was enacted did not constitute abuse, the Court reasoned.
The Court separately rejected reliance on Section 96(1)(d), which concerns arrangements entered into or carried out through means or in a manner not ordinarily employed for bona fide purposes.
That provision, the Bench explained, focuses on the means and manner of carrying out an arrangement.
Here, the transactions were executed through a SEBI-regulated stock exchange, with applicable transaction levies discharged. The Court regarded this as an ordinary and conventional method of investing in listed securities.
The Revenue had therefore failed to establish that the manner in which the taxpayer dealt in shares satisfied the conditions of clause (d).
The Bench also noted that the search had yielded no incriminating material against the taxpayer. Of approximately 105 assessments of the group reopened following the search, 104 had been completed with nil or minimal adjustments.
Against that background, invoking GAAR in the present assessment required a careful and reasoned demonstration of each statutory ingredient. The Court found that demonstration absent.
The High Court set aside the Approving Panel’s directions dated February 23, 2022, and held that the taxpayer was entitled to the claimed set-off of ₹49.33 crore against the long-term capital gains from the slump sale.
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