Advocate Dharan V. Gandhi has conducted a thorough analysis of the recent judgement of the Supreme Court in PCIT vs. NRA Iron & Steel 412 ITR 161 on the taxability of bogus share capital and premium u/s 68 of the Income-tax Act. He has explained the nuances of the judgement and also offered valuable advice on what taxpayers should do to be able to successfully distinguish the said judgement from applying to the facts of their case
The most effective and lethal weapon used by the Income-tax Department (‘Department’) against evasive tactics used by the assessees, to convert their unaccounted money in accounted one, is section 68 of the Income-tax Act, 1961 (‘Act’).
Even prior to the insertion of the said section or its predecessor, there were ample authorities to the same effect as section 68. In this regard, one may profitably refer to the judgment of the Apex Court in case of Kale Khan Mohammad Hanif vs. CIT - 50 ITR 1 (SC), wherein the Court has held as under:
“It is well established that the onus of proving the source of a sum of money found to have been received by the assessee is on him. If he disputes liability for tax, it is for him to show either that the receipt was not income or that if it was, it was exempt from taxation under the provisions of the Act. In the absence of such proof, the Income-tax Officer is entitled to treat it as taxable income”.
Similar finding was given by the Apex Court in case of A. Govindarajulu Mudaliar vs. CIT –  34 ITR 807 (SC).
It was only later that the above dictum of the Apex Court found embodiment in section 68 of the Act.
Background of section 68
Section 68 does not need any introduction. To summarise, it taxes any credit appearing in the books of an assessee, where the assessee is not able to or not satisfactorily able to explain the nature and source of such credit. It is a deeming fiction, which taxes a credit as income on unsatisfactory explanation about nature and source thereof and such fiction is applicable whether or not the credit is otherwise income chargeable to tax.
Initial onus is on the assessee to demonstrate the “nature and source” of the credit and when the same is discharged, the burden shifts onto the Department to prove that the credit is income chargeable to tax. It is now settled by various judgments that the term “nature and source of a sum found credited” would require an assessee to explain three things (ingredients) viz.
a. Identity of the creditor
b. capacity of the creditor to advance money and
c. genuineness of the transaction.
The term ‘any sum found credited’ also takes under its sweep any sum credited as share capital, share premium or share application money or any such amount by whatever name called [Refer Sophia Finance Ltd – 205 ITR 98 (Del); CIT vs. Ruby Traders and Exporters Ltd. -263 ITR 300 (Cal); – CIT vs. Divine Leasing and Finance Pvt. Ltd. – 299 ITR 268 (Del)]
Judgment in case of Lovely export
The Hon’ble Supreme Court in case of CIT vs. Lovely Exports P. Ltd. – 216 CTR 195(SC), while dealing with the issue of applicability of section 68 on receipt of share capital and burden of proof on the assessee, held that ‘if the share application money is received by the assessee company from alleged bogus shareholders, whose names are given to the AO, then the Department is free to proceed to reopen their individual assessments in accordance with law.’
Thus, the said judgment reduced the rigours of section 68 in so far as, share capital etc. is concerned, in as much as, the Court held that the onus is discharged on giving names and PAN of the investor. It further held that, if at all, the Department would like to assess any income, the same can be done in the hands of the investor. Thus, unlike other credits, wherein one has to explain three ingredients as stated above, the onus on the assessee company is limited while explaining credit in the nature of share capital etc.
Following the said judgment, many courts had earlier taken a view that, where the identity has been established and PAN has been furnished, no addition can be made u/s 68 of the Act and that the Department can take necessary actions against the investors [Refer CIT vs. Siri Ram Syal Hydro Power (P) Ltd.-196 Taxman 441(Del); CIT vs. vs. GP International Ltd.-325 ITR 25(P&H); CIT vs. Dwarkadhish Investment (P) Ltd. – 330 ITR 298(Del); CIT vs. Creative World Telefilms Ltd.-333 ITR 100 (Bom)]
Judgment in case of Lovely Export distinguished
However, many courts have, off late, distinguished the said judgment [refer CIT vs. Nipun Builders and Developers P. Ltd.-350 ITR 407(Del); CIT vs. Nova Promoters and Finlease (P) Ltd. -342 ITR 169 (Del.); CIT vs. Oasis Hospitalities Pvt. Ltd. -333 ITR 119 (Del.); Rajmandir Estates Private Limited vs. PCIT -386 ITR 162 (Cal)].
From the above referred judgments, it can be seen that the Delhi High Court and the Calcutta High Court have distinguished the judgment in case of Lovely Exports on the ground that private placement of shares would invite higher burden on the assessees to explain the nature and source of the share capital etc. rather than mere provision of name and PAN.
Though, some courts, are still following the judgment of the Apex Court in case of Lovely Exports (supra) [Refer PCIT vs. Veedhata Tower Pvt. Ltd. -403 ITR 415(Bom); PCIT vs. Apeak Infotech -397 ITR 148(Bom); CIT vs. Gagandeep Infrastructure (P.) Ltd.-394 ITR 680(Bom)].
In light of the various judgments which have come off late, one may say that the ratio of the judgment of the Apex Court in case of Lovely Exports (supra) has been diluted to a lot extent. In fact, even the assessees are making a point to demonstrate the three ingredients even in case of credit in the nature of share capital etc. instead of merely submitting the name and PAN. Nonetheless, there still do not exist any requirement to explain the source of source or origin of origin in case of credit in the nature of share capital etc.
Judgment in case of NRA Iron and Steel Ltd.
Recently the Hon’ble Supreme Court was seized with the issue of applicability of section 68 on receipt of share capital and share premium in case of Principal Commissioner of Income-tax (Central)-1 vs. NRA Iron & Steel (P.) Ltd. reported in  103 taxmann.com 48 / 262 Taxman 74 / 412 ITR 161 (SC). The Court gave out its verdict on 05th March, 2019, laying down certain important ratios. Before going into the findings of the Court, it will be pertinent to analyse the facts of the case.
Appeal pertained to the AY 2009-10. The assessee company had received share capital and share premium totalling to Rs. 17.60 crores from 19 companies, of which, 6 were based in Mumbai, 11 in Kolkata and 2 in Guwahati. Each company had invested an amount of Rs. 90 lakh or Rs. 95 lakh. The shares issued were having face value of Rs. 10 and the premium charged was Rs. 190. The assessment of the assessee company was reopened based on some information received from the investigation wing of the Department.
During the course of assessment proceedings, the assessee submitted that the share capital money was received through banking channel and it submitted confirmations, income tax return acknowledgments and bank accounts in respect of the investor companies.
The AO carried out certain independent investigation into receipt of such share capital. The AO issued summons to the investor companies, however, none appeared before the AO. Some companies had replied to the summons by filing their submission through dak. Some companies did not file any reply.
Summary of such investigation by the AO is stated hereunder:
a. Companies to whom notice served but no response received – 3 companies
b. Company in respect of which the address was found to be incorrect and at new address, office was found to be closed – 1 company
c. Companies in respect of which notice could not be served as investor-company was not available at the address and some other person owned the premises – 2 companies
d. Reply received through dak. Details as to cheque number and share capital and number of shares given. Further, detail as to return of income for the concerned year given which showed very meagre income in the range of Nil to Rs. 28000 – 9 companies
e. Reply received through dak stating that it had applied for shares but did not specify how many shares and at what premium etc. Further, the company did not furnish bank statement and had returned meagre income – 2 companies.
Also, field inquiries were conducted, wherein it was found that out of 4 companies in Mumbai, 2 companies were found to be non-existent and similarly, both the companies based in Guwahati were found to be non-existent at the address furnished.
As a result, the AO added such amount of share capital and share premium to the total income of the assessee u/s 68 of the Act, on the ground that none of the investor companies could justify such high premium, while some were found to be non-existent and that none of the companies produced bank statement to justify the source of their investment especially when the returned income of such investor companies was meagre and none appeared before the AO.
CIT(A) and ITAT decided the issue in favour of the assessee on the ground that the onus laid down on the assessee was discharged as it had furnished confirmations, IT return acknowledgment with PAN of the investors and bank statement to show payment by banking channels. The Hon’ble Delhi High Court did not entertain the appeal in view of factual issues being involved.
The Department carried the matter to the Hon’ble Apex Court. None appeared on behalf of the assessee before the Court inspite of serving the notice.
Findings of the Court
The Court after considering the submissions of the Department, reversed the order of the CIT(A), ITAT and the High Court and restored the order of the AO. While doing so, it gave certain important findings after considering various judgments of the different court. The findings are bifurcated in two parts viz. general finding and findings specific to the facts of the case.
General findings given by the Court are brought out hereunder:
1. Section 68 of the Act would cover within its ambit credit in the nature of share capital and share premium.
2. Initial onus is on the assessee to establish the identity of the person, creditworthiness of the person in the sense of financial capacity and the genuineness of the transaction, as the facts are within the exclusive knowledge of the assessee. If onus is not discharged to the satisfaction of the AO, then the amount of credit would be treated as income without anything further to be done.
3. AO is duty bound to investigate into the identity, creditworthiness of the party and genuineness of the transaction. If the inquiries and investigation reveal that the identity is doubtful or that the creditor lacks creditworthiness, then the genuineness of the transaction would not be said to have been established.
4. Practice of conversion of cloak of unaccounted money into share premium must be subjected to careful scrutiny particularly in case of private placement of shares where higher onus is required since the information is within the personal knowledge of the assessee.
The above were the general findings of the Court. The Court also gave findings which were specific to the facts of the case before them as under:
1. AO’s detailed inquiry revealed that there was no material on record to prove that share application money was received from independent legal entities as some of the companies were found to be non-existent and had no office at the address mentioned. Since, the companies were non-existent, the onus to establish the identity was held to be not discharged.
2. Some companies did not appear nor did they produce the bank statement to substantiate the source of the funds.
3. Investor companies had filed return with negligible income, therefore, there was no financial capacity with the investor to invest huge amount of about Rs. 90 lakh. Thus, in the facts of the case, the Court held that the investor had to explain how they had invested such huge sums of money. As a result, the Court held that the onus to establish the creditworthiness was not discharged.
4. No explanation was offered by the investor as to charging of high premium.
5. As a result of the above discrepancies, the genuineness was found to be doubtful
In the light of the above averred general and specific findings, the Court restored the addition made by the AO.
Analysis and going forward
It is quite settled that any judgment of a Court has to be read in the context of the case before the Court. The Hon’ble Apex Court in case of CIT vs. Sun Engineering Works (P) Ltd. –(1992) 198 ITR 0297 (SC) has held that “The judgment must be read as a whole and the observations from the judgment have to be considered in the light of the questions which were before this Court. A decision of this Court takes its colour from the questions involved in the case in which it is rendered and, while applying the decision to a later case, the Courts must carefully try to ascertain the true principle laid down by the decision of this Court and not to pick out words or sentences from the judgment, divorced from the context of the questions under consideration by this Court, to support their reasoning.”
Similarly, the judgment of the Court as rendered in the impugned case, has to be considered in the light of the facts existing in the case. The Court itself, in para 15, states that in the facts of the present case, the assessee company failed to discharge the onus laid down u/s 68 of the Act.
Also, it is well known that the additions made u/s 68 of the Act are fact specific. It depends upon the details and evidences produced by the assessee to discharge the initial onus and the inquiry and investigation of the AO in the course of assessment proceedings. Thus, carte blanche application of the present judgment to all the cases involving addition of share capital etc. u/s 68 of the Act would not be justified.
Nevertheless, the Court has laid down some important ratios which would be applicable to similar cases.
In the earlier paras, I have bifurcated the findings of the Court into two part viz. general findings and specific findings qua the facts of the case. Such general findings of the Court would have to be taken note of while analysing similar issue. Most of the general findings of the Court are quite settled principles and therefore, would not require much deliberation, except one which is “Practice of conversion of cloak of unaccounted money into share premium must be subjected to careful scrutiny particularly in case of private placement of shares where higher onus is required since the information is within the personal knowledge of the assessee.“
Importantly, he above finding of the Court, in my opinion, points out to one fact that the ratio laid down by the same Court in case of Lovely Export (supra) would no longer apply to private placement of shares. Though, there is no discussion in the impugned order in respect of the judgment in case of Lovely Export, however, the Court was very well aware of the said judgment as the CIT(A) and ITAT had swayed in favour of the assessee by relying on this very judgment. Nonetheless, the ratio in case of Lovely Export, in my opinion, would be still be alive and kicking in case of issue of shares other than by way of private placement.
In so far as the specific findings of the Court are concerned, the same should be read in the context of the judgment. As already stated above, one cannot pick and choose a finding of the Court divorced from the facts of that case and universally apply the same. In the impugned case, what can be discerned is that all the specific findings cumulatively lead to adverse opinion of the Court. Thus, in my humble opinion, each specific finding independently cannot justify an addition in other cases and one should analyse other factors also before coming to any conclusion.
The specific findings of the Court are discussed hereunder:
The Court in the facts of the case held that explanation should be given in respect of high premium. This fact of high premium per se cannot be a factor to make an addition u/s 68 of the Act, if the other three ingredients are well established. The section merely requires nature and source to be explained. For this very reason, section 56(2)(viib) was inserted in the statute book, wherein excess share premium received over the fair market value can be taxed. In this regard, one can refer to the judgment of the Hon’ble Madhya Pradesh High Court in case of PCIT vs. Chain House International (P.) Ltd. –  98 taxmann.com 47 (MP), wherein it has been held that once genuineness, creditworthiness and identity of investors are established, no addition can be made only on ground that shares were issued at excess premium. In fact, SLP filed against the said judgment has been dismissed by the very same bench of the Apex Court [SLP(Civil) Diary No(s). 1992/2019].
The Court also held that the investor companies did not produce their bank statement to explain their source of funds. This requirement of explaining the source of funds was justified in the facts of the case before the Court because of meagre income shown by investors for the relevant years.
However, once the creditworthiness is satisfied, there is no requirement for a person to prove the source of source. Secondly, such requirement now finds a specific mention in the statute book in the form of Proviso to section 68 which has come into effect from 1.4.2013. The Hon’ble Bombay High Court in case of CIT vs. Gagandeep Infrastructure Pvt. Ltd.-394 ITR 680(Bom), has held that such proviso is prospective in nature. Thus, prior to the said date, there cannot be any requirement on the assessee to prove the source of source.
Of course, this would not prohibit the AO to enquire into the source of source. But then the question would be, if the investor is not able to explain his source, should the additions be made in the hands of the investors or in the hands of the company. One can argue that if the investor company fails to offer any explanation about the source of their funds for investment, the addition should be made in the hands of the investor company and not the assessee company.
This is because, the wording used in section 68 are “the sum so credited may be charged to tax as the income of the assessee”. The section is worded in such a manner so as to give discretionary power to the AO to make addition unlike section 56(2)(x) wherein the difference is automatically considered the income of the assessee. Thus, the option is with the AO to tax it in the hands of the assessee and that he can exercise his discretion to tax it in the hand of the investor.
However, post insertion of the proviso to section 68 i.e. w.e.f. 1.4.2013, if the investor fails to offer the explanation of source of their investment then addition has to be made in the hands of the assessee-company.
The Court in the discussed case referred to the meagre income of the investor companies to hold that creditworthiness was not proved. This may be because, the other details like the availability of funds in other form or past profits may not be available with the Court. This inference can also be drawn because the Court also held that the investor companies did not demonstrate the source of funds for investment. Thus, merely because in the year in which shares are subscribed, the investor company has earned meagre income or suffered a loss would not mean that the investor company has no creditworthiness. If the investor company is able to demonstrate from the balance sheet that it had sufficient funds available with it to invest, then creditworthiness can be said to have been established. The Hon’ble Delhi High Court in case of CIT vs. Ms. Mayawati – 338 ITR 0563(Del) has held that the capacity of any person does not mean how much they earn monthly or annually, but the term capacity has wide meaning and the same can be perceived by how wealthy a person is.
In so far as the identity aspect is concerned, the Court held that in case of some parties, they were found to be non-existent at the address already furnished. This would lead to the conclusion that the identity is not established. Thus, the traditional concept of giving name, PAN and address has been enlarged to this effect. However, if the person bring confirmation, gives new address and the investor party replies to the summons of the AO, then one can say, in my opinion, that the identity has been established.
It is important to note that the said judgment of the Court was considered by the Kolkata Bench of ITAT in case of M/s Baba Bhootnath Trade & Commerce Ltd. vs. ITO (ITA No. 1494/Kol/2017). In the said judgment, the Tribunal has distinguished the judgment in case of NRA Iron and Steel (supra) on similar grounds that the facts of the case were different as compared to the facts in the case before the Apex Court. The Tribunal distinguished the judgment of the Apex Court on the following counts:
a. the AO in the case before the Apex Court had made extensive enquiries and from that he had found that some of the investor companies were non-existent which was not the case before the Tribunal.
b. In the case before the Apex Court, certain investor companies did not produce their bank statements proving the source for making investments in Assessee Company, which was not the case before the Tribunal. In the case before the Tribunal, the entire details of source of source were duly furnished by all the respective share subscribing companies before the AO in response to summons u/s 131 of the Act by complying with the personal appearance of directors.
From the above discussion, I may humbly opine that the specific findings of the Court cannot be isolated from other specific findings of the Court to make addition in a particular case. As already specified earlier, the findings of the Court have to be read in the context of the case and not otherwise. In the context of the impugned case, the specific findings are supported by other specific findings which cumulatively lead the Court to give the said judgment.
It is interesting to note that the Tribunal in the case of NRA Iron and Steel Pvt. Ltd. (ITA.No.3611/Del./2014), while deciding in favour of the assessee had relied upon judgment of the co-ordinate bench of the Tribunal – [ACIT vs. M/s. Adamine Construction Pvt. Ltd. -ITA No. 6175/Del/2013] wherein identical issues were involved, in fact, few of the investor companies were also common. In the case of the said company i.e. M/s. Adamine Construction Pvt. Ltd., the matter travelled upto the Hon’ble Supreme Court and in that case, the Court had dismissed the SLP of the Department [PCIT v. Adamine Construction (P.) Ltd. (2018) 259 Taxman 131 (SC)]. Ironically, one of the judges in both the cases is common.
Notably, the judgment would cause little impact after 1.4.2013, as the Legislature has already taken required measures vide Finance Act, 2012. The proviso to section 68, is a very strong measure wherein a company is required to even explain the source of the investor, which presupposes the fact that the company would be able to get those evidences easily as the investor would be a known party.
However, prior to AY 2013-14, i.e. in case of pending disputes pertaining to earlier years, the judgment of the Apex Court so discussed, would have a considerable impact. One has to carefully distinguish the said judgment, so as to reduce it rigours, while applying to the facts of other cases. In any case, there should no longer be any doubt that one has to now furnish a lot details to discharge the onus and one cannot simply wash his hands by furnishing name, address and PAN.
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