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Banking channel not enough to prove the credit worthiness of investors u/s 68 - SC Case law

Siddharth Sharma , Last updated: 05 April 2019  

Cost of (Un) representation
Analyzing: PCIT vs. NRA Iron and Steel Works

First the verdict

A two judge Supreme Court (SC) bench, comprising of Justice Indu Malhotra and Justice U.U. Lalit held that merely providing the identity of investors and showing that the investments were made using proper banking channels would not be enough to discharge the onus on assessee u/s 68 to prove the genuineness and creditworthiness of the investors.

The investigation

When the Assessing Office (AO) conducted an investigation into the list of investors provided by the assessee, it was found that:

• Some of the companies did not exist at the address provided by the assessee
• None of the investors provided bank statements to establish the source of funds for the investment.

On the basis of this, the AO added the entirety of the investment to the income of the assessee u/s 68 of the IT Act.

The case journey
On appeal however, the CIT(A), ITAT and the High Court (HC) all ruled in favor of the assessee.

The decision of the CIT and ITAT seems to have been based on the ruling of the Delhi HC in the case of CIT vs. Divine Leasing [(2008) 299 ITR 268 (Del)](an SLP against this order was dismissed by the SC in CIT vs. Lovely Exports([2008] 216 CTR 195 (S.C.)), wherein the court ruled that since the AO had failed to present any cogent evidence to indicate the non-genuineness of the creditors, the assessee had discharged the primary burden u/s 68 by providing the details of the investors.

The HC dismissed the matter stating that the lower authorities had taken care of factual aspects and no substantial question of law arose for their judgment.

Supreme Court differs

The SC however held that the assessee had failed to discharge the primary burden on it to prove the genuineness of the investorsu/s 68 and the ruled in favour of the Revenue, based on the following:

• Nemi Chand Kothari (Gauhati HC)(2003) 264 ITR 254 (Gau): The mere use of proper banking channels for making the payment is not sufficient to show that the creditor is genuine.

• The detailed enquiry of the AO had shown that most of the investors were merely paper companies and there was no evidence adduced by either the investors or the assessee to show otherwise.

Why the judgments differed?

There is a material difference between the case we are analyzing and the Divine Leasing case, on which the CIT and ITATrelied on.

• In Divine Leasing, and the cases cited therein, the AO had neglected to conduct a detailed investigation into the alleged creditors. He had simply issued summons u/s 131 and had not followed up with any investigation. In such circumstances, the court held that if the assessee had provided the details of the investors and the AO had no cogent evidence to show that their veracity could be doubted, the burden of proof would stand discharged on the part of the assessee.

• However, in this case, the AO’s detailed investigation unearthed compelling evidence to doubt the genuineness of the transaction and the creditors. In view of this, the judgments in Divine Leasing and Lovely Exports would become inapplicable due to the substantial variation on facts.

• Moreover, the Parliament has also amended Section 68 effective from AY 2013-14 to the effect that in case of share application money, the investors must also offer a satisfactory explanation in order for the assessee to discharge its burden of proving the genuineness of the investment.

Missing in action

It is interesting to note that the assessee was not represented at the High Court and Supreme Court and both the decisions were given ex-parte.

The assessee’s corporate record reflects that it used to be a group company of Bhushan Steel Ltd. which was admitted into a resolution program at the behest of lenders on 26 July, 2017 immediately prior to the order of ITAT. Thereafter, the resolution professional would have taken control over the main company of the group and the subsequent corporate difficulties may have contributed to NRA’s inability to defend the proceedings before the High Court and Supreme Court.

The absence could have been a contributing factor in the outcome of the decision.

Know thy judges

A quick look at the judge profiles of the two presiding judges in the case reveals an important insight – neither of them had ever presided over a case relating to Section 68 or the issue of bogus share application money before. This presented a golden opportunity to either party to shape the narrative of the case and guide the judges through a chain of case law favorable to them. The Revenue seems to have done just that in a case heard ex-parte as the judgment merely mentions the cases of Lovely Exports and Divine Leasing without ever launching into an in-depth analysis of the case law. In fact, a quick look at all the precedents discussed in case show that they are overwhelmingly pro revenue.

Analysis of ex-parte cases

Interestingly enough, over the years the SC has had to decide 7 tax cases ex-parte. In 3 instances the side with representation has won the case, while the other 4 have gone the way of the unrepresented party.

However, the last time an unrepresented party won was in 1971. It seems safe to say that not entering an appearance put NRA at a substantial disadvantage in this particular case.

What are your thoughts on this case? Leave a comment below and let us know!

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Published by

Siddharth Sharma
(Finance Professional)
Category LAW   Report

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