Minimising tax liabilities through lawful means is not illegal: Mumbai ITAT

The dividing line between tax planning and tax avoidance is very thin and a matter of disputes and litigation between the tax collector and taxpayers.

ITAT Mumbai has recently held that minimising tax liabilities through lawful means is not illegal. The citation of the case is as under:

Michael E Desa Vs ITO

ITA No. 4286/Mum/17

Short overview of the case:

Whether minimising tax liabilities through lawful means is not illegal – YES: ITAT

1. Assessee, an NRI, was fiscally domiciled in US. During relevant previous year.

2. Assessee had sold a property, of which he was 50% co-owner and reported earning of LTCG.

3. Besides, the assessee had reported long-term capital loss on sale of certain shares in VCAM Investment Managers Pvt. Ltd. to its Director Saldhana.

4. AO noted that the assessee knew Saldhana for over 10 years and had close business connections with him.

5. Under Section 23 and 24 of Contract Act, when the object was to defeat any provisions of law and when consideration was of such nature that if permitted, it would defeat provisions of any law, the contract would be void.

6. AO held that the share transaction was only to nullify levy of LTCG.

7. Thus, the contract for sale of shares was vitiated in law.

8. Besides, Saldhana being one of the directors of the company, had every reason to know that company was worthless.

9. In these circumstances, purchase of shares was motivated for tax benefits to assessee rather than any material gains to Saldhana.

10. AO observed that transfer of shares by assessee to Mr. Saldhana was preconceived, preordained and fabricated for extra commercial considerations and a device to generate artificial and incorrect long-term capital loss in hands of assessee.

11. As CIT(A) upheld AO’s order of declining set off of long-term capital loss incurred by assessee on sale of shares of VCAM against LTCG earned by assessee on sale of property, assessee filed a present appeal.

On Appeal, the issue placed before ITAT by the assessee was as to whether minimising tax liabilities through lawful means is not illegal?

ITAT decided the appeal in favour of the assessee with following observation:

1. AO should not take a call on how the assessee should organise his fiscal affairs so as to serve the interests of revenue authorities.

2. Instant transactions may be tax motivated but that factor did not, by itself, render the transaction a sham transaction or a colourable device so as to be.

3. Not tax planning simpliciter but tax planning through dubious methods or colourable devices had been deprecated by courts.

4. Tax planning may be legitimate provided it was within the framework of law.

5. Every taxpayer was entitled to arrange his affairs so that his taxes shall be as low as possible and that he was not bound to choose that pattern which would replenish the treasury.

6. Assessee and Saldhana were shareholders in the company.

7. As the assessee was no longer living in India, was not in any way associated with the company and as investment in the company turned out to be a dud investment, he sold entire shareholdings in the company to Saldhana. There was nothing unusual about it.

8. It was a commercial decision of Saldhana to buy the shares on a token consideration, almost the same amount as its net effective worth and book value.

9. There was nothing wrong or even unusual in the transaction.

10. Proposition that impugned transaction was illegal under section 23 and 24 of Contract Act proceeded on fallacious assumption that minimising tax liabilities through lawful means, even if sale of shares be treated as tax-motivated, was illegal.

11. When a contract’s object was illegality or something which would frustrate law, such contract was void but minimisation of tax liability, as long as it was through legitimate tax planning and without using colourable devices, was not at all illegal;

12. It is not even immoral as it was everybody’s duty to himself to manage his affairs properly within the framework of law.

13. Benefit of LTCG could not be declined to the assessee only on ground that if the assessee had not taken proactive measures, i.e., sale of shares, he would have paid more taxes.

14. Assessee may end up saving taxes but that was perfectly legitimate.

15. AO could not disregard a transaction just because it resulted in tax advantage to assessee.

16. Just as tax evasion through colourable devices and tax shelters could not be legitimised and glorified, genuine tax planning within the framework of law could not be deprecated and disapproved.

17. Line of demarcation between what was permissible tax planning and what turned into impermissible tax avoidance may be somewhat thin but that could not be an excuse enough for tax authorities to err on the side of excessive caution.

18.  Thus, AO was directed to allow set-off of long-term capital loss on sale of shares in VCAM against LTCG on sale of property.