10 January 2014
Dear Seniors My client has received a notice u/s 147 from IT dept Pune for detailed scrutiny for AY 2010-11. Here are the facts of the case My client was a director in company ABC and XYZ which was promoted by the same person.However he received salary only in ABC and not in XYZ. He also resigned as a director from XYZ in 2010 but still continues to be a director in ABC which is non operational. The TDS of amt Rs 10000 has been deducted under 92 for AY 2010-11 as salary received in company ABC. Hoever the problem is with the contractor income he received under 94C. My client has always received a salary income and has filed his ITR till AY 2013-14. My client in good faith & on the initiation of the promoter of ABC & XYZ accepted an amount of Rs 15 lacs from another company into his account in the June 2009.This amount of Rs 15 lacs was paid to my client for advertisement expenses supposedly carried by him.The company which paid him Rs 15 lacs deducted the TDS @ 2% + ST+ cess and the same is reflecting in his Form 26S. The amount after deduction of TDS was deposited in my client's bank account and the very next day the entire amount of Rs 15 lacs (less TDS etc) was RTGS to bank account of company XYZ. My client filed his IT returns for AY 2010-11 stating this was contract income that he received and the entire amt was transferred to company XYZ from his bank a/c in which he was director as he had sub contracted the entire advertisement campaign to company XYZ. As he was an individual he need not have to deduct TDS of 1% for sub contracting.The TDS for salary was adjusted to the TDS deducted on account of TDS deduction under 94C. However the company XYZ converted the entire amount of Rs 15 lacs as equity in the name of my client and have filed their annual returns for the given year.But my client resigned as a director from company XYZ in May 2010 and his shares were transferred to another director of company XYZ and no amount was paid to him for the share transfer nor was the same claimed by my client.Infact no share certificates were issued in the name of my client as far his best knowledge.
As of now the IT department is not convinced with my client's theory and insist that the amount of Rs 15 lacs is his income and have computed tax on the same.However my client has been explaining them that this has been contract income that he sub contracted to the company XYZ in which he was a namesake director receiving no perks or salary what so ever. But the IT department want's to know why was the amount given by my client converted into equity. To this my client has stated that if it was his investment on his resignation he would have asked for the amount back corresponding to the total shares,which is not the case.Also since he received no salary what so ever from the company XYZ why would he invest his supposedly hard earned Rs 15 lacs.
My question is based on the above facts What is my clients best line of defence as this income was not generated by him nor was his.It was only in good faith & trust that he accepted the income and filed his returns for AY 2010-11. What would the company XYZ explanation for showing contract income as equity in the name of my client considering that on his resignation neither my client has asked for the money given nor the company has given any money during equity transfer from my client to another director. In case the company denies having done any sub contrating work how can my client prove the same as this was a verbal contract between my client and company XYZ. Can my client now accept this as his money and show expenses to avoid huge tax liability.
Please respond as I am unable to find the answers to the same.
10 January 2014
well you continue to go by the stand taken at the time of filing the tax return ie the payment was made for the sub-contract..
this can further be substantiated by the fact that when the XYZ company transferred your shares to another person, no consideration is paid to you. So you can claim ignorance of the entries passed by the said company once you resigned that company.
problem of changing stands is that you would face higher penalties..
let the XYZ company explains its conduct...let it face the heat...even the other director will have to explain the receipt of shares without payment!!!! And where they are unable to explain, you can claima fraud committed against you!!
also even if you accept that the said expense was not yours, how would you new expenses to reduce your tax liability!!
10 January 2014
Dear Nikhil Thanks for your reply. So from your experience and expertise it would be prudent to continue to state that it was my client's income which was sub contracted to company XYZ. Also my client made the entire payment through a one shot RTGS from his bank account to the company bank account. However on the fact of equity being allotted to my client without a share certificate and its subsequent transfer to another Director you have mentioned to claim a fraud. I am confused how can my client claim fraud when he has not invested in the company to start with and the money was given as part of a sub contracting verbal agreement.Also the share allotment happened when my client was a Director in the company.So can he still claim ignorance to the entries passed by the company. More over my client's argument that he was not receiving any remuneration or benefits from company XYZ should help prove his point! To sum it up please guide me on a) The fraud committed on my client by the company. b)And most importantly can I client claim that he was unaware of new equity being added on his name as he is not in receipt of any share certificate or signed any legally binding document.
10 January 2014
1. I am not saying that you should claim fraud in the first instance...but there is clear fraud given that the XYZ company has 1. illegally issued shares in your name, 2. illegally transferred those shares and 3. must have made wrong declarations to the ROC in their annual returns.
So, yes you need to claim ignorance (which is also the fact. Wherein the XYZ is questioned, they would be at sea to explain their conduct!
So as I believe we both agree that continue on the status quo and "in no case make submission for accepting it as your income or alternatively claim that expenditure was not made."
11 January 2014
However what are my remedies if the AO passes an order u/s 144 and what would be right course of appeal.
Also can company XYZ put up an addendum stating that the entry was wrongly passed and the create a back dated agreement with my client saying it was sub-contracted and executed the given assignment.
The IT dept is not interested in the company XYZ at present but my client who as of now is a salaried individual and not a director in the company XYZ.
2. For XYZ company to change its stand would be a lot more problematic.. a) ROC would get involved as shares were issued and transferred which have to be reported in annual returns...
3. I would suggest that you stick to your stand...I give you an example, recently in Tarun Tejpal (tehalka matter), it was reported that Ram Jethmalani has shares of company owning tehalka..however, Jethmalani categorically stated that he only gave donations to the company and never applied for shares....such frauds often happen..given that director had already resigned would go in his favor..
15 January 2014
Before challenging the order I am the given view. Is it illegal for an individual who is a director in a given company to sub contract an entire contract to the same company where he/she is a director. This can be proved by the entire amt recvd by my client for contracting to be RTGS to the company bank account he subcontracted.
If it is not illegal then what the company does with the money received cannot be the outlook of my client.
Please correct if my line of thought is correct and if so what provisions can I invoke.
15 January 2014
it is not illegal...but both the contracts at the time of receiving and sub-contracting should have in compliance with Companies Act Section 297/299 and 301.
For this even director is responsible till the date he is holding that position.
15 January 2014
Thank you so much Nikhil However can I go with this stand to IT dept:
Does my client need to produce a contract copy of his sub contracting to the company along with the clearances u/s 299 297 of the Companies Act.Should this be presented while arguing our case.
Is it the responsibility of the Director (who has not signed the ABS for that Financial year)to ensure the allocation of the sub contracted amount transferred by him to the company in lieu of the contractual agreement be assigned properly.
02 August 2025
Happy to help! Here’s a concise yet comprehensive guidance you can follow in this complex case under section 147 scrutiny:
---
### 1. **Client’s Best Stand Before the IT Department**
* **Maintain the Original Stand:** The Rs. 15 lakh was received as contract income and immediately subcontracted to company XYZ. The RTGS transfer on the very next day is strong proof the client did not retain or benefit from this income. * **No Personal Income:** This amount should not be treated as your client’s personal income since he only acted as an intermediary/sub-contractor. * **Equity Conversion Irregularity:** Since your client never received any share certificate, did not pay consideration, and resigned before shares were allotted/transferred, he can claim **ignorance** of the allotment and transfer. This supports your client’s claim that the equity conversion was improper or unauthorized by him.
---
### 2. **Dealing with Lack of Written Contract**
* Since the contract was verbal, produce **supporting evidence** like:
* Bank statements showing the receipt and onward transfer of funds. * Affidavits or declarations from your client and promoters confirming the verbal agreement. * Any correspondence or minutes that can show intent or verbal approval.
---
### 3. **Legal Position on Subcontracting by a Director**
* **Not Illegal Per Se:** Subcontracting a contract by a director to the same company is not illegal but must comply with Companies Act provisions:
* **Section 297:** Approval for contracts between company and related parties. * **Section 299:** Restrictions on directors’ interests in contracts. * **Section 301:** Approval of board/shareholders for such contracts. * Your client is responsible only while he was a director, and compliance with these provisions must be verified.
---
### 4. **Regarding Equity Allotment and Transfer**
* The company cannot issue shares or transfer shares without the shareholder’s consent. * Your client can claim:
* No knowledge or consent was given. * No share certificate was issued. * No consideration was received for the shares. * This points towards possible **illegal acts or fraud by company XYZ**. * If needed, your client can raise this issue legally (e.g., with ROC, company law tribunal) to clarify/shareholder status.
---
### 5. **If AO Passes Order u/s 144 (Best Judgment Assessment)**
* **File an Appeal:**
* Appeal to the Commissioner of Income Tax (Appeals) \[CIT(A)]. * Subsequently to the Income Tax Appellate Tribunal (ITAT) if needed. * In appeal, emphasize:
* Transfer of funds to company XYZ immediately. * No retention or benefit of income. * Irregularities in equity allotment and transfer. * Lack of legal/contractual basis for tax department’s claim.
---
### 6. **Should Client Produce Contract & Approvals?**
* Yes, if available, producing copies of any contract (even verbal) and approvals under Sections 297, 299, 301 will strengthen your case. * If not available, explain the situation honestly and produce affidavits/declarations. * IT Dept. expects proof of contract legitimacy, so do your best to supply any documentary evidence.
---
### 7. **Responsibility of Director Regarding ABS and Contract Allocation**
* A director has a fiduciary responsibility to ensure company transactions are properly authorized. * However, if your client resigned before allotment/transfer and never signed the Annual Return/Balance Sheet (ABS) for that period, this supports his ignorance of equity allotment. * The burden to justify the allotment lies on company XYZ and its management.
---
### **Summary of Your Arguments to IT Department:**
* The Rs. 15 lakh was **not your client’s income**, only a pass-through/subcontract. * The equity conversion was **done without client’s consent or benefit**. * Client **did not receive share certificates** nor consideration. * **Verbal contract was based on good faith**; RTGS transactions prove flow of funds. * **XYZ company is responsible** for any irregularity or misdeclaration. * Client’s stand remains consistent; changing stand may invite penalty. * You are ready to cooperate with the IT department and provide all possible documentary and testimonial evidence.
---
If you want, I can help draft a **detailed response letter** to the AO or a submission explaining these points clearly. Would that help?
CAclubindia
