Unraveling the Maze of Round-Tripping: The Doctrine of "Source of Source" in Share Capital Transactions 2024 (4) TMI 989 - CALCUTTA HIGH COURT - HC

Deciphering Legal Judgments: A Comprehensive Analysis of Case Law Reported as: 2024 (4) TMI 989 - CALCUTTA HIGH COURT Introduction This article analyzes a recent judgment of the High Court concerning the issue of creditworthiness and genuineness of share capital transactions u/s 68 of the Income Tax Act, 1961 . The case involved an assessee company that received substantial share application money from various investor companies, and the revenue authorities questioned the genuineness of these transactions. Arguments Presented The assessee contended that the transactions were genuine, as the investor companies were registered entities, and the payments were made through banking channels. The revenue authorities, however, argued that the assessee failed to establish the creditworthiness of the investors and the genuineness of the transactions, as the funds were merely round-tripped among the group companies. Discussions and Findings of the Court Legal Principles The court discussed various legal principles and precedents concerning the burden of proof u/s 68 of the Income Tax Act, 1961. The court emphasized that the assessee has a legal obligation to prove the genuineness of the transaction, the identity of the creditors/investors, and their creditworthiness to the satisfaction of the Assessing Officer (AO). The court referred to the decisions in Commissioner of Income Tax Versus NR Portfolio Pvt. Ltd. - 2013 (11) TMI 1381 - DELHI HIGH COURT and Principal Commissioner of Income Tax (Central) - 1 Versus NRA Iron Steel Pvt. Ltd. - 2019 (3) TMI 323 - Supreme Court , which held that the creditworthiness or genuineness of a transaction depends on various factors, such as the relationship between the parties, the mode of approach, the quantum of money involved, the object and purpose of the investment, and whether the transaction is documented. The court also noted the amendment to Section 68 introduced by the Finance Bill, 2012 , which placed an additional onus on closely held companies to explain the source of funds in the hands of the resident shareholders, except for well-regulated entities like Venture Capital Funds. Analysis of the Facts The court conducted a detailed analysis of the factual matrix, including the bank statements of the investor companies and the assessee. It observed a pattern of circular transactions, where funds were received by the investor companies from other entities and immediately transferred to the assessee, leaving negligible balances in the accounts. The court noted that the directors of the investor companies were closely related to the director of the assessee company, and in one case, the assessee's director was himself a director in one of the investor companies. This raised doubts about the creditworthiness and genuineness of the transactions. The court also observed that the investor companies had purchased shares at a high premium without any business operations or earnings to justify such valuations. The court found that the fixing of the premium rate was arbitrary and devoid of any financial or accounting rationale. Analysis and Decision by the Court The court held that the assessee failed to discharge its legal obligation to prove the genuineness of the transactions and the creditworthiness of the investors. The court applied the doctrine of source of source or origin of origin and concluded that the transactions were part of a premeditated plan to introduce unaccounted money into the assessee company through a circular rotation of funds. The court criticized the Tribunal's finding that the CIT(A) had not pointed out any doubt or discrepancy regarding the identity of the investors, stating that the crucial question was whether the investors had the requisite creditworthiness and whether the transactions were genuine. The court upheld the CIT(A)'s order and set aside the Tribunal's order, answering the substantial questions of law in favor of the revenue authorities. Doctrine or Principle Discussed The court discussed and applied the doctrine of source of source or origin of origin in this case, which requires an inquiry into the real nature of the transaction and the creditworthiness of the investors by lifting the corporate veil. Comprehensive Summary The High Court, in this judgment, upheld the principles established by the Supreme Court and various High Courts regarding the burden of proof u/s 68 of the Income Tax Act, 1961 . The court emphasized that the assessee has a legal obligation to prove the genuineness of the transaction, the identity of the creditors/investors, and their creditworthiness to the satisfaction of the Assessing Officer. The court conducted a detailed analysis of the factual matrix, including the bank statements and the relationships between the assessee company, the investor companies, and their directors. It observed a pattern of circular transactions and round-tripping of funds among the group companies, raising doubts about the creditworthiness and genuineness of the transactions. Applying the doctrine of source of source or origin of origin, the court concluded that the transactions were part of a premeditated plan to introduce unaccounted money into the assessee company through a circular rotation of funds among closely related entities. The court upheld the CIT(A)'s order and set aside the Tribunal's order, answering the substantial questions of law in favor of the revenue authorities. Full Text : 2024 (4) TMI 989 - CALCUTTA HIGH COURT