Objective
The Author in this article discusses two issues namely:
1) Application of section 68 in case of share application money to the web of intermediaries and
2) how one can-not misuse rule 27 of ITAT rules.
Both the issues are based on recent judgements of Mumbai tribunal
Structure-:
The article gives authors own analysis. This article is based on a judicial pronouncement and is divided into following 2 parts.
| Part – 1 – Judgement in brief | Part – 2 – Judgement in Detail | Principles of law |
| Background | Citation of the judgement | A bit more about rule 27 |
| Facts in brief | Facts of the case | Facts relevant to section 68 |
| Take away points | Facts in the case of rule 27 | Assumptions related to Valuation Report |
| Principles of Law | Principles of law | |
| Application of principles of law | Broad modus operandi of functioning of shell companies |
Part – 1 – Judgement in brief
Background
There is a typical system of creation of multi-level web of companies to route the un-accounted money and bring it as share application money.
In Leena Power case, the ITAT has made a threadbare analysis of the facts, applicable law and has applied the law to the facts on hand.
In LIC case, the ITAT has explained the purpose and scope of rule 27 of the Income Tax (Appellate Tribunal) Rules, 1963 that visualises a situation where in the absence of such a right given to respondent he may have to lose his case on account of some ground which was raised before the first appellate authority, but could not find favour with him.
Take away point
To study and understand the manner in which complex web of multi-layer companies through which un-accounted money routed so that one will remain vigilent in this regard.
Rule 27, is an extension of the principle of natural justice and can be used as a mis-chief to gain a benefit which other wise not available
Part – 2 – Judgement in Detail
Citation of the judgements
Both the judgements are of Mumbai ITAT – Bench A, authored by Mr. Pramod Kumar, VP.
DCIT, Circle 15(1)(2), Mumbai v Leena Power Tech Engineers Pvt Ltd dated September 21, 2021, with ITA No. 1313/Mum/20, Assessment year: 2011-12 [Leena Power case]
ACIT v Life Insurance Corporation of India Ltd. dated October 4, 2021 with IT Appeal No. 3567 (mum.) of 2019 ASSESSMENT YEAR 2009-10] [2021] 131 taxmann.com 26 (Mumbai – Trib.) [LIC case]
Facts of the case
The Leena Power case mainly deals with un-explained cash credit u/s 68 and also includes an issue u/r 27 of ITAT Rules.
The LIC case mainly includes an issue u/r 27 of ITAT Rules. Let’s firstly complete the issue u/r 27 of ITAT Rules
Facts relevant to rule 27
An order of re-opening of assessment u/s 147 r.w.s 148 was passed. The CIT(A) dealt with the grounds of appeal as follows;
| Ground | Decision |
| Re-opening of assessment proceedings is invalid – | No |
| Addition u/s 14A is un-sustainable in law | Yes |
| Suo mottu withdrawal of foreign tax credit which was not done in original assessment | Yes |
Principles of law.
One must note that rule 27 of the ITAT Rules 1963 provides that “(t)he respondent, though he may not have appealed, may support the order appealed against on any of the grounds decided against him”. What can thus be supported is the order impugned in appeal, and, in effect, the conclusions arrived at in the impugned order. In other words, even though the respondent may support on any of the grounds decided against the respondent by the CIT(A), he can never seek more than what the CIT(A) has given him. It is for this reason that the respondent can only “support the order”.
Application of principles to the facts
The assessee approached the ITAT for quashing the order of CIT(A) in totality.
The ITAT decided the matter on merit in favour of the assessee. The learned AR pressed the issue u/r 27 of ITAT Rules.
The ITAT took into consideration the totality picture and visualized the impact of quashing the order of CIT(A). IT would have had the effect that the foreign tax credit which was properly dis-allowed by CIT(A) would have been set aside and the assessee would have got the credit which was granted errorenously.
Later, ITAT observed that, even if we are to uphold the plea of the assessee against reopening of the assessment, it has to essentially come with a rider that the relief eventually to be given to the assessee will not exceed the relief available to the assessee in the impugned order passed by the CIT(A). When the grievance against the withdrawal of foreign tax credit to the tune of Rs. 7.57 crore was not even challenged in appeal before the CIT(A), the assessee will not be eligible for any relief on that aspect- directly or indirectly. The assessee thus gets no additional advantage by the petition under rule 27.
A bit more about rule 27
The genesis of Rule 27 can be found in Order XLI, rule 22, of Code of Civil Procedures, 1908 which reads as:
(I) Any respondent, though he may not have appealed from any part of the decree, may not only support the decree on any of the grounds decided against him in the court below, but take any cross-objection to the decree which he could have taken by way of appeal…..
It has been very beautifully summarised by Justice Chagla in the case of New India Life Assurance Co. [1957] 31 ITR 844 (Bom) in the following passage as:
“The position with regard to the respondent is different; it is not open to him to urge before the court of appeal and get a relief which would adversely affect the appellant. If the respondent wanted to challenge the decision of the trial court, it was open to him to file a cross-appeal or cross-objections. But the very fact that he has not done so shows that he is quite content with the decision given by the trial court. Therefore, under these circumstances, his only right is to support the decision of the trial court. It is true that he may support the decision of the trial court, not only on the grounds contained in the judgment of the trial court, but on any other ground. In appreciating the question that arises before us, one must clearly bear in mind the fundamental difference in the positions of the appellant and the respondent. The appellant is the party who is dissatisfied with the judgment ; the respondent is the party who is satisfied with the judgment.”
Supreme Court in S. Nazeer Ahmed v. State Bank of Mysore AIR 2007 SCW 766 it was held and observed as under:
“7. The High Court, in our view, was clearly in error in holding that the appellant not having filed a memorandum of cross-objections in terms of Order XLI Rule 22 of the Code, could not challenge the finding of the trial court that the suit was not barred by Order II Rule 2 of the Code. The respondent in an appeal is entitled to support the decree of the trial court even by challenging any of the findings that might have been rendered by the trial court against himself. For supporting the decree passed by the trial court, it is not necessary for a respondent in the appeal, to file a memorandum of cross-objections challenging a particular finding that is rendered by the trial court against him when the ultimate decree itself is in his favour. A memorandum of cross-objections is needed only if the respondent claims any relief which had been negatived to him by the trial court and in addition to what he has already been given by the decree under challenge. We have therefore no hesitation in accepting the submission of the learned counsel for the appellant that the High Court was in error in proceeding on the basis that the appellant not having filed a memorandum of cross-objections, was not entitled to canvass the correctness of the finding on the bar of Order II Rule 2 rendered by the trial court.”
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Facts relevant to section 68
It is a bit difficult to carve our pure facts purely un-influenced by observation. An Attempt is made to remain as neutral as possible.
Rohini Vyapar Pvt Ltd
All figures are reported in Lakhs.
|
Practically everything that is received is passed on to other company(ies). There is no clarity on who are the ultimate beneficiary owners. Additionally the company does not have any managerial rights in shares in which investment is made. | ||||||||||||||||||||||||||||
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Difficult to accept that the compay making such aggressive investments does not have any managerial system. |
MANBHAWAN COMMERCIAL PRIVATE LIMITED
Balance sheet as at 31-3-2011
All the figures are in Crores
| Sources of funds – Mar 31, | 2011 | 2010 | Application of funds – Mar 31, | 2011 | 2010 |
| Creditors | 40.69 | 6.00 | debtors | 61.45 | 7.01 |
As per the information available, there is never any fixed asset or stock etc.
Statement of Profit and Loss for the year ending March 31, 2011
| Expenditure– Mar 31, | 2011 | 2010 | Income – Mar 31, | 2011 | 2010 |
| Purchases / expenses | 33.31 | Not available | sale | 90.11 | 35.56 |
Assumptions made in the valuation report
a) These turnover figures are taken as a base figure, but the valuation also assumes that this figure will further keep on growing by 10% each year, and that despite such an increase, the profit after tax will continue to be at 4.25% on the turnover which is exactly the same as in the financial year ending 31st March 2011.
b) Except for a capital investment of Rs 8 crores in the financial year 2010-11, no increase in investments is provided for.
c) It is also not clear as to on what basis does the valuer come to the conclusion that only additional investment required by the company is Rs 8 crores.
d) As a matter of fact, barring a small investment of Rs 1,00,000 at face value by two Howrah based ladies subscribing to memorandum of association- namely Sangeeta Agarwal and Asha Agarwal, other share capital of the RVPL seems to be issued at huge premium, once again to shell entities which are similarly funded by other shell entities- constituting a different layer of this multi-layer transaction, and, as evident from share premium reserve of Rs 975 lakhs- as against share capital of Rs 25 lakhs.
e) Once again, the shares are issued at premium that too in a company which has no other activity except for routing the funds to another company, i.e. the assessee, by making investments therein at a huge premium.
f) The assessee company is stated to be not connected with Rohini Vyapar Pvt Ltd in any manner, and yet the share subscriber had such a faith in the assessee company that it subscribed to the shares at 900% premium.
g) The investment so made, in the usual course of business, does not make any sense at all. The share premium, at which the shares are issued, is wholly unrealistic.
h) The discounting rate is taken at 15%.
i) The DCF valuation, shows the figure of Rs 1,67,46,057 for the financial year ended 31st March 2010. This figure is arrived at by adding depreciation (Rs 16,96,610) to net profit after tax (Rs 15,04,94,427).
j) Similarly, the net cash flow is computed for the subsequent years. Barring for the immediately succeeding financial period, wherein cash inflow is reduced by Rs 8 crores towards capital investments, no other adjustments are envisaged.
k) That proceeds on the assumption that entire profit and depreciation will result in net positive cash flow. It overlooked the increase in net current assets from Rs 5.36 crore (as on 31.3.2010) to Rs 22.48 crores (as on 31.3.2011) whereas the cash and bank balances have remained almost the same at Rs 9.82 lakhs as on 31.3.2011 as against Rs 8.52 lakhs as on 31.3.2010.
l) As against a net profit of Rs 3.11 crore and depreciation of Rs 16.96 lakhs, the net cash inflow is only Rs 1.30 lakhs which is less than 0.4% of the profit plus depreciation. Yet, in the computations of DCF value, the net cash flow is taken at Rs 1,67,46,057 which is overstated, when compared with the actual financial statements, by almost 130 times i.e. around 13,000%, and the valuation computations are based on this highly exaggerated figure.
m) Even a simple cross reference to the financial statements of the assessee company would show that cash inflows are exaggerated by 13,000% and then discounted accordingly. The assumption in the valuation report is unrealistic, and the base figure itself, being 250% increase over immediately preceding year, is doubtful.
Principles of law
The fundamental legal position that the onus is on the assessee to prove ‘bonafides’ or ‘genuineness’ of the share application money credited in his books of accounts.
Section 68, which provides that where any sum is found credited in the books of an assessee maintained for any previous year, and the assessee offers no explanation about the nature and source thereof or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the sum so credited may be charged to income tax as the income of that assessee for that previous year
| Judgement citation | Principle |
| Youth Construction [1] | “it involves three ingredients, namely,
a) the proof regarding the identity of the share applicants, b) their creditworthiness to purchase the shares and c) the genuineness of the transaction as a whole” |
| United Commercial [2] | it was necessary for the assessee to prove prima facie the identity of creditors, the capacity of such creditors and lastly the genuineness of transactions”. |
| Precision Finance [3] | “it is for the assessee to prove the identity of creditors, their creditworthiness and genuineness of transactions |
| Durga Prasad More [4] | “Science has not yet invented any instrument to test the reliability of the evidence placed before a court or tribunal. Therefore, the courts and Tribunals have to judge the evidence before them by applying the test of human probabilities”. “it is true that an apparent must be considered real until it is shown that there are reasons to believe that the apparent is not the real party who relies on a recital in a deed has to establish the truth of those recitals, otherwise it will be very easy to make self-serving statements in documents either executed or taken by a party and rely on those recitals. If all that an assessee who wants to evade tax is to have some recitals made in a document either executed by him or executed in his favour then the door will be left wide open to evade tax. A little probing was sufficient in the present case to show that the apparent was not the real. The taxing authorities were not required to put on blinkers while looking at the documents produced before them. They were entitled to look into the surrounding circumstances to find out the reality of the recitals made in those documents”.
“human minds may differ as to the reliability of a piece of evidence but in that sphere the decision of the final fact finding authority is made conclusive by law”. |
| Sumati Dayal [5] | This, in our opinion, is a superficial approach to the problem. The matter has to be considered in the light of human probabilities………..Similarly the observation ……….that if it is alleged that these tickets were obtained through fraudulent means, it is upon the alleger to prove that it is so, ignores the reality. The transaction about purchase of winning ticket takes place in secret and direct evidence about such purchase would be rarely available …..In our opinion, the majority opinion after considering surrounding circumstances and applying the test of human probabilities has rightly concluded that the appellant’s claim about the amount being her winning from races is not genuine. It cannot be said that the explanation offered by the appellant in respect of the said amounts has been rejected unreasonably |
| Mumbai Kamgar [6] | It is trite, going by Anglophonic principles that a ruling of a superior court is binding law. It is not of scriptural sanctity but of ratio-wise luminosity within the edifice of facts where the judicial lamp plays the legal flame. Beyond those walls and de hors the milieu we cannot impart eternal vernal value to the decisions, exalting the precedents into a prison house of bigotry, regardless of the varying circumstances and myriad developments. Realism dictates that a judgment has to be read, subject to the facts directly presented for consideration and not affecting the matters which may lurk in the dark |
| NRA Iron [7] | The practice of conversion of un-accounted money through the cloak of Share Capital / Premium must be subjected to careful scrutiny. This would be particularly so in the case of private placement of shares, where a higher onus is required to be placed on the assessee since the information is within the personal knowledge of the assessee. The assessee is under a legal obligation to prove the receipt of share capital/premium to the satisfaction of the AO, failure of which, would justify addition of the said amount to the income of the assessee”. |
| Phool Chand [8] | Thus, where the transaction itself on the basis of subsequent information, is found to be a bogus transaction, the mere disclosure of that transaction at the time of original assessment proceedings, cannot be said to be a disclosure of the ‘true’ and ‘full’ facts in the case and the ITO would have the jurisdiction to reopen the concluded assessment in such a case. I….. …. an ITO acquires jurisdiction to reopen assessment under section 147(a) read with section 148 only if on the basis of specific, reliable and relevant information coming to his possession subsequently, he has reasons which he must record, to believe that by reason of omission or failure on the part of the assessee to make a true and full disclosure of all material facts necessary for his assessment during the concluded assessment proceedings, any part of his income, profit or gains chargeable to income-tax has escaped assessment.
21. We are not persuaded to accept the argument of Mr. Sharma that the question regarding truthfulness or falsehood of the transactions reflected in the return can only be examined during the original assessment proceedings and not at any stage subsequent thereto. The argument is too broad and general in nature and does violence to the plain phraseology of sections 147(a) and 148 and is against he settled law by this Court. We have to look to the purpose and intent of the provisions. One of the purposes of section 147, appears to us to be, to ensure that a party cannot get away by willfully making a false or untrue statement at the time of original assessment and when that falsity comes to notice, to turn around and say ‘you accepted my lie, now your hands are tied and you can do nothing’. It would be travesty of justice to allow the assessee that latitude |
| Shri Krishna [9] | Now, what needs to be emphasised is that the obligation on the assessee to disclose the material facts – or what are called, primary facts – is not a mere disclosure but a disclosure which is full and true. A false disclosure is not a true disclosure. The disclosure must not only be true but must be full – ‘fully and truly’. A false assertion, or statement, of material fact, therefore, attracts the jurisdiction of the ITO under section 34/ 147. …….It is necessary to remember that we are at the stage of re-opening only. The question is whether, in the above circumstances, the assessee can say, with any justification, that he had fully and truly disclosed the material facts necessary for his assessment for that year. ……… Indubitably, whether a loan, alleged to have been taken by the assessee, is true or false, is a material fact – and not an inference, factual or legal, to be drawn from given facts. …….Does it not furnish a reasonable ground for the ITO to believe that on account of the failure – indeed not a mere failure but a positive design to mislead – of the assessee to disclose all material facts, fully and truly, necessary for his assessment for that year, income has escaped assessment ? We are of the firm opinion that it does. It is necessary to reiterate that we are now at the stage of the validity of the notice under section 148/147. The enquiry at this stage is only to see whether there are reasonable grounds for the ITO to believe and not whether the omission/failure and the escapement of income is established. It is necessary to keep this distinction in mind” |
| Om Vinyl Pvt Ltd, [10] | A disclosure, even if full, may not be true. All information may be furnished which are necessary for assessment. Yet, if this disclosure is not true, it would not satisfy the test of true and full disclosure, and, therefore, assessee’s contention that it has disclosed all the facts, during original assessment, cannot be considered as true” |
| Aradhana [11] | Such material was perused by the Assessing Officer and upon examination thereof, he formed a belief that the petitioner company had received share application and share premium money from as many as 20 different investor companies who were found to be shell companies and indulging in giving accommodation entries. From our view point, the Assessing Officer had sufficient material at his command to form such a belief. Such materials did not form part of the original assessment proceedings and was placed before the Assessing Officer only after the assessment was completed. Since on the basis of such materials, Assessing Officer, as we have recorded, came to a reasonable belief that income chargeable to tax had escaped assessment, merely because these transactions were scrutinised by the Assessing Officer during the original assessment also would not preclude him from reopening the assessment. His scrutiny during the assessment will necessarily be on the basis of the disclosures made by the assessee.
“16. Ostensibly, thus, there was disclosure and the occasion would not arise to term this as the assessee not having disclosed fully and truly all the material facts necessary for assessment. However, in essence, if the unsecured loans obtained from Basant Marketing Pvt Ltd. from the material supplied by them, the DCIT, Kolkata reveals that the same was as a result of accommodation entry in the form of loans and advances from Basant Marketing Pvt. Ltd. to the tune of Rs. 8.71 crore, the case of the assessee would surely be covered under the said provision of law as it would not amount to full and true disclosure on the part of the assessee. At this stage, the reasons recorded shall have to be regarded, which have been based on the information contained in the report of the DCIT, Kolkata, dated March 24, 2013, wherein it had been noticed that the assessee company obtained accommodation entry in the form of loans and advances from Basant Marketing Pvt. Ltd. and, therefore, the Assessing Officer based his reason to believe that the income chargeable to tax had escaped the assessment. |
| Jayant Security & Finance [12] | If the Assessing Officer has information to form a reasonable opinion that prima facie the entire transaction itself was sham and bogus, as reference to such transaction during the original assessment and raising certain queries in this respect would not prevent him from reopening the assessment on the principle of change of opinion. As noted, the opinion would be formed on the basis of disclosures. When disclosures are found to be prima facie untrue, the opinion formed earlier would not prevent Assessing Officer from examining the issue. |
| Rajesh Jhaveri [13] | “At the stage of issue of notice, the only question is whether there was relevant material on which a reasonable person could have formed a requisite belief” |
Broad modus operandi of functioning of shell companies
a) A shell entity, by itself, is not an illegal entity, but it is their act of abatement of, and being part of, financial manoeuvring to legitimize illicit monies and evade taxes, that takes it actions beyond what is legally permissible.
b) These entities have every semblance of a genuine business- its legal ownership by persons in existence, statutory documentation as necessary for a legitimate business and a documentation trail as a legitimate transaction would normally follow.
c) The only thing which sets it apart from a genuine business entity is lack of genuineness in its actual operations.
d) The operations carried out by these entities, are only to facilitate financial manoeuvring for the benefit of its clients, or, with that predominant underlying objective, to give the colour of genuineness to these entities.
e) These shell entities, which are routinely used to launder unaccounted monies, are a fact of life, and as much a part of the underbelly of the financial world, as many other evils.
Application of principles of law
On application of the principles of law to the facts of the case, one will come to a conclusion that, in this case, section 68 is attracted as the assessee failed to prove its important three ingredients, namely,
a) the proof regarding the identity of the share applicants,
b) their creditworthiness to purchase the shares and
c) the genuineness of the transaction as a whole”
Bibliography
| [01] | PCIT Vs Youth Construction Pvt Ltd [(2013) 357 ITR 197 (Del)] |
| [02] | CIT v. United Commercial and Industrial Co (P.) Ltd [1991] 187 ITR 596 (Cal)], |
| [03] | CIT v. Precision Finance (P.) Ltd [1994] 208 ITR 465 (Cal)], |
| [04] | CIT v. Durga Prasad More [(1971) 82 ITR 540 (SC)], |
| [05] | Sumati Dayal v. CIT [(1995) 214 ITR 801 (SC)], |
| [06] | Mumbai Kamgar Sabha v. Abdulbahi Faizullabhai AIR 1976 SC 1455 |
| [07] | PCIT Vs NRA Iron and Steel Pvt Ltd [(2019) 412 ITR 161 (SC) |
| [08] | Phool Chand Bajrang Lal Vs ITO [(1993) 203 ITR 456 (SC)] |
| [09] | Shri Krishna (P.) Ltd. vs. ITO [(1996) 221 ITR 538 (SC)], |
| [10] | Om Vinyl Pvt Ltd, Bombay HC |
| [11] | Aradhana Estate Pvt Ltd Vs DCIT [(2018) 404 ITR 105 (Guj)] |
| [12] | Jayant Security & Finance Ltd. v. Asstt. CIT [Special Civil Application No.18921/2017, [Guj] |
| [13] | Rajesh Jhaveri Stock Brokers Pvt Ltd [(2007) 291 ITR 500 (SC)], |
Author Bio
