A brief history
The question of substance over form has been a recurring theme in the interpretation of taxation laws. Indian judicial decisions have taken divergent approaches, where some courts in certain circumstances have held that the legal form of transactions can be dispensed with and the real substance of transaction can be considered while applying the taxation laws, whereas the others have held that form is to be given sanctity.
The foundation of anti-avoidance principles in India rests largely on judicial pronouncements. Although certain specific anti-avoidance provisions (like transfer pricing provisions) exist in the Income-tax framework, the concept of general anti-avoidance had, until recently, evolved solely through precedents.
To safeguard the tax base against erosion through aggressive tax planning, especially with the increasing usage of sophisticated structures and low-tax jurisdictions, the need to statutorily codify the doctrine of substance over form was recognised and the General Anti-Avoidance Rules (‘GAAR’) were introduced in India through the Finance Act, 2012. The intent was to ensure that tax consequences reflect the real purpose, effect, and intent of an arrangement, rather than its superficial legal structure.
However, this framework is not devoid of challenges. One of the major global criticisms of GAAR is the broad discretionary power it confers upon the tax authorities, which at times is prone to be misused, because of which several questions continue to spark debate even years after the introduction of Chapter XA embodying the GAAR provisions. Where does legitimate tax planning end and tax avoidance begin? Can GAAR be invoked even when a Specific Anti-Avoidance Rule (‘SAAR’) applies? The line, though drawn in law, often blurs in practice.
Recent developments in the applicability of GAAR
This framework of GAAR has recently seen its application tested by the Telangana High Court through two consequential, yet contrasting, rulings. These judgments in the case of Ayodhya Rami Reddy Alla v. PCIT[1] and Smt. Anvida Bandi v. DCIT[2] have provided a long-awaited clarity on the demarcation between an aggressive, artificial tax avoidance scheme and legitimate, albeit strategically timed, investment activities. The core takeaway from this emerging jurisprudence is that while contrived arrangements lacking commercial substance will be struck down by the overarching power of GAAR, the mere timing of a genuine transaction on a public exchange will not automatically trigger its severe provisions.
A classic case of artificial loss: GAAR to apply
The Hon’ble Telangana High Court’s judgment in the case of Ayodhya Rami Reddy Alla (supra), marks the beginning of the judicial analysis of the complex interplay between GAAR and SAAR. The judgment dealt with a complex series of intra-group transactions involving a technique known as bonus stripping of shares and the write-off of an inter-corporate deposit.
The tax authority’s scrutiny revealed a meticulous sequence of events: the taxpayer acquired shares in a group company, immediately prompted a bonus issue to drastically reduce the per-share value, and then sold the original shares to another related entity at the reduced price, thereby generating a massive Short-Term Capital Loss (STCL). This loss was then set off against Long-Term Capital Gains, significantly reducing the tax liability.
It was also observed that the entire arrangement also involved round-tripping of funds, as the purchaser of the shares (Advisory Services Private Limited or ‘ADR’) did not utilize its own resources but instead received funds from a related group company, M/s. Oxford Ayyapa Consulting Services India Private Limited. These funds were subsequently rotated within the group through internal transfers, demonstrating that the transaction lacked commercial substance.
The tax authorities therefore contended that the entire arrangement, including the share sale and subsequent circular funding (round-tripping), lacked commercial substance and was an Impermissible Avoidance Arrangement (‘IAA’) under the GAAR.
The assessee argued that the transaction, which amounted to bonus stripping, should be governed by the specific anti-avoidance provision under Section 94(8) of the Income Tax Act, 1961 (‘IT Act’). Consequently, it was argued that for the relevant AY 2019-20, since Section 94(8) was explicitly applicable only to units of mutual funds and not to shares, the loss becomes available for the benefit of set off and carry forward. Therefore, the assessee has placed reliance on the legal principle Generalia specialibus non derogant (general law does not abrogate special law) and argued that what the specific rule (SAAR) excluded could not be covered by the general rule (GAAR).
In the present facts, the Hon’ble Court has held that the present transaction lacked commercial substance as the series of transactions were carried out solely with a view to reduce the tax liability, and there was no commercial justification for the same. Hence, the reference u/s 144BA for determining whether the transaction in question qualified to be an impermissible avoidance arrangement (IAA) or not, was valid. However, in doing so, the Hon’ble Court went on to observe that GAAR is merely a structural codification of the traditional Judicial Anti-Avoidance Rules (‘JAAR’) that were previously in vogue; but JAAR, was solely aimed at tackling colourable devices, i.e., transactions that are one thing in substance but coloured in a different legal form, with the sole intent to evade taxes; purely genuine transactions done within the four walls of the law to achieve tax efficiency or reduce tax impact were not within the purview of JAAR, and generally not targeted.
The Hon’ble High Court also dismissed the petitioner’s argument that the SAAR should override GAAR, and clarified the vexed GAAR vs. SAAR debate, holding that GAAR, a later-enacted provision with a non-obstante clause, has an overriding effect and can be applied to an arrangement that is clearly abusive, even if an existing SAAR like Section 94(8) dealing with bonus stripping of units and securities, did not technically cover share transactions at that time.
It is pertinent to note that Section 94(8) of the IT Act was amended vide the Finance Act, 2023, to explicitly include bonus stripping even in respect of shares. This amendment suggests that during the relevant period, the government sought to specifically target such transactions, rather than relying on a broad, generalized framework like the GAAR. Had GAAR alone been sufficient to cover these transactions, the amendment to Section 94(8) would likely not have been necessary. This crucial nuance, that the subsequent legislative amendment to Section 94(8) reflects the government’s intent to address bonus stripping in shares through a SAAR rather than through GAAR, thereby implying that such transactions may not have fallen within GAAR’s scope at the relevant time was, however, not adequately considered by the High Court in its judgment.
Given that Section 94(8) constitutes a SAAR, its existence, and more significantly, its subsequent amendment, indicates that the blanket application of GAAR to bonus stripping transactions during the pre-amendment period may not have been appropriate. This is particularly significant in light of the Shome Committee Report[3], which clearly recommended that where a SAAR exists, GAAR should not ordinarily be invoked, the underlying principle being that GAAR should not override or operate parallel to a SAAR.
A case of the genuine market transaction: Out of GAAR’s purview
In the case of Smt. Anvida Bandi (supra), the taxpayer, a regular investor, filed a writ petition challenging the directions issued by the Approving Panel under Section 144BA(6) of the IT Act. The case pertained to Assessment Year 2020-21, wherein the assessee sold certain investments in an unlisted company, generating long-term capital gains (LTCG). Subsequently, the assessee incurred a STCL on the sale of listed equity shares and sought to set off this STCL against the LTCG.
During the assessment proceedings, the Assessing Officer referred the matter under Section 144BA, and the Approving Panel concluded that the transaction resulting in the STCL constituted an IAA on the basis that it had been undertaken solely to claim the tax set-off. The assessee challenged this finding, arguing that there was no arrangement with any counterparty, all trades were executed through recognised stock exchanges, and full disclosures had been made in her return of income. Reliance was also placed on the Shome Committee Report, which expressly noted that GAAR should not apply to regular stock market transactions.
While not explicitly recorded in the judgment, it appears that HCL Technologies declared a bonus issue during the relevant period, which led to a fall in share prices. The assessee subsequently sold the original shares post-bonus, incurring a significant short-term capital loss, a hallmark of classic bonus stripping. Nonetheless, the Hon’ble High Court allowed the writ petition, holding that the Revenue had failed to establish that the transaction met the conditions under Section 96(1) of the Act to qualify as an IAA. Importantly, the Court accepted that these were genuine market transactions and therefore fell outside the scope of GAAR.
The fact that the transaction in Anvida Bandi (supra) was executed through the stock exchange (unlike in Ayodhya Rami Reddy Alla (supra) where the transaction was carried out off the market), was a key factor for the Court to conclude that the transaction failed to qualify as an IAA despite the underlying facts (particularly with respect to bonus stripping ) being quite similar in both these judgements.
It is important to recognise that not every instance of bonus stripping, especially those carried out prior to the amendment to Section 94(8) of the IT Act, amounts to a transaction lacking commercial substance. With the growing market for unlisted securities, a more nuanced analysis i.e., one that considers the broader context and intent, is required for determining whether the transaction is an IAA or not. Mere fact that a tax efficient share trading is carried out off the market should not ipso facto result in the same being treated as an IAA.
It is a settled principle that taxpayers are entitled to structure their affairs in a tax-efficient manner. The mere availability of a tax benefit should not automatically render a transaction devoid of commercial substance. Loss generation through bonus stripping may lack substance when examined in isolation, but the larger context, such as the overall investment strategy and market risks, must also be considered. Legal provisions allowing the set-off of genuine losses and exemptions exist to be utilised, and their lawful use should not attract penal consequences.
In conclusion, while it is possible that a bonus stripping transaction may, in certain cases, be viewed as lacking commercial substance, the application of GAAR must be undertaken with care and a holistic view of the transaction. The objective should be to curb abusive practices, not to penalise legitimate tax planning. A nuanced and balanced application of anti-avoidance rules is therefore essential to ensure legal certainty and to protect bona fide investors from unwarranted litigation.
[The authors are Senior Associate and Associate Director, respectively, in Direct Tax practice at Lakshmikumaran & Sridharan Attorneys, Chennai]
[1] Ayodhya Rami Reddy Alla v. PCIT (Central) [[2024] 163 taxmann.com 277 (Telangana)]
[2] Smt. Anvida Bandi v. DCIT [[2025] 177 taxmann.com 726 (Telangana)]
