Acuity Law


Acuity Law
In the words of Indian judiciary "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...
India Tax
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In the words of Indian judiciary1 "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". Indian Courts have time and again operated on the principle of substance over form, thereby questioning the basic intent of the transaction and declaring them as entered for avoidance of tax. In order to continue the anti-avoidance principles, special anti-avoidance rules (SAAR) and general anti-avoidance rules (GAAR) have been introduced to the Income-tax Act, 1961 (IT Act) over a period of time.

In the recent landmark decision, the Telangana High Court (High Court) ruled against the taxpayer in the case of Ayodhya Rami Reddy Alla vs. Principal Commissioner of Income tax Central2 (Taxpayer), wherein the Taxpayer had challenged the initiation of proceedings by the income-tax department (ITD) under the GAAR provisions.

In this article, we have discussed the ruling of the High Court in the ensuing paragraphs:


The Taxpayer had subscribed to the shares of Ramky Estate and Farms Limited (REFL). REFL had decided to issue bonus shares in the ratio of 1: 5. Owing to the issuance of bonus shares, the face value of each share of REFL got reduced to 1/6th of its value. Immediately, after reduction in the face value of the shares, the Taxpayer sold the shares to another firm. Apparently, the buyer entity lacked the necessary funds to complete the acquisition of shares. The purchase transaction was funded by another entity, which was part of the same corporate group.

As the Taxpayer had transferred the shares at a reduced price, it had incurred short-term capital loss. Such loss was set-off against the long-term capital gains made on another transaction. Thus, the Taxpayer reported income under the head 'Capital gains' after adjusting the capital loss and paid the requisite tax.

The entire series of transactions were questioned by the ITD under the GAAR provisions and issued notice under section 144BA of the IT Act against the Taxpayer. This notice was challenged before the High Court by way of a writ petition, wherein it was contended that the notice under section 144BA and all consequent proceedings thereto were illegal, arbitrary, ultra vires the IT Act and lacked jurisdiction.

The Taxpayer contended the following before the High Court:

  • since the transactions undertaken fall within the provisions of section 94(8) of the IT Act i.e., SAAR, provisions relating to GAAR are not applicable to the facts of the present case.
  • what has been specifically excluded from the provisions curbing bonus stripping by way of SAAR cannot be indirectly curbed by applying GAAR. Such an application would be expansion of the scope of a specific provision in the IT Act which is otherwise impermissible under the law.
  • the provision of section 94(8) of the IT Act being a specific provision, therefore impliedly excludes the application of the general provision i.e. section 96 (GAAR provisions).
  • the transactions undertaken involved subscription and sale of shares and not units of mutual fund. As section 94(8) of the IT Act is applicable on buying and acquiring units of mutual funds, this provision is not applicable in the present facts. Hence the Taxpayer was entitled to set-off the losses against the gains.
  • the Shome Committee (Committee set up to provide recommendations on GAAR provisions) recommended that where SAAR is applicable to a particular transaction, then GAAR should not be invoked.

The ITD strongly contended that this entire exercise has been carried out with the sole motive of evading taxes. The transaction was nothing but round tripping of funds with no commercial substance and was done only with mala fide intent to avoid payment of taxes by creating losses.

Ruling of the Hon'ble High Court

Special provision vs. General provision

On the contention of the Taxpayer that special provision should prevail over general provision, the High Court observed that generally, a special provision is enacted when a general provision is already in existence. In those cases, general provision of law would not and cannot be invoked. However, in the present case, GAAR provisions have been brought into force with effect from 01.04.2016 only and thus, this contention of the Taxpayer cannot be accepted. The High Court also rejected this contention on the basis of the contradictory assertions made by the Taxpayer and held that "[T]his contention, however, is fundamentally flawed and lacks consistency. The reason being the Petitioner's own previous assertion that Section 94(8) is not applicable to shares during the relevant time frame. This inherent contradiction in the Petitioner's stance significantly weakens the overall credibility of their argument".

The High Court negating the contention of the Taxpayer, that SAAR should be made applicable against GAAR relying on the Shome Committee report, also observed that Central Board of Direct Taxes has clarified that both GAAR and SAAR will be applied depending upon the facts of each case.

Overriding Effect of GAAR provisions

The High Court analysed the interaction between SAAR under chapter X and GAAR under chapter X-A of the IT Act and who should take precedence. The High Court observed that "chapter X-A begins with a non-obstante clause...This in other words means that by virtue of the aforesaid non-obstante clause, the provisions of chapter X-A gets an overriding effect over and above the other existing provisions of law."

Judicial Anti-Avoidance Rules (JAAR) and Introduction of GAAR

The High Court laid emphasis on the fact that before the enactment of the GAAR provisions, judiciary played a critical role in scrutinizing the transaction for any foul play and declared them as entered for avoidance of tax. The High Court observed that "[J]AAR operated under the principle of 'substance over form', essentially seeking to uncover misleading structures or transactional arrangements that lacked real commercial substance. These rules weren't arbitrary but were carefully crafted tools designed to scrutinize transactions and financial arrangements that might otherwise escape tax obligations through legal loopholes. The legal amendments that followed were driven by the judiciary's firm commitment to uphold these anti-avoidance principles, using the power of law to enforce it".

Commercial Substance of Transactions

The High Court scrutinised the transactions involving the issuance and sale of bonus shares and the application of section 94(8) of the IT Act. The High Court observed that section 94(8) of the IT Act might be relevant in a simple, isolated case of the issuance of bonus shares, provided such issuance has an underlying commercial substance. However, this provision does not apply to the current case, as issuance of bonus shares here is evidently an artificial avoidance arrangement that lacks any logical or practical justification.

On the commercial intent of the transaction, the High Court relied on the judgment of the Hon'ble Supreme Court in the case of Vodafone and made a critical observation that "[T]he judgment implies that the business intent behind a transaction could serve as a strong piece of evidence that the transaction isn't a deceptive or artificial arrangement. The commercial motive behind a transaction often reveals the true nature of the transaction".


Based on the above analysis, the High Court concluded that the transactions entered by the Taxpayer have created unusual rights and obligations, which are not in line with the general principles of fair dealing, leading to the conclusion that it's an impermissible avoidance agreement under section 96 of the IT Act. Consequently, the arrangement falls under the purview of chapter X-A of the IT Act. The High Court held that "there is clear and convincing evidence to suggest that the entire arrangement was intricately designed with the sole intent of evading tax. The Petitioner, on their part, hasn't been able to provide substantial and persuasive proof to counter this claim".

Our thoughts

The Hon'ble High Court of Telangana has pronounced a one-of-a-kind ruling, as it is the first to address whether GAAR is applicable to a particular transaction or not. A very critical aspect which the High Court emphasized is the commercial intent of entering into a transaction, giving credence to the motive and maintaining robust documentation to support the commercial rationale. The ruling will have a far-reaching impact on the applicability of GAAR, even in cases where SAAR can be applied. Technically, the fact pattern in this case did not fall within the ambit of SAAR in the first place, due to its restrictive applicability to units of mutual fund (during the assessment year under consideration) and not shares. Therefore, the question of applicability of SAAR over GAAR does not arise at all.


1 Ayodhya Rami Reddy Alla vs. Principal Commissioner of Income tax Central (TS-398-HC-2024(TEL)

2 Ibid

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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