GAAR cannot be invoked where the capital loss is a consequence of the statutory computation mechanism under the Act
RELEVANT PROVISIONS:
• The Income-tax Act, 1961 (“the Act”) seeks to curb tax avoidance and tax evasion, inter alia, through General Anti-Avoidance Rule (“GAAR”).
• GAAR provisions are contained in Chapter X-A of the Act and are applicable from Assessment Year (“AY”) 2018-19. Under the GAAR provisions, an arrangement entered into by a taxpayer may be declared to be an Impermissible Avoidance Arrangement (“IAA”) and the consequences in relation to tax arising therefrom may be determined accordingly.
• Section 96(1) of the Act defines “IAA” as an arrangement, the main purpose of which is to obtain a tax benefit, and which (a) creates rights, or obligations not ordinarily created between persons dealing at arm’s length, (b) results in the misuse, or abuse, of the provisions of this Act, (c) which lacks commercial substance, or (d) is entered into by means or in manner not ordinarily employed for bona fide purposes.
• Section 102(1) of the Act defines the term "arrangement" to mean any step in, or a part or whole of, any transaction, operation, scheme, agreement or understanding, whether enforceable or not, and includes the alienation of any property in such transaction, operation, scheme, agreement or understanding.
• Section 70(2) of the Act permits the set-off of a short-term capital loss against any capital gains arising during the relevant previous year, including both short-term capital gains and long-term capital gains.
• Section 55 of the Act, inter alia, prescribes the cost of acquisition of bonus shares for the purposes of computing capital gains. In the case of bonus shares allotted without any payment by the shareholder, the cost of acquisition of such bonus shares is taken as Nil.
• CBDT Circular No. 704 dated 28 April 1995 prescribes the First-In-First-Out (“FIFO”) method for identifying securities transferred where shares have been acquired in different lots at different points of time and cost.
BRIEF FACTS
• The Taxpayer[1] transferred its retail business undertaking to Vedant Fashions Limited as a going concern by way of slump sale for a consideration of approximately INR 210.46 crore, resulting in long-term capital gains.
• Upon discharge of its liabilities, the Taxpayer was left with substantial surplus funds available for deployment. Acting on professional advice received from financial institutions and investment consultants, the Taxpayer, inter alia, acquired shares of several listed companies prior to the announcement and allotment of bonus shares and subsequently sold, through the stock exchange, shares equivalent in number to the original shares purchased.
• In accordance with the statutory provisions governing the cost of acquisition of bonus shares and the prescribed FIFO method for identifying the shares transferred, the Taxpayer incurred a short-term capital loss of approximately INR 49.33 crore.
• The Taxpayer set off the aforesaid short-term capital loss against the long-term capital gains arising from the slump sale in accordance with Section 70(2) of the Act.
• During the course of assessment proceedings, undertaken pursuant to a search and seizure operation, the Revenue alleged that the aforesaid transactions constituted an IAA within the meaning of Chapter X-A of the Act and referred the matter to the Approving Panel.
• The Approving Panel held that the transactions constituted an IAA and directed invocation of GAAR by placing reliance on Sections 96(1)(b) and 96(1)(d) of the Act.
• Aggrieved by the directions of the Approving Panel, the Taxpayer filed a writ petition before the Telangana High Court challenging the directions of the Approving Panel.
CONTROVERSY
• Whether the purchase of listed shares prior to a bonus issue and the subsequent sale, after allotment of bonus shares, of shares equal in number to the original shares purchased, resulting in a short-term capital loss set off against long-term capital gains, constituted an “Impermissible Avoidance Arrangement” within the meaning of Sections 96 and 102 of the Act?
JUDGEMENT OF THE TELANGANA HIGH COURT:
• The Court held that for invocation of Section 96, the Revenue is required to establish the existence of an “arrangement” within the meaning of Section 102(1), the main purpose of such arrangement being obtaining of a tax benefit, and satisfaction of at least one of the conditions specified in clauses (a) to (d) of Section 96(1).
• The Taxpayer had acquired and sold shares of listed companies through recognised stock exchanges at prevailing market prices in arm’s length and transparent transactions, without any identified counterparty.
• In transactions executed through a stock exchange, the counterparty is unknown and the outcome depends entirely upon market forces. The profit or loss arising therefrom therefore cannot be regarded as pre-ordained, predetermined or controlled by the Taxpayer.
• The expressions “transaction”, “operation”, “scheme”, “agreement” and “understanding” occurring in Section 102(1) postulate some element of concert, design, pre-arrangement or coordinated conduct involving identifiable persons. The Revenue failed to establish the existence of any such arrangement in the present case.
• The material on record demonstrated that the investments were made as part of a genuine strategy for deployment of surplus funds arising from the slump sale and not with the primary objective of obtaining a tax benefit.
• The mere fact that a transaction results in a tax benefit does not lead to the conclusion that obtaining such tax benefit was its main purpose for the purposes of Section 96(1).
• The short-term capital loss arose as a consequence of applying the statutory provisions relating to the cost of acquisition of bonus shares and the prescribed FIFO method for identification of shares sold.
• The set-off of such short-term capital loss against long-term capital gains was specifically permitted under Section 70(2) of the Act and constituted part of the statutory computation mechanism envisaged under the Act.
• The Taxpayer had merely applied Sections 55 and 70(2) of the Act, together with the prescribed FIFO method, in the manner contemplated by the statutory framework. Accordingly, the transactions could not be regarded as resulting in any misuse or abuse of the provisions of the Act within the meaning of Section 96(1)(b).
• Transactions undertaken through recognised stock exchanges regulated by SEBI represent an ordinary, transparent and bona fide mode of dealing in securities and therefore cannot be said to have been carried out by means or in a manner not ordinarily employed for bona fide purposes under Section 96(1)(d).
• Accordingly, the Court held that the impugned transactions did not constitute an “arrangement” or an “impermissible avoidance arrangement” within the meaning of Sections 102(1) and 96 of the Act and consequently set aside the directions issued by the Approving Panel.
LKS COMMENTS
• This is a significant ruling on the scope and limits of GAAR in the context of bona fide capital market transactions undertaken through recognised stock exchanges. The judgment underscores that Chapter X-A is intended to target abusive tax arrangements and not genuine commercial transactions which merely result in a favourable tax consequence.
• The Court has drawn an important distinction between a transaction which results in a tax benefit and a transaction whose principal objective is obtaining a tax benefit. The Court rejected the approach of the Approving Panel in reasoning backwards from effect (tax benefit) to intention (purpose). The former, by itself, does not justify invocation of GAAR.
• The judgment reinforces the proposition that utilisation of statutory computational mechanisms cannot by itself constitute misuse or abuse of the Act. Where the tax outcome flows directly from the application of the provisions enacted by Parliament, invocation of GAAR would require something more than the mere existence of a tax advantage.
• Significantly, the Court has held that transactions executed on anonymous stock-exchange platforms may not readily satisfy the threshold requirement of an “arrangement” under Section 102(1) of the Act. In the absence of evidence demonstrating any pre-arrangement, collusion, concerted action or coordinated conduct between identifiable parties, ordinary market transactions may fall outside the scope of Chapter X-A. The decision therefore substantially restricts the scope for invoking GAAR in respect of anonymous stock-exchange transactions.
• The ruling affirms that gains and losses arising from stock exchange transactions are subject to market forces beyond the control of the taxpayer. Consequently, where the outcome of a transaction is neither predetermined nor controlled by the taxpayer, such transactions cannot be characterised as pre-ordained arrangements designed to secure a tax benefit.
• The judgment is consistent with the settled principle that a taxpayer is entitled to arrange its affairs in a tax-efficient manner, provided the transactions are genuine and otherwise permissible under law. Legitimate tax planning cannot be equated with tax avoidance merely because it results in reduction of tax liability. This principle finds support in Union of India v. Azadi Bachao Andolan [2003] 263 ITR 706 (SC), approving the reasoning in M.V. Valliappan v. ITO [1988] 170 ITR 238 (Mad).
• Another noteworthy aspect of the decision is that there was no allegation of price manipulation, accommodation transactions, collusive conduct, market abuse or artificial creation of losses. The Revenue’s challenge was directed primarily towards the timing and sequencing of the transactions, which the Court found insufficient for invoking GAAR. The ruling may therefore provide substantial support in future disputes involving bonus stripping, capital loss harvesting and similar securities transactions, particularly where the Revenue seeks to invoke GAAR despite the absence of collusion, artificiality, sham elements or any departure from ordinary commercial conduct.
• The ruling reiterates that the burden of establishing the existence of an “arrangement”, the main purpose of obtaining a tax benefit and the satisfaction of at least one of the conditions prescribed in Section 96(1)(a) to (d) rests upon the Revenue. The mere existence of a tax advantage cannot substitute proof of the statutory conditions required for invocation of GAAR.
• The ruling reiterates the position that directions issued by GAAR Panel u/s. 144BA(6) of the Act, though not appealable, can be challenged by way of a writ before the High Court under Article 226 of the Constitution of India.
[1] M/s. EKGE Retail LLP v. Assistant Commissioner of Income-tax & Ors. [Writ Petition No. 21210 of 2022, Judgment dated 13 October 2026 (Telangana High Court)].
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