Hydrabad : In a significant ruling that clarifies the scope of the General Anti-Avoidance Rules (GAAR) under the Income Tax Act, the Telangana High Court has set aside an order passed by the Approving Panel holding that a company’s share transactions constituted an impermissible avoidance arrangement. The court held that the Revenue had failed to establish the essential ingredients required to invoke GAAR and that the assessee was entitled to set off its short-term capital loss against long-term capital gains arising from a slump sale.
The judgment, delivered by the division bench of Acting Chief Justice P. Sam Koshy and Justice Narsing Rao Nandikonda on October 13, 2026, comes as a relief to M/s. EKGE Retail LLP, the petitioner, which had challenged the directions dated February 23, 2022, passed under Section 144BA(6) of the Income Tax Act, 1961, for the assessment year 2018-19.
Background of the Case
The dispute traces its origins to the sale of the “Mebaz” brand business by New Meena Bazar International Pvt. Ltd., a company engaged in the manufacture, sale, distribution, and trading of apparel and accessories. As of March 31, 2017, the company operated 20 retail stores across the country with an annual gross turnover of Rs. 144 crores. In June 2017, New Meena Bazar sold its business as a going concern to Vedant Fashions Pvt. Ltd. for a total consideration of Rs. 2,10,46,21,110.
Following a series of amalgamations, New Meena Bazar merged into Madevsag Retail Pvt. Ltd. with an appointed date of April 1, 2017, and subsequently, Madevsag Retail merged into EKGE Retail Private Limited. The petitioner thus became the successor in business and inherited the proceeds of the slump sale.
After discharging liabilities to the extent of Rs. 59.40 crores, the petitioner was left with a surplus of approximately Rs. 151.06 crores. Excluding a final tranche of about Rs. 20 crores received a year later, a surplus of Rs. 130 crores was available for investment. Neither the petitioner nor its promoters had previously handled an investable surplus of such magnitude, and the company engaged with multiple wealth managers, including representatives from ICICI, HDFC, IIFL, Anand Rathi, and Kotak, as well as an internal consultant, to plan the deployment of these funds.
Pending a final decision, the surplus was parked in liquid mutual funds. Ultimately, the petitioner decided to allocate approximately one-third of the corpus, about Rs. 50 crores, to equities and shares of listed companies, and two-thirds, about Rs. 80 crores, to bonds and units of debt mutual funds.
The Bonus Share Strategy and Capital Loss
The petitioner was advised that purchasing shares before a bonus issue and selling an equivalent quantity after the allotment of bonus shares could yield a short-term additional return of one to three percent within a week or two, based on historical market trends. The rationale was that while the theoretical ex-bonus price should fall proportionately, in practice the market price often does not fall to the theoretically exact level, creating a small arbitrage opportunity.
Acting on this strategy, the petitioner invested an aggregate of Rs. 106.31 crores in pre-bonus shares of large listed companies from time to time, sold shares worth Rs. 57.24 crores post-bonus, and retained a net investment at cost of Rs. 49.07 crores. The transactions resulted in a short-term capital loss of Rs. 49,32,71,673.
Since the transfer of the business had been effected as a going concern for a lump sum consideration, the gains were computed under Section 50B of the Act. The net worth of the undertaking was determined at Rs. 33,70,26,715, and as the business had been held for more than thirty-six months, long-term capital gains of Rs. 1,75,91,50,508 were worked out. The petitioner sought to set off the short-term capital loss against these long-term capital gains under Section 70(2) of the Act.
For the assessment year 2018-19, the petitioner filed its return of income on September 29, 2018, declaring a total income of Rs. 1,23,81,04,840.
Search, Reopening, and Invocation of GAAR
On November 27, 2018, a search and seizure operation was carried out at the petitioner’s premises. Pursuant to the search, the Revenue reopened approximately 105 assessments of the petitioner’s group, of which 104 were completed with nil or minimal adjustment to the returned income. The assessment of the petitioner alone remained pending.
The petitioner’s return for the assessment year 2018-19 was subsequently picked up for scrutiny vide notice dated September 21, 2019, issued under Section 143(2) of the Act, to verify issues relating to capital gains and losses, depreciation claims, expenses incurred for earning exempt income, disallowance under Section 40A(7), and business expenses.
After a lapse of about 14 months, the Assessing Officer invoked the GAAR provisions. The petitioner filed its objections on April 20, 2021. The Principal Commissioner of Income Tax thereafter issued a show cause notice proposing to invoke Sections 96(1)(b) and 96(1)(d) of the Act, alleging that the main purpose of the arrangement was to obtain a tax benefit. Not being satisfied with the petitioner’s objections, a reference was made to the Approving Panel under Section 144BA(4) of the Act.
The Approving Panel, vide directions dated February 23, 2022, under Section 144BA(6) of the Act, held that the sale-purchase transactions in shares resulting in short-term capital loss, set off against long-term capital gains arising from the slump sale, constituted an impermissible avoidance arrangement under the GAAR provisions.
Petitioner’s Arguments
Senior Counsel Lakshmikumaran Sridharan, appearing for the petitioner, argued that there was no tax benefit in the transactions and that the impugned order completely ignored the plain mandate of Section 70(2) of the Act. He contended that income tax is a single, unified annual levy concerned with the affairs of the taxpayer for the year taken as a whole, and that total income can be arrived at only after setting off losses from some activities against income from others.
The counsel further argued that the purchase and sale of shares of large, reputed publicly listed companies through a recognised stock exchange at open market rates, at arm’s length and in a transparent manner, did not constitute an “arrangement” as defined under Section 102(1) of the Act. The price of the stock was based entirely on market forces, and the counterparty to the transactions could not be identified. The precise quantum of profit or loss was not preordained.
It was also contended that the main purpose of the transactions was not to obtain a tax benefit, and that neither the purchase nor sale of shares of listed companies through a recognised stock exchange in an open and transparent manner could be considered an impermissible avoidance arrangement.
Revenue’s Stand
The Senior Standing Counsel for the Income Tax Department, B. Sapna Reddy, submitted that on receipt of the reference from the Assessing Officer, the Principal Commissioner issued a notice under Section 144BA(2) of the Act calling for the assessee’s objections. After considering the objections, a reference was made to the Approving Panel, which passed directions under Section 144BA(6) of the Act directing the Assessing Officer to regard the impugned transactions as an impermissible avoidance arrangement under Chapter X-A of the Act.
The Revenue contended that the assessee had planned the entire transaction in such a way that various provisions of the Act were abused, and that incurring short-term capital losses and setting them off against bona fide gains with a view to gaining a tax benefit attracted the GAAR provisions.
Court’s Reasoning and Observations
The High Court framed the central question as whether the purchase of shares of large listed companies on a recognised stock exchange prior to the declaration of bonus, and the sale of an equivalent quantity of shares after allotment of bonus shares, resulting in a short-term capital loss set off against long-term capital gains from a slump sale, could be treated as an impermissible avoidance arrangement under Chapter X-A of the Act.
The court noted that the scheme of Chapter X-A is one of considerable rigour and that its conditions must be construed strictly. Section 96(1) declares an arrangement to be an impermissible avoidance arrangement only where two conditions are cumulatively satisfied: first, that the main purpose of the arrangement is to obtain a tax benefit; and second, that the arrangement additionally answers any one of the four descriptions in clauses (a) to (d). The threshold requirement is that there must exist an “arrangement” as defined in Section 102(1). The burden of establishing each of these ingredients rests upon the Revenue.
The court found considerable force in the petitioner’s submission that the conclusion of the Approving Panel could not be sustained on the admitted facts. It observed that the petitioner purchased and sold shares of large and reputed publicly listed companies on a recognised stock exchange at prevailing open market rates in transactions that were entirely at arm’s length and wholly transparent. On a recognised exchange, the counterparty to any given trade is neither known nor capable of being identified by the transacting party.
The court held that the expressions “transaction”, “operation”, “scheme”, “agreement or understanding” employed in Section 102(1) must be read in their setting, and each of those expressions read in the company of the others connotes a degree of concert, design, or arrangement between identifiable parties, or at the very least a pre-ordained set of steps whose outcome is within the control of the person said to have entered into it. Since the quantum of gain or loss was not and could not be pre-ordained, being wholly dependent upon market movements over which the petitioner exercised no control, it was difficult to characterise the petitioner’s trade as an “operation” or “scheme” within the meaning of the definition.
The court further noted that the petitioner transacted on a stock exchange regulated by the Securities and Exchange Board of India, discharged Securities Transaction Tax and applicable Service Tax on those transactions, and did so through the most conventional and routinely employed channel available for dealing in securities. There was, quite simply, no more legitimate or transparent mode by which an investor could have deployed surplus funds in the equity market.
On the question of “main purpose”, the court observed that the statute uses the words “main purpose”, not “a purpose” or “an incidental consequence”. It held that an assessee, having incurred a loss, thereafter claiming the set-off which the statute itself expressly permits, cannot by itself convert the earning of that loss into an exercise whose main purpose was the obtaining of a tax benefit.
The court noted the commercial narrative disclosed by the record, which the Approving Panel had left substantially unaddressed. The petitioner came into possession of an investable surplus of approximately Rs. 130 crores, engaged with representatives of virtually every leading financial institution, retained an internal consultant, and ultimately arrived at a considered allocation of one-third into listed equities and two-thirds into bonds and debt mutual funds. The court found it telling that the petitioner retained a net investment at cost of Rs. 49.07 crores, observing that “an assessee whose sole object was the manufacturing of a capital loss would have had no reason to remain invested to that extent in the underlying scrip.”
The court further observed that the Approving Panel had approached the question from the wrong end. “Instead of asking whether the material established that the dominant purpose of the petitioner’s investment decisions was the obtaining of a tax benefit, the impugned directions proceed from the premise that because a tax benefit resulted, the purpose must have been to obtain it. That is to reason backwards from effect to intention and it is not the enquiry that Section 96(1) mandates.”
The court reiterated the well-settled principle that an assessee is entitled to so arrange its affairs as to attract the least incidence of tax, provided it does so within the four corners of the law, and that the mere circumstance that a lawful course adopted by an assessee also happens to be tax-efficient does not render that course impermissible.
Legal Analysis of Section 70(2)
The court found merit in the petitioner’s fundamental submission that the impugned directions overlooked the plain mandate of Section 70(2) of the Act. It observed that income tax is a single, unified, and annual levy, not an aggregate of discrete taxes upon discrete receipts. The total income of an assessee for a previous year can be arrived at only after the losses sustained in some activities are set off against the gains derived from others. This is not a concession granted to the assessee but an intrinsic feature of the manner in which taxable income is computed under the Act.
Section 70(2) gives statutory expression to this principle by permitting a short-term capital loss to be set off against capital gains, whether short-term or long-term, arising in the same year. Section 74 carries the same principle forward to subsequent years.
The court held that when the petitioner set off a short-term capital loss of Rs. 49,32,71,673 against the long-term capital gains of Rs. 1,75,91,50,508 computed under Section 50B on the slump sale, it did no more than compute its total income in the manner that the Act itself prescribes. “To describe the working out of a computation provision according to its own terms as the obtaining of a ‘tax benefit’ is to misapprehend the nature of the levy. A ‘tax benefit’ within the contemplation of Chapter X-A must be something that the assessee secures by circumventing or subverting the scheme of the Act and not something that flows from the direct and unavoidable operation of a computation provision upon a loss that was genuinely and commercially sustained.”
Findings on Clauses (b) and (d) of Section 96(1)
On clause (d) of Section 96(1), which applies where the arrangement is entered into or carried out by means or in a manner not ordinarily employed for bona fide purposes, the court held that the clause is directed at the means and the manner, not at the outcome. Purchases and sales of listed securities on a recognised stock exchange regulated by SEBI, with securities transaction tax and service tax duly discharged, represent the most ordinary, conventional, and universally employed means of transacting in securities in the country. “To hold that recourse to a regulated stock exchange is a means not ordinarily employed for bona fide purposes would be to stand the clause upon its head.”
On clause (b) of Section 96(1), which speaks of an arrangement that results directly or indirectly in the misuse or abuse of the provisions of the Act, the court held that there had been no misuse and no abuse. The petitioner invoked Section 70(2) according to its terms, computed the cost of bonus shares as the statute commanded under Section 55, applied the First-In-First-Out method as the Board’s Circular required, and computed its slump sale gains under Section 50B. “Abuse connotes the employment of a provision for a purpose alien to that for which it was enacted. Set-off under Section 70(2) exists precisely so that losses may be set against gains in arriving at total income, and the petitioner used it for no other purpose.”
Unaddressed Features of the Record
The court also noted two features of the record that the impugned directions left unexplained. First, the search and seizure operation conducted on November 27 and 28, 2018, yielded no incriminating material whatsoever against the petitioner, and although the statement of its Director was recorded, nothing incriminating emerged. Second, of the approximately 105 assessments of the petitioner’s group reopened in consequence of that search, 104 were completed with nil or minimal adjustment to the returned income. Against this backdrop, the court observed that the singling out of the present assessment for the invocation of the extraordinary machinery of Chapter X-A required, at the very least, a careful and reasoned application of mind.
Court’s Conclusion and Directions
The court concluded that the Revenue had failed to establish the existence of an “arrangement” within the meaning of Section 102(1) of the Act, had failed to establish that the main purpose of the petitioner’s transactions was the obtaining of a tax benefit within the meaning of Section 96(1), and had failed to bring the case within either clause (b) or clause (d) thereof.
The impugned directions dated February 23, 2022, holding the petitioner’s transactions to constitute an impermissible avoidance arrangement, were therefore set aside. The court held that the petitioner is entitled to the benefit of set-off claimed under Section 70(2) of the Act in respect of the short-term capital loss of Rs. 49,32,71,673 against the long-term capital gains arising on the slump sale. The question of law framed in the case was answered in favour of the petitioner and against the Revenue.
The writ petition was accordingly allowed, and the impugned directions passed by the Approving Panel under Section 144BA(6) of the Act for the assessment year 2018-19 were quashed. Miscellaneous petitions pending, if any, were closed, with no order as to costs.
Significance and Implications
The judgment is significant for several reasons. It clarifies that the GAAR provisions cannot be invoked merely because a tax benefit results from a transaction; the Revenue must establish that the main purpose of the arrangement was to obtain a tax benefit. It reaffirms the principle that transactions carried out on a recognised stock exchange at arm’s length, with applicable taxes duly discharged, cannot be characterised as an impermissible avoidance arrangement merely because they result in a capital loss that is set off against capital gains.
The ruling also underscores the fundamental nature of set-off provisions under Sections 70 and 74 of the Act, holding that the working out of a computation provision according to its own terms cannot be described as obtaining a tax benefit. It emphasises that income tax is a single, unified, and annual levy, and that the setting off of losses against gains is an intrinsic feature of income computation, not a concession.
The judgment further reinforces the principle that an assessee is entitled to arrange its affairs to attract the least incidence of tax within the four corners of the law, and that tax efficiency alone does not render a lawful course impermissible. It also serves as a caution to tax authorities against reasoning backwards from effect to intention when invoking the GAAR machinery, which carries grave consequences for the assessee.
For taxpayers, particularly those undertaking legitimate investment transactions that may result in capital losses, the ruling provides reassurance that such transactions will not be branded as impermissible avoidance arrangements without clear evidence of a dominant tax-avoidance purpose. It also highlights the importance of maintaining a robust commercial narrative and documentary record to demonstrate the bona fide rationale behind investment decisions.
Case Reference:
Writ Petition No. 21210 of 2022 (CNR No. HBHC010287632022) The petitioner, M/s. EKGE Retail LLP, was represented by Senior Counsel Lakshmikumaran Sridharan, while the Income Tax Department was represented by Senior Standing Counsel B. Sapna Reddy.
