For the past few decades, the method of accommodation entries done by shell companies in order to convert black money into legitimate income has increased tremendously in India.
Some of the ways by which this is done include buying shares at high premium above their fair value price, share capital, gifts, penny stocks and unsecured loans involving an operator, and creating shell companies.
To combat this menace, the income tax authorities use Section 68 of the Income Tax Act, 1961.
To understand how these transactions operate, first it is important to know the meanings of "accommodation entry" and "shell company", considering there is no legislative definition of the said terms.
The former was defined in the case of Gala Finance v. ITO, wherein it was stated to be a bogus entry in the books of account of a person to accommodate and to bring in the books of accounts the own income of the impugned person, camouflaging it in the name of some other person. These entries are done to accommodate the assessee's own income in its books of accounts not directly and truthfully, but in the name of some other person, and not by way of an income.
The latter was recently defined by the Gauhati High Court in Assam Company India Ltd. and Another v. UOI as having only a nominal existence; it exists only on paper without having any office and employee. It may be used as a deliberate financial arrangement providing service as a tool or vehicle of others without itself having any significant assets or operations.
The usual parties in this modus operandi are the operator, who opens shell companies with all technical compliances, and a beneficiary. The beneficiary gives cash to the operator who draws a certain commission for conducting the whole transaction. Then, the amount is deposited in shell companies usually through cash or cheques by other bogus companies, creating a layer of transactions. Later, to avoid suspicion after a certain time, this money is invested in the beneficiary company by an unsecured loan transaction, share capital etc.
It is pertinent to mention here that in certain cases, the operator acts as a middleman between two parties wherein one wants to convert black money into white while the other requires unaccounted money. In these cases, transactions work simultaneously, and later if the need arises, they can be squared off.
Section 68, Income Tax Act, 1961
The Supreme Court in Principal CIT v. NRA Iron & Steel Pvt. Ltd. recently reiterated the settled position of law regarding Section 68 wherein the initial onus is on the assessee to establish by cogent evidence the identity of the creditors, genuineness of the transaction, and credit-worthiness of the investors under Section 68 of the Act.
Proof of identity of the creditors
The assessee discharges this onus by providing PAN identity, share registered form, balance sheet, incorporation form, bank accounts, acknowledgment copy of the return of income, MOA/AOA and board resolution of the investing companies.
The Delhi High Court in CIT v. Winstral Petrochemicals Pvt. Ltd. held that if the applicant companies were duly incorporated, were issued PAN cards, and had bank accounts from which the money was transferred to the assessee by way of account payee cheques, they could not be said to be non-existent.
Contrary to this, in CIT v. NR Portfolio Pvt. Ltd, it was held that mere production of incorporation details, PAN numbers, or the fact that third persons or companies had filed income tax details in case of a private limited company may not be sufficient.
But there are cases such as CIT v. Dwarkadhish Capital Pvt. Ltd., wherein it was held that just because the creditors/share application could not be found at the address given, it would not give the Revenue the right to invoke Section 68. One must not lose sight of the fact that it is the Revenue which has all the power and wherewithal to trace any person.
Recently, the Supreme Court in NRA Iron & Steel Pvt. Ltd.’s Case, allowed the addition under Section 68 of the Act, by reversing the judgments of lower authorities on the field enquiry report of the assessing officer wherein the companies were found to be non-existent.
Capacity of creditors to advance money
The assessee is required to discharge this onus by showing the creditworthiness of the creditor or the investing company. The assessee does the same by showing the balance sheet, net worth, cash deposits in the creditors companies. Here, the issue arises as to whether these documents and entries of the creditor companies will discharge the onus of the assessee.
In Giri Roadlines & Commercial Trading Pvt. Ltd. v. ITO, the tribunal held that nil or meagre income cannot be a conclusion that the assessee has no creditworthiness. Furthermore, in CIT v. Kamdhenu Steel & Alloys Ltd., it was held that creditworthiness can be proved by sufficient bank balance. Recently, in ITO v. Vulvan Traders, the tribunal approved the observation of CIT(A) that considering that the net current assets and net worth being positive and high respectively, it cannot be said that the companies do not have credibility to advance money.
It is pertinent to mention that the Revenue authorities, in order to add income under Section 68 the Act, shows that the circumstances under which the transactions were undertaken does not show the true credibility of the creditor companies. The two sub-headings herein show the same-
Source of Source
The doctrine of ‘Source of Source’ means the source of funds of the creditor/investor company enabling it to infuse cash entries in the assessee company. The Delhi High Court in CIT v. NR Portfolio Pvt. Ltd. held that the said doctrine cannot be applied universally, without reference to the factual matrix. This is contradictory to various judgments wherein it has been held that the assessee is not required to prove the source of source. The Bombay High Court recently in Gaurav Triyugi Singh v. ITO, held that it is a settled proposition that the assessee is not required to prove source of source.
Immediate deposit of cash before accommodation entry
The courts see whether when the accommodation entry was made, there was any cash deposit, usually immediately, or if a similar amount was deposited with the creditor/investor, enabling it to enter into the transaction. If there is no such deposit in addition to other facts and circumstances of the case such as proper identification or genuineness of the creditors/investors, then there is no addition under Section 68 of the Act.
In Hillman Properties Pvt. Ltd. v. ITO, the ITAT analyzed that the amount which was deposited in the bank accounts of the investor companies was exactly the same in every transaction entered with the assessee company; therefore the addition was valid.
Genuineness of transaction
The assessee discharges the onus of proving genuineness of transactions by showing that it was done through banking channels, account payee cheques, and TDS deduction. The Gujarat High Court in CIT VI v. Gujarat Ship Trading Corporation, dismissed the appeal of the Revenue on the ground that the amount and interests were paid by cheque and the creditors also reflected the same in their assessment proceedings.
Furthermore, the ITAT in Deputy CIT v. Samco Auto India, held that by doing the transactions through banking channels, TDS deduction and creditors get assessed to Income Tax, thus genuineness of transaction is proved.
But there are also contradictory cases such as PCIT v. Bikram Singh, in which the Delhi High Court held that even if a transaction of loan is made through cheque, it cannot be presumed to be genuine in the absence of any agreement, security and interest payment.
Recently, in Hillman Properties v. ITO, the ITAT held that transactions done through banking channels does not prove the genuineness of the transaction by applying the test of human probability with respect to evidence.
Conclusion
Parliament introduced an amendment to Section 68 of the IT Act, 1961 in the year 2012 to require the assessee to prove the source of source, which should be satisfactory in the opinion of the assessing officer. But unfortunately, there are judgments ignoring the said amendment.
Furthermore, the judiciary requires a higher burden of proof from the Revenue to show that the money emanated from the coffers of the assessee. In Jaidka Woolen & Hosiery Mills Pvt. Ltd., the ITAT held that there was no evidence to show that money actually emanated from the coffers of the assessee-company so as to be treated as undisclosed income. Additionally, if the loan taken by the assessee has been repaid to the creditor company, then no addition is allowed, even though such transactions are done to square off the entries entered earlier.
In certain cases it is observed that due to lack of independent enquiry, there exists a failure to cross-examine adverse witness, not providing documents, and taking a general view on all the entries, which result in deletion of the amount under the said provision.
Madhav Lahoti is a fifth-year law student at National Law University, Jodhpur. Keshav Khandelwal is a fourth-year law student at Nirma University, Ahmedabad.