Calcutta High Court Upholds Addition Due To Assessee's Failure To Prove Genuineness Of The Transaction And Creditworthiness Of The Investor

Calcutta High Court Upholds Addition Due To Assessee's Failure To Prove Genuineness Of The Transaction And Creditworthiness Of The Investor

The Calcutta High Court has ruled that solely establishing the identity of the investors does not fulfill the burden on the assessee if the capacity or creditworthiness remains unverified.

Chief Justice T.S. Sivagnanam and Justice Hiranmay Bhattacharyya's bench noted that the assessee failed to prove the investors' capacity to provide funds for purchasing shares at a significant premium. The creditworthiness of these investors' companies is dubious, and the explanation provided by the assessee, under no circumstances, can be deemed a satisfactory explanation of the source's nature.

The respondent or assessee submitted its income tax return. Subsequently, the case underwent scrutiny, and a notice accompanied by a questionnaire was issued.

During the assessment process, the assessing officer noted that the assessee had issued shares to five companies. The officer highlighted a prevalent practice where undisclosed income was allegedly introduced through share applications or allotments to various entities or individuals. These companies purportedly exploited the corporate veil to funnel undisclosed income. In response to this practice, the Income Tax Act was amended, effective April 1, 2012. Referring to a letter dated January 23, 2015, served on the assessee, the assessing officer requested the appearance of the new shareholders and directors within 15 days to substantiate the authenticity and creditworthiness of their investments.

The assessing officer concluded that the assessee company engaged in a share transaction with the investor to introduce unaccounted income disguised as share applications or allocations. There were no regular business dealings or established relationships with the investors. The investors lacked plausible reasons to invest substantial amounts in the assessee's business, indicating that the transaction was primarily aimed at circumventing the provisions of the Act. Consequently, the entire share application and allocation funds were reinstated under Section 68 as undisclosed cash credits. Additionally, the assessee was notified of separate penalty proceedings under Section 271(1)(c).

The CIT(A) observed that the assessee failed to fulfill the burden of proving the identity, creditworthiness, and genuineness of the share transaction. It was determined that the income tax returns filed by the assessee's shareholders indicated a lack of genuine business operations with no history of earning taxable income. Despite this, they were involved in transactions worth millions of dollars, purportedly for investing and receiving funds for share capital at an excessively high premium.

The assessee appealed the matter to the tribunal, arguing that all share applicants were liable to income tax and that the entire share application funds were received through legitimate banking channels. Therefore, the addition made by the assessing officer and upheld by the CIT(A) was unwarranted.

The tribunal determined that the assessee operates in the steel industry with promising future prospects. As they expanded their operations and experienced a rise in fixed assets, the need for funds became apparent. Additionally, the assessee's turnover surged by 73%. The decision to invest was influenced by strategic relationships established by associates or group companies with directors closely connected to the assessee's directors.

The department argued that while the assessee may have proven the identity and creditworthiness of the share applicants at the pertinent time, the genuineness of the transaction, which is the third and crucial factor, must also be established. Without the simultaneous establishment of all three factors, the revenue was entirely justified in invoking Section 68.

The court acknowledged that the CIT(A) appropriately employed a logical process of reasoning, taking into account the entirety of the facts and circumstances surrounding the allegations against the assessee. By considering the minimum and proximate facts and circumstances pertaining to the events upon which the charges were based, the CIT(A) arrived at a reasonable conclusion. The court affirmed that the test applied by the CIT(A) was in line with what a reasonable or prudent individual would use to reach a conclusion.

"We are persuaded to conclude that the assessee failed to demonstrate the investors' capacity to provide funds for the purchase of the aforementioned shares at a substantial premium. The creditworthiness of the investors' companies raises doubts, and the explanation provided by the assessee cannot reasonably be considered satisfactory in explaining the source of the funds," stated the court.

In ruling in favor of the department, the court held that the assessee had utterly failed to establish the genuineness of the transaction with compelling and credible evidence, casting doubt on the authenticity of the investments made in its share capital.