Tax Evasion through Shell Companies under Income Tax and GST

Introduction

In recent years, many taxpayers have faced serious issues under both Income Tax and GST law due to direct or indirect transactions with shell companies, paper entities, accommodation-entry providers, non-existent suppliers and fake-invoice operators. In many cases, the taxpayer may have made payments through banking channels and may also possess invoices or confirmations, but still proceedings are initiated when the Department finds that the other party has no real business activity, lacks financial capacity, is not available at the registered address, has issued invoices without actual supply, or has been identified as part of an accommodation-entry or bogus ITC network.

Such transactions may result in serious consequences under the Income-tax Act, 1961, the Income-tax Act, 2025 and the CGST Act, 2017. Under Income Tax law, the amount may be treated as unexplained credit, unexplained investment, unexplained expenditure or false entry, leading to tax, penalty and reassessment proceedings. Under GST law, the taxpayer may face denial of input tax credit, demand of tax, interest, penalty, summons, search proceedings, registration suspension or cancellation, and in serious cases, prosecution.

It is important to understand that there is usually no separate statutory notice titled as a “shell company notice”. The Income-tax Department and GST authorities generally issue notices under regular statutory provisions, using terms such as “bogus share capital”, “bogus share premium”, “unsecured loan from paper company”, “accommodation entry”, “fake invoice”, “non-existent supplier”, “circular trading”, “bogus ITC” or “invoice without actual supply”.

With effect from 1 April 2026, the Income-tax Act, 2025 has replaced the Income-tax Act, 1961 for future operation. However, proceedings relating to earlier assessment years may still involve provisions of the Income-tax Act, 1961, subject to the applicable transition provisions. Therefore, while discussing shell-company cases, both the Income-tax Act, 1961 and the corresponding provisions of the Income-tax Act, 2025 are relevant.

I. Income-tax Law: Role in Shell Company and Accommodation Entry Cases

1. Section 68 of the Income-tax Act, 1961 / Section 102 of the Income-tax Act, 2025: Unexplained Credits

Section 68 of the Income-tax Act, 1961 and section 102 of the Income-tax Act, 2025 are the principal provisions used in cases involving bogus share capital, share premium, unsecured loans and accommodation entries.

Where any sum is found credited in the books of the assessee and the assessee fails to offer a satisfactory explanation regarding its nature and source, the amount may be treated as income of the assessee.

In shell-company cases, the assessee is generally required to establish:

1. Identity of the investor or creditor;

2. Creditworthiness of such investor or creditor; and

3. Genuineness of the transaction.

In case of closely held companies receiving share application money, share capital, share premium, loan or borrowing, the inquiry may also extend to the source of funds in the hands of the investor or creditor.

2. Sections 69 to 69D of the Income-tax Act, 1961 / Sections 103 to 106 of the Income-tax Act, 2025: Unexplained Investment, Asset, Expenditure and Hundi Transactions

Where the issue is not merely a credit entry but involves unexplained investment, asset, money, expenditure or hundi transaction, the Department may invoke sections 69 to 69D of the Income-tax Act, 1961 or the corresponding provisions under sections 103 to 106 of the Income-tax Act, 2025.

Under the Income-tax Act, 2025, the drafting has been reorganised. Therefore, while preparing a reply or legal submission, the exact provision should be selected after examining whether the issue relates to unexplained credit, investment, asset, expenditure or hundi transaction.

For example, where bogus purchases or fake expenses are booked through entry operators, the issue may be examined under section 69C of the 1961 Act or section 105 of the 2025 Act, apart from possible disallowance of expenditure, depending upon facts.

3. Section 115BBE of the Income-tax Act, 1961 / Section 195 of the Income-tax Act, 2025: Tax on Unexplained Income

Additions made under section 68 or sections 69 to 69D of the Income-tax Act, 1961 are generally taxed under section 115BBE. Under the Income-tax Act, 2025, the corresponding provision is section 195, which deals with tax on income referred to in sections 102 to 106.

These provisions are important because accommodation-entry transactions are generally used to convert unaccounted money into apparently legitimate money. Once such amount is treated as unexplained income, deduction of expenses, allowance or set-off of loss may not be available against such income, as per the applicable provision.

4. Penalty Provisions

After making additions in shell-company or accommodation-entry cases, penalty proceedings may also be initiated.

Section 271AAD of the Income-tax Act, 1961 and section 444 of the Income-tax Act, 2025 are particularly relevant where the Department alleges false entries, bogus invoices, accommodation entries or fake purchase/sale transactions.

The penalty exposure should always be examined with reference to the exact allegation. A case of mere explanation not accepted by the Department may stand on a different footing from a case involving alleged false entry, fake invoice or invoice without actual supply.

5. Investigation and Information-Gathering Powers

The Income-tax law gives wide powers to trace the real beneficiary behind shell-company structures.

These provisions are commonly used where information is received from Investigation Wing, SFT/AIS data, bank analysis, seized documents, statements of entry operators, GST data or invoice-related information.

II. Income-tax Notices Commonly Issued in Shell Company Cases

1. Notice for Calling Information: Section 133(6) of the 1961 Act / Section 252 of the 2025 Act

The Department may call information from banks, investors, lenders, companies, buyers, sellers, directors and other third parties. In share capital or loan cases, the Department may call for financial statements, bank statements, confirmations, income-tax returns, ROC records, board resolutions and details of source of funds.

2. Summons: Section 131 of the 1961 Act / Section 246 of the 2025 Act

Summons may be issued to directors, investors, lenders, entry operators, bank officials, accountants or any person whose statement is considered relevant. Where the Department relies upon third-party statements, the assessee should seek copies of such statements, relied-upon documents and opportunity of cross-examination.

3. Assessment Questionnaire: Section 142(1) of the 1961 Act / Section 268 of the 2025 Act

A detailed questionnaire is generally issued during assessment or reassessment. It may require the assessee to explain the nature and source of credits, source of source, identity and creditworthiness of parties, bank trail, reason for share premium, loan documentation, confirmation and genuineness of transaction.

4. Scrutiny Notice: Section 143(2) of the 1961 Act / Section 270(8) of the 2025 Act

A scrutiny notice is issued where the return is selected for detailed examination. In shell-company cases, scrutiny selection may be based on risk management, Investigation Wing report, high-value transactions, suspicious credits or financial patterns.

5. Reassessment Show-Cause and Notice: Sections 148A and 148 of the 1961 Act / Sections 281 and 280 of the 2025 Act

Where the Department has information suggesting escapement of income, reassessment may be initiated. In accommodation-entry cases, the notice may allege that the assessee received bogus share capital, unsecured loan or other credit from a paper company or entry provider.

A proper reply should examine whether:

1. Specific material has been supplied;

2. Bank trail has been provided;

3. Statement of entry operator has been supplied;

4. Live link exists between information and escapement of income;

5. The Assessing Officer has applied independent mind;

6. The notice is within limitation;

7. Cross-examination is required;

8. The amount and tax year / assessment year are correct.

III. GST Law and Fake Invoice / Shell Supplier Cases

Under GST, shell-company issues usually arise in the form of fake invoices, non-existent suppliers, circular trading and wrongful availment or utilisation of input tax credit.

The relevant provisions are section 16, section 61, section 67, section 70, section 73, section 74, section 74A, section 122 and section 132 of the CGST Act, 2017.

1. Section 16: Eligibility and Conditions for ITC

Section 16 is the primary provision governing input tax credit. In fake invoice cases, the Department usually alleges that ITC is not available because:

1. Goods or services were not actually received;

2. Supplier was non-existent;

3. Invoice was issued without supply;

4. Tax was not paid through the proper chain;

5. ITC conditions were not fulfilled.

Therefore, while replying to such notices, the taxpayer must establish actual receipt, use, payment trail and documentary support for the transaction.

2. Section 61 read with Rule 99: Scrutiny of Returns

Where GST returns are selected for scrutiny, notice may be issued in FORM GST ASMT-10. The taxpayer replies in FORM GST ASMT-11, and if the explanation is accepted, the proceedings may be concluded through FORM GST ASMT-12.

Common issues in ASMT-10 notices include:

1. GSTR-2A / 2B mismatch;

2. ITC from cancelled suppliers;

3. ITC from non-filers;

4. Mismatch with e-way bills;

5. Excess ITC claim;

6. High-risk purchases;

7. Purchase from newly registered or suspicious suppliers.

3. Section 70: Summons

Section 70 empowers the proper officer to summon any person to give evidence or produce documents. In fake ITC cases, summons may seek:

1. Tax invoices;

2. Purchase and sales ledgers;

3. E-way bills;

4. Transport documents;

5. Bank statements;

6. Stock records;

7. Supplier confirmations;

8. GSTR-2A / 2B reconciliation;

9. GSTR-3B workings.

Summons proceedings are inquiry proceedings. Therefore, proper compliance should be made, but statements should be given carefully and only after verifying records.

4. Section 67: Inspection, Search and Seizure

Section 67 may be invoked in serious cases where the Department has reason to believe that:

1. Goods are suppressed;

2. Documents are secreted;

3. Invoices are issued without supply;

4. ITC has been wrongly availed;

5. Supplier is non-existent at the declared place of business;

6. Records are maintained to pass bogus ITC.

In such cases, taxpayers should preserve books, invoices, stock records, transport evidence, payment details and communication with suppliers.

5. DRC-01A and DRC-01 Proceedings

Before issuing a formal demand notice, the Department may issue pre-show-cause intimation in FORM GST DRC-01A under Rule 142. The formal show-cause notice is issued with summary in FORM GST DRC-01. Reply is generally filed in FORM GST DRC-06, and order summary is issued in FORM GST DRC-07.

In fake invoice cases, the SCN generally alleges non-existent supplier, no actual receipt of goods, no movement of goods, fake vehicle details, circular payments, supplier non-filing of GSTR-3B, invoices without supply or violation of section 16 conditions.

6. Registration Suspension or Cancellation

GST registration may also be suspended or cancelled where the Department alleges that the taxpayer:

1. Is not conducting business from declared premises;

2. Has issued invoices without supply;

3. Has wrongly availed ITC;

4. Has furnished incorrect outward supply details;

5. Has violated GST registration conditions.

Relevant provisions include Rule 21 and Rule 21A of the CGST Rules. Common forms include:

In cancellation matters, the reply should specifically request exact allegations, invoice-wise details, physical verification report, relied-upon documents and opportunity of personal hearing.

Conclusion

Shell companies and accommodation-entry networks are tackled under tax law through substantive additions, investigation powers, penalty provisions and prosecution measures.

Under the Income-tax Act, 1961, section 68 remains the most important provision for bogus share capital, share premium and unsecured loans, supported by sections 69 to 69D, section 115BBE and penalty provisions. Under the Income-tax Act, 2025, the corresponding framework is contained mainly in sections 102 to 106, section 195, section 439, section 444 and the assessment / reassessment provisions under sections 268, 270, 279, 280 and 281.

Under GST, fake invoice and bogus ITC cases are generally examined through section 16, scrutiny under section 61, summons under section 70, search under section 67 and demand proceedings under section 73, section 74 or section 74A.

At the same time, tax additions and GST demands must be based on specific material, proper inquiry and observance of natural justice. The taxpayer must respond with complete documentary evidence, transaction trail and clear legal objections wherever the notice is vague, based only on third-party material or issued without supplying relied-upon documents.

The author can also be reached at varunmukeshgupta96@gmail.com