IT Appeal No. 871 (Bang.) of 2012
[ASSESSMENT YEAR 2006-07]

N.V. VASUDEVAN, JUDICIAL MEMBER AND JASON P. BOAZ, ACCOUNTANT MEMBER

ORDER

N.V. Vasudevan, Judicial Member - This is an appeal by the Assessee against the order dated 22.03.2012 of the CIT(Appeals), LTU, Bangalore dated 22.03.2012 relating to assessment year 2006-07.

2. The Assessee is an individual. For AY 06-07, the assessee filed return of income on 30-07-2006 declaring total income of Rs. 133,30,97,440/-. In an order passed u/s. 143(3) of the Act dated 29-12-2008 the AO disallowed the claim of the Assessee for deduction of short term capital loss of Rs.26,39,632/- on sale of units of Birla Dividend fund by invoking the provisions of Sec.94(7) of the Income Tax Act, 1961 (the Act).

3. The facts with regard to the short term capital loss are as follows: The Assessee purchased 38,25,554 units of Birla Dividend Fund on 15.09.2005. On 14-02-2006, the assessee redeemed 38,25,554 units of Birla Dividend Funds. It is on the sale (redemption) of these that the assessee had incurred a Short Term Capital Loss of Rs. 26,39,632/-. The units were purchased at Rs. 13-07 per unit and redeemed at Rs. 12-38 per unit resulting in the loss of Rs. 26,39,632/- (382554 x 0.69 paise). Between the date of purchase (i.e., 15-09-2005) and the date of redemption (i.e., 14-02-2006) dividend was declared twice on these units by Birla Dividend Fund on following dates.

4. The Assessing Officer in the assessment order dated 29-12-2008 held the above transaction involving purchase and redemption of units to be a dividend stripping transaction covered by section 94(7) of the Act.

5. An understanding of what is dividend stripping, is necessary to appreciate the controversy involved in this appeal. It is a devise adopted to legitimately avoid payment of taxes on taxable income. Suppose an Assessee has a short-term capital gain of Rs. 2 lakh during the previous year and if the Assessee does not resort to dividend stripping, he would pay approximately Rs. 60,000 as tax. Alternatively, the Assessee could invest this sum in a fund that has an NAV of Rs. 20, and which declares a dividend of 50 per cent. This means that for each unit, investors receive Rs. 5 as dividend and the NAV goes down to Rs. 15. For Rs. 2-lakh invested, the Assessee would get Rs. 50,000 as dividend. However, the NAV of the unit would now stand reduced to Rs. 1.5 lakh - a loss of Rs. 50,000. The Assessee would sell the units and incur a loss of Rs. 50,000. The amount of capital loss on sale of units will now reduce your original short-term capital gain of Rs. 2 lakh to Rs. 1.5 lakh. The tax liability on this amount will be Rs. 45,000. In addition, the Assessee earns tax free dividend income on units of Rs. 50,000. Thus, the Assessee's total tax liability is down from Rs. 60,000 to Rs. 45,000. Besides this the Assessee would also get a tax free dividend income of Rs. 50,000.

6. With a view to disallow such losses, the Finance Act, 2001 introduced Sub-Section (7) to Sec.94 w.e.f. 1.4.2002. The provisions so introduced reads thus:
'Sec.94: Avoidance of tax by certain transactions in securities.
(7) Where—

Explanation : For the purposes of this section,-
(a) "interest" includes a dividend;
(aa) "record date" means such date as may be fixed by-

7. The aforesaid provisions provides for a minimum holding period of securities or units after its purchase and before its sale. The holding period is determined with reference to the record date. Record date has been defined for the purpose of the aforesaid provisions to be "record date" means such date as may be fixed by a company/mutual fund for the purposes of entitlement of the holder of the securities/units to receive dividend. The minimum holding period from the date of purchase till the record date is 3 months. The minimum holding period after the record date before the units can be sold is 9 months. It is not in dispute that as laid down by the Hon'ble Delhi High Court in the case of CIT v. Shambhu Mercantile Ltd. [2003] 183 Taxman 251 to attract the provisions of section 94(7) of the Act, all the three conditions provided (in clause (a) (b) & (c) of Sec. 94(7) of the Act) therein have to be cumulatively satisfied. There is no dispute that conditions laid down in clause (b) & (c) of Sec. 94(7) of the Act are satisfied. The dispute is only with regard to satisfaction of conditions mentioned in Sec. 94(7)(a) of the Act.

8. According to the AO, the date of purchase of the units by the Assessee was on 15-09-2005. The date of sale/ redemption of these units was on 14.2.2006. The mutual fund had declared two dividends between the date of purchase of the units by the Assessee and their sale/redemption i.e., on 28-10-2005 and on 13-01-2006. If the record date is reckoned with reference to the declaration of dividend on 28.10.2005, which is the case of the AO, the purchase of the units would be within a period of 3 months prior to the record date and therefore clause (a) of Sec.94(7) of the Act would also be attracted. If on the other hand the record date is reckoned with reference to the declaration of dividend on 13.01.2006, which is the claim of the Assessee, then the purchase of the units would be beyond 3 months prior to the record date and therefore the condition specified in Clause (a) of Sec. 94(7) of Act would not be applicable and consequently the loss claimed by the Assessee has to be allowed. The provisions of sec.94(7) of the Act are silent on which record date is to be reckoned for applying those provisions when there are two record dates between the date of purchase of units and sale of those units.

9. The AO adopted 28-10-2005 as the record date for the purpose of ascertaining the applicability of sec. 94(7) of the I.T. Act, 1961 and accordingly held all the conditions specified in Sec.94(7) of the Act were satisfied and thus disallowed the claim of the Assessee for deduction of loss on sale of units.

10. Before CIT(A) the Assessee submitted the legislative history and intent of sec. 94(7) was to curb the mischief/misuse of dividend exemption by a tax avoidance practice, popularly known as dividend stripping. The Assessee pointed out that the memorandum explaining the provisions of Finance Bill, 2001 and CBDT Circular No. 14, dated 09-11-2001, confirm the fact that the amendment was to cure a mischief/abuse/defect of the Act. It was argued that those provisions have therefore to be interpreted to the extent necessary to suppress the mischief and advance the remedy. It was argued that when there are more than one record date, the record date nearest to the sale/redemption is to be considered as record date for applicability of sec. 94(7).

11. The CIT(A) firstly noticed that provisions of Sec. 94(7) of the Act were silent when there were two record dates between the date of purchase and sale of units. The CIT(A) held that the record date closest to the date of purchase should be taken as the record date in the case of the Assessee. The CIT(A) thereafter gave the following reasons for his conclusions as above:-

"6.1.2 More importantly, however, one needs to examine the issue from the point of view of the guiding principles enunciated in the mischief rule. In other words, the interpretation should be such as to suppress the mischief and advance the remedy. It is important, in my considered view, to examine the facts of the instant case holistically. In a nutshell, the appellant purchased a big block of about 38 lakh units on 15-09-2005 at a purchase price of Rs. 13.07 per unit. On Oct 28th, 2005, i.e., less than two months from purchase, a dividend of Rs. 0.80 per unit was declared and on 13-01-2006 another dividend of Rs. 1.20 per unit was declared. Within about a month of declaration of this latter dividend, the appellant redeemed all the units at a price of Rs. 12.38 per unit. To sum up, within a period of about five months, the appellant earned Rs. 2.00 per unit by virtue of tax-free dividend income and was also, on the basis of using the second date as the date of record, all set to set-off the short-term capital loss resulting from the redemption against other short-term gains. In my understanding, the fact of two possible record dates notwithstanding, this is a classic case of dividend stripping, and to allow a technicality such as what record date to use to allow the transaction to slip out of the net of S. 94(7) would be to defeat the purpose of the enactment. In terms of the mischief rule, it would tend to advance the mischief and defeat the remedy.

6.1.3 I am also of the view that the timing of purchase is hard to accept as being a mere coincidence. The appellant comes from a very successful business family and would, I assume, also have highly competent advisors advising her on her investment options. Stock markets were booming at the time and expecting a dividend on completion of six months of the financial year was not out of place. The two dividend declarations were a mere two and a half months apart. Considering the facts, there is every reason to treat the date of first dividend as the record date. In such circumstances, the transaction is squarely hit by the provisions of S. 94(7). In the light of the diktats of the mischief rule and also treating the first date of declaration of dividend as the record date, I am inclined to accept the stance taken by the AO in regard to the single point in issue. Consequently, Grounds 2 & 3 fail."

12. Aggrieved by the order of the CIT(A), the Assessee is in appeal before the Tribunal.

13. The learned counsel for the Assessee reiterated the plea of the Assessee as put forth before CIT(A). The learned DR relied on the order of the CIT(A).

14. We have considered the rival submissions. The CBDT in Circular No. 14, dated 22nd November, 2001 containing Explanatory Notes on the Provisions of the Finance Act, 2001 explains the above provisions thus :
"56. Measures to curb creation of short-term losses by certain transactions in securities and units

56.1 Under the existing provisions contained in section 94, where the owner of any securities enters into transactions of sale and re-purchase of those securities which result in the interest or dividend in respect of such securities being received by a person other than such owner, the transactions are to be ignored and the interest or dividend from such securities is required to be included in the total income of the owner.

56.2 The existing provisions did not cover a case where a person buys securities (including units of a mutual fund) shortly before the record date fixed for declaration of dividends, and sells the same shortly after the record date. Since the cum-dividend price at which the securities are purchased would normally be higher than the ex-dividend price at which they are sold, such transactions would result in a loss which could be set off against other income of the year. At the same time, the dividends received would be exempt from tax under section 10(33). The net result would be the creation of a tax loss, without any actual outgoings.

56.3 With a view to curb the creation of such short-term losses, the Act has inserted a new sub-section (7) in the section to provide that where any person buys or acquires securities or units within a period of three months prior to the record date fixed for declaration of dividend or distribution of income in respect of the securities or units, and sells or transfers the same within a period of three months after such record date, and the dividend or income received or receivable is exempt, then, the loss, if any, arising from such purchase or sale shall be ignored to the extent such loss does not exceed the amount of such dividend or interest, in the computation of the income chargeable to tax of such person.

56.4 Definitions of the terms "record date" and "unit" have also been provided in the Explanation after sub-section (7) of section 94.
56.5 This amendment will take effect from 1st April, 2002, and will, accordingly, apply in relation to the assessment year 2002-03 and subsequent years."

15. The provisions of Sec.94(7) of the Act are silent as to which record date is to be reckoned for applying those provisions when there are two record dates between the date of purchase and sale of units. It is the argument of the learned counsel for the Assessee that creation of short term loss is only due to the sale of the units and therefore it is only the record date that is closest to the date of sale that should be taken for the purpose of Sec. 94(7) of the Act. In this regard he relied on the CBDT Circular explaining the provisions of Sec. 94(7) of the Act which lays emphasis on "creation of short term loss". The argument of the Assessee is that it is the point of sale that creates a loss and therefore the record date that is closest to the date of sale should be taken for the purpose of Sec. 94(7)(a) of the Act. The learned counsel for the Assessee has laid emphasis on adopting the "mischief rule" of interpretation, which would advance the Assessee's plea. We do not wish to go into the arguments on the applicability of the "mischief rule" as application of that rule in favour of the assessee or the revenue (as held by the CIT(A) in his order) can equally be justified by both of them. We also do not agree with the observations of the CIT(A) regarding the timing of purchase not being a mere coincidence because the Assessee comes from a very successful business family and would have had highly competent advisors advising her on her investment options. These factors in our view would be irrelevant for deciding the controversy. We would therefore go by the plain words of the section. The provisions of Sec. 94(7) of the Act prescribe a minimum holding period of units from the date of purchase to the date of sale. The Section i.e., Sec. 94(7)(a) starts with date of purchase of units and fixes that date as a date three months prior to the record date. It therefore follows that the first record date should alone be considered. Sec. 94(7)(b) then fixes the date on which the units purchased should not be sold and that date is fixed with reference to the record date applicable to Sec. 94(7)(a). The argument of the learned counsel for the Assessee to the effect that when there are more than one record date, the record date nearest to the sale/redemption is to be considered as record date for applicability of Sec. 94(7) cannot therefore be accepted on a plain reading of the section. For the reasons given above, we confirm the order of the CIT(A) and dismiss the appeal of the Assessee.

16. In the result the appeal is dismissed.