(2010) 326 ITR 1 (SC)
Expenditure relating to exempt income; avoidance of tax by certain transactions in securities
No. The loss was real and arose on an actual transaction. The disallowance for expenditure relating to exempt income does not reach a loss on sale, and the court will not supply an anti-avoidance provision the legislature has not enacted.
Where a taxpayer buys mutual fund units cum-dividend, receives a tax-free dividend and sells the units ex-dividend at a loss, may the loss be disallowed in the absence of a provision saying so?
The assessee purchased units of a mutual fund shortly before the record date at a price that reflected the dividend about to be declared. It received the dividend, which was exempt from tax, and then sold the units shortly afterwards at the reduced ex-dividend price, realising a loss roughly equal to the dividend received. It claimed that loss in computing its business income. The Revenue disallowed it, contending that the loss was in substance the cost of obtaining exempt income and fell within the provision disallowing expenditure incurred in relation to income not forming part of total income. The transaction took place before the specific provision addressing dividend stripping was enacted.
The Tribunal and the Bombay High Court decided in the assessee's favour. The Revenue appealed to the Supreme Court, which affirmed and examined the scope of the disallowance provision as well as the significance of the later anti-stripping amendment.
For the assessee
The disallowance provision speaks of expenditure incurred in relation to exempt income. A loss suffered on the sale of an asset is not expenditure; it is the result of a real purchase and a real sale at market prices. The price paid for the units was for the units themselves, not for the dividend, and the whole of it was applied in acquiring a capital asset that was subsequently sold.
For the Revenue
Viewed commercially, the assessee laid out money and got back the same money in two parts — an exempt dividend and a reduced sale price. The loss is the price of obtaining the exempt dividend and is expenditure in relation to it. Allowing the loss lets the taxpayer convert exempt income into a deduction.
The Court held that the disallowance provision is directed at expenditure, and that the words used cannot be stretched to cover a loss arising on the sale of an asset. Expenditure implies a paying out or away of money; the assessee had paid for units and received units, and the subsequent fall in their value on going ex-dividend produced a loss, not an outgoing referable to the dividend. The Court further held that the purchase price was applied wholly to acquiring the units, and that it could not be dissected into a component attributable to the dividend and a component attributable to the units themselves. On the wider point, the Court observed that Parliament had subsequently enacted a specific provision to deal with dividend stripping, restricting the loss to the extent of the exempt dividend, and that the enactment of that provision was itself an indication that no such restriction existed before. Where the legislature has identified a form of avoidance and legislated against it prospectively, the court will not achieve the same result for earlier years by straining the language of a different provision. The loss was accordingly allowable.
The reason the specific anti-stripping rule exists, now in Section 175 of the IT Act 2025, with the exempt income disallowance in Section 14. Its wider importance is as the counterpoint to a general anti-avoidance rule: for as long as India relied on specific provisions alone, a form of avoidance not yet legislated against succeeded, and the courts declined to fill the gap. That limitation is what the general rule in Sections 178 to 184 was designed to overcome, and Ayodhya Rami Reddy Alla shows the general rule being used to reach precisely the kind of stripping arrangement a specific provision had left uncovered.