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Unexplained cash credit walking the tightrope
May, 10th 2008

In the context of share application money, it would be impossible for a company to go behind the identity of each of the subscribers, except to the extent of obtaining the statutory information.

Students and practitioners of income-tax have grappled with problems of unexplained cash credit, unexplained investments, unexplained money, and so on. The provisions dealing with these are contained in Sections 68, 69 and 69A of the Income-Tax Act, 1961.

Investigative tax assessments are both challenging and sometimes quite disturbing. Gone are the days where additions were confined to the expenditure side of the profit and loss account. Today, understanding and scrutinising entries and disclosure in the balance-sheet have assumed significance to make meaningful additions.

In the liability side of the balance-sheet, share capital, borrowings and credits come up for detailed analysis during assessment proceedings. Does paid-up share capital constitute unexplained credit in some situations? This issue came up in Commissioner of Income Tax vs Divine Leasing and Finance Ltd (2008) 299 ITR 268 Delhi).

Facts, issues

The assessee-company had commenced its business of extending finance to industrial enterprises. The total issued, subscribed and paid-up capital in the assessment years 1984-85, 1985-86 and 1986-87 was Rs 99,80,000 received from directors/promoters and also by way of a public issue.

These sums were received through banking channels and complete records were maintained. The assessing officer (AO) made additions to the income for all the years. In March 1987, the assessee filed a revised return for the assessment years 1984-85 and 1985-86 taking advantage of the Amnesty scheme and surrendered Rs 62,500 and Rs 1,87,000 in the respective years.

In these fresh assessment proceedings, the AO issued summons under Section 131 of the I-T Act and thereafter impounded the shareholders register, share application forms and share transfer register. The assessee contended that because these materials were in the custody of the Department it was unable to furnish any further details pertaining to the subscribers.

The Income-Tax Appellate Tribunal (ITAT) noted that the assessee was a public limited company which had received subscriptions to the public issue through banking channels and the shares were allotted in consonance with the provisions of the Securities Contracts (Regulation) Act, 1956, as also the rules and regulations of the Delhi Stock Exchange. Complete details appeared to have been furnished.

The ITAT further recorded that the AO had not brought any positive material or evidence which would indicate that the shareholders were (a) benamidars,(b) fictitious persons, or (c) that any part of the share capital represented the companys own income from undisclosed sources. The addition of Rs 76,51,650 for the assessment year 1986-87 deleted by the Commissioner (Appeals) was upheld. The tribunal reversed the decision of the lower authorities and categorically held that the assessee had discharged its onus of proving the identity of the share subscribers. The matter reached the High court.

Court decision

The Delhi High Court ruled that based on the factual matrix, the question of unexplained credit as envisaged in Section 68 will not apply and the identity of the share subscribers were duly proved. The court made some pointed observations which lay down some benchmark on dealing with issue relating to investment in shares and identity of the subscribers.

There cannot be two opinions on the aspect that the pernicious practice of conversion of unaccounted money through the masquerade or channel of investment in the share capital of a company must be firmly excoriated by the Revenue.

Equally, where the preponderance of evidence indicates absence of culpability and complexity of the assessee it should not be harassed by the Revenues insistence that it should prove the negative. In the case of a public issue, the company concerned cannot be expected to know every detail pertaining to the identity as well as financial worth of each of its subscribers. The company must, however maintain and make available to the Assessing Officer for his perusal, all the information contained in the statutory share application documents.

In the case of private placement the legal regime would not be the same. A delicate balance must be maintained while walking the tightrope of Sections 68 and 69 of the Income-tax Act. The burden of proof can seldom be discharged to the hilt by the assessee; if the Assessing Officer harbours doubts of the legitimacy of any subscription he is empowered, nay duty-bound, to carry out thorough investigations.

But if the Assessing Officer fails to unearth any wrong or illegal dealings, he cannot obdurately adhere to his suspicions and treat the subscribed capital as the undisclosed income of the company.

These are loaded observations and provide the necessary basis for dealing with share capital and identity of the subscribers. With all the necessary controls in place through corporate laws and other legislation there is still this uneasy feeling of how to substantiate the genuiness of such payments.

Burden of proof

While Section 68 places the burden of proof on the taxpayer to explain the nature and source of the credit found in the books, this at best can be the initial burden. Where the explanation is prima facie credible, the burden shifts to the other party.

In the context of share application money running into several transactions and crores of rupees it would be impossible for the company to go behind the identity of each of the subscribers, except to the extent of obtaining the statutory information.

In Hindustan Tea Trading Co vs CIT (2003 263 ITR 289), subscriptions for share application money were received from the public and the assessee had disclosed all the particulars, including the addresses of the subscribers, the question of treating the same as unexplained credit does not arise.

Similarly, in the CIT vs Shree Barkha Synthetics Ltd (2004 270 ITR 477) case, the Rajasthan High Court held that in the case of the company receiving contribution as share capital, in cases where the details of GI/PAN of the contributors were available, the identity of the subscribers were established but where details were not available the same has to be treated as unexplained credit.

The Supreme Court, in CIT vs Stellar Investment Ltd (2001 251 ITR 263), did not have the occasion to deal with the subject in detail except to say that if some bogus shareholders had been detected their assessment could justifiably be reopened.

No last word, yet

The last word is yet to be pronounced on the subject but by all accounts routing unaccounted money through the share capital mechanism is a fairly regular phenomena. Listed companies have SEBI and corporate laws to adhere to in taking the necessary precautions. But small, private limited companies are sometimes used as a convenient vehicle to park such funds.

To what extent does one go to trace the source of money invested as share capital? There is only a thin line that separates the genuine and the not-so-genuine and, at the end of the day, it all depends on the facts and documentation that supports those facts.

R. Anand
(The author is Partner, Global Tax and Advisory Services, Ernst & Young.)

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