In a major blow to the tax claims of around Rs 2,000 crore on cases of dividend stripping prior to 2002-03, the Bombay High Court has ruled that losses arising from the purchase and subsequent sale of mutual fund units, soon after receiving dividend on the units, can be allowed as an expense for deduction from taxable income.
In all its tax claims, the I-T department was of the view that losses arising from such transactions amounted to artificial or coloured transactions for evading taxes and was not a sound commercial decision.
For the assessment year 2001-02, Mumbai-based broking firm Walfort Share, purchased 4.55 billion units from Chola MF on March 23, 2000, at Rs 17.57 per unit totalling Rs 8 crore. On the same day, Chola MF distributed a dividend amount of Rs 1.8 crore at 40 per cent per unit.
On the next day (March 27, 2000), the assessee sold the units by way of redemption and Chola MF repurchased them at Rs 12.97 each and paid Rs 5.90 crore as the repurchase price. The assessee (Walfort) had also received Rs 2.3 crore as an incentive for purchase and sale of such units. So, against an investment of Rs 8 crore, the assessee received Rs 7.96 crore (in the form of dividend income, incentive income and sale consideration).
At the same time, on the units sale, the broking firm made a loss of around Rs 2.1 crore (Rs 8 crore less Rs 5.90 crore). Since the dividend income was exempt from tax under Section 10(33) of the I-T Act, the assessee claimed business loss of around Rs 2.1 crore to be set off against other income.
However, the tax authorities were of the opinion that the loss was created through pre-designed set of transactions to avoid paying tax and added it back to the trading income of the assessee. However, HC in its ruling in August was of the view that such transactions need to be seen with reference to Section 94(7) that deals with tax avoidance transactions.
The section provides that where the units are purchased and sold within a stipulated time and the income from such units is exempt, then, while computing losses of such persons, the losses to the extent of the income received should be ignored.
Thus, losses in excess of the income should be allowed for deduction.
