This document discusses the judicial doctrine of substance over form in Indian tax law through various judicial precedents and perspectives. It notes that substance over form allows tax authorities to ignore the legal form of an arrangement and look at the actual substance to prevent tax avoidance. However, courts generally apply substance over form only when the legal form has no commercial justification and is completely tax driven. There is ongoing debate around the appropriate test for applying this doctrine and its relationship to statutory anti-avoidance rules.

1. Pramod Kumar
International Taxation Conference – FIT, India December 6,2012
Pramod Kumar
International Taxation Conference, Mumbai  December 6, 2012.

2. This presentation seeks to present the factual and legal
elements relating to various points of view about the
concept of substance over form in Indian Tax laws. This
presentation is only a compilation of such points of view
and does not canvass or support any particular point of
view. The views expressed herein, therefore, do not
necessarily reflect the views or the understanding of the
author or his employer i.e. the Income Tax Appellate
Tribunal, Government of India.
This presentation deals only with the judicial doctrine of
substance over form, and does not deal with GAAR, on
which a separate presentation is being made later, as also
on statutory provisions dealing with substance over form.

3.  Doctrine of substance over form is a judicial creation. It is
invoked in cases in which taxpayer has conducted a scheme
of transactional relationships in documents and has a view on
tax advantages that flow from tax reporting based on such
transactional relationships, rather than on the substance of
arrangement. The economic reality is thus hidden and
transaction exists in form only.
 This doctrine allows tax authorities to ignore the legal form
of an arrangement and to look at its actual substance, so as
to prevent artificial structures from being used for tax
avoidance purposes.

4.  In its pure form, when, on the basis of evaluation of
evidence and analysis of facts, judicial authorities find
that tax motivation outweighs business purpose or
profit objective, it is held that the taxpayer‟s efforts of
form does not reflect the substance of economic
transactions, and intended tax benefits are declined.
 Recent Indian decisions, however, can be viewed as
proceeding on the basis that substance prevails over
form only when the form has no commercial
justification whatsoever and is completely tax driven.

5.  It is extremely difficult, if not altogether impossible, for
legislation to keep pace with dynamism of, and innovations
in, business and commerce, and therefore, normative
systems, which legal provisions inherently are, cannot
effectively handle the aggressive tax positions taken by the
businesses.
 This doctrine provides flexibility to judges to deal with the
cases not visualized by the legislature and, as a judicial
doctrine, it is inherently more flexible than a statutory rule, it
can develop gradually and it cannot be undermined by
microscopic examination in search of loopholes.

6.  Substance over form is one of the fundamental tax issues
debated right from the initial days of tax laws in India, but initial
controversies about characterization of income and expenditure,
and nomenclature assigned to the same by the taxpayers.
Relatively simple matters and no major issues arose on
application of this doctrine.
 The focus is now due to revenue‟s challenge to investment and
transaction structures on the basis that use of intermediate
companies is for dominant purpose of obtaining tax benefits –
through treaty or otherwise. Relatively complex issues but
doctrine of substance over form applied mainly when the
structure is completely tax driven and devoid of any commercial
justification whatsoever.

7.  Judiciary cannot be a silent spectator when facts and
circumstances clearly warrant the inference that there has been a
dubious, though seemingly legal, method adopted with the sole
motive of avoiding taxes.
 The role played by judges while handling tax cases is a tight
rope walk. On the one hand, they should be entirely neutral
towards the parties, even if not value neutral, and, on the other
hand, their judgments should be objective, fair, reasonable and
unaffected by their ideologies. Indian judicial doctrine on the
substance over form, by and large, reflect this position.

8.  Not everyone in the judiciary is, or can be, really confident
in meeting the challenge of looking through the complex
maze of contrived transactions, and understanding the
core economic and business realities of such transactions.
Is that the reason, as many believe, judiciary prefers to go
by the form and prone to err on the side of excessive
caution at the cost of the exchequer ?
 Should the judiciary be content with foundationalist
approach to interpretation of tax statutes by implementing
its plain meaning, intent or purpose, or has the time come
that judges should approach the tax statutes by exploring
for most sensible policy option. Will latter will essentially
lead to more emphasis on substance over form ?

9.  It is a controversial issue as to whether doctrine of substance
over form can be invoked only when the form of transaction
is completely tax driven or whether it can also be invoked
when tax motivation clearly outweighs the business purpose
or profit objective. Judicial precedents seem to be in favour of
the former approach as on now, but there is little conceptual
justification in its support.
 Is the legislation on GAAR intended to fill in this gap created
by, what tax administration may perceive as, judicial inertia
and inconsistency in applying judicial doctrine of substance
over form ?

10. Legal substance :
Legal substance generally prevails over form. When despite the
legal steps, intended legal results not obtained, the court could
be justified in ignoring the intermediate steps.
Economic substance :
Economic substance applies over form, it is often argued, only
when it is completely tax driven, devoid of any other
consideration and revenue authorities are able to demonstrate
that position.

11.  If the Court finds that notwithstanding a series of legal steps
taken by an assessee, the intended legal results have not
been achieved, the Court might be justified in overlooking the
intermediate steps, but it would not be possible for the Court
to treat the intervening steps as non est based on some
hypothetical assessment of real motive of the assessee. In our
view, the Court must deal with what is tangible in an objective
manner and cannot afford to chase a will-o'-the-wisp
Union of India Vs Azadi Bachao Andolan
(263 ITR 706 – Supreme Court)

12.  “………It is well established that in a matter of this description
the Income- tax authorities are entitled to pierce the veil of
corporate entity and to look at the reality of the transaction. It
is true that from the juristic point of view the company is a
legal personality entirely distinct from its members and the
company is capable of enjoying rights and being subjected to
duties which are not the same as those enjoyed or borne by
its members. But in certain exceptional cases the Court is
entitled to lift the veil of corporate entity and to pay regard to
the economic realities behind the legal facade. For example,
the Court has power to disregard the corporate entity if it is
used for tax evasion or to circumvent tax obligation.”
 CIT Vs Meenakshi Mills Ltd (63 ITR 609)

13.  “It is true that apparent must be considered real unless it is
shown that there are reasons to believe that apparent is not
real. If all that an assessee, who wants to evade tax, is to have
some recital made in documents either executed by him or
executed in his favour, then the door will be left wide open to
evade tax. …….The taxing authorities were not required to
put on blinkers while looking at the documents produced
before them. They were entitled to look into surrounding
circumstances to find out reality of recitals made in those
documents….”
CIT Vs Durga Prasad More
82 ITR 540 - Supreme Court

14.  “Tax planning may be legitimate provided it is within
the framework of law. Colourable devices cannot be
part of tax planning and it is wrong to encourage the
belief that it is honourable to avoid tax by resorting to
subterfuges. It is the obligation of every citizen to pay
the taxes honestly without resorting to subterfuges
 “On this aspect (i.e. tax evasion through use of
colorable devices and by using dubious methods and
subterfuges*), one of us, Chainappa Reddy J, has
proposed a separate opinion with which agree.”
 McDowell & Co Ltd Vs CTO (154 ITR 148)
Justice Ranganath Mishra (speaking for the majority )
* See Justice Kapadia‟s observations in Vodafone case

15.  “……….in the very country of its birth, the principle of
Westminster has been given a decent burial and in that very
country where the phrase 'tax avoidance' originated the
judicial attitude towards tax avoidance has changed and the
smile, cynical or even affectionate though it might have been
at one time, has now frozen into a deep frown. The Courts
are now concerning themselves not merely with the
genuineness of a transaction, but with the intended effect of
it for fiscal purposes. No one can now get away with a tax
avoidance project with the mere statement that there is
nothing illegal about it.”

16.  “ It is neither fair not 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 consider whether the situation created by the devices
could be related to the existing legislation with the aid of
'emerging' techniques of interpretation was done in Ramsay
(1982 AC 300), Burma Oil (1982 STC 30) and Dawson (1984-
1 All ER 530), to expose the devices for what they really are
and to refuse to give judicial benediction.”

17.  …. opinion of the majority is a far cry from the view of
Chinnappa Reddy,J (in McDowells‟s case): "In our view the
proper way to construe a taxing statute, while considering a
device to avoid tax, is not to ask whether a provision should
be construed liberally or principally, nor whether the
transaction is not unreal and not prohibited by the statute,
but whether the transaction is a device to avoid tax, and
whether the transaction is such that the judicial process may
accord its approval to it." We are afraid that we are unable to
read or comprehend the majority judgment in McDowell as
having endorsed this extreme view of Chinnappa Reddy,J,
which, in our considered opinion, actually militates against
the observations of the majority of the Judges…

18.  We may also refer to the judgment of Gujarat High Court in
Banyan and Berry v. Commissioner of Income-Tax where
referring to McDowell , 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…. The ratio of any
decision has to be understood in the context it has been
made. ………….

19.  …………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.
 This accords with our own view of the matter.”

20. “ In our view, although Justice Chainappa Reddy makes a number of
observations regarding the need to depart from the „Westminster‟
and tax avoidance – these are clearly in the context of artificial and
colourable devices. Reading McDowell, in the manner indicated
hereinabove, in cases of treaty shopping and/ or tax avoidance,
there is no conflict between Mc Dowell and Azadi Bachao…”
(Justice Kapadia)

“..a clear cut distinction between tax avoidance and tax evasion is
still to emerge in England and in the absence of any legislative
guidelines, there is bound to be uncertainty ...................... ............
….emphasized that the Ramsay approach as a principle of statutory
interpretation rather than an over-arching anti avoidance doctrine
imposed upon tax laws. (Justice Radhakrishna)


21.  “When it comes to taxation of a holding structure, the burden
is on the Revenue to allege and establish tax abuse, in the
sense of tax avoidance in the creation and/ or use of such
structure(s).”
 “In the application of a judicial anti avoidance rule, the
Revenue may invoke the “substance over form” principle or
“piercing the corporate veil” test only after it is able to
establish, on the basis of facts and circumstances
surrounding the transaction that the impugned transaction is
a sham or tax avoidant.”

22.  “To give an example, if a structure is used for circular
trading or round tripping or to pay bribes then such
transactions, though having a legal form, should be
discarded by applying the test of fiscal nullity. Similarly, in
a case where the Revenue finds that in a Holding Structure
an entity which has no commercial/business substance has
been interposed only to avoid tax then in such cases
applying the test of fiscal nullity it would be open to the
Revenue to discard such interpositioning of that entity.
However, this has to be done at the threshold.”
 “It is the task of the Revenue/Court to ascertain the legal
nature of the transaction and while doing so it has to look
at the entire transaction as a whole and not to adopt a
dissecting approach.”

23.  “...we are of the view that every strategic foreign direct
investment coming to India, as an investment destination,
should be seen in a holistic manner. While doing so, the
Revenue/Courts should keep in mind the following factors:
the concept of participation in investment, the duration of
time during which the Holding Structure exists; the period of
business operations in India; the generation of taxable
revenues in India; the timing of the exit; the continuity of
business on such exit. In short, the onus will be on the
Revenue to identify the scheme and its dominant purpose.”
Although there is a mention of „dominant purpose‟ of the
scheme here, earlier observations refer to discarding the
structure when it has “no commercial/ business substance”.

24. The doctrine of substance over form well entrenched in Indian
tax laws, even as its application may not be as uniform and
consistent as aggressively pursued by the revenue authorities.
It is only in extreme cases where form of a transaction is not at
all defensible on commercial basis (other than for tax planning)
that the doctrine of substance over form is invoked. As long as
there is some commercial justification for the form of a
transaction, judiciary generally refrains from invoking it
Schemes and transactions where economic substance is
significantly different from the legal form, or where an entity
without economic substance is used in a transaction, are at risk.

25. Thank you !
pramod.kumar@itat.nic.in