In its recent ruling[1], Kolkata bench of Income Tax Appellate Tribunal (“ITAT”) rejected the retrospective application of General Anti-Avoidance Rule (“GAAR”) on a scheme of amalgamation approved by the Punjab & Haryana High Court (“HC”) and Delhi HC.

Background

M/s. JCT Limited (“Assessee”) is a public limited company, engaged in the business of manufacturing, sale and export of textiles, nylon and different varieties of yarns. M/s Gupta and Syal Ltd. (“Subsidiary”) was a wholly-owned subsidiary of the Assessee. During Assessment Year (“AY”) 2011-12, the business of the Subsidiary was amalgamated with the Assessee by a scheme of amalgamation approved by the Punjab & Haryana HC as well as the Delhi HC. Prior to the amalgamation, the Subsidiary had no substantial business activity and the only income earned by the Subsidiary in that financial year was in the nature of rent and receipts from sale of a land. Upon amalgamation, the long-term capital gains (“LTCG”) from the sale of land of the Subsidiary were set off against the losses and unabsorbed depreciation of the Assessee for AY2011-12.

During the scrutiny assessment, the Assessing Officer (“AO”) rejected the treatment of the gains from the sale of land as LTCG. According to the AO, these gains were in the nature of short-term capital gains (“STCG”), considering that the Subsidiary got freehold rights of the said land only in 2010, after paying the required conversion charges. Prior to this, the Subsidiary only held leasehold rights in the land. Therefore, in his view, the period of holding had to be considered from the date of acquiring freehold rights, which was less than 36 months. Accordingly, the AO treated the gains as STCG and re-computed the tax payable by the Assessee.

On appeal to the Commissioner of Income Tax (Appeals) (“CIT(A)”), the CIT(A) invoked powers to enhance the assessment of the Assessee, on the finding that the entire purpose of the amalgamation was to set-off the gains made by the Subsidiary from the sale of land, against the losses and unabsorbed depreciation of the Assessee. The CIT(A) was of the view that the entire amalgamation was a colourable device and there was a requirement to pierce the corporate veil and look through the substance of the transaction, and not the form. The CIT(A) acknowledged that the provisions of GAAR were not applicable in the subject AY, yet he drew strength from the provisions of GAAR to claim that the transaction was a sham transaction. Consequently, the CIT(A) disallowed the set-off of losses and unabsorbed depreciation against the capital gains of the Subsidiary. With respect to the nature of the gains being LTCG vs STCG, the CIT(A) upheld the order of the AO that the gains were in the nature of STCG and rejected the indexation on the cost of acquisition claimed by the Assessee for the purpose of computing capital gains.

The Decision of the ITAT

Aggrieved by the  decision  of the CIT(A), the Assessee filed an appeal before the ITAT on the grounds, which inter alia included objection on lifting of the corporate veil by the CIT(A) and characterising the gains from sale of land as STCG as against LTCG.

The ITAT noted that the amalgamation was approved by the relevant HCs. The ITAT also observed that when the HCs had approved the scheme of amalgamation, and passed the order approving the scheme, it allowed for income and profits of the Subsidiary to be treated as income and profits of the Assessee for all purposes. Thus, the rejection of the set-off of capital gains of the Subsidiary against the losses and unabsorbed depreciation of the Assessee was against the order of the HCs. The ITAT relied on co-ordinate bench’s decision in the case of Electrocast Sales[2] in support of the view that once the scheme of amalgamation was approved by the HC, it was fair to assume that the HC had given its approval after conducting its due diligence. The revenue authorities were given an opportunity to oppose the scheme on the ground of lack of any commercial substance to it or any other reason. The ITAT held that, after all the opportunities were given to the tax department and the HC had approved the scheme, questioning the same on the ground that it is a colorable device, is illegal and devoid of any factual or legal base. Further, the retrospective invocation of GAAR provisions, by CIT(A), in the AY when they were not applicable, was bad in law.

With respect to rejection of indexation benefit on account of receipts being STCG, the ITAT held that the Subsidiary had leasehold right on the land from the financial year (“FY”) 1996-97 and got freehold rights with effect from November 26, 2010, upon paying the requisite conversion charges. As these charges were not included while computing the cost of acquisition for the purposes of capital gains, the ITAT allowed the gains to be treated as long terms capital gains.

Our Analysis

Though the GAAR provisions were incorporated into the Indian Income Tax Act, 1961 (“IT Act”), vide Finance Act, 2013, they became effective from FY commencing April 1, 2017. Relevant rules to smoothen the operation of GAAR were also introduced in Income Tax Rules, 1962 (“IT Rules”). The amalgamation pertains to assessment year 2011-12 when GAAR provisions were not in effect. It is therefore too aggressive and ambitious of the tax department to apply the rules pertaining to GAAR in that year!

However, the fact that GAAR was not effective in that year does not stop the tax department from looking at the substance over form of the transaction, adopting a ‘look through’ approach. Piercing of corporate veil and disregarding a sham or subterfuge transaction was upheld by the Supreme Court ruling in the landmark judgement of McDowell[3]. However, in the facts of this case, where the HC not only had all the detailed information set out in the Scheme of arrangement which it approved, the tax department was given the opportunity to object to the same  and no such objection was raised. It seems that the issue raised later was an afterthought of the tax department.

Another important point in this case is the dichotomy in the approach of the CIT(A). On the one hand, the CIT(A) denied the set-off of capital gains against the brought forward losses and unabsorbed depreciation of the Assessee. On the other hand, it sought to tax the capital gains realised by the subsidiary as STCG in the hands of the Assessee.

It is thus important to note that the tax department can take aggressive views, even if they are contradictory and hence the taxpayer is well advised to have all the detailed documentation and reasoning to support the commercial exigencies of any transaction. That said, the Tribunal has to be credited for discouraging abusive mechanisms of tax authorities by a fair interpretation of applicability of GAAR provision and upholding the sanctity of the order of the HCs in approving the scheme of amalgamation.

[1] M/s JCT limited v. DCIT, Circle – 11(1), Kolkata, ITA No. 2389/Kol/ 2018

[2] Electrocast Sales India Ltd. v. DCIT, ITA No. 2145/ Kol/ 2014, Kolkata ITAT

[3] McDowell & Co. Ltd. v. Commercial tax officer [1985] 22 Taxmann 11 (SC)