ANANYA FINANCE FOR INCLUSIVE GROWTH PVT.LTD.,,AHMEDABAD vs. DY.COMMISSIONER OF INCOME TAX,CIRCLE-1(1)(2),, AHMEDABAD

Grounds of appeal raised by the assessee are as under:

As is evident from the grounds, there are two issues raised by the assessee in the present appeal viz.

Brief background of the case, leading to the impugned disallowance of depreciation, is that during the impugned year the assessee had claimed deprecation of Rs.7.58 crores on addition of Rs.30.32 crores under the head intangible assets. During assessment proceedings it transpired that the intangible assets pertained to know-how, acquired by the assessee under a Business Transfer Agreement (BTA) entered into with a trust viz. Friends of Women’s World Banking (FWWB for short), for transfer of its Micro Finance Division (MFD for short) to the assessee. As per the BTA the entire consideration paid for transfer was Rs.45 crores out of which Rs.14.68 crores related to the net value of the business and remaining Rs.30.32 crores was paid for intangible assets acquired. During assessment proceedings the Assessing Officer (AO) asked the assessee to justify and substantiate the acquisition of any intangible assets as such by way of the BTA, to justify and substantiate its valuation and accordingly also the claim of depreciation on it. Due replies were filed by the assessee, after considering which the AO denied the claim of depreciation, finding no intangible assets as such to have been acquired by the assessee, and even if acquired, it was found over-valued with no basis for valuation being given by the assessee. The AO held the entire arrangement of acquisition of business of Micro Finance Division of FWWB by the assessee, which was noted to be with a related party of the assessee, as being with the only purpose of the assessee claiming depreciation and FWWB not paying any taxes on the capital gain; thus, claiming depreciation and avoiding any payment of taxes

We have heard both the parties.

Before proceeding to adjudicate the issue, it is pertinent to outline certain relevant facts relating to the issue which are not disputed before us.

As is revealed from the order of the authorities below and also from the documents filed before us in a paper book ,there are three entities which are closely involved in the impugned transaction of acquiring business of Micro Finance Lending by the assessee which has resulted in acquisition of intangible asset on which depreciation of Rs.7.58 Crs has been claimed by the assessee . The entities are –

The involvement of the three entities is on account of: • the Business Transfer Agreement resulting in acquisition of intangible assets by the assessee, being between the assessee and Friends For Women’s World Bank ( FWWB) for acquiring its business relating to lending and investment to Micro Finance Institutions for on lending small value micro loans to women of the weaker sections of society. • Assessee in turn being a wholly owned subsidiary of IFIG ,a trust, which held 99.97 % shares in the assessee company

FWWB is a charitable institution registered under the Societies Registration Act, 1860 and also registered under Bombay Trust Act, 1950. It was also registered as a charitable Trust u/s 12A of the Act, claiming exemption under section 11 and 12 of the Income Tax Act, 1961. The Micro Finance Division (MFD) of FWWB was started three decades back.

The assessee company, i.e Ananya Finance for Inclusive Growth Pvt. Ltd ,was incorporated on 22.4.2009 .The entire expenses incurred by the assessee-company in Asst.Year 2010-11,i.e the year of incorporation and the preceding A.Y, were paid by IFIG since the assessee had no assets or funds of its own.

The audited financial statements of FWWB for the year ending 31-03-2011 filed before us at P.B 337-356 reveals that both the assessee and IFIG are related parties of FWWB as under:

Arguments of the ld.counsel for the assessee before us, briefly stated was that –

The ld.DR, on the other hand, emphasized that -

The ld.counsel for the assessee countered by stating that basis of estimation had been provided to both the AO as well as CIT(A) but both had chosen to ignore the same.

Taking up the first aspect, whether any intangible assets were actually transferred to the assessee by virtue of this BTA, the ld.counsel for the assessee demonstrated the same by drawing our attention to various clauses of BTA defining the terms such as business, intellectual property rights, lenders, receivables and contended that since business transfer agreement was for transfer of business of micro finance lending, the interpretation of the above terms clearly revealed that even intangible assets were transferred to the assessee in the process. Our attention was drawn to the interpretation of term “business” given at para 1.1.1 of the BTA as under:

Thereafter our attention was drawn to section 3 of the clause dealing with transfer of business pointing out therefrom that it was the business of FWWB which was purchased by the assessee, and in view of the definition of term “business” as above, even intangible assets were transferred to the assessee.

The ld.DR, per contra, contended that nothing could be derived from the above clauses of BTA, as pointed out by the ld.counsel for the assessee. Referring to the assessment order at page no.7, he pointed out that intellectual property rights (IPR) meaning specific logo of FWWB could not have been possibly transferred to the assessee since its copy right was still under progress on the date of business transfer. As for Micro Finance Institution lending and investment method mentioned in the intellectual property rights, it was a generic term having no substance; mechanism developed for effective control over the management of funds mentioned in clause of the intellectual property rights was also a generic term. He therefore contended that no specific intellectual property as stated was transferred to the assessee as claimed by it, and the assessee had not demonstrated and substantiated that it acquired any specialized knowhow from the FWWB. He further countered the contention of the assessee that brand, software for MIS etc. were transferred to the assessee by stating that there could be no question of any brand being transferred to the assessee since the assessee functioned in the name of Ananya Finance P.Ltd. only and no benefit of brand of FWWB was therefore given to the assessee. As

As regards the issue of valuation, the ld.counsel for the assessee drew our attention to valuation report dated 3.5.2011 placed before us at PB Page No.15-23 and our attention was drawn to page no.17 pointing out basis of the valuation of entire business done as under:

He further drawn our attention to valuation report placed at page no.21 in PB before us as under:

He then drew our attention to the documents supporting the valuation of the intangible assets stating that it had been absolutely justified by a comprehensive chart showing future surplus of micro finance business of FWWB placed at Page no.55-56 of the Paper book; chart showing profit of SKS Microfinance Ltd to appreciate growth of MFI ‘s of India at Page No.57 of the PB; CRISIL’s report with respect to brief portfolio of largest MFIs of India at page no.58- 69; Offer letter from SIDBI, WWB, ISIS and Trodos & Deon at Page

Referring to the above, he contended that the estimated financial position of the assessee-company for the purpose of arriving at the valuation of goodwill was duly supported by the above documents.

The ld.DR on the other hand, pointed out that these contentions of the assessee need to be outrightly rejected since actual performance showed totally contradictory position with the assessee showing losses year to year and no explanation being given for the completely changed circumstances between the projections and actual. He also drew our attention to the finding of the AO at page no.5 of the order that while projecting interest income from MFI and processing fee, increase by 8.2 times was shown increasing from Rs.46 crores to Rs.370 crores and expenses increased by only 5.6 times only, that PBT increased from Rs.3 to Rs.35 i.e. 45 times and annual appreciation on return in equity investment was shown at 9.024 in Asst.Year 2010-11 and 410.02 in Asst.Year 2011-12 which was 45 times. He contended that these data itself reflected that valuation was highly inflated. He further pointed out that the actual profitability largely differed from the projections for which no explanation was given by the assessee, which proved that the valuation was highly inflated. He drew our attention to the projected and actual profits for the period considered for the purposes of valuation as under: Projected Profit & Loss Account Amount in crores 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16

Considering the contentions of both the parties as above, we find, that it is clear that the assessee was unable to justify what intangibles had been paid for and also its valuation at Rs.30.32 crores. The assesses contention that the intangibles comprised of knowhow(software for MIS, accounting system, internal control system),trade mark ,franchise, logo, brand etc. has been justifiable countered by the Revenue pointing out that the brand still remaining with FWWB there could not have been any intangible transferred to the assessee on this account. As for Software for MIS and accounting system these are measurable items and need not be valued by projections. The logo, it was pointed out was still under progress. As for the MFI lending and investment method and mechanism developed for accounting and effective control over management of funds, firstly these are very generic terms and even otherwise these are basically management systems developed over time, to which alone the future flow of profits cannot be attributed so as to constitute as an intangible asset. The assesses claim of established business of a long period of time with its dedicated customers and practices as constituting intangibles we find also is

Further even if out of all the intangibles claimed to be transferred, we consider lending and investment mechanism and established customer base as intangibles, the assesses valuation applied to all the stated intangibles cannot apply with respect to these two alone. Even otherwise we find that there is no palpable justification given for its valuation at double the value of the net business itself ,being Rs.30.32 Crs as against business valuation of Rs.14.68 crs. For the measurement of intangibles the Standard states that it should be measured based on the probability that future economic benefits will flow to the entity therefrom ,which

An intangible asset should be recognised if, and only if:

An enterprise should assess the probability of future economic benefits using reasonable and supportable assumptions that represent best estimate of the set of economic conditions that will exist over the useful life of the asset.

In the present case the Ld.Counsel has pointed out that the basis was justified by filing reports of similar entities showing growth in the business of Micro Finance lending and also report of CRISIL giving brief portfolio of 50 largest MFI’s of India and such other material. But what cannot be lost sight of is the fact that though the future projections showed an extremely rosy picture for the MFI lending business ,the actual picture was in stark contrast to the same ,showing losses from year to year. If the basis of future projections was justified, as claimed by the assessee, there surely must have been some extraordinary reason for a complete reversal of picture in actual, which the assessee must be aware of. But no such reason has been given by the assessee to explain the starkly different picture of financials in projections taken for valuation purposes and the actual results. In the absence of any such explanation, the assumptions by the valuer cannot be said to represent the true set of economic conditions existing over the useful life of the asset and the valuation therefore ,we hold has been rightly

A close look at the entire transaction glaringly reveals that there was no real/actual transfer of business by FWWB to an independent separate entity, i.e the assessee, as claimed. The business was very much owned, though indirectly, by FWWB only. And as a consequence no intangible asset could have been created in the own business of FWWB nor was any created. The following facts when considered in totality lead to the above inescapable findings.

The assessee admittedly is a new entity formed only in the preceding financial year i.e FY 2009-10, on 22-04-2009. It had no assets, no premises of its own nor enough money to carry out its day to day business expenses. Its entire expenses in the preceding year were paid for by another trust IFIG. All these facts find mention at para 2 of the assessment order and have not been controverted before us. So the question arises as to how it managed to buy a business worth Rs.45 Crs. The answer lies in the facts again mentioned in the assessment order para 2, that Rs.45 Crs were provided by IFIG as investment in share capital of the assessee ,IFIG in turn having received this identical amount of Rs.45 Crs from FWWB as corpus donation.

As is evident from the facts stated above, the assessee is not simply an wholly owned subsidiary of IFIG ,on the contrary it is in reality a subsidiary of FWWB only, the funds for investment in entire share capital of the assessee having been routed by FWWB through IFIG as corpus donation to it. Another very pertinent fact adding to and supporting our finding is that the promoter director of the assessee company, Mrs.Vijaylaxmi Das ,was a trustee of FWWB, which fact was disclosed in the Audited Balance Sheet of FWWB and also the assessee company. The share capital in the assessee company being routed by FWWB through IFIG in the assessee and even the founder director of the assessee company being a trustee of FWWB, both monetarily and management wise the assessee was under control of FWWB. It is a foregone conclusion therefore that the assessee company was in reality the wholly owned subsidiary or a division of FWWB only . And the only purpose of this arrangement was to create intangibles, which did not actually exist, in a purportedly separate entity and claim benefit of depreciation.

The apparent is not the real in the present case. It is not as simple and straight a case of sale of business by one entity to another and the entire flow of events reveal a larger and different picture. FWWB rotated Rs.45 Crs by giving corpus donation to IFIG, which in turn flowed to the assessee as share capital investment, from where it went back to FWWB as consideration for business purchase and in the process FWWB siphoned off the MFD division and created intangibles worth Rs.30.32 Crs for claiming benefit of depreciation against profits of MFD division. The entire transaction is ,we agree with the Revenue, nothing but a colorable device for tax evasion .

The doctrine of lifting the corporate veil in tax matters has always been judicially recognized right from the decision of the Hon’ble apex court in Mcdowell and Company Ltd. Vs Commercial Tax Officer reported in 154 ITR 148 (SC) wherein it was categorically held that colorable devices cannot be part of tax planning and avoidance of tax payment by resorting to dubious methods should not be encouraged. The Hon’ble apex court in the case of CIT vs Shree Meenakshi Mills Ltd. 63 ITR 609(SC) and in the case of Juggilal Kamlapat vs CIT 73 ITR 702 (SC) approved looking behind the apparent transaction to the arrangement or scheme involved therein for the purposes of taxation. The Hon’ble Delhi High Court in a recent decision in the case of Commissioner of Income Tax vs Shiv Raj Gupta 372 ITR 337 (Del) held the separate payment of purchase price for shares of a company and non compete fees for not indulging in similar activity as the said company, to the assessee, as a mere colorable device in the facts and circumstances that by virtue of sale of shares, entire control and management had transferred and the non compete fees was accordingly held to be not a separate fees paid but part of consideration of sale of shares only. The assessee had claimed the non compete fees to be not taxable but the Hon’ble court, finding the component of the same to be many times the price of shares and noting that entire control and management had been transferred by virtue of sale of shares , held that charging separately for sale of shares and non compete fees was only a colorable device so as to avoid payment of taxes on the non compete fees which were otherwise not taxable in nature. The Hon’ble court held the transaction to be abusive tax avoidance and held that the real nature of the transaction needed to be unearthed.

The aforesaid decision in Vodafone’s case (supra) does not prescribe criterion simply predicated on preordained, circular or self cancelling transactions with a step or steps having no commercial or business purpose other than obtaining tax advantage. The decision does not exert the doctrine of economic substance. The ratio steers clear from using the said tests or principles. The said propositions and premise as specific tests stands disapproved and rejected.

The precise test enunciated and prescribed as a tenet, negates and disqualifies colourable device, deceit and sham as a legitimate and acceptable tax event. These terms have some- what ethical and casuistical connotations and are the elective test for differentiating tax planning from abusive tax avoidance.

To appreciate the concept of abusive tax avoidance, it would be appropriate to first delineate with precision the expressions “tax mitigation” and “tax evasion” as their boundaries and confines would enable us to draw lines amongst the four concepts; tax mitigation, tax evasion, acceptable tax avoidance and abusive tax avoidance. Each of the said expressions involves an element of tax planning. It would be hard to conceive of a

Tax mitigation in simple words would refer to a taxpayer taking advantage or benefit of a beneficent provision under the tax code and complying with the requisites to his lower the tax liability. In the words of Lord Nolan in CIR versus Willoughby [1997] 4 All ER 65, it is:-

Tax evasion is illegal and consists of wilful violation or circumvention of applicable tax laws to minimise tax liability. The assessed breaches the relevant law and it involves contumacious behaviour or actual knowledge of wrong doing. This can happen when an assessee deliberately fails to report an item in the income tax return, or knowingly claims a deduction which he is aware he is not entitled to, or consciously omits to supply information even when there is duty to furnish the said details. It can also apply to situations when the assessee fails to clarify a matter, which has been misunderstood by the income tax authorities, and keeps quiet. In these cases, there is element of wilfulness, dishonesty or contemptuous conduct or even absence of honest belief. If the taxpayer cannot show that he had an honest belief that he was not liable to tax or liable to a lower tax, then prima facie such conduct would fall within the ambit/scope of tax evasion.

Tax avoidance by elimination would mean the residual and surplus, after we exclude cases of tax mitigation and tax evasion. Tax mitigation and tax evasion are two end points. It is easier and more beneficial to follow this discernment to define tax avoidance, for the confines and bounds of tax mitigation and tax evasion are easier to decipher and define legally and also identify with some exactness in practice. (Refer Tax Avoidance, Tax Evasion & Tax Mitigation by Philip Baker.)

It is equally important to distinguish and differentiate acceptable tax avoidance and abusive tax avoidance. The Supreme Court in CIT versus Raman (A.) & Co. [1968] 67 ITR 11, at p.17 had observed:-

In clear and categorical terms the aforesaid ratio was resonated and approved by the Supreme Court in the Vodafone’s case (supra). Thus, the test of ‘devoid of business purpose’ or ‘lack of economic substance’ is not accepted and applied in India

Naturally, the dividing line between acceptable and abusive tax avoidance cannot be deduced or inferred from lowering or elimination of the tax liability. Latter is the consequence and the tax effect. It is the post facto consequence under the tax code of the event selected by the assessed. The test applied should not curtail the freedom of choice to adopt a particular transaction or combination of transactions to reduce or eliminate the tax liability.

At the same time, the dividing line as per the ratio in Vodafone’s case (supra) is ethically principled and moralistic as tax avoidance is disapproved when the assessee adopts a colourable device, dubiousness and otherwise indulges in a sham arrangement or transaction. This would mean that pre-ordained, circular or self- cancelling transaction with a step or steps having no commercial purpose or lack of economic or business purpose could in a given case be, though not necessarily, a relevant fact, yet they are not the touchstone, yardstick or the final test. These could be circumstances or facts to infer and discern whether the taxable event selected was a colourable device, sham or deceit and not the tax event intended by the parties. Right to choice to select the most beneficial legal way and manner to execute a transaction is unquestionable and perennial. A fact is not the test; rather the corrupt and mendacious conduct, i.e. colourable device, sham or deceit, is the specified bright line, dividing acceptable tax avoidance from abusive tax avoidance.

The assessed is well within his right to choose any one event between two or more events and select an event to minimize or reduce his tax liability. The Act, i.e. the Income Tax Act, 1961, imposes and saddles tax liability on the chosen tax event. The Act per se, unless a provision so stipulates, does not restrict or curtail the right of choice. Tax is determined and gets crystallized on the tax event adopted by the assessee. For example, in Vodafone’s case (supra), the assessed had several options and therefore, right to choose a particular tax event. As long as the choice is within the framework of law, the Assessing Officer cannot disturb the tax effect or liability, which is the consequence of the event. The choice of the assessee is not abrogated or invalidated. For example, a company has several legal options, and therefore, right to choose how to dispose of a capital asset, as in Vodafone’s case (supra). Similarly, an assessee can opt for and has multiple options for raising debt to finance business expansion

Tax reduction is not an evil if you do not do it evilly [Murphy Logging Co. vs. US, 378 F.2d 222 (1967)]. The assessee acts evilly when there is camouflage or dubiousity to mask and masquerade the real intent of the transaction which the parties intended and the document(s)/transaction(s), is at variance with the actual intent. The assessed in such cases does not choose the real event as one from the multiple choices, but adopts a sham or colourable event. The assessed then acts fraudulently, deceitfully or in a corrupt manner. He does not choose an event which is useful, viable and tenable, but employs deception and visors to pretense a state of affair which is different from the actual or real state of affairs. The event propounded is contrary to his intention. When the event selected is artificial it can be treated as colourable, deceitful or sham. The artificial event is one which purports to be one thing but in fact is another. Thus, abusive tax avoidance is a matter of evil intention and a result of dishonest behaviour of the assessed.

In such cases, question of ignorance as to tax or administrative incompetence would arise for consideration, for abusive tax avoidance scheme requires a mind set and propensity to act evilly. It requires a degree of knowledge and absence of honest belief.

The aforesaid doctrine of abusive tax avoidance is a Judge made law or a judicial doctrine. The Parliament can legislate and

A caveat, the aforesaid discussion does not examine and elucidate scope and ambit of Section 271(1)(c) of the Act.”

In the context of Vodafone’s tests, we would paraphrase the words of Lord Nicholls in MacNiven (Inspector of Taxes) versus Wesmoreland Investments Ltd. (2002) 225 ITR 612; the decision in Ramsay’s case (supra) had not enunciated a new legal principle but reiterated the courts’ duty to determine the legal nature of the transaction and then relate the finding to the fiscal legislation. Thus, when there is one or a series or combination of transactions intended to operate as such, the courts are entitled to look the real scheme as such or as a whole, even when a particular stage is only an expectation without any contractual force. This does not mean that the transaction or any step in the transaction is treated as sham or given a legal effect different from the legal effect intended by the parties. Nor does it imply going behind the transaction or the series of transactions for some supposed underlying substance. It means looking at the document(s) or the act(s) in the context to which it properly belongs. Ramsay’s approach promises ascertaining the legal nature of the transaction(s) and is a principle of interpretation applicable to taxing statutes.

In view of the aforesaid discussion and our findings on the true and real nature of the transaction camouflaged as ‘non- compete fee’, we have no hesitation and reservation that the respondent-assessee had indulged in abusive tax avoidance. The real and true nature of the transaction or event was the sale of shares and transfer of control and management of CDBL in favour

In view of our findings as above that the BTA is a mere cover- up/colorable device and there is no transfer of business by FWWB to an independent entity, the question of claim of depreciation on the resulting intangibles created on acquisition of business by the assessee, stands answered against the assessee. There are no intangibles created, as held above by us, and accordingly the assessee we hold is not entitled to claim depreciation of Rs.7.58 Crs.

In view of the above, we uphold the order of the Ld.CIT(A) denying the claim of depreciation on intangibles amounting to Rs.7.58 Crs.

Grounds raised by the assessee in this regard are accordingly dismissed.

Next issue relates of expenses incurred purportedly for earning exempt income as per provision of section 14A of the Act.

The ld.counsel for the assessee has pointed out that, clearly the assessee had owned interest free funds seven times than the amount of investment made. He contended that it is settled law that where the assessee had sufficient interest free funds, the disallowance under section 14A was unwarranted. Reliance was placed on the following case laws: > CIT vs. Reliance Industries Ltd. - 410 ITR 466 (SC) > CIT vs. Torrent Power Ltd. - 363 ITR 474 (Guj.) > CIT vs. Suzlon Energy Ltd. - 354 ITR 630 (Guj) > CIT vs. Gujarat Power Corporation Ltd. - 352 ITR 583 (Guj) > CIT vs. Reliance Utilities & Power Ltd. - 313 ITR 340 (Bom) > Munjal Sales Corporation vs. CIT - 298 ITR 298 (SC)

The ld.DR was unable to controvert either factual contentions of the assessee that it had sufficient interest free funds for making investment in relation to which the expenses had been disallowed under section 14A of the Act, nor he able to distinguish the judicial decisions relied upon by the ld.counsel for the assessee in support of his contentions that where sufficient owned interest free fund is available presumption was that same was deployed for making the impugned investment.

In view of the above, considering the proposition of law, as pointed out by the ld.counsel for the assessee before us, and considering the factual position that the assessee had owned sufficient interest free funds for making investment, we hold that no disallowance under section 14A of the Act was called for, and accordingly, direct deletion of the disallowance sustained by the ld.counsel for the assessee to the extent of Rs.24,45,490/-. This ground of appeal raised in this assessee is allowed.

In the result, the appeal of the assessee is partly allowed.