ANGELED OUT

“Those who cannot remember the past are condemned to repeat it”-George Santayana

The quote has a more popular form and more apt for the present context:‘’Those who forget their history are condemned to repeat it.’’

There are lawmen and there are laymen.When supposedly erudite commentators commenting as lawmen exhibit no sense of history and purpose we have wild cheering of the sort going on for the abolishing of so called ángel tax’[the term does not even exist in lawbook]from the laymen who don’t know they have been waylaid.
Commerce has prevailed over equity and tax again.Simply put.

Following is a nuts and bolts view and regrettably includes some technicalities which are interwoven into the fabric of the subject matter.

Instead of realizing the doing away of indexation in capital gains is a major hit in the solar plexus (after Dividend Distribution Tax knock out punch delivered few years back),and increase in LTCG rates wiping out the nominal benefit of raising exemption limit of taxable CGs ,we are clapping for something we don’t even know what it stands for.

A disclaimer first.This is a pure lawman’s pov ,unencumbered by any other inclination and is a humble attempt to express,analyze and educate purely from perspective of law.Nothing is to be read in between the lines because there is nothing there.

The proposing body of this act of abolishing the so called angel tax is of course the Central Board of Direct Taxes TPL wing and contrary to what many may know, it’s the experts in bureaucracy which engineer the final proposal ,advice on the good and the bad on demands from business ecosystem, which wants the moon and the stars and would rather have no tax system and free flow of money making.

I.THERE IS NO SUCH THING AS ANGEL TAX :

Contrary to what many would like to believe,there is no such phrase in the book of law.Its not just a euphemism but a downright distorted caricature.

2.The Proposal in the Finance Bill 2024:

23. In section 56 of the Income-tax Act, in sub-section (2), in clause (viib), after the second proviso, the following proviso shall be inserted with effect from the 1st day of April, 2025, namely:––
“Provided also that the provisions of this clause shall not apply on or after the 1st day of April, 2025.”.

Latin and Greek,eh?

Memorandum explaining the budget ,sourced from the site www.indiabudget.gov.in explains:
Amendment of Section 56 of the Act
Section 56 of the Act is related to Income from other sources.

2. Vide Finance Act, 2012, a new clause (viib) was inserted in sub-section (2) of section 56 to provide that where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares, if the consideration received for issue of shares exceeds the face value of such shares, the aggregate consideration received for such shares exceeding such fair market value shall be
chargeable to income tax under the head “Income from other sources”.

3. It has been decided by the Government to sun-set the provisions of clause (viib) of sub-section (2) of section 56 of the Act. Consequent to said decision, amendment to clause (viib) of sub-section (2) of section 56 of the Act is being carried out to provide that the provisions of this clause shall not apply from the assessment year 2025-26.

4. This amendment is proposed to be made effective from the 1st day of April, 2025, and shall accordingly apply from assessment year 2025-26.
[Clause 23]

3.The History we forgot:

A.The seeds of the amendment of 2012 which brought the original provision, were actually sown in the year 2010.Here is that slice of history:
The memorandum for the Budget 2010 which is relevant for this section -:

“Taxation of certain transactions without consideration or for inadequate consideration
Under the existing provisions of section 56(2)(vii), any sum of money or any property in kind which is received without consideration or for inadequate consideration (in excess of the prescribed limit of Rs. 50,000) by an individual or an HUF is chargeable to income-tax in the hands of recipient under the head ‘income from other sources’.
However, receipts from relatives or on the occasion of marriage or under a will are outside the scope of this provision. The existing definition of property for the purposes of section 56(2)(vii) includes immovable property being land or building or both, shares and securities, jewellery, archaeological collection, drawings, paintings, sculpture or any work of art.

A. These are anti-abuse provisions which are currently applicable only if an individual or an HUF is the recipient. Therefore, transfer of shares of a company to a firm or a company, instead of an individual or an HUF, without consideration or at a price lower than the fair market value does not attract the anti-abuse provision.
In order to prevent the practice of transferring unlisted shares at prices much below their fair market value, it is proposed to amend section 56 to also include within its ambit transactions undertaken in shares of a company (not being a company in which public are substantially interested) either for inadequate consideration or without consideration where the recipient is a firm or a company (not being a company in which public are substantially interested). Section 2(18) provides the definition of a company in which the public are substantially interested.
It is also proposed to exclude the transactions undertaken for business reorganization, amalgamation and demerger which are not regarded as transfer under clauses (via), (vic), (vicb), (vid) and (vii) of section 47 of the Act.
Consequential amendments are proposed in—
(i) section 2(24), to include the value of such shares in the definition of income;
(ii) section 49, to provide that the cost of acquisition of such shares will be the value which has been taken into account and has been subjected to tax under the provisions of section 56(2).
These amendments are proposed to take effect from 1st June, 2010 and will, accordingly, apply in relation to the assessment year 2011-12 and subsequent years.

B. The provisions of section 56(2)(vii) were introduced as a counter evasion mechanism to prevent laundering of unaccounted income under the garb of gifts, particularly after abolition of the Gift Tax Act. The provisions were intended to extend the tax net to such transactions in kind. The intent is not to tax the transactions entered into in the normal course of business or trade, the profits of which are taxable under specific head of income. It is, therefore, proposed to amend the definition of property so as to provide that section 56(2)(vii) will have application to the ‘property’ which is in the nature of a capital asset of the recipient and therefore would not apply to stock-in-trade, raw material and consumable stores of any business of such recipient.

C. I……………………..
These amendments are proposed to take effect retrospectively from 1st October, 2009 and will, accordingly, apply in relation to the assessment year 2010-11 and subsequent years.

D. It is proposed to amend the definition of ‘property’ as provided under section 56 so as to include transactions in respect of ‘bullion’.
This amendment is proposed to take effect from 1st June, 2010 and will, accordingly, apply in relation to the assessment year 2011-12 and subsequent years.

E. It is proposed to amend section 142A(1) to allow the Assessing Officer to make a reference to the Valuation Officer for an estimate of the value of property for the purposes of section 56(2).
This amendment is proposed to take effect from 1st July, 2010.”

B.This led to the introduction of clause viib in the year 2012.
Just a few questions you should address:
Why was s 56(2)(viib) necessitated?
Why was it brought into statute?
Was it to increase the tax base?
Provide new source of revenue?
No.

C.The amendment itself was classified under the heading “Measures to Prevent Generation and Circulation of Unaccounted Money”. Companies were issuing shares at a substantial premium to convert the unaccounted money without providing any valuation for justifying the premium.

We can also look at it as a a SAAR(specific anti avoidance rule): an anti abuse provision to prevent the setting up of shell companies and laundering money through them.

D.2012 BUDGET was a landmark one as it noted the notoriety of money laundering via corporate route ,amending s 68 also to compel closely held companies to reveal their source in case of cash credits. In addition the landmark GAAR was finally introduced in law in 2012.

E.Although provision for verification of unexplained investments was already in the statue, by virtue of section 68 of Income Tax Act, 1961 but it hit the unexplained source of investment. By introducing this new provision, the extent of difference of issue price and fair market value of the Shares, in case of such shares issued at the price more than its face value was directly charged to tax .
In my view it was a tremendously well engineered move.Every beneficial provision brought into statute carries within itself,seeds of misuse.The Trojan horse was torpedoed by this.

F.The original Provision in brief

56(2): In particular, and without prejudice to the generality of the provisions of sub-section (1), the following incomes, shall be chargeable to income-tax under the head “Income from other sources”, namely: –
(i)** ** **

(vii)(b):-Where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares:

Provided that this clause shall not apply where the consideration for issue of shares is received
(i) by a venture capital undertaking from a venture capital company or a venture capital fund; or
(ii) by a company from a class or classes of persons as may be notified by the Central Government in this behalf.
Explanation. —For the purposes of this clause, —
(a) the fair market value of the shares shall be the value—
(i) as may be determined in accordance with such method as may be prescribed; or
(ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value, on the date of issue of shares, of its assets, including intangible assets being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature,
whichever is higher;
……….

It was already unduly liberal ,exempting VCUs and further providing leverage by exempting non resident investors.

G.Let us consider the corresponding Memorandum of 2012:

‘’Share premium in excess of the fair market value to be treated as income Section 56(2) provides for the specific category of incomes that shall be chargeable to income-tax under the head “Income from other sources”. It is proposed to insert a new clause in section 56(2). The new clause will apply where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares. In such a case if the consideration received for issue of shares exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be chargeable to incometax under the head “Income from other sources. However, this provision shall not apply where the consideration for issue of shares is received by a venture capital undertaking from a venture capital company or a venture capital fund. Further, it is also proposed to provide the company an opportunity to substantiate its claim regarding the fair market value. Accordingly, it is proposed that the fair market value of the shares shall be the higher of the value— (i) as may be determined in accordance with the method as may be prescribed; or (ii) as may be substantiated by the company to the satisfaction of the Assessing Officer, based on the value of its assets, including intangible assets, being goodwill, know-how, patents, copyrights, trademarks, licences, franchises or any other business or commercial rights of similar nature. This amendment will take effect from 1st April, 2013 and will, accordingly, apply in relation to the assessment year 2013- 14 and subsequent assessment years. [Clause 21]’’

H.There was a corresponding amendment in s 68 as well.

Here is the memorandum explaining it:

‘’C. MEASURES TO PREVENT GENERATION AND CIRCULATION OF UNACCOUNTED MONEY

Cash credits under section 68 of the Act

Section 68 of the Act provides that if any sum is found credited in the books of an assessee and such assessee either
(i) does not offer any explanation about nature and source of money; or
(ii) the explanation offered by the assessee is found to be not satisfactory by the Assessing Officer,
then, such amount can be taxed as income of the assessee.

The onus of satisfactorily explaining such credits remains on the person in whose books such sum is credited. If such person fails to offer an explanation or the explanation is not found to be satisfactory then the sum is added to the total income of the person.
Certain judicial pronouncements have created doubts about the onus of proof and the requirements of this section, particularly, in cases where the sum which is credited as share capital, share premium etc.

Judicial pronouncements, while recognizing that the pernicious practice of conversion of unaccounted money through masquerade of investment in the share capital of a company needs to be prevented, have advised a balance to be maintained regarding onus of proof to be placed on the company. The Courts have drawn a distinction and emphasized that in case of private placement of shares the legal regime should be different from that which is followed in case of a company seeking share capital from the public at large.

In the case of closely held companies, investments are made by known persons. Therefore, a higher onus is required to be placed on such companies besides the general onus to establish identity and credit worthiness of creditor and genuineness of transaction. This additional onus, needs to be placed on such companies to also prove the source of money in the hands of such shareholder or persons making payment towards issue of shares before such sum is accepted as genuine credit. If the company fails to discharge the additional onus, the sum shall be treated as income of the company and added to its income.

It is, therefore, proposed to amend section 68 of the Act to provide that the nature and source of any sum credited, as share capital, share premium etc., in the books of a closely held company shall be treated as explained only if the source of funds is also explained by the assessee company in the hands of the resident shareholder. However, even in the case of closely held companies, it is proposed that this additional onus of satisfactorily explaining the source in the hands of the shareholder, would not apply if the shareholder is a well regulated entity, i.e. a Venture Capital Fund, Venture Capital Company registered with the Securities Exchange Board of India (SEBI).
This amendment will take effect from 1st April, 2013 and will, accordingly, apply in relation to the assessment year 2013-14 and subsequent years.
[Clause 22]’’

I.So the noose against circulation of unaccounted money was twofold:

1.Obliged to explain the source of money in the hands of the investor.Else the whole amount hit by s 68.

2.Even if source explained ,the difference in excess of market value is taxable.
The second is gone.Campaign to do away with first is in the offing.

4.Another slice of history we forget is:

i.CBDT notified START UP Company as class of person, who is exempt from this provision under the clause (ii) of Proviso to this section, vide notification no. 45/2016 [F.NO.173/103/2016-ITA-I] on 14th June 2016.

[A startup is a company that is in the first stage of its operations. It is basically a business model that aims to meet a marketplace need by developing or offering an innovative product, process or service.]

The section also exempted a venture capital undertaking receiving the consideration for issue of shares from a venture capital company or a venture capital fund registered with the Securities and Exchange Board of India (SEBI).

ii.Litigation arose on different issues:

a.FIRST AND MAJOR ISSUE:VALUATION:

As per Section 56(2)(viib) and Rule 11UA(2), Discounted Cash Flow Method (DCF Method) or Net Asset Value Method (NAV Method) was used to calculate the Fair Market Value of the shares.However, the mechanism of share valuation adopted by the taxpayers and its test by the tax authorities became bone of contention. The methods adopted by the taxpayers were being examined and rejected by the Assessing Officers.Supposedly officers tended to question the model used for valuation by the valuer, or the basis of assumptions/projections used for deriving the valuation.

2.The AOs were ,it was alleged, unable to understand how the startups are valued.This was the crux of contest.Claim was that the startups are valued on the basis of the idea & business potential and not on basis of the net assets appearing in the balance sheet of the company. The innovative startup ventures were(are) appreciated by the ‘angels’ who spotted potential in an idea and invested in the early phase of startup lifecycle at a premium.The angel investor, supposedly perceived potential gains due to likely substantial increase in the value of startup in future. On the other hand, taxmen restricted their analyses to the rules provided in the statute books. The difference triggered the entire controversy of valuation variance, and hence the trigger for Angel tax.

3.Furthermore it was alleged that at times taxmen allegedly tried to value startups with reference to the subsequent round of investment. If the valuation of shares was lower in a subsequent round of investment, excess premium collected in the previous investment got questioned supposedly without appreciating the change in circumstances at the time of respective investments.

As per law then, the valuations were not challenged when the investment was raised from the Non-resident investors or Venture Capital Funds. However, they got challenged when the funds were raised from the resident Indian investors, i.e., so called Angel Investors.

ii.SECOND MAIN ISSUE:

Further, the Assessing Officers issued notices asking for the details of the angel investors, their source of income, bank statements and copy of Income Tax Returns. This, allegedly discouraged the angel investment in startups.
iii.Illustrative case laws:

1.Rameshwaram Strong Glass (P.) Ltd. v. Income-tax Officer [2018] 96 taxmann.com 542, can be fruitfully referred wherein it was held that where the assessee-company determined Fair Market Value of shares issued at premium on the basis of DCF Method in accordance with Rule 11UA(2)(b), read with Section 56(2)(viib) and valuation report was prepared as per guidelines given by the ICAI and no fault was found in the same, Assessing Officer was unjustified in changing the method of valuation of shares at premium to Net Asset Value Method.

2.However, in the case of Agro Portfolio Pvt. Ltd. ITA No. 2189/Del/2018, [2018] 53 CCH 0043 (Delhi – Trib.), it was held that to determine the fair market value, the tax officer could reject the method of valuation adopted by the taxpayer, if the taxpayer failed to produce evidences to substantiate the basis of data supplied to arrive at the FMV.

5.POLICY INTERVENTIONS TO CIRCUMVENT CONTEST:

1.Even this issue was addressed. The Central Board of Direct Taxes (CBDT) on 20th December’ 2018 stated that “No coercive action and measures to recover the demands of completed assessments under Income Tax would be taken against start-ups and angel investors. CBDT recognizes that startups are going to bring a lot of innovation to the country and, therefore, have to be supported in every possible manner.”

2.Vide Finance Act 2016, section 80IAC was introduced providing for full tax exemption for three years in a specified block on profits earned by start-ups that were incorporated between April 01, 2016 and March 31, 2019 and were further approved by Department of Industrial Policy and Promotion (DIPP).

3.The Department of Industrial Policy and Promotion (DIPP) issued a notification on 11th April’2018 wherein a special relief was provided to startup companies from the applicability of so called Angel Tax.

The startup shall be eligible to apply for approval for the purposes of clause (viib) of sub-section (2) of section 56 of the Act, if the prescribed conditions :
(1) The aggregate amount of paid-up share capital and share premium of the startup after the proposed issue of shares does not exceed 10 crore rupees,
(2) The investor/proposed investor, who proposed to subscribe to the issue of shares of the startup has,
(a) The average returned income of 25 lakh rupees or more for the preceding three financial years; or
(b) The net worth 2 crore rupees or more as on the last date of the preceding financial year, and
(3) The startup has obtained a report from a merchant banker specifying the fair market value of shares in accordance with Rule 11UA of the Income-tax Rules, 1962.
Over 80,000 DPIIT-registered start-ups already ,so not in the ambit of the section anyway at that point in time..Just note the figure-over 80,000.[Presently above 1.41 lacs].

4.Further, the DIPP issued the Clarification on IT Notice to Angel Investors/Start-ups on 19th December’2018 that “DIPP has again taken up this matter of issue of IT notices with the Department of Revenue (DoR) so that there is no harassment of Angel Investors or Start-ups. Government is committed to protecting bona fide investments into startups.”

5.DIPP issued another Notification dated January 16, 2019 wherein the preconditions of filing Form 2 were further tweaked wherein the limit of last years returned income of investor was enhanced from 25 lakhs to 50 lakhs combined with the requirement of net worth of 2 crores. The merchant bankers valuation report did not find a place in the updated Form 2 issued in the aforesaid Notification by DIPP. The application received by DIPP was to be forwarded to CBDT which was supposed to grant or decline approval within 45 days of receipt of such application.

6.The Clear and Present Danger:

1.What more was needed? Revenue was already bending backwards to accommodate all issues.Was some other intention at work in this ruckus being created? What was the REAL concern? I will tell.

2.Unbridled capital infusion in new Companies through equity investments without any oversight mechanism could be instrumental in circulation of unaccounted money in the economy.

Was this addressed by the righteously indignant? Was it not a real concern?

3.We all know the infamous NGO rackets and the uncharitable charitable trusts as channels of money laundering and enjoying untaxed comforts.This was made to scale.By this logic ,all oversight mechanisms and legal provisions are anti commerce and anti growth.This is unprecedented and not seen even among the fastest growing and open economies worldwide.

4.Smart alecs still found ways: preference shares are on a totally different footing than shares(see Gold Line Studio 173 ITD 200 (Mum).So that route was open.
And use CCDs also because it is a mere conversion of loan to equity.No fresh funds introduced ,section circumvented.

Also ,the option of debt instruments to raise money from foreign investors was still open even after 2023 amendment(discussed hereunder).

4.Robbing Peter(the public)to pay Paul(the laundering start ups,the shell companies)-was this not the clear and present danger?

7.THE FINAL BONE OF CONTENTION:2023 AMENDMENT
a.Still it was only an undercurrent .Amplification of the self righteous angst came when faced with the amendment in 2023.

The 2023 amendment, included the consideration received from a non-resident also under the ambit of section 56(2)(viib) by removing the phrase ‘being a resident’ from the said clause.The clause was omitted by the FINANCE ACT, 2023 (Act No. 8 of 2023) with effect from the 1st day of April, 2024.

b.WHY WAS THIS CHANGE BROUGHT?

This makes for very interesting reading .Following is the relevant note from CIRCULAR NO. 1/2024 Dated the 23rd of January, 2024, F. No. 370142/38/2023 issued by CBDT.

‘’31. Bringing the non-resident investors within the ambit of section 56(2)(viib) to eliminate the possibility of tax avoidance

31.1. Prior to FA, 2023, section 56(2)(viib) of the Act, inter-alia, provided that where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares shall be chargeable to income-tax under the head ‘Income from other sources’. Rule 11UA of the Rules provides the formula for computation of the fair market value of unquoted equity shares for the purposes of the Section 56(2) (viib) of the Act.

31.2. Clause (viib) of sub section (2) of section 56 of the Act was inserted vide Finance Act, 2012 to prevent generation and circulation of unaccounted money through share premium received from resident investors in a closely held company in excess of its fair market value. However, the said section was not applicable for consideration (share application money/share premium) received from non-resident investors.

31.3. Accordingly, FA 2023 has included the consideration received from a non resident also under the ambit of clause (viib) by removing the phrase ‘being a resident’ from the said clause. This will make the provision applicable for receipt of consideration for issue of shares from any person irrespective of his residency status.

Applicability: These amendments will be effective from 1st April, 2024 and shall accordingly, apply in relation to the assessment year 2024-25 and subsequent assessment years’’

c.Barely 4 months passed from the coming into effect, the removal of the word ‘resident’that it got knocked off.

So what happened?Was it suddenly seen that there was no threat of conversion of black money into white ,not just by non resident but also resident investors?

This circular is dated 23.1.2024.In a matter of weeks ,the apex tax body knocked of ,not just the expansion ,but the whole provision itself! When adding so many exemption options as we shall see presently.

d.In the same circular concessions for ‘’ease of doing business’’ were also given.See the following extract:

‘’31.4. In this context, in order to promote ease of doing business and encourage foreign investment, Vide Notification No.29/2023 dated 24.5.2023 (S.O. 2274[E]), certain class or classes of persons, being non-resident investors to whom clause (viib) of sub-section (2) of section 56 of the Act shall not be applicable, have been notified.

31.5. Further, Notification No. 30/2023 dated 24.5.2023 (S.O 2275[E]), 2023 has been issued, modifying Notification No. S.O 1131(E) dated 5th March, 2019 providing that the provisions of section 56(2)(viib) of the Act shall not apply to consideration received from any person by start-ups covered in para 4 & 5 of Notification dated 19.2.2019 issued by the Ministry of Commerce and Industry in the Department for Promotion of Industry and Internal Trade (DPIIT).

31.6. Furthermore, Draft Notification amending Rule 11UA of the Rules, providing the manner of computation of valuation of fair market value of unquoted equity shares for the purposes of the Section 56(2) (viib) of the Act was put in the public domain for comments. Taking into consideration the suggestions received in this regard and detailed interactions held with stakeholders, Rule 11UA has been amended vide Notification No. 81/2023 dated 25.9.2023 (GSR 685 [E]). The notified Rule provides for expansion of the valuation methodologies to include globally accepted methodology.’’

e.Any erudite student of tax law shall be shocked.Every objection and issue stood addressed.Every single one.And yet.And yet.The volte face by CBDT in form of the sunset clause in the new bill.

What divine revelation occurred that the section was expanded first and totally knocked off later in a matter of months?In January 24 you continue to explain it as an anti avoidance measure.And in July 24 you say its not needed,not even for resident investors?
What should we think about this?

f.The threat was veiled but clear in the background and opinion engineering was happening even in articles in law journals- covertly advocating the surreptitious cause: Section 56(2)(viib) might be outlasting its stated objective , Indian entrepreneurs are having to consider shifting HQs abroad ,investment coming from abroad would be choked etc etc etc.An ET report dated 23.7.24 dated tells us that total fundraising by startups fell by 3.8% in first half of 2024.But it was still 5.1 billion$.On flip side it was pleaded that removal of provision would greatly aid capital formation.The same report informs we have over 141000 DPIIT registered start ups.
The effort bore fruit.

Barely 4 months passed from the coming into effect the removal of the word ‘resident’that it got knocked off.

8.THE NEXT TARGET :2022 AMENDMENT IN S 68 COMPELLING SOURCE OF SOURCE ALSO TO BE PROVED.

i.In 2022 ,the amendment of 2012 in s 68 was sought to be carried forward.
In section 68 of the Income-tax Act, with effect from the 1st day of April, 2023––

(i) in the first proviso, for the words “Provided that”, the following shall be substituted, namely:––

“Provided that where the sum so credited consists of loan or borrowing or any such amount, by whatever name called, any explanation offered by such assessee shall be deemed to be not satisfactory, unless—

(a) the person in whose name such credit is recorded in the books of such assessee also offers an explanation about the nature and source of such sum so credited; and
(b) such explanation in the opinion of the Assessing Officer aforesaid has been found to be satisfactory:

Provided further that”;
(ii) in the second proviso,––
(a) for the words “Provided further”, the words “Provided also” shall be substituted;
(b) for the words “first proviso”, the words “first proviso or second proviso” shall be substituted.

ii.MEMORANDUM EXPLAINING THE PROVISIONS IN THE FINANCE BILL, 2022

‘’Section 68 of the Act provides that where any sum is found to be credited in the books of an assessee maintained for any previous year, and the assessee offers no explanation about the nature and source thereof or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the sum so credited may be charged to income-tax as the income of the assessee of that previous year.

2. The onus of satisfactorily explaining such credits remains on the person in
whose books such sum is credited. If such person fails to offer an explanation or the explanation is not found to be satisfactory then the sum is added to the total income of the person. Certain judicial pronouncements have created doubts about the onus of proof and the requirements of this section, particularly, in cases where the sum which is credited as loan or borrowing.

3. It is noticed that there is a pernicious practice of conversion of unaccounted money by crediting it to the books of assesses through a masquerade of loan or borrowing.

4. Vide Finance Act, 2012, it was provided that the nature and source of any sum, in the nature of share application money, share capital, share premium or any such amount by whatever name called, credited in the books of a closely held company shall be treated as explained only if the source of funds is also explained in the hands of the shareholder. However, in case of loan or borrowing, the judicial decisions have held that only identity and creditworthiness of creditor and genuineness of transactions for explaining the credit in the books of account is sufficient, and the onus does not
extend to explaining the source of funds in the hands of the creditor.

5. It is proposed to amend the provisions of section 68 of the Act so as to provide that the nature and source of any sum, whether in form of loan or borrowing, or any other liability credited in the books of an assessee shall be treated as explained only if the source of funds is also explained in the hands of the creditor or entry provider. However, this additional onus of proof of satisfactorily explaining the source in the hands of the creditor, would not apply if the creditor is a well regulated entity, i.e., it is a Venture Capital Fund, Venture Capital Company registered with SEBI.

6. This amendment will take effect from 1st April, 2023 and will accordingly apply in relation to the assessment year 2023-24 and subsequent assessment years.
[Clause 17]’’

iii.[This is the classic source of source controversy which has many other ramifications.I wrote extensively thereon including the non necessary nature of this amendment .Those interested can access the following published article written by me:.https://itatonline.org/digest/articles/section-68-source-of-source-a-layered-controversy/ ]

iv.Now ,challenge to this is the future threat to revenue.Not just this,the 2012 amendment is likely to be on the radar under the garb of ‘’ease of doing business’’.
You read it here first.

v.In a shocker of an article on the topic , an esteemed publication published an article with its 3 authors arguing as under:

‘’The premise of angel tax was supposedly restricting the influx of ‘black money’ through capital markets.

However, the same logic does not seem to be applied by tax authorities since 2012, as evinced by the continued strain of litigation on start-ups receiving funding through proper banking channels. With funds such as Sequoia and Blackstone having billions of dollars at their behest, does one really need a provision to confirm the creditworthiness and source of funds?’’ [2023] 152 taxmann.com 637 (Article)]

This is as specious and legally perverse as it can get.It is so absurd and hilarious ,that it did not deserve a response,were it not for the sheer seriousness of the issue.
Why not ,I ask?

The fund laundering is at its most voluminous and most dangerous at the highest levels.Hiding behind a truckload of paper covering millions of transactions ,multi layered creating cold trails,any amount can be moved ,using these platforms as pass through vehicles.First they challenge s 68 while ostensibly contesting s 56 and then they argue about the holier than thou status of these platforms based on sheer volumes?This is the gaslighting theme for time to come.

9. THE PENAL PURPOSE & DOLE INCENTIVIZING:

i.Good thing is ,that the section stands eliminated w.e.f 1.4.2025.Its a sunset clause.The revenue has the power still.But does it have the vision and the will?

ii.If any law has to have teeth ,there must be penal consequences for violation thereof.And penal consequences in law do not serve the mere purpose of punishment-they serve the bigger purpose-that of deterrent.The implementational creases could have been ironed out .But we chose to do away with the garment instead.

iii.Dole incentivizing for boosting economic activity rarely works.We reduced Corporation tax to 22.5% a few years back with the stated objective of a big surge in Capex.

What happened?Balance sheets got fatter .

iv.We should know.Where even social responsibility has to be built in law(CSR) in order for it to be actuated, what hope in high hell do we have of honest rupees flowing in economic mainstream all by themselves ?

10.CONCLUSION:

i.The basic issue and the classic cleavage always is considerations of commerce vis a vis undue permissiveness leading to influx of unaccounted money-what does a governing system find more desirable and expedient?There are countries where you can literally buy a citizenship.That is what is desirable for them.Many others have skeletal taxation.Some choose to be tax havens like Caymen Islands and Mauritius.

ii.All tax limits and channels commerce.An anti abuse provision cannot be judged by potential disincentivizing of the so called free trade.That is what a finance system needs to balance –by a rational ,unpressured commercial pragmatism and robust tax system where ethics is rewarded too and backdoors are not left open while channeling the front gate.

iii.We are defined by the choices we make.In this case ,faced with some overenthusiastic implementation we have chosen to deadend the provision, in our endeavour to be seen as investor friendly.Every oversight and regulatory mechanism like this is meant to keep the players honest.They limit commercial misadventure.

iv.Not much separates weakness from false bravado.A step here ,a step there-and you can reach either side.Who knows ,GAAR- used by the most advanced countries like the UK, France, Germany, The Netherlands, Belgium, Canada, China, Singapore, Italy, , Australia-may see a sunset clause too-or be converted into a toothless tiger- for that is where I fear the next agitation for ‘’ease of business’’ will be. I am afraid the story isn’t over yet.Watch this space.

v.The bottom line question is are we now going to judge the merits of our fiscal laws by the potential damage they may cause to the free will of upstart start ups who know only profit and little else ?

Are we going to decide which fiscal laws will remain in the statute book by the yardstick of the hurt amour propre of the interest groups and pure considerations of commerce ?

vi.Meanwhile.
What happened here?
We have thrown the baby out with the water.
That is the long and short of it.

E & OE

Posted on: July 26th, 2024