“INTERPRETATION OF TAXING STATUTE”

______________________________________________________________________________________ SSUBMITTEDUBMITTED TOTO: M: MRR. C. R. C. RAMESHAMESH

FFACULTYACULTY, L, LAWAW OFOF T TAXATIONAXATION

______________________________________________________________________________________________________________________

SSUBMITTEDUBMITTED BYBY: 06B146: 06B146

SSEMESTEREMESTER: VIII: VIII (IV Y(IV YEAREAR) )

GUJARAT NATIONAL LAW UNIVERSITY

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A cknowledgement

The present project has been able to get its final shape with the support and help of

people from various quarters. A lot of people and factors contribute to the making of the

project and mine is no different. So at completion of this project, I would like to

acknowledge all those who had been an active as well as passive part of this assignment.

With immense pleasure, I express my deepest sense of gratitude to Mr. C. Ramesh for

assigning and helping me in my project and for his active and valuable guidance, and

helping me throughout in researching for this topic.

I would also like to thank librarian and the staff of GNLU library and all my friends for

their active and courageous support.

Last but not the least I would like to thank the Almighty and my parents whose blessings helped me to complete the project.

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TABLE OF CONTENTS

CHAPTER 1

TAXING STATUTES: INTRODUCTION………………………………..…………..4

CHAPTER 2

GENERAL PRINCIPLES OF STRICT CONSTRUCTION…………………….…..6

CHAPTER 3

EVASION OF STATUTES…………………………………………………….………9

CHAPTER 4

LANDMARK CASES………………………………………………………...……….12

CHAPTER 5

JUDICIAL TREND IN INDIA WITH REGARD TO INTERPRETATION

OF TAXING STATUTES……………………………………………………..……..14

CHAPTER 6

CONCLUSION………………………………………………………………...……..18

BIBLIOGRAPHY………………………………………………………………...….20

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CHAPTER 1

TAXING STATUTES: INTRODUCTION

As per Article 265 of the Constitution

“No tax shall be levied or collected except by the authority of law”

Article 366(28) of the Constitution which reads taxation and tax reads: “Taxation

includes the imposition of any tax or impost whether general or local or special and tax

shall be construed accordingly.”

There are three components of a taxing statute, viz., subject of the tax, person liable to

pay the tax and the rate at which tax is levied. There are three stages in the imposition of

tax

(1) declaration of liability in respect of persons and property

(2) assessment of tax that quantifies the sum which the person liable has to pay

(3) methods of recovery if the person taxed does not voluntarily pay1

The constitution makes a distinction between tax and fee which are both impositions

made by a state for raising revenue of the state. A fee in contrast is imposed for rendering

services and bears a broad co-relationship with the services rendered. Taxes are

specifically named and distributed between the Union and States by various entries in

List I and List II of the Constitution. A tax not so mentioned can be levied by the Union

under Parliament’s residuary power in entry 97 of List 1. Power to levy fee is conferred

by the last entry in each list in general terms in respect of any matter in the list. A taxing

statute is meant any Act making compulsory imposition of tax or fee.

1 Kalwa dewdattam v. Union of India AIR 1964 SC 880

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The nature of the tax imposed by a statute has to be determined by examining the pith

and substance of the statute and by paying more attention to the charging section than to

the basis or machinery adopted for assessment or collection of tax. 2

2 Rallaram v. Province of Pumjab AIR 1949 FC 81

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CHAPTER 2

GENERAL PRINCIPLES OF STRICT CONSTRUCTION

1. A taxing statute is to be construed strictly.

In the case of Re Micklethwait3 it was held by Lord Wenslaydale “ The subject is not to

be taxed without clear words for that purpose; and also that every act of parliament must

be read according to the natural construction of the words.”

Lord Cairns has stated the principle that “if the person sought to be taxed comes within

the letter of law he must be taxed, however great the hardship may appear to the the

judicial mind to be. On the other hand, if the crown seeking to recover the tax, cannot

bring the subject within the letter of law, the subject is free however apparently within

the spirit of law might otherwise appear to be. In other words, if there is admissible in

any statute, what is called an equitable construction, certainly, such a construction is not

admissible in a taxing stature where you can simply adhere to the words of the statute.”4

The supreme court of India has also illustrated the principle. J. Bhagwati has stated that

“In construing fiscal statutes and in determining the liability of a subject to tax one must

have regard to the strict letter of law. If the revenue satisfies the court that the case falls

strictly within the provisions of the law the subject can be taxed. If on the other hand, the

case is not covered under within the four corners of the provisions of the taxing statute,

no tax can be imposed by inference or by analogy or by trying to probe into the intentions

of the legislature and by considering what was the subject matter.”5

J. Shah has formulated the principle thus: “In interpreting a taxing statute equitable

considerations are entirely out of place. Nor can taxing statutes be interpreted on any

3 (1885) 11 Ex 4524 Partington v. A.G (1869) LR 4 HL 1005 A.V Fernandez v. State of Kerala

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presumptions or assumptions. The courts must look squarely at the word of the statutes

and interpret them. It must interpret a taxing statute in what is clearly expressed; it cannot

import provision in the statute so as to supply and assume deficiency. 6

J. K.Iyer observed: “Taxation consideration may stem from administrative experience

and other factors of life and not artistic visualization or neat logic and so the literal

though pedestrian interpretation must prevail.”7

As a general rule, taxing provisions, as opposed to exemption provisions, are to be

construed liberally in favor of the taxpayer, and strictly against the government.8Doubts

as to their interpretation and application are to be resolved against the government and in

favor of the taxpayer.9 On the other hand, it has been declared that provisions in aid of the

collection of revenues are to be liberally construed and applied, within reason, so as to

favor the government. 10

2. Principle of avoidance of double taxation

The principle applied to income tax Legislations is that if the words of the Act on one

construction result in double taxation of the same income that result will be avoided by

adopting another construction which may reasonably be open.11

Viscount Radcilffe explains the principle: “Double Taxation in itself, however which is

not beyond the power of the Legislature to provide for, when constructing a tax scheme.

It is rather that given that a situation would really involve double taxation, it is so

unlikely that there would have been an intention to penalize particular forms of income in

this way that the law approaches the interpretation of the complicated structure of the

code with a strong bias against achieving such a result.”

6 Sales tax Commissoner v. Modi Sugar Mills AIR 1961 SC 10477 Martand Dairy and Farm v. Union of India AIR 1975 SC 14928 Xerox Corp. v. U.S., 41 F.3d 647, 94-2 U.S. Tax Cas. (CCH) ¶50623, 74 A.F.T.R.2d 94-7097 (Fed. Cir. 1994)9 Security Bank Minnesota v. C.I.R., 994 F.2d 432, 93-1 U.S. Tax Cas. (CCH) ¶50301, 71 A.F.T.R.2d 93-1959 (8th Cir. 1993)10 U.S. v. Sullivan, 333 F.2d 100, 64-1 U.S. Tax Cas. (CCH) 9392, 13 A.F.T.R.2d 1178 (3d Cir. 1964).

11 IRC v. F.S Securities (1964) 2 All ER 691 (HL)

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The rule of avoidance of double taxation is merely a rule of interpretation and the rule

ceased to have any effect if the legislature expressly enacts a statute in which it provides

for double taxation.

There is no general principle that there can be no double taxation in the levy of excise

duty but the court may lean in favour of a construction if that be open which will avoid

double taxation.12

3. The charging section and the computation section together constitute

an integrated code

In the Income Tax Act the charging section and the computation section are considered as

a code and therefore when there is a provision in which the computation code cannot be

applied at all, it can be concluded that such a case was not intended to be brought within

the charging section. 13

4. A penalty provision in a taxing Act distinguished from a provision

creating an offence does not attract the rule of mens rea

5. Autonomy of tax law

Meaning thereby that tax laws pursue aims that are different from other laws. The tax

claim is a claim under public law. Principles applicable to relationships under private law

such as law of contracts, therefore, cannot be invoked to interpret provisions of tax law.

CHAPTER 3

EVASION OF STATUTES 12 Premier Tyres Limited v. Collector of Central Excise (1987) 1 SCC 69713 CIT v. B.C Srinivasa Setty AIR 1981 SC 972

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It is permissible to evade an act of the Parliament in the sense that a person may not do

that which the Act prohibits but he is free to do anything which though equally

advantageous to him as that which is prohibited is nevertheless outside the prohibition,

penalty or burden imposed by the Act. 14

However this principle has no application where what is done is really the thing

prohibited although under cloak or colour of a different transaction not prohibited by the

statute.

Tax planning is legitimate provided it is within the framework of the law; but colourable

tax devices cannot be a part of the tax planning. 15

The taxing laws have always been the subject of evasion in the sense of avoiding

something disagreeable and there are many dicta to the effect that a citizen is entitled to

so arrange his affairs that the tax burden does not fall on him and there is nothing illegal

or immoral in adopting such a course.

There is a fundamental difference between acceptable tax mitigation and unacceptable

tax avoidance. The former are the cases where the tax payer takes advantage of law to

plan his affairs so as to minimize the incidence of tax. Unacceptable tax avoidance

involves the creation of artificial structures by which the tax payer conjures a loss or a

gain or whatever there may be which never existed. These are designed to achieve an

advantageous tax benefit and it is a raid on the public funds at the expense of the general

body of the tax payer.

The courts have now gone to the extent of not recognizing tax avoidance schemes or

devices even if they are not strictly genuine.16

This approach has been accepted in India.17 Chinappa Reddy J. has held “We now live in

a welfare state whose financial needs, if backed by the law, have to be respected and met.

We must recognize that there is behind taxation laws as much moral sanction as behind

any other welfare legislation and it is a pertinence to say that avoidance of taxation is not

14 Yorkshire Railway Wagon Company v. Maclure (1882) 21 Ch D 30915 Union of India v. Play Worlds Electronics Pvt Ltd. AIR 1990 SC 20216 W.T Ramsay Ltd. v. Inland Revenue Commissioners (1981) 1 All ER 865 (HL)17 Mc Dowell and Company Ltd.

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unethical and that it stands on no less moral plane than honest payment of taxation. In our

view the proper way to construe a taxing statute, while considering a device to avoid tax,

is not to ask whether the provisions should be construed liberally or literally, nor whether

the transaction is unreal and not prohibited by the statute, but where the transaction is a

device to avoid the tax, and whether the transaction is such that the judicial process may

accord its approval to it. It is neither fair nor desirable to expect the legislature to

intervene and take care of every device and scheme to avoid taxation. It is up to the court

to take stock to determine the nature of the new and sophisticated legal devices to avoid

tax and to consider whether the situation created by the devices to avoid tax and consider

whether the situation created by the devices could be related to the existing legislation

with the aid of emerging techniques of interpretation to expose the devices for what they

really are and refuse to give judicial benediction.

It makes the principle laid down in IRC v. Duke of West minister18 that one has to see

only the legal nature of the transaction and not substance the matter inapplicable to a tax

avoidance scheme consisting of a series of transactions or a composite transaction when

the conditions necessary for the application of the new approach are satisfied. In the

words of Lord Keith “The court must first construe the relevant enactment in order to

ascertain its meaning; it must then analyze the series of transactions and finally it must

apply the enactment so construed to the true effect of the series of transactions and so

decide whether the or not the enactment was intended to cover it. The most important

feature of the principle is that the series of transaction should be considered as a whole.

In ascertaining the true legal effect of the series it is relevant to take into account, if it be

the case, that all the steps in it were contractually agreed in advance or had been

determined on in advance by a guiding will which was in a position, for all practical

purposes, to secure that all of them were carried through to completion. It is also relevant

to take into account, if it is the case, that one or more of the steps were introduced into

the series with no business purpose other than the avoidance of tax.

18 (1936) AC 1 HL

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CHAPTER 4

LANDMARK CASES

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1. IRC v. Duke of Westminster 19

The Duke executed a series of deeds in favour of his employees in which is

covenanted to pay certain weekly sums for a period of seven years in consideration of

past services during the joint lives of himself and the employee concerned. It was

provided in the deeds that the payments were ‘without prejudice to such remuneration

as the annuitant will become entitled to in respect of such services as the annuitant

may hereafter render’ to the Duke. The recipients in all the cases continued in the

employment and continued to receive such sums as with the sums payable by the

deed made up the amount of the wages or salary payable before the deed and no

more. The Dukes contention was that the payment was annual payment and which he

was entitled to deduct as surtax, whereas the contention of the Revenue department

was that it was payment in consideration of services and as such could not be

deducted. The House of Lords rejected the contention of the Revenue and held that

when a deed is not challenges as non genuine or a mere cloak to conceal a different

transaction the substance of the matter cannot be distinguished from the legal rights

and obligations arising under the deed.

2. Pott’s Executor’s v. IRC20

By a settlement the assessee settled a large sum on his infant grandchildren and the

trustees of the settlement purchased from the settlement moneys almost the entire

share capital of a company which was held by the settler who was the governing

director. The settler had an account with the company which made, on his behalf and

at his request numerous payments to third parties and debited his account with those

sums. The question before the House of Lords was whether these payments made by

the company to the third partied and not to the settler himself were “any sum paid by

way of loan’ ‘directly or indirectly’ by a corporate body connected with the

settlement ‘to the settler’ and constituted his income within section 40 of the Finance

Act, 1938. The contentions of the revenue was that payments by the company to third 19 (1935) All ER 259 (HL)20 (1951) All ER 76 (HL)

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parties who could retain the money and were not accountable to the settler although

made at the request or on behalf of the settler were not payments by way of a loan to

the settler. Lord Salmond said “I am not, in the construction of a statute entitled to say

that because the legal or the business result is the same whether on one hand I borrow

money from the company and with it make certain payments on my implied promise

to repay, therefore it is immaterial what words are in the statute of that result is

attained. Lord Normand similarly observed that “ This is a taxing statute and its terms

are not to be enlarged by reasoning that the same final result is achieved as by a loan

made to the settler followed by a payment made by him to a third party. The court is

not entitled to say that for the purposes of taxation the actual transaction is to be

disregarded as ‘machinery’ and that the substance or equivalent financial results are

the relevant considerations. It may indeed be said that if these loose principles of

construction had been liberally applied that would in many instances have been

adequate to deal with tax evasion and there would have been less frequent cause for

the intervention of parliament.

These cases illustrate the principle that doctrine of substance of matter has no

application to a taxing statute. Legal position in case of tax avoidance should be taken

as altered in the light of three judgments of the House of Lords (i) Ramsay vs I R (54

T C 101) (ii) I R vs. Burmah Oil (54 T C 200) (iii) Furniss vs Dawon (55 T C 324).

CHAPTER 5

JUDICIAL TREND IN INDIA WITH REGARD TO INTERPRETATION

OF TAXING STATUTES

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It is a recognized principle of law which was laid down by the British courts known

as the Westminster principle that tax planning is the prerogative of the tax payer and

he can resort to legal measures in order to avoid tax.

However this principle was overruled by the Indian Supreme Court in the case of Mc

Dowell and Company v. CTO21. In this case the Supreme Court blurred the distinction

between tax avoidance and tax evasion. It interpreted the power of the government to

collect and levy taxes in a broad way and held that any avoidance or planning by a

person to avoid tax is incorrect and should not be allowed. They based their decision

on the fact that the English courts had departed from the Westminster principle.

However the court laid down in the case of Union of India & Anr.

Vs. Azadi Bachao Andolan & Anr.22 That the presumption made in the Mc Dowel

case was wrong. It criticized the judgment given in the case. It held that the decision

in the Mc Dowell case was an exception and not the norm.

Banyan and Berry v. CIT 23 where referring to McDowell (supra), the court observed:

"The court nowhere said that every action or inaction on the part of the taxpayer

which results in reduction of tax liability to which he may be subjected in future, is to

be viewed with suspicion and be treated as a device for avoidance of tax irrespective

of legitimacy or genuineness of the act; an inference which unfortunately, in our

opinion, the Tribunal apparently appears to have drawn from the enunciation made in

McDowell case (1985) 154 ITR 148 (SC). The ratio of any decision has to be

understood in the context it has been made. The facts and circumstances which lead

to McDowell’s decision leave us in no doubt that the principle enunciated in the

above case has not affected the freedom of the citizen to act in a manner according to

his requirements, his wishes in the manner of doing any trade, activity or planning his

affairs with circumspection, within the framework of law, unless the same fall in the

category of colourable device which may properly be called a device or a dubious

method or a subterfuge clothed with apparent dignity."

21 1985 154 ITR 148 SC22 [2003] 132 TAXMAN 373 (SC)23 MANU/GJ/0026/1995

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Mathuram Agrawal v. State of Madhya Pradesh24 another Constitution Bench had

occasion to consider the issue. The Bench observed:

"The intention of the legislature in a taxation statute is to be gathered from the

language of the provisions particularly where the language is plain and unambiguous.

In a taxing Act it is not possible to assume any intention or governing purpose of the

statute more than what is stated in the plain language. It is not the economic results

sought to be obtained by making the provision which is relevant in interpreting a

fiscal statute. Equally impermissible is an interpretation which does not follow from

the plain, unambiguous language of the statute. Words cannot be added to or

substituted so as to give a meaning to the statute which will serve the spirit and

intention of the legislature."

The Constitution Bench reiterated the observations in Bank of Chettinad Ltd. v. CIT

(1940) 8 ITR 522 (PC), quoting with approval the observations of Lord Russell of

Killowen in IRC v. Duke of Westminster (supra) and the observations of Lord Simonds

in Russell v. Scott (1948) 2 All ER 15.

The situation in the United State is reflected in the following passage from American

Jurisprudence American Jurisprudence25 :

"The legal right of a taxpayer to decrease the amount of what otherwise would be his

taxes, or altogether to avoid them, by means which the law permits, cannot be

doubted. A tax-saving motivation does not justify the taxing authorities or the courts

in nullifying or disregarding a taxpayers otherwise proper and bona fide choice

among courses of action, and the state cannot complain, when a taxpayer resorts to a

legal method available to him to compute his tax liability, that the result is more

beneficial to the taxpayer than was intended. It has even been said that it is common

knowledge that not infrequently changes in the basic facts affecting liability to

taxation are made for the purpose of avoiding taxation, but that where such changes

are actual and not merely simulated, although made for the purpose of avoiding

24 MANU/SC/0692/199925 1973 2nd Ed. Vol.71

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taxation, they do not constitute evasion of taxation. Thus, a man may change his

residence to avoid taxation, or change the form of his property by putting his money

into non-taxable securities, or in the form of property which would be taxed less, and

not be guilty of fraud. On the other hand, if a taxpayer at assessment time converts

taxable property into non-taxable property for the purpose of avoiding taxation,

without intending a permanent change, and shortly after the time for assessment has

passed reconverts the property to its original form, it is a discreditable evasion of the

taxing laws, a fraud, and will not be sustained."

US Courts were cited in respect of the proposition that motive of tax avoidance is

irrelevant in consideration of the legal efficacy of a transactional situation.26

Thus the position in India as it stands now is the same as earlier and the

temporary havoc created by the McDowell case has been avoided.

In the recent case of State of W.Bengal vs. Kesoram Industries Ltd.27 has held as

follows.

“The judicial opinion of binding authority flowing from several pronouncements of

this court has settled these principles: (i) in interpreting a taxing statute, equitable

considerations are entirely out of place. Taxing statutes cannot be interpreted on any

presumption or assumption. A taxing statute has to be interpreted in the light of what

is clearly expressed; it cannot imply anything which is not expressed; it cannot import

provisions in the statute so as to supply any deficiency; (ii) before taxing any person

it must be shown that he falls within the ambit of the charging section by clear words

used in the section; and (iii) if the words are ambiguous and open to two

interpretations, the benefit of interpretation is given to the subject.

26 Helvering v. St. Louis Trust Company 296 US 48, 56 S. Ct. 78, 80L; Becker v. St. Louis Union Trust Company 296 US 48, 56 S.Ct. 78, 80L.)

27 (2004) (266 ITR 721)

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CHAPTER 6

CONCLUSION

Thus as can be seen that there are rules for interpretation of a taxation statute are

different from that of an ordinary statute. The reason being that tax is a compulsory

levy by the state to the citizens of the country. The state has to perform its duty of

welfare and development of the state as well as ensuring that there is equitable

distribution of wealth. Tax is levied by the state. This tax is always resisted by the

factions it is imposed upon. Taxes it can be said are unfair on the privileged faction in

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order to promote the needs of those who are not so privileged. One faction will

always complain that they are unjust and inequitable.

This is one reason that the courts are required to construe the statute strictly and there

are no grounds of equity or unjustness while construing a taxing statute.

Secondly in our constitution the separation doctrine though not strictly followed is

recognized. The power of each body is recognized. Thus there should not be any

interference of one body to another body. That is why the courts have to strictly

construe the statute. They cannot go into the intent or the purpose for which the tax is

levied or the rate of tax which is levied etc. This aspect clearly falls within the

legislative area. The legislature is elected by the people and has been given the power

by the Constitution of our country to impose tax and thus it depends on the policy that

the legislature deems fit for the levy and collection of tax and thus the court if

meddles with this would enter the field of legislation rather than construction.

Thirdly where there is any ambiguity in relation to a tax the benefit of the doubt

should be given to the assessee. This is because it is the tax payer who has to suffer

and making him liable unnecessarily would be clearly unfair.

Thus the interpretation of taxing statutes is somewhat different from that of

ordinary statutes due to the nature of the statutes.

Taxing statutes are mostly complex and require calculations and many deductions.

The Income tax Act is very complex and has been amended several number of times.

Thus due to the ever changing and flexibility of the statutes there is a different

interpretation given to them.

Due to the various amendments in the statute and the changing policies of the

government it becomes difficult of not impossible for the court to understand the

legislative intent. Thus this can also be one of the reasons as to why these statutes are

to be construed strictly.

It can also be concluded that the judicial trend in the last 75 years has been to make

an essential difference in tax evasion and tax avoidance. Tax planning whereby tax is

avoided while staying within the legal realm has been held valid. Thus if a person is

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careful enough to avoid tax, the legislature cannot hold him liable since he comes

within the spirit of law. This principle has also been recognized and it respects the

creativity and the intelligence of the tax payer vis a vis that of the tax imposing

authority.

BIBLIOGRAPHY

STATUTES

Income Tax Act, 1961 General Clauses Act, 1897

BOOKS

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Justice G.P Singh, Principles of Statutory Interpretation ( 9th edn, Wadhwa and Company, Ngpur)Maxwell on Interpretation of Statutes, Ed. 2003 (Lexus Nexus, Butterworths, New Delhi Ch 2)Vepa Sarathi, Interpretation of Statutes, 4th ed 2003, Eastern Book Co. Nagpur, Ch I

WEBSITES

1. http://www.itatonline.org/interpretation/interpretation22.php2. http://www.thehindubusinessline.com/2003/12/27/stories/2003122700010900.htm3. http://www.thehindubusinessline.com/2005/04/30/stories/2005043000171000.htm4. http://www.nls.ac.in/distanceeducationnotes/PGDEL/BASIC%20TENETS

%20OF%20INTERPRETATION%20OF%20STATUTES.pdf5. http://www.manulawbooks.in/OnlineBook/OnlineBook/Image/SamplePage/

SRPCh.%2070--(56)-SAMPLE%20PAGE.pdf6. http://www.itatonline.org/interpretation/interpretation14.php7. www.manupatra.com8. www.westlaw.com

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