Revenue wins appeal: Company failed to prove genuineness of share capital advances worth ₹5.65 crores

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Case Name

Principal Commissioner of Income Tax vs M/s. SRM Systems and Software P. Ltd (High Court of Madras)

T.C.A.No.875 of 2018

Date: 17th February 2021

Key Takeaways

• Companies must prove three things about share capital: identity of investors, their creditworthiness, and genuineness of transactions
• Simply providing a list of names and addresses isn’t enough - you need solid evidence
• The burden of proof is on the company, not the tax officer
• Forms filed under Companies Act don’t substitute for proper tax compliance documentation
• If you can’t prove your case initially, the tax officer doesn’t need to investigate further

Issue

The main legal question was: Whether the Income Tax Appellate Tribunal was correct in accepting the company’s explanation about share capital advances when the company failed to provide adequate proof of the investors’ identity, creditworthiness, and transaction genuineness under Section 68 (of Income Tax Act, 1961).

Facts

SRM Systems and Software is a software development company. For the assessment year 2006-07, they claimed expenses of ₹7.40 crores and disclosed share capital advances of ₹6.17 crores (later clarified as ₹5.65 crores).

When the tax officer asked for details about who provided this money, the company initially didn’t provide proper information. They later submitted some documents including a list of 290 people (mostly from Andhra Pradesh) who supposedly invested, but they didn’t provide crucial details like:

• Confirmation letters from investors
• Bank account evidence
• PAN numbers of investors
• Proof of investors’ financial capacity

The tax officer added this amount to the company’s income as undisclosed money. The company appealed, and both the CIT(A) and the Tribunal initially sided with the company, but the High Court reversed this decision.

Arguments

Revenue’s (Tax Department’s) Arguments:

• The company failed to discharge its primary burden under Section 68 (of Income Tax Act, 1961)
• Mere furnishing of names and addresses isn’t sufficient compliance
• The company couldn’t prove the genuineness of transactions
• Form No. 2 under Companies Act doesn’t contain PAN numbers and isn’t adequate proof

Company’s Arguments:

• Transactions were conducted through banking channels
• They provided Form No. 2 under Companies Act showing share allotment
• They furnished lists of allottees and evidence of payment for increasing authorized capital
• The fact that investors were from Andhra Pradesh shouldn’t disqualify the transactions

Key Legal Precedents

The court relied heavily on these important cases:

1. Principal Commissioner of Income Tax, Central I vs. NRA Iron & Steel Pvt. Ltd. [(2019) 103 taxmann.com 48 (SC)] - This Supreme Court case established that companies must prove by “cogent and reliable evidence” the identity, creditworthiness, and genuineness of share capital transactions.
2. J.J. Development Private Ltd. vs. CIT, Calcutta IV [(2018) 100 taxmann.com 101 (Cal)] - Calcutta High Court case where similar lack of proper documentation led to rejection of the company’s claims.
3. CIT vs. Electro Polychem Ltd. [(2007) 294 ITR 661 (Madras)] - Referenced by the lower authorities but distinguished by the High Court.

The court also mentioned CIT vs. Gopi Textiles Ltd. [(2007) 294 ITR 663 (Madras)] and CIT vs. Lovely Exports (P.) Ltd. [(2008) 216 CTR 195 (SC)] as cases where companies had successfully discharged their burden of proof.

Judgement

The Madras High Court allowed the Revenue’s appeal and ruled against the company. Here’s their reasoning:

The court applied Section 68 (of Income Tax Act, 1961), which says that if money is credited in a company’s books and they can’t satisfactorily explain its nature and source, it can be taxed as the company’s income.

The court found that the company failed to establish three crucial elements:

1. Identity of the persons who provided share capital
2. Creditworthiness of these investors
3. Genuineness of the transactions

The court emphasized that the NRA Iron & Steel case clearly established that companies have the “primary onus” to prove these elements with “cogent and credible evidence.” Since the company didn’t meet this initial burden, the tax officer wasn’t required to investigate further.

The court specifically criticized the lower authorities for ignoring the adverse remand report and accepting inadequate documentation like Company Act forms that don’t contain PAN numbers.

FAQs

Q1: What does Section 68 (of Income Tax Act, 1961) require?

A: It requires companies to satisfactorily explain the nature and source of any money credited in their books. If they can’t, that money can be treated as their taxable income.

Q2: What exactly must a company prove regarding share capital?

A: Three things - the identity of investors, their creditworthiness (financial capacity to invest), and that the transactions are genuine (not bogus or circular).

Q3: Is providing a list of investors’ names and addresses enough?

A: No, the court clearly said “mere furnishing of the list of persons…will not constitute sufficient compliance.” You need solid documentary evidence.

Q4: Can Company Act forms substitute for Income Tax Act requirements?

A: No, the court noted that Company Act forms don’t contain PAN numbers and other details required for tax purposes.

Q5: What happens if a company can’t prove these elements initially?

A: The tax officer doesn’t need to investigate further - the burden remains on the company to provide adequate proof.

Q6: Does the location of investors matter?

A: The court clarified that the issue wasn’t that investors were from Andhra Pradesh, but that the company failed to provide proper documentation about any of the investors, regardless of location.

This appeal, by the appellant/Revenue, filed under Section 260A (of Income Tax Act, 1961) (hereinafter referred to as “the Act”), is directed against the order dated 13.06.2016, passed by the Income Tax Appellate Tribunal 'D' Bench, Chennai (for brevity “the Tribunal”), in I.T.A.No.1635/Mds/2013 for the assessment year 2006-07.

2.The appeal was admitted on 06.12.2019, on the following

substantial questions of law:-

“1.Whether on the facts and circumstances of the

case, the Appellate Tribunal is correct in law in shifting

the responsibility of proving genuineness of share

application money to the Assessing Officer even though

a prima facie evidence against the assessee lies and the

assessee failed to discharge his initial burden on this

account?

2.On the facts and circumstances of the case,

whether mere furnishing list of person who have

claimed to have advanced towards share capital thus

constitute sufficient compliance on the part of the

assessee? and

3.Whether the Appellate Tribunal is correct in

giving relief to the assessee even after the assessee

defaulted in filing return of income in time and thereby

took self advantage of his own action, by restricting the

scope of enquiry through delay of return of income and

non compliance?”

3.The assessee is engaged in the business of development of software.

For the assessment year under consideration AY 2006-07, the assessee

claimed expenses of Rs.7,40,55,450/- under various heads. The assessee

was called upon to produce books of accounts, bank statements etc. The

assessee disclosed share capital advance to the tune of Rs.6,17,81,000/- and

they were directed to furnish names and addresses of the persons, who

contributed the advance share capital. The assessee, by reply dated

15.12.2010, stated that the advance towards share capital is Rs.5,65,96,723/-

however, did not furnish any details with regard to their names, addresses,

Permanent Account Numbers (PAN), proof in respect of their credit

worthiness and proof in respect of genuineness. In the absence of any

documents, the Assessing Officer added the said amount to the returned

income as undisclosed income in the assessment order dated 31.12.2010,

under Section 143(3) (of Income Tax Act, 1961) read with Section 147 (of Income Tax Act, 1961). Aggrieved by such

order, the assessee preferred appeal before the Commissioner of Income

Tax(A) (C)-II, Chennai (for brevity, “the CIT(A)”).

4.The CIT(A) after referring to the remand report, which was called

for, held that the transaction of share capital advances were through banking

channel, the assessee furnished Form No.2 prescribed in Section 75(1) (of Income Tax Act, 1961) of

the Companies Act, 1956, in respect of the return of allotment of 88,24,200

shares having face value of Rs.10/- per share amounting to Rs.8,82,42,000/-

and the shares were allotted in the subsequent financial year on 03.10.2006.

Further, the CIT(A) pointed out that the assessee has enclosed list of the

allottees as well as Form No.5 and evidence of payment of Rs.18,00,500/-

for increase in authorized share capital of the company from

Rs.3,00,00,000/- to Rs.36,00,00,000/-. Further, after referring to the earlier

decision of the Tribunal and the decision of this Court in CIT vs. Electro

Polychem Ltd., [(2007) 294 ITR 661 (Madras)], partly allowed the appeal

filed by the assessee. Aggrieved by the same, the Revenue preferred appeal

before the Tribunal.

5.The Tribunal rejected the appeal filed by the Revenue by observing

that there is no allegation that the share application money emanated from

the corpus of the assessee and that the assessee has filed names and

addresses of the share applicants and merely because the share applicants

are from Andhra Pradesh that cannot be a reason to disallow the claim of the

assessee. Aggrieved by the same, the Revenue has filed this appeal.

6.We have elaborately heard Mr.T.R.Senthil Kumar, learned Senior

Standing Counsel for the appellant/Revenue and Mr.G.Baskar, learned

counsel appearing for the respondent/assessee.

7.From the remand report dated 30.04.2013, we find that the same

was wholly adverse to the interest of the assessee. The Assessing Officer

has stated, in no uncertain terms, that the assessee has not produced any

details such as confirmation letter, bank account evidencing the receipt of

share application money, the list contains 290 persons, who have given their

addresses in Andhra Pradesh, the assessee has not produced any one person

to verify the genuineness of the receipt of the share application money and

therefore, the assessee's claim that the advance share capital received by

cheque may not be entertained. To decide the correctness of the order

passed by the Tribunal confirming the order of the CIT(A), we need to take

note of Section 68 (of Income Tax Act, 1961), which reads as follows:-

“Section 68 (of Income Tax Act, 1961):-

Where any sum is found 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.”

8.In terms of the above provision, if the assessee offers no

explanation about the nature and source of the amounts found credited in

their books or the explanation offered by the assessee is not in the opinion

of the Assessing Officer, satisfactory, the same so credited, may be charged

to income tax, as the income of the assessee of that previous year.

Therefore, to establish, the assessee was required to produce the

creditworthiness of various persons, who are said to have made the share

capital advance. Therefore, what is required to be established is the identity

of the person, who has made the share capital advance, his creditworthiness

and genuineness of the transaction. The onus is on the assessee to establish

these factors and mere furnishing of the list of persons, who have claimed to

have advanced towards share capital, will not constitute sufficient

compliance of the onus placed on the assessee.

9.The CIT(A) has brushed aside the remand report submitted by the

Assessing Officer, which would clearly indicate that the assessee failed to

establish the genuineness of the amounts received as advance towards share

capital. The CIT(A) has made an observation that the assessee has

produced Form No.2, which is under under the provisions of the Companies

Act and as rightly submitted by the learned Senior Standing Counsel, the

same will not contain the PAN numbers of the persons, who are said to have

advanced monies.

10.In Principal Commissioner of Income Tax, Central I vs. NRA

Iron & Steel Pvt. Ltd., [(2019) 103 taxmann.com 48 (SC)], the issue, which

fell for consideration, was whether the share capital/premium credited in the

books of accounts of the assessee-company, the onus of proof is on the

assessee to establish by cogent and reliable evidence of the identity of the

investor companies, the creditworthiness of the investors and genuineness

of the transaction to the satisfaction of the Assessing Officer. While

answering the said issue, the Hon'ble Supreme Court held that it is for the

assessee to prove by cogent and credible evidence that the investments

made in share capital are genuine borrowings, since the facts are exclusively

within the assessee's knowledge. After referring to several decisions, the

principles, which emerged there from, were summed up in paragraph 11 of

the judgment on the following terms:-

“11. The principles which emerge where sums of

money are credited as Share Capital/Premium are :

i. The assessee is under a legal obligation to

prove the genuineness of the transaction, the identity of

the creditors, and credit-worthiness of the investors

who should have the financial capacity to make the

investment in question, to the satisfaction of the AO, so

as to discharge the primary onus.

ii. The Assessing Officer is duty bound to

investigate the credit-worthiness of the creditor/

subscriber, verify the identity of the subscribers, and

ascertain whether the transaction is genuine, or these

are bogus entries of name-lenders.

iii. If the enquiries and investigations reveal that

the identity of the creditors to be dubious or doubtful,

or lack credit-worthiness, then the genuineness of the

transaction would not be established. In such a case,

the assessee would not have discharged the primary

onus contemplated by Section 68 (of Income Tax Act, 1961).

11.The Review application filed against the above decision was

dismissed by a speaking order as reported in (2020) 117 taxmann.com 752

(SC).

12.From the facts of the case, which we have set out in the preceding

paragraphs, it is clear that the assessee has not discharged the legal

obligation cast upon them to prove the genuineness of the transaction, the

identity of the creditors and creditworthiness of the investors, who should

have the financial capacity to make the investment in question to the

satisfaction of the Assessing Officer so as to discharge the primary onus.

Since the assessee did not discharge the primary onus cast upon them, the

question of the Assessing Officer to investigate the creditworthiness of the

creditors/subscribers would not arise in the case on hand. Therefore, the

above decision is a clear answer to the assessee's case, which would

necessitate us to decide the same in favour of the Revenue.

13.We may also refer to the decision of the High Court of Calcutta in

J.J.Development Private Ltd., vs. CIT, Calcutta IV [(2018) 100

taxmann.com 101 (Cal.)] wherein, it was held that when there was no

plausible explanation that was furnished by the assessee to discharge the

onus cast upon them and the identities of the alleged share applicants having

not been established and the documents of the alleged share applicants

carried by the assessee before the Assessing Officer did not reveal the

investments that the assessee claimed such alleged applicants had made in

the assessee, there was no reason to interfere with the order of the Assessing

Officer. The Special Leave Petition filed by the assessee therein was

dismissed by the Hon'ble Supreme Court in the decision reported in (2018)

100 taxmann.com 102.

14.In the decisions referred to by Ms.G.Baskar in the case of CIT vs.

Gopi Textiles Ltd., [(2007) 294 ITR 663 (Madras)] and the decision of the

Hon'ble Supreme Court in CIT vs. Lovely Exports (P.) Ltd., [(2008) 216

CTR 195 (SC)], the stand taken by the assessee was accepted as the Court

found that the assessee had furnished full information thereby discharging

the onus cast upon him and once the onus is discharged by the assessee, it is

for the Assessing Officer, who has to prove the contrary. In the case on

hand, we find that the initial onus, which has been cast on the assessee has

not be discharged by them. Reference to a statutory form prescribed under

the Companies Act is of little avail, as it does not reveal the PAN numbers

of the alleged investors.

15.In the light of the above facts, we have no hesitation to conclude

that the Tribunal erred in confirming the order passed by the CIT(A) by

observing that merely because the share applicants are from Andhra Pradesh

that cannot be a reason to disallow the claim of the assessee. The factual

position being, the Assessing Officer did not do so, but disallowed the same

on the ground that the assessee has not furnished any details, viz., the names

and addresses of the persons, who paid the share capital advances, the

cheque numbers, the name of the bank, PAN numbers etc. Thus, the order

passed by the Tribunal calls for interference.

16.Accordingly, the Tax Case Appeal is allowed, the order passed by

the Tribunal is set aside and the substantial questions of law are decided in

favour of the Revenue. No costs.