Transaction within four corners of law can be treated as “sham” & “colourable device” by looking at “human probabilities”

Killick Nixon Ltd vs. DCIT (Bombay High Court)

In AY 2000-01 the assessee borrowed Rs. 48 crores from the G. K. Rathi group and used that to buy shares in three 100% subsidiary companies. Though the fair value of the shares was Rs. 24, the assessee paid Rs. 150 for each share. The amount received by the said subsidiary companies was transferred back to another company of the G.K. Rathi group. In AY 2001-02, the said shares were sold for Rs. 5 each and a short-term capital loss was claimed and this was set-off against other long-term capital gains. The AO, CIT (A) & Tribunal (order attached) rejected the transaction of investment into, and sale of, shares as a sham. On appeal by the assessee, HELD dismissing the appeal:

 Whenever there are reasons to believe that the apparent is not real; then the taxing authorities are entitled to look into surrounding circumstances to find out the reality and apply the test of human probabilities. The judgement of the Supreme Court in Vodafone International vs. UOI makes it clear that a colourable device cannot be a part of tax planning. Where a transaction is sham and not genuine, it cannot be considered to be a part of tax planning or legitimate avoidance of tax liability. It was clarified that there is no conflict between McDowell 154 ITR 148 (SC), Azadi Bachao Andolan 263 ITR 706 (SC) & Mathuram Agarwal. On facts, as the purchase and sale of shares was found to be a sham, the loss cannot be allowed (Sumati Dayal 214 ITR 801 (SC) followed)

Contrast with Azadi Bachao 263 ITR 706 (SC) where it was held that the “motive” of the transaction could not be examined & Wallfort Shares where “dividend stripping loss” was upheld.