The department says my restructuring was a device and is taxing me on the substance. How far can it go behind a transaction that is perfectly legal on its face?
It depends, and this is the case both sides cite. A five-judge Bench of the Supreme Court held that excise duty paid direct to the authorities by the buyers still formed part of the manufacturer's turnover, because the payment was made on the manufacturer's account and was part of the consideration. In doing so the Court said that colourable devices cannot be part of tax planning and that it is wrong to think it honourable to avoid tax by dubious methods. Chinnappa Reddy J went further in a separate opinion, treating the Westminster principle as spent.
Decided by the Supreme Court (Supreme Court of India, Y.V. Chandrachud C.J., D.A. Desai, E.S. Venkataramiah, O. Chinnappa Reddy and Ranganath Misra, JJ.) on 1985-04-17, reported as [1985] INSC 91; 1985 SCR (3) 791; (1985) 3 SCC 230; AIR 1986 SC 649; also reported at (1985) 154 ITR 148 (SC). It bears on the Income Tax Act 1961, in How Tax Law Is Read matters.
This is the source of the substance-over-form argument in Indian tax and the intellectual ancestor of the general anti-avoidance rule in Chapter X-A. The Revenue leads with it in every recharacterisation and treaty-shopping dispute. But it cannot be read alone: Azadi Bachao Andolan and Vodafone confine it, treating Chinnappa Reddy J's wider observations as not the ratio and restoring the taxpayer's right to arrange affairs within the law. A practitioner needs all three, and needs to be able to say precisely which sentences of McDowell are the judgment of the Court and which are the separate opinion.
Binding on every court and authority in India.
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McDowell manufactured Indian liquor in Andhra Pradesh. Under the excise rules the duty had to be paid before the liquor could be removed from the distillery, and the buyers paid it direct to the excise authorities. McDowell left the duty out of its bills and out of the turnover it returned under the Andhra Pradesh General Sales Tax Act, 1957, on the footing that the money never passed through its hands. The sales tax authorities included the excise duty so paid in the manufacturer's taxable turnover. An earlier round of the same litigation had gone in the assessee's favour on the reasoning that a duty which never entered the dealer's till could not be turnover. The matter came to a Constitution Bench of five judges.
The appeal was dismissed. Excise duty paid by the buyers direct to the excise authorities forms part of the manufacturer's taxable turnover. The liability to excise duty is that of the manufacturer and attaches on manufacture, even though its collection is deferred to the point of removal for administrative convenience; when the buyer pays it, he pays it on the manufacturer's account and the payment is part of the consideration for the sale. Turnover, as defined, takes in the whole consideration charged, whether or not the duty is separately shown or folded into the price, so the earlier test — that a duty which never reaches the dealer's coffers cannot be turnover — was not decisive. Along the way the Court said that colourable devices cannot be part of tax planning and that it is not honourable to avoid tax by dubious methods; Chinnappa Reddy J wrote separately and at length on the decline of the Westminster principle.
The Court began with the incidence of excise. Duty is charged on the fact of manufacture, and the rule requiring payment before removal is a matter of collection, not of liability. It followed that the liability was McDowell's throughout; the buyer who paid the duty discharged the manufacturer's obligation and did so as part of what he gave for the goods. Turnover being defined as the total amount set out in the bill of sale as the consideration, the question was whether the excise duty was part of that consideration in substance, not whether it appeared as a separate line in the bill; in normal commercial dealing the duty would be built into the price, and an arrangement under which the buyer paid it separately did not alter what the sale was worth. The Court therefore declined to let the form of the billing arrangement determine the tax. That reasoning led directly into its observations on avoidance: a device adopted to reduce a liability that would otherwise attach cannot be dressed up as legitimate planning, and it is the duty of the court to look at the true nature of the transaction. Chinnappa Reddy J, concurring, traced the retreat from the Duke of Westminster case and said that no one can now escape a tax avoidance project merely by saying there is nothing illegal in it. That passage, rather than the turnover holding, is what the case is usually cited for, and later Benches have had to mark off how much of it is binding.
Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods.
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Handle my notice → Ask a CA on WhatsAppIt depends, and this is the case both sides cite. A five-judge Bench of the Supreme Court held that excise duty paid direct to the authorities by the buyers still formed part of the manufacturer's turnover, because the payment was made on the manufacturer's account and was part of the consideration. In doing so the Court said that colourable devices cannot be part of tax planning and that it is wrong to think it honourable to avoid tax by dubious methods. Chinnappa Reddy J went further in a separate opinion, treating the Westminster principle as spent. This was decided by the Supreme Court (Supreme Court of India, Y.V. Chandrachud C.J., D.A. Desai, E.S. Venkataramiah, O. Chinnappa Reddy and Ranganath Misra, JJ.) and bears on the Income Tax Act 1961. It is reported as [1985] INSC 91; 1985 SCR (3) 791; (1985) 3 SCC 230; AIR 1986 SC 649; also reported at (1985) 154 ITR 148 (SC). This is the source of the substance-over-form argument in Indian tax and the intellectual ancestor of the general anti-avoidance rule in Chapter X-A. The Revenue leads with it in every recharacterisation and treaty-shopping dispute. But it cannot be read alone: Azadi Bachao Andolan and Vodafone confine it, treating Chinnappa Reddy J's wider observations as not the ratio and restoring the taxpayer's right to arrange affairs within the law. A practitioner needs all three, and needs to be able to say precisely which sentences of McDowell are the judgment of the Court and which are the separate opinion. If it applies to you, the first step is this: Separate the two opinions when you cite or answer it: the Court's own words are that colourable devices are not tax planning, while the wider attack on the Westminster principle is Chinnappa Reddy J's separate opinion.
McDowell manufactured Indian liquor in Andhra Pradesh. Under the excise rules the duty had to be paid before the liquor could be removed from the distillery, and the buyers paid it direct to the excise authorities. McDowell left the duty out of its bills and out of the turnover it returned under the Andhra Pradesh General Sales Tax Act, 1957, on the footing that the money never passed through its hands. The sales tax authorities included the excise duty so paid in the manufacturer's taxable turnover. An earlier round of the same litigation had gone in the assessee's favour on the reasoning that a duty which never entered the dealer's till could not be turnover. The matter came to a Constitution Bench of five judges. The matter was decided on 1985-04-17 by the Supreme Court (Supreme Court of India, Y.V. Chandrachud C.J., D.A. Desai, E.S. Venkataramiah, O. Chinnappa Reddy and Ranganath Misra, JJ.). On those facts the Supreme Court held as follows. The appeal was dismissed. Excise duty paid by the buyers direct to the excise authorities forms part of the manufacturer's taxable turnover. The liability to excise duty is that of the manufacturer and attaches on manufacture, even though its collection is deferred to the point of removal for administrative convenience; when the buyer pays it, he pays it on the manufacturer's account and the payment is part of the consideration for the sale. Turnover, as defined, takes in the whole consideration charged, whether or not the duty is separately shown or folded into the price, so the earlier test — that a duty which never reaches the dealer's coffers cannot be turnover — was not decisive. Along the way the Court said that colourable devices cannot be part of tax planning and that it is not honourable to avoid tax by dubious methods; Chinnappa Reddy J wrote separately and at length on the decline of the Westminster principle.
The Court began with the incidence of excise. Duty is charged on the fact of manufacture, and the rule requiring payment before removal is a matter of collection, not of liability. It followed that the liability was McDowell's throughout; the buyer who paid the duty discharged the manufacturer's obligation and did so as part of what he gave for the goods. Turnover being defined as the total amount set out in the bill of sale as the consideration, the question was whether the excise duty was part of that consideration in substance, not whether it appeared as a separate line in the bill; in normal commercial dealing the duty would be built into the price, and an arrangement under which the buyer paid it separately did not alter what the sale was worth. The Court therefore declined to let the form of the billing arrangement determine the tax. That reasoning led directly into its observations on avoidance: a device adopted to reduce a liability that would otherwise attach cannot be dressed up as legitimate planning, and it is the duty of the court to look at the true nature of the transaction. Chinnappa Reddy J, concurring, traced the retreat from the Duke of Westminster case and said that no one can now escape a tax avoidance project merely by saying there is nothing illegal in it. That passage, rather than the turnover holding, is what the case is usually cited for, and later Benches have had to mark off how much of it is binding. In the words reproduced by the source cited on this page: "Colourable devices cannot be part of tax planning and it is wrong to encourage or entertain the belief that it is honourable to avoid the payment of tax by resorting to dubious methods."
It was decided by the Supreme Court on 1985-04-17 and is reported as [1985] INSC 91; 1985 SCR (3) 791; (1985) 3 SCC 230; AIR 1986 SC 649; also reported at (1985) 154 ITR 148 (SC). Binding on every court and authority in India. A Supreme Court decision binds every assessing officer, every Commissioner (Appeals), every bench of the Income Tax Appellate Tribunal and every High Court in India. An officer who declines to follow it is acting contrary to law, and that refusal is itself a ground of appeal. On the sections in issue, the practical question is whether the facts of your own notice match the facts of this case closely enough for the same rule to apply.
It helps the department, and it appears in this library for that reason — you need to know what the Assessing Officer will cite against you. The appeal was dismissed. Excise duty paid by the buyers direct to the excise authorities forms part of the manufacturer's taxable turnover. The liability to excise duty is that of the manufacturer and attaches on manufacture, even though its collection is deferred to the point of removal for administrative convenience; when the buyer pays it, he pays it on the manufacturer's account and the payment is part of the consideration for the sale. Turnover, as defined, takes in the whole consideration charged, whether or not the duty is separately shown or folded into the price, so the earlier test — that a duty which never reaches the dealer's coffers cannot be turnover — was not decisive. Along the way the Court said that colourable devices cannot be part of tax planning and that it is not honourable to avoid tax by dubious methods; Chinnappa Reddy J wrote separately and at length on the decline of the Westminster principle. It arises in How Tax Law Is Read matters, on the relevant sections of the Income Tax Act 1961, and was decided by Supreme Court of India, Y.V. Chandrachud C.J., D.A. Desai, E.S. Venkataramiah, O. Chinnappa Reddy and Ranganath Misra, JJ.. Before relying on it, read the source linked on this page and check whether it has since been distinguished, overruled or overtaken by an amendment to the Income Tax Act. In practice the steps that follow from it are these. If the Revenue relies on McDowell alone, put Azadi Bachao Andolan and Vodafone against it and show that a genuine transaction is not struck down merely because it is tax-efficient. Build the file on commercial purpose: minutes, correspondence and contemporaneous reasons for the structure, because the enquiry the case invites is whether the arrangement is real or a device. For arrangements after 1 April 2017 argue the statutory test in Chapter X-A on its own terms rather than the general language of McDowell.
Still good law. Not overruled, but materially confined. Union of India v Azadi Bachao Andolan (2003) and Vodafone International Holdings BV v Union of India (2012) held that the wider observations of Chinnappa Reddy J are not the ratio and that a taxpayer may lawfully arrange his affairs to reduce tax. Those two decisions were not read for this note; the qualification is stated here as the reason the case cannot be cited on its own. No source could be cited for that finding. Checking whether an authority still stands matters as much as knowing what it held: a decision may be overruled on one point and survive on another, or the provision it interprets may have been amended since. Read the source and the editor's note on this page before relying on it in a reply to an Assessing Officer or in an appeal.
The judgment was read on a free reproduction of the Supreme Court's text, not on an official Supreme Court URL, and the concurring opinion of Chinnappa Reddy J was read only in outline, so the exact scope of his reasoning is not set out here. The sections field is left empty because this is a sales tax appeal under the Andhra Pradesh General Sales Tax Act, 1957 and turns on no section of the Income-tax Act, 1961; the audit note's suggestion of sections 95 and 96 refers to the general anti-avoidance rule enacted long afterwards, which the case obviously does not decide. The (1985) 154 ITR 148 citation in the audit note was not checked against the report. This library shows the verification state of every entry openly. This entry has not yet been read in full by a chartered accountant. The summary reflects the sources listed on this page. Read the source before you rely on it in a reply to an Assessing Officer or in an appeal before the Commissioner (Appeals) or the Income Tax Appellate Tribunal.
The appeal was dismissed. Excise duty paid by the buyers direct to the excise authorities forms part of the manufacturer's taxable turnover. The liability to excise duty is that of the manufacturer and attaches on manufacture, even though its collection is deferred to the point of removal for administrative convenience; when the buyer pays it, he pays it on the manufacturer's account and the payment is part of the consideration for the sale. Turnover, as defined, takes in the whole consideration charged, whether or not the duty is separately shown or folded into the price, so the earlier test — that a duty which never reaches the dealer's coffers cannot be turnover — was not decisive. Along the way the Court said that colourable devices cannot be part of tax planning and that it is not honourable to avoid tax by dubious methods; Chinnappa Reddy J wrote separately and at length on the decline of the Westminster principle.
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