Doctrine of form and substance:
One of the reasons which prompts a tax payer to resort to tax planning is the existence of the doctrine of form and substance. The principle involved in this doctrine is simple. How far Court may stretch the wording of a Statute to cover a particular set of facts, where those facts have clearly been created by a tax payer in order to avoid or minimise his tax and the literal interpretation of the Statute is not, at first sight apt to cover them? Is it possible to ignore the form of a transaction and determine the substance thereof?
In Commissioner of Income tax vs. Motor and General Stores (P) Ltd. (1967) 66 ITR 692 (SC.) the Supreme Court had observed that in the absence of any suggestion of bad faith or fraud the true principle is that the taxing statute has to be applied in accordance with the legal rights of the parties to the transaction. According to the court when the transaction is embodied in a document the liability to tax depends upon the-meaning and content of the language used in accordance with the ordinary rules of construction. The House of Lords in Duke of Westminster vs. ICR (1936) 19 ATC 498 held that in considering the substance of the transaction, the legal form cannot be disregarded.
It was held in CIT vs. B.M. Kharwar (1969) 72 ITR 603 (SC) that the taxing authority is entitled and is indeed bound to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by device the legal relat ion, it is open to the taxing authority to unravel the device and to determine the true character of the relationship. However, the legal effect of a transaction cannot be displaced by probing into ‘the substance of the transaction‘. This principle applies alike to cases in which the legal relation is recorded in a formal document and to cases where it has to be gathered from the evidence – oral and documentary – and the conduct of the parties to the transaction. However, this view of the Supreme Court has now been expressly disapproved by the Supreme Court in Mc Dowell & Co. Ltd’s case.
Justice Shah, in Ram Laxman Sugar Mills vs. CIT (1967) 66 ITR 613, 617 (SC) , has stated that to ascertain the legal effect of a transaction, the court seeks, in the first in stance, to determine the intention of the parties and if ambiguous expressions are used, the court may normally adopt such interpretation consistent with the parties thereto having acted on the assumption of its validity. Thus any claim made by a tax-payer will be scrutinized from the point of view of his intention and if there was any intention to defraud the revenue, the court will consider the transaction or the claim as fraud.
Thus, we can say that unless there is clear evidence of malafide intention resulting in a form which is a “colourable device” or “mere legal facade” or “non -genuine” form the tax authorities are not justified in disregarding the legal form and probing into the substance of the transaction.
- Principles governing the form and substance : Theory of interpretation of a taxing statute:
(i) It is well settled that when a transaction is arranged in one form known to law, it will attract tax liability while, if it is entered into in another form which is equally lawful, it may not. In considering, therefore, whether a transaction attracts tax or not, the form of the transaction put through by the assessee is to be considered and not the substance thereof.
(ii) The above rule cannot naturally apply where the transaction, as put through by the assessee, is not genuine but colourable or is a mere device. For here, the question is not one between ‘form‘ and ‘substance‘ but between appearance and truth.
(iii) In deciding whether the transaction is a genuine or colourable one, it will be open to the authorities to pierce the corporate veil and look behind the legal facade at the reality of the transaction.
(iv) Where the authorities are charged under the Act with the duty of determining the nature or purpose of and payment or receipt on the facts of a case, it is open to them to work at the substance of the matter and the formal aspect may be ignored.
(v) Where the terms of a transaction are embodied in a document, it should not be construed only in its formal or technical aspect. While the words used should be looked at, too much importance should not be attached to the name or label given by the parties and the document should be interpreted so as to accord with the real intention of the parties as appearing from the instrument.
As noted earlier, the decisions of the Supreme Court in the cases of Mc Dowell, Karthikeya Sarabhai and Associated Rubber Industries, clearly show a preference for the ‘substance‘ over the ‘form‘, if the circumstances of the case warrant such a preference. Where the transactions are genuine, perfectly authentic and not sham, the mere fact that the transaction results in less liability or no liability to tax should not put the transaction to a legal scrutiny questioning the substance of the transaction, attributing a motive behind it. It is up to the Court to take stock of the situation, weigh out sophisticated legal devices and expose the devices for what they really are.