Back to top

Cash Credits taxability – Issue still alive and further evolving….

May 17, 2019
  • Author
    Amit Nayyar Director, Business Tax Deloitte Haskins & Sells, LLP
  • Author
    Vipin Sharma Manager, Business Tax Deloitte Haskins & Sells, LLP

In addition to general anti-avoidance measures, the Income Tax Act, 1961 (‘Act’) incorporates various provisions designed to prevent the flow of concealed or disguised income in the economy. Section 68 of the Act is one such provision, which empowers Indian Tax authorities to tax suspicious or dubious cash credits being share application money, loans etc. in the books of taxpayer, unless the assessee in respect of nature or source thereof provides any satisfactory explanation.

In nutshell, section 68 of the Act casts an obligation on the taxpayer to provide ‘satisfactory’ explanation with respect to the nature of the credit in the books of accounts and the source of said credit.

Additions under section 68 of the Act have been subject matter of myriad of litigation ever since the introduction of such section on various technical aspects, the primary issue being whether or not the taxpayer has discharged its obligation to avoid trigger of section 68 of the Act.

The expression ‘nature and source’ in section 68 of the Act has been judicially interpreted to refer to the following key ingredients in respect of which the taxpayer should discharge his onus under section 68 of the Act:

Identity of Investor;

Credit worthiness of the investor; and

Genuineness of the underlying transaction

In case the taxpayer fails to corroborate the above-mentioned aspects in toto with the support of cogent evidence, it will be open for the tax officer to treat such credit as income of the taxpayer.

Also, an additional burden has been imposed on closely held companies (generally private companies) for proving source of source i.e. the investors/ lenders will be required to provide information in respect of the source of loans/ deposits made by them in the closely held company. The burden of obtaining the said information and sharing the same with tax officer lies with the taxpayer.

Certain specific aspects pertaining to section 68 as promulgated through various judicial precedents are briefly stated as under:

 

S. No.

Issue involved

Key Principle

Reference

1.

Coverage of section 68

All types of credit entries

[(1975) Gumani Ram Siri Ram v CIT [TS-5041-HC-1973(Punjab & Haryana)-O]

2.

Parameters/documents corroborating identity/existence of creditors/ share applicants

· Name of creditors,

· Address, Bank details , PAN,

· Certificate of incorporation of investors, etc.

[(2010) CIT vs Dwarkadish Investment  [TS-5547-HC-2010(Delhi)-O],

[(2007) CIT vs Divine Leasing & Finance Ltd. [TS-39-HC-2006(Delhi)-O]

3.

Parameters/ documents corroborating genuineness of transaction

· Share application/ allotment form, Allotment letters

· Shareholders’ register, Board resolutions

· Share purchase agreement, 

· Confirmation from investors, correspondence with investors/lenders, Affidavits   etc.

[(2008) CIT vs Lovely Exports (P) Ltd.  [TS-85-SC-2008-O],

[2014 CIT vs N.R. Portfolio (P) Ltd.  [TS-5820-HC-2013(Delhi)-O]

[(2011) CIT vs STL Extrusion (P) Ltd.  [TS-5783-HC-2010(Madhya pradesh)-O]

4.

Situations corroborating creditworthiness of creditor/lender/investors

· Statement made by Director of Investee company,

· Bank statements of donors,

· Income details of donors,

· Gift deed, Affidavit furnished by creditors.

[(2018) PCIT vs Chain House International (P) Ltd.  [TS-7060-HC-2018(Madhya Pradesh)-O]

[(2013) CIT vs Arun Kumar Kothari  [TS-5617-HC-2012(Rajasthan)-O]

[(2009) CIT vs Laul Transport Corp.  [TS-5726-HC-2008(Punjab & Haryana)-O]

5.

Situations raising doubt on genuineness of the transaction

· Cash deposited in bank accounts of investors/ lenders before the transaction,

· Huge share premium in a company without net worth,

· Inquiries and investigations conducted by tax authorities,

· Non-compliances to notice issued u/s 133(6) and summons u/s 131 of the Act

[(2019) NRA Iron & Steel  [TS-5030-SC-2019-O]

[(2012) CIT vs Kamdhenu Steel & Alloys Ltd. [TS-808-HC-2011(Delhi)-O]

[(2019) PCIT vs NDR Promoters (P) Ltd.  [TS-5023-HC-2019(Delhi)-O]

 

At this juncture it is also relevant to refer to the recent judgment of SC in the case of Pr. CIT v. NRA Iron & Steel (P.) Ltd. (supra), which is yet another ruling in the long list of precedents on the matter wherein SC has dealt with addition made u/s 68 because of high share premium received by the taxpayer.

In the said case the tax officer requested the taxpayer to furnish details of amount received towards share capital and provide evidence to establish the identity and creditworthiness of investor companies as well as genuineness of the transaction. In response to same, the taxpayer furnished the income tax return acknowledgement of investor companies. The tax officer proceeded diligently by issuing summons to representatives of the investors. However, nobody appeared. In certain cases, replies were received through post which further created suspicion in mind of the tax officer. Further, on the basis of independent field enquiries, tax officer found that in respect of none of the investors, the taxpayer fulfilled the conditions for avoiding section 68 of the Act. Accordingly, addition was made u/s 68 of the Act. The CIT(A) by placing reliance on decision of SC in case of Lovely Exports (supra), deleted the additions. Subsequently, the Tribunal and HC also ruled in favour of the taxpayer. Now, the tax department filed an appeal before SC wherein the question framed was whether the taxpayer had discharged the primary onus to establish the genuineness of transaction required under section 68 of the Act.

The Hon’ble SC while passing an ex-parte order analysed various judgements of different courts on subject issue and carved out the following principles:

Merely proving the identity of investor does not discharge the onus of the taxpayer, if the financial capacities or credit worthiness of investors has not been established;

Merely because the transaction has taken place through normal banking channel/cheque/ demand draft is not sufficient to discharge the burden;

The tax officer is duty bound to investigate the creditworthiness of subscriber, verify the identity of subscriber and ascertain whether or not the transaction is genuine;

Thus, based on the findings of tax officer, SC held that assessee has failed to discharge the onus required under section 68 of the Act and accordingly, upheld the action of tax officer.   

However, it is interesting to note that SC has neither distinguished nor overruled its earlier judgement in the case of Lovely Exports Ltd. (supra), the ratio laid in the said ruling appears to be contradictory to ruling in case of NRA Iron (supra). In Lovely Exports Ruling, the assessee had furnished the necessary details of the investors such as PAN, income-tax jurisdiction, ration card of the share applicants etc. The monies were received through proper banking channel. It was held that all such details constitute acceptable explanation. The SC held that tax department is free to proceed to reopen their individual cases, and even if share capital was bogus, the addition should be made in the hands of share applicants and not the assessee.  

Prima facie, on reading both the rulings of the SC harmoniously, it appears that if the tax officer undertakes detailed investigation and has cogent evidence to support his allegation that the investors are not identifiable/ financially capable/ genuine, he is justified in making the addition under section 68 of the Act. On the other hand, in case the tax officer fails to make relevant inquiries into the investors, the taxpayer may take support of the SC ruling in Lovely Exports against the trigger of section 68 of the Act.  

Thus, one would observe that despite numerous judgements on the said issue, the issue appears to be still alive and evolving. Accordingly, the taxpayer must maintain required documentation and devise a system to check credit worthiness of the creditors/ share applicants in order to avoid any adverse additions.

Similar Columns
by Amit Nayyar, Vipin Sharma
related tags