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First judgment on GAAR holds bonus-stripping to be an impermissible tax-avoidance arrangement

The provisions of General Anti-Avoidance Rules (“GAAR”) were implemented into Income Tax Act, 1961 (“IT Act”), for the first time with effect from the financial year 2017–18. The GAAR provisions provide the Indian Revenue Authorities (“IRA”) with wide powers, including even recharacterising a transaction, ignoring a part or the whole of a series of transactions, disallowing expenses incurred, etc., if the main purpose of the transaction was to obtain tax benefits. Considering the aggressive nature in which the IRA generally scrutinises the GAAR cases, the industry is always apprehensive that these GAAR provisions could be invoked in a wide-spread manner. However, much to the relief of the taxpayers, the IRA have rarely invoked these provisions.

Seven years since the implementation of GAAR provisions, the Telengana High Court recently dealt with one of the first GAAR provision-related cases.[1] The Court held that the scheme of transactions a taxpayer had undertaken was tantamount to impermissible tax avoidance arrangements. The IRA had alleged that the taxpayer had undertaken a “bonus stripping” transaction, where shares were issued to the taxpayer as bonus shares in the ratio of 5:1 before being transferred to another company, allegedly for the sole purpose of claiming tax losses.


The taxpayer and another sister concern (“XYZ”) were allotted shares of ABC at INR 115 per share. Within a few days, the taxpayer purchased the remaining shares from XYZ. Immediately after the said acquisition, ABC declared bonus in the ratio of 5:1 and on account of the same, the value of shares reduced to INR 19.20 from INR 115. Thereafter, in another 10 days from the said bonus issuance, the taxpayer sold such shares to another entity (“PQR”) and claimed a short-term capital loss of INR 4,620 million. Considering XYZ funded the purchase consideration of PQR, the Court held that this was round-tripping of funds because the consideration that the taxpayer had initially paid XYZ was then routed back to the taxpayer through PQR.

The taxpayer contended that GAAR provisions should not be invoked when the transaction is covered under the Specific Anti-Avoidance Rules (“SAAR”) under the IT Act. It submitted that Section 94(8) of the IT Act specifically prevented taxpayers from claiming losses arising on account of bonus stripping (i.e., sale of shares immediately after the bonus issuance for the purposes of claiming losses), but the said provision restricts its scope to mutual funds[2] and does not extend to shares. Therefore, the taxpayer claimed that since the legislature had specifically excluded the applicability of bonus-stripping-related provisions to shares from the ambit of SAAR provisions, the IRA could not attempt to prevent the losses arising from a bonus-stripping under GAAR provisions. The taxpayer relied on the observations made by the Shome Committee, which was constituted to finalise the guidelines for GAAR provisions. The committee had specifically recommended not invoking GAAR provisions where SAAR provisions were applicable.


The Court, however, brushed aside the taxpayer’s arguments by holding that since GAAR provisions begin with a non-obstante clause, it should override all the other provisions. It further held that while Section 94(8) of the IT Act could apply to issuance of bonus shares in an underlying commercial substance, it would not apply to the instant case because the entire scheme was designed primarily to bypass tax obligations. The Court supplemented its position by referring to the Finance Minister’s speech while introducing the GAAR provisions, which had clarified that the applicability of GAAR or SAAR would be determined on a case-to-case basis.

The Court also held that the judiciary had already established principle of “substance over form” much before the introduction of GAAR provisions, essentially to uncover misleading structures or transactional arrangements that lacked real commercial substance. It relied on the Supreme Court’s landmark decision in the Vodafone International Holdings B.V[3] case to hold that business intent behind a transaction could serve as a strong piece of evidence to determine whether it was a deceptive or artificial arrangement. The Court concluded that colourable devices could not be a part of tax planning and the facts of the instant case clearly established that the taxpayer had undertaken impermissible tax avoidance arrangements.

Significant Takeaways

With the tax authorities expected to become more aggressive, it is imperative for taxpayers to be extremely careful while bringing out the business exigencies of such transactions. At the same time, it is also hoped and expected that the IRA will not treat the rationale of this case as precedent to apply GAAR provisions in legitimate mergers and acquisitions. It is also worthwhile to note that the courts are increasingly analysing the transactions on a holistic basis and desist from deciding cases in favour of taxpayers purely on technical grounds. Often, tax considerations become a major factor while choosing between one form of transaction vis-à-vis another. However, with new ammunition and sophisticated tools and knowledge being made available to the tax administrators, it is imperative for the taxpayers to capture and record in an appropriate manner the underlying commercial rationale behind every transaction,  especially when there are tax advantages, so that tax administrators do not challenge such transactions by invoking the GAAR principles.

[1] W.P No 46510/ 2022 dated June 07, 2024.

[2] With effect from FY 2022-23, the scope of section 94(8) is expanded to shares and securities as well.

[3] 341 ITR 1