Source of Source – Section 68

In the recent judgement of DCIT Vs M/S. Kejriwal Industries Ltd, I.T.A No.1509/AHD/2016 dated 4-5-2020, Hon’ble ITAT Surat held in favour of assessee. On the issue of section 68 of Income Tax Act 1961, Hon’ble ITAT held that assessee need not prove ‘source of source‘. The relevant part of the judgement is hereby reproduced:

“… In view of above, we are of the considered view that the assessee has discharged the initial onus which lay on him in the terms of section 68 of the Act by providing identity of creditors and same has not been doubted by the AO also. Further, the assessee has proved the creditworthiness by way of filing ITR returns, bank account, balance sheet, confirmation of the creditors. The assessee is not expected to prove the genuineness of cash deposits in bank accounts of those creditors because under the law the assessee can be asked to prove source of credit but not the source of the source as held by the Hon`ble Bombay High Court in the case of Orient Trading Co. v. CIT [1963] 49 ITR 723 (Bombay)…”

This judgment once again brings forth the issue which has been a subject matter of numerous litigations in taxation history of India- whether an assessee is required to prove “source of source” in cases of cash credit within the meaning of section 68 of Income Tax Act 1961.

The proviso to section 68, added through Finance Act 2012 made a clear cut distinction between company making private placement of shares and company raising funds through public issue of shares. The intention of the amendment was to place a higher onus on the assessee in addition to general onus of “identity, credit worthiness and genuineness”. This is because it was observed that closely held companies have a special knowledge of investments made in their shares as a result of which they must be held accountable if “source of source” is not proved. So if a shareholder is not able to satisfactorily prove the source of its investment, addition shall be made in the hands of assessee company and not its shareholder. The proviso thus cleared the confusion created by an earlier decision of Supreme Court in CIT Vs. Lovely Exports 216 CTR 195 in which relief was given only to public issue of shares. The decision was being erringly quoted by assesses to evade their onus of proving “source of source” even in case of private placement of shares.

Hence, by addition of the aforementioned proviso, the statute incorporates that which was already being recognized by earlier judicial pronouncements. Two such landmark cases are Sumati Dayal vs Commissioner Of Income Tax 1995 and Commissioner Of Income Tax vs Durga Prasad More 1971 wherein the Supreme Court has underlined that what is apparent may not be real and one needs to apply the test of surrounding circumstances and human probabilities to understand the veracity of a particular claim. The principles laid therein continue to act as a litmus test to verify whether a transaction is genuine or simply a colorable device to defraud the revenue.Thus, the case of private placement of shares has become a classic example illustrative of the above principles.

What is worth highlighting here is that proviso to section 68 unequivocally recognizes that when a particular fact is in the special knowledge of an assessee, the assessee is under a higher onus to provide proof, which in this case means proving the “source of source” i.e. the source of shareholder’s/subscriber’s investments.So the underlying tenet behind the addition of the proviso to section 68 of Income Tax Act 1961 was that the investment made in closely held companies is very well within the special knowledge of the assessee. The test of human probabilities and surrounding circumstances point out that no one in a sound frame of mind would invest in shares of such a closely held company which has no significant business activities or future prospects. So if an investor is nevertheless subscribing to such shares it naturally raises reasonable suspicion as to what is apparent may not be real.

In my opinion the aforementioned principles outlined in the proviso apply in totality to all cases where unsecured loans are shown as credit in books of an assessee. By its very definition unsecured loan means loan without collateral. It provides the lenders with little security and increases the lender’s risk manifold. Even then if a lender is giving unsecured loan to assessee, the test of human probabilities naturally raises reasonable suspicion. How is this scenario any different than the case of bogus shareholders which proviso to section 68 intends to unveil. Doesn’t this situation then warrant a further investigation into “source of source” ? It takes no rocket science to infer here that lender and assessee have full knowledge and confidence in their mutual transaction. Clearly assessee is in full and peculiar knowledge of the lender and its whereabouts. Assessee cannot then hide behind the technicality that it is not required to prove unsecured loan’s “source of source”.

There have been numerous searches throughout the country and the modus operandi has been sufficiently highlighted as to how assessee’s own black money is being routed through accommodation entry providers through transactions of unsecured loan and share application. Even then in many of such cases assessee has been able to go scot free because it proves the genuineness of its source through documentary evidences of ITR, bank statements etc. But such cases are living proof of the fact that what is apparent may not be real.The devil in such cases lies in the details of “source of source”. So in my opinion, providing a blanket immunity to the assessee with respect to unsecured loan’s “source of source” is logically incomprehensible. Each unsecured loan case should be decided based on peculiar facts and circumstances and once a preponderance of evidence is established by revenue, the onus shifts back on the assessee to further prove the “source of source”. Failing this, addition in hands of assessee is justified.

There have been numerous judgments by various appellate forums rejecting the need to prove “source of source” in the above case. One such judgment is case of Banwari Lal vs ITO ITA No.1542/Del./2012 dated 15-01-2016. Relevant section of the judgment is quoted as under:

“…. if the Assessing Officer wishes to assess the said loan as the income of the assessee from undisclosed source, to prove either by direct evidence or indirect/ circumstantial evidence that the money, which the assessee received from the creditor actually belonged to, and was owned by, the assessee himself. If there is direct evidence to show that the loan received by the assessee actually belonged to the assessee, there will be no difficulty in assessing such amount as the income of the assessee from undisclosed source ; but if there is no direct evidence in this regard, then, the indirect or circumstantial evidence has to be conclusive in nature and must in such circumstances, unerringly point to the assessee as the person from whom the money had actually flown to the hands of the sub-creditor and, then, routed through the hands of the subcreditor to the hands of the creditor. For this purpose, the circumstantial evidence has to be not only consistent with the hypothesis that the money belonged to the assessee, but that this hypothesis must also be inconsistent with the hypothesis that none other than the assessee owned the said money…”

It is sufficiently clear from the aforementioned decision that Hon’ble ITAT directed revenue to prove beyond doubt the culpability of the assessee. A point worthy of discussion here is the evidentiary standards and burden of proof which are different for civil and criminal cases. In criminal cases a prosecutor needs to prove beyond doubt that the party is guilty whereas in civil cases there should be a preponderance of evidence against the accused. In my view, since income tax law suits are civil suits, it is sufficient that the revenue only proves that its proposition against assessee is more likely to be true than not true.

Let us now refer to section 106 of the Indian Evidence Act. Since in almost all cases, judicial forums have relied on section 106 of the Indian Evidence Act 1872, it becomes imperative to analyze section 68 of Income Tax act 1961 in light of section 106 of Indian Evidence Act 1872. Now, as per section 106 of Evidence Act, revenue is deemed to have discharged its onus if it brings forth direct or circumstantial evidence which is adequate to raise a presumption in its favor. Any further onus to prove that revenue has erred and the credit of money in assessee’s books is in fact innocent is on assessee itself. Assessee needs to rebut the department’s presumption with facts which are in assessee’s special and peculiar knowledge. Only then, a harmonious interpretation between the principles laid in the two laws would arise.

I shall now attempt to analyze the case of ACIT Vs M/s. H.K. Pujara Builders ITA No. 3127/Mum/2017, dated 22-02-2019. In this case, it was observed that the assessee made transactions of unsecured loans through banking channels, paid TDS on interest of unsecured loan and submitted other documentary evidences such as ITR, loan confirmations, audited financials, 26AS etc. It was however found that assessee had taken loan from an entity M/s Grafton Merchant Pvt. Ltd which was one of the companies of Mr. J Purohit, an accommodation entry provider. Mr. J Purohit had admitted u/s 131 of Income Tax Act 1961 during a search operation of investigation wing that he gave bogus loans or bogus share application money against payment of cash through companies floated by him or his employees. One such company was M/s Grafton Merchant Pvt. Ltd. However, this statement was later retracted after 29 months. Nevertheless, the assessing Officer made addition based on the preponderance of evidence available. This addition was subsequently deleted by Hon’ble ITAT in light of documentary evidences submitted by assessee. Given this background,there are certain moot points which arise :

1. It is true that retraction when made on an affidavit would constitute an important piece of evidence. But we also need to understand that if an assessee agrees to make disclosure during a search action, and search team stops any further action based on that admission of assessee and later on the assessee retracts his admission – Doesn’t the doctrine of promissory estoppel apply here ?

2. Another important point worth highlighting here is the duration within which statement was retracted. Was it immediately after search action or after a considerable gap of say 29 months as in the above case or was it for the first time during assessment proceedings.

3. It is a common knowledge that more often not, assesses retract their statement made during search seizure action as having been obtained under pressure. Section 24 of Evidence Act states that admissions can be rebutted on grounds of threat or promise. However under section 31 of Evidence Act admissions are to be treated as admitted facts and hence act as estoppels in further proceedings although they may not be conclusive proof. How do we then harmoniously interpret these two sections?

I would like to conclude by saying that inclusion of a specific case of share capital by means of proviso to section 68 is an attempt by legislature to provide remedy to the mischief which was widely being resorted to by assessees. Today the mischief has changed its form to that of unexplained unsecured loan. So, instead of granting immunity to assessee in a routine manner, the appellate forums could distinguish the different cases of unexplained unsecured loan based upon specific facts and circumstances of each case.

Taking cue from “Dissimilum dissimilisest ratio”, I understand the proviso section 68 as being indicative of the intention of the legislature to simply qualify one particular instance of “source of source” to address the then prevailing mischief. This proviso in no manner bars addition on same grounds in cases of unaccounted unsecured loan, being a mischief of similar kind. Having said that,it is important to understand that while the proviso to section 68 provides for an automatic addition in the hands of assessee in all cases of unexplained “source of source”,I am in no way suggesting for an automatic addition in all cases of unexplained “source of source” of unsecured loans. The addition in latter case should be on a case to case basis as explained earlier.

Section 68 of Income Tax Act 1961 can possibly be considered as a case of Casus Omissus meaning thereby an omission in statute which has not been provided for by mistake or any other reason. This should however be reconciled with the fact that it may not be possible to provide for an exhaustive list of all possible mischief in any statute. The solution then lies in the history of the taxation jurisprudence of India which has always stepped upto the evolving exigencies of time. May be the time has come again to plug certain loopholes which have become a common knowledge.

Disclaimer : Views Expressed are personal

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