Reassessment Initiated Under Section 69A Quashed As Assessee Did Not Knowingly Participate In Fictitious Loss Scheme

“12. The Hon’ble Bombay High Court in case of Karan Maheshwari (supra) in similar facts has held as under.

“11. Mr. Gautam Thacker contended that firstly, petitioner cannot be held to be responsible for any transaction or violation of law by JM Financial. Petitioner was merely an investor in the mutual fund and had neither any control nor any knowledge of any activities, illegal, or otherwise being conducted by JM Financial. It is not even so alleged in the notice. Secondly, petitioner had made investments through banking channels that are reflected in its books of account and there is no reason to believe the same to be anything less than genuine. Thirdly, the notice and the order, impugned herein, are based merely on information allegedly received from the DDIT (Inv)- 3(1), Mumbai, and petitioner’s implication in the matter is purely based on conjectures and surmises. Fourthly, the information provided in the notice is ambiguous and does not establish any live link with evidence that income of assessee has escaped assessment. Lastly, the jurisdictional pre-conditions have not been satisfied, rendering the reassessment proceedings, illegal and bad in law. Mr. Thacker thus, seeks quashing of the notice and order impugned herein.

12. Mr. Singh defended the reopening of assessment by placing the onus of demonstrating that the dividend income and capital loss shown in his income tax return from the investment made in JM Financial Mutual Fund is not a result of a sham transaction undertaken by the said JM Financial Mutual Fund completely on petitioner. Mr. Singh contended that the information available with the Assessing Officer is in light of the findings from the survey action under Section 133A of the Act on JM Financial. Mr. Singh further stated that petitioner is not eligible to claim exempt dividend income under Section 10(35) of the Act and also not eligible to adjust the fictitious, short-term capital loss against the long-term capital gains, being generated on account of sham transactions by JM Financial. The thrust of Mr. Singh’s argument revolves around the sham transactions and illegalities allegedly committed by JM Financial. Mr. Singh draws our attention to paragraph 7.4 of the impugned order which contains statements of Mr. Chhabria, the Fund Manager, Mr. Suvendra Rakshit, the Head of Sales Team, Mr. Deepan Doshi, the Institutional Sales Head, and Mrs. Diana D’sa, the Compliance Head of JM Financial. All these persons, according to Mr. Singh, have admitted that the due process mandated by SEBI has not been followed by JM Financial. Mr. Singh urged to dismiss the petition.

13. It is necessary to observe that the officer has conveniently not mentioned the date on which he received the information because the earlier notice for reopening on the basis of dividend earned by petitioner was issued on 2nd June 2021 and closed on 26th July 2022. We should note that the notice now issued also does not indicate when the information was uploaded and when the Income Tax Department flagged the information under high risk CRIU/VRU information.

Admittedly, petitioner had sought various documents from the department. Without providing any information as requested, the impugned order was passed. Surprisingly, the Assessing Officer has relied upon information which has not been made available to petitioner. Petitioner has admittedly been found blameworthy of acts which he has not been permitted to defend on merits. Petitioner was not given an opportunity to meet and explain his actions based on information withheld from him on one hand but used against him on the other.

14. Without providing any information, as sought for by petitioner, the impugned order dated 30th September 2022 under Section 148A(d) of the Act has been passed. In the order, things which have not been made available to petitioner has been relied upon.

15. It is the contention of department that between 23 rd April 2015 and 15th June 2015 the mutual fund received an inflow of Rs.19.18 Crores. Thereafter between 15th June 2015 and 18th June 2015 there was an inflow of Rs.2719.33 Crores in the mutual fund. Between 20 th June 2015 to 27th December 2015 a further inflow of Rs.2259.28 Crores was made in the mutual fund and between 28 th December 2015 to 30th June 2016 there was a further inflow of Rs.4698.28 Crores into the mutual fund. In this, petitioner’s investment was only Rs.1,10,00,000/- on 17 th June 2015 and Rs.6,00,00,000/- on 25th August 2015.

16. It is thus clear that petitioner is only a small fry in the larger scheme of things and in fact himself a victim of the alleged fraud of JM Financial and again being victimised by the Assessing Officer. Even in the order where it is mentioned that statement of the key management personnel of the mutual fund was recorded, there is nothing to indicate that petitioner was part of the alleged sham mutual fund. Infact in paragraph 7.4 of the impugned order referred to by Mr. Singh, in the statement of Mr. Suvendu Rakshith, it is recorded that the sales team had been passing on the hints to the distributors about the prospective dividend distribution, much in advance, “to lure” the prospective clients. Admittedly petitioner was not a distributor and was only a client.

17. In the notice issued under Section 148A(b) of the Act, it is alleged that petitioner was one of the persons who claimed fictitious short term capital loss. There is nothing in the notice to indicate on what basis it is alleged that the short term capital loss claimed was fictitious. Petitioner had, based on public announcement, invested in the mutual fund. The fact that petitioner received tax free dividend fund cannot be held against petitioner. The fact that petitioner had suffered a loss also cannot be held against petitioner. Even assuming that the transaction was pre-planned, there is nothing to impeach the genuineness of the transaction. Petitioner was free to carry on his business which he did within the four corners of law. Mere tax planning without any motive to evade taxes through colourable devices is not frowned upon even by the judgment of the Apex Court in McDowell & Co. Ltd. V/s. Commercial Tax Officer. Paragraphs 18 and 20 of the judgment of the Apex Court in Commissioner of Income Tax, Mumbai V/s. Walfort Share & Stock Brokers (P). Ltd. read as under :

18. The next point which arises for determination is whether the “loss” pertaining to exempted income was deductible against the chargeable income. In other words, whether the loss in the sale of units could be disallowed on the ground that the impugned transaction was a transaction of dividend stripping. The AO in the present case has disallowed the loss of Rs. 1,82,12,862 on the sale of 40% tax-free units of the mutual fund. The AO held that the assessee had purposely and in a planned manner entered into a pre- meditated transaction of buying and selling units yielding exempted income with the full knowledge about the guaranteed fall in the market value of the units and the payment of tax-free dividend, hence, disallowance of the loss.

\20. The real objection of the Department appears to be that the assessee is getting tax-free dividend; that at the same time it is claiming loss on the sale of the units; that the assessee had purposely and in a planned manner entered into a pre-meditated transaction of buying and selling units yielding exempted dividends with full knowledge about the fall in the NAV after the record date and the payment of tax- free dividend and, therefore, loss on sale was not genuine. We find no merit in the above argument of the Department. At the outset, we may state that we have two sets of cases before us. The lead matter covers assessment years before insertion of Sectopm 94(7) vide Finance Act, 2001 w.e.f. 1.4.2002. With regard to such cases we may state that on facts it is established that there was a “sale”. The sale-price was received by the assessee. That, the assessee did receive dividend. The fact that the dividend received was tax-free is the position recognized under Section 10(33) of the Act. The assessee had made use of the said provision of the Act. That such use cannot be called “abuse of law”. Even assuming that the transaction was pre-planned there is nothing to impeach the genuineness of the transaction. With regard to the ruling in McDowell & Co. Ltd. v. Commercial Tax Officer [154 ITR 148(SC)], it may be stated that in the later decision of this Court in Union of India v. Azadi Bacho Andolan [263 ITR 706(SC)] it has been held that a citizen is free to carry on its business within the four corners of the law. That, mere tax planning, without any motive to evade taxes through colourable devices is not frowned upon even by the judgment of this Court in McDowell & Co. Ltd.’s case (supra). Hence, in the cases arising before 1.4.2002, losses pertaining to exempted income cannot be disallowed. However, after 1.4.2002, such losses to the extent of dividend received by the assessee could be ignored by the AO in view of Section 94(7). The object of Section 94(7) is to curb the short term losses. Applying Section 94(7) in a case for the assessment year(s) falling after 1.4.2002, the loss to be ignored would be only to the extent of the dividend received and not the entire loss. In other words, losses over and above the amount of the dividend received would still be allowed from which it follows that the Parliament has not treated the dividend stripping transaction as sham or bogus. It has not treated the entire loss as fictitious or only a fiscal loss. After 1.4.2002, losses over and above the dividend received will not be ignored under Section 94(7). If the argument of the Department is to be accepted, it would mean that before 1.4.2002 the entire loss would be disallowed as not genuine but, after 1.4.2002, a part of it would be allowable under Section 94(7) which cannot be the object of Section 94(7) which is inserted to curb tax avoidance by certain types of transactions in securities. There is one more way of answering this point. Sections 14A and 94(7) were simultaneously inserted by the same Finance Act, 2001. As stated above, Section 14A was inserted w.e.f. 1.4.1962 whereas Section 94(7) was inserted w.e.f. 1.4.2002. The reason is obvious. Parliament realized that several public sector undertakings and public sector enterprises had invested huge amounts over last couple of years in the impugned dividend stripping transactions so also declaration of dividends by mutual fund are being vetted and regulated by SEBI for last couple of years. If Section 94(7) would have been brought into effect from 1.4.1962, as in the case of Section 14A, it would have resulted in reversal of large number of transactions. This could be one reason why the Parliament intended to give effect to Section 94(7) only w.e.f. 1.4.2002. It is important to clarify that this last reasoning has nothing to do with the interpretations given by us to Sections 14A and 94(7). However, it is the duty of the court to examine the circumstances and reasons why Section 14A inserted by Finance Act 2001 stood inserted w.e.f. 1.4.1962 while Section 94(7) inserted by the same Finance Act as brought into force w.e.f. 1.4.2002. (emphasis supplied)

18. It is settled law that the reasons for the formation of the belief that there has been escapement of income must have a rational connection with or relevant bearing on the information. Rational connection postulates that there must be a direct nexus or live link between the material coming to the notice of the Income Tax Officer and his view that there has been escapement of income of the assessee from assessment in the particular year. It is settled law that it is not any and every material, howsoever vague and indefinite or distant, remote and far-fetched which would suggest escapement of the income of the assessee from assessment. The powers of the Income Tax Officer to reopen assessment, though wide, are not plenary. The Act, no doubt, contemplates the reopening of the assessment if grounds exist for believing that income of the assessee has escaped assessment. The live link or close nexus should be there between the information before the Income Tax Officer and the belief which he has to prima facie form an opinion regarding the escapement of the income of the assessee. The relevant paragraphs of Income Tax Officer V/s. Lakhmani Mewal Das read as under :

As stated earlier, the reasons for the formation of the belief must have a rational connection with or relevant bearing on the formation of the belief. Rational connection postulates that there must be a direct nexus or live link between the material coming to the notice of the Income-tax Officer and the formation of his belief that there has been escapement of the income of the assessee from assessment in the particular year because of his failure to disclose fully and truly all material facts. It is no doubt true that the court cannot go into the sufficiency or adequacy of the material and substitute its own opinion for that of the Income-tax Officer on the point as to whether action should be initiated for reopening assessment. At the same time we have to bear in mind that it is not any and every material, howsoever vague and indefinite or distant, remote and far-fetched, which would warrant the formation of the belief relating to escapement of the income of the assessee from assessment. The fact that the words “definite information” which were there in section 34 of the Act of 1922 at one time before its amendment in 1948 are not there in section 147 of the Act of 1961 would not lead to the conclusion that action cannot be taken for reopening assessment even if the information is wholly vague, indefinite, far-fetched and remote. The reason for the formation of the belief must be held in good faith and should not be a mere pretence.

The powers of the Income-tax Officer to reopen assessment though wide are not plenary. The words of the statute are “reason to believe” and not “reason to suspect”. The reopening of the assessment after the lapse of many years is a serious matter. The Act, no doubt, contemplates the reopening of the assessment if grounds exist for believing that income of the assessee has escaped assessment. The underlying reason for that is that instances of concealed income or other income escaping assessment in a large number of cases come to the notice of the income-tax authorities after the assessment has been completed. The provisions of the Act in this respect depart from the normal rule that there should be, subject to right of appeal and revision, finality about orders made in judicial and quasi- judicial proceedings. It is, therefore, essential that before such action is taken the requirements of the law should be satisfied. The live link or close nexus which should be there between the material before the Income-tax Officer in the present case and the belief which he was to form regarding the escapement of the income of the assessee from assessment because of the latter’s failure or omission to disclose fully and truly all material facts was missing in the case. In any event, the link was too tenuous to provide a legally sound basis for reopening the assessment. The majority of the learned Judges in the High Court, in our opinion, were not in error in holding that the said material could not have led to the formation of the belief that the income of the assessee respondent had escaped assessment because of his failure or omission to disclose fully and truly all material facts. We would, therefore, uphold the view of the majority and dismiss the appeal with costs. (emphasis supplied)

It is also trite law that while the Court cannot investigate into the adequacy or sufficiency of the reasons, which have weighed with the Income Tax Officer in coming to the belief, the Court can certainly examine whether the reasons are relevant and have a bearing on the matter in regard to which the Assessing Officer is required to entertain the belief before he can issue notice under Section 148 of the Act. If there is no rational or intelligible nexus between the reasons and the belief, the exercise undertaken by the Income Tax Officer can be interfered with.

19. In the notice issued under Section 148A(b) of the Act, the Assessing Officer alleges that JM Financial had manipulated accounting methodology so as to artificially inflate the distributable surplus and the investors, in order to reduce their tax liability, entered into these sham transactions and received dividend and short term capital loss. These are allegations against JM Financial and do not implicate petitioner in any manner. There is nothing to indicate that petitioner had participated knowingly in a sham transaction to reduce his tax liability or to earn dividend or book short term capital loss. Infact in the notice, in the first paragraph, it says II In the course of survey, it was found that JM Balanced Fund-Annual Dividend Option Regular Scheme (the Plan) of JM Financial had manipulated accounting methodology so as to artificially inflate the distributable surplus …….

In the next paragraph, it says II investors, in order to reduce their tax liability, entered into these sham transactions and received dividend and short term capital loss ….. ….. …..

In the next paragraph, it says II the assessee is one of the beneficiaries, who have received dividend and claimed fictitious losses in equity / derivative trading in JM Equity Hybrid Fund-Quarterly Dividend of JM Financial Asset Management Limited, to the tune of Rs.3,41,12,651/- during the F.Y. 2015-16 relevant to the A.Y. 2016-17 ……

Therefore, the Assessing Officer is also not clear whether the assessee had booked loss or claimed dividend in the JM Balanced Fund – Annual Dividend Option Regular scheme or JM Equity Hybrid Fund- Quarterly Dividend. This also indicates non application of mind by the Assessing Officer.

20. For all these reasons above, notice dated 20 th August 2022 under Section 148A(b) of the Income Tax Act, 1961 (the Act), order dated 30th September 2022 under Section 148A(d) of the Act and notices dated 30th September 2022 and 7th October 2022 under Section 148 of the Act are hereby quashed and set aside.”

13. On perusal of the above decision of the Bombay High Court rendered in the similar facts of transactions for violation of law by JM Financial, the respondent- Assessing Officer could not have assumed the jurisdiction for reopening the assessment and adopting the same reasoning as per the aforesaid decisions, we are also of the opinion that the impugned notice as well as order are required to be quashed and set aside.

14. Accordingly, impugned notice dated 10/03/2022 issued under Section 148A(b) of the Income Tax Act, 1961 (for short, ‘the Act’) and the order dated 06/04/2022 passed under Section 148A(d) of the Act and the notice issued under Section 148 of the Act of the even date are quashed and set aside. Rule is made absolute to the aforesaid extent. No order as to costs.”

8. The aforesaid decision has become final. The respondent is unable to dispute the applicability of the same in case of the petitioner. Moreover, in the scrutiny assessment under Section 147 of the Act, the petitioner was confronted with the very same issue relating to short term capital loss in relation to J.M.Balance fund, and after considering the explanation of the petitioner, an order under Section 143(3) of the Act was passed. Hence, the reopening is premised on change of opinion, since it is not shown by the revenue that it was in possession of any fresh tangible material other than the one, which was examined during the scrutiny assessment. On this count also the reopening of the assessment deserves to be quashed. Hence, the impugned order passed under Section 148A(d) of the Act dated 22.03.2023 along with a notice issued under Section 148 of the Act dated 22.03.2023 for A.Y.2016- 17 are quashed and set aside. Rule is made absolute to the aforesaid extent.”