Bogus Share Capital under Indian Income-Tax Law: Judicial Trajectories, Statutory Nuances, and Policy Implications

Bogus Share Capital under Indian Income-Tax Law: Judicial Trajectories, Statutory Nuances, and Policy Implications

1. Introduction

The phenomenon of “bogus share capital” describes the practice whereby assessees, typically closely-held companies, introduce unaccounted money into their books under the guise of share capital or share premium. The issue, recurrent since the early 1990s, falls predominantly within the domain of the Income-tax Act, 1961 (“the Act”), and is principally examined through Section 68, which empowers the Assessing Officer (“AO”) to treat unexplained credits as income. Over three decades, Indian courts have oscillated between a deferential approach that protects corporate autonomy and a stringent stance prioritising revenue interests. This article critically maps that trajectory, analyses the current doctrinal position, and assesses wider policy ramifications.

2. Statutory Framework

2.1 Section 68: Text and Elements

Section 68 deems any unexplained sum credited in the books of an assessee as income for the relevant year unless the assessee offers a “satisfactory” explanation regarding its nature and source. Jurisprudence crystallises three cumulative tests: (i) identity of the investor, (ii) credit-worthiness, and (iii) genuineness of the transaction.[1]

2.2 Supplementary Provisions

  • Section 56(2)(viib) (post 2012) taxes excessive share premiums in certain cases, though prospectively.[2]
  • Section 131 and Section 133(6) empower the AO to summon and seek information from shareholders.
  • Section 147/148 facilitate reassessment when new information surfaces (e.g., Investigation Wing reports).
  • Section 263 enables the Principal Commissioner to revise erroneous and prejudicial assessment orders, frequently invoked where the AO’s inquiry into share capital is superficial.[3]

3. Evolution of Judicial Approach

3.1 The Early Lenient Phase

In Commissioner of Income-Tax v. Stellar Investment Ltd. (1991, Del HC) the Court held that even if subscribers were bogus, the capital could not be taxed in the hands of the company.[4] The Supreme Court’s brief dismissal of the Department’s SLP in 2001 seemingly endorsed this view, spawning a line of decisions—Divine Leasing (2006), Lovely Exports (2008)—that emphasised assessees’ limited burden once shareholder identity was furnished.[5]

3.2 The Shift towards Heightened Scrutiny

Concerns over large-scale abuse prompted a doctrinal recalibration. In Sophia Finance (1993, Del HC Full Bench) the Court clarified that Section 68 can apply to share capital if shareholders are fictitious.[6] Subsequent cases—Nova Promoters (2012), NDR Promoters (2019), and the Supreme Court decision in NRA Iron & Steel (2019)—cemented a more rigorous approach, holding that failure to prove credit-worthiness and genuineness legitimises additions.[7]

3.3 Contemporary Duality

Current jurisprudence exhibits a dual standard:

  • Liberal line: Where documentation is robust and investor entities exist, additions are unwarranted (Nipun Builders, 2011; Chain House International, 2018).[8]
  • Rigorous line: Where patterns reveal accommodation entries, high premiums sans business rationale, or circular money flows, additions stand (Best Infrastructure, 2017; Onassis Axles, 2014).[9]

4. Burden of Proof Matrix

4.1 Assessee’s Initial Onus

The assessee must prima facie establish all three pillars—identity, credit-worthiness, genuineness. Documentary evidence ordinarily includes: share application forms, PAN/Aadhaar, bank statements, board resolutions, and confirmation affidavits.[10]

4.2 Shifting Onus on the Revenue

Once prima facie discharge occurs, the burden shifts. However, courts have clarified that mere non-response to summons by investors does not ipso facto vitiate the assessee’s case (Divine Leasing). The AO must marshal positive material—field enquiries, bank trail analysis, statements of entry operators—to rebut explanations (NRA Iron).[11]

4.3 “Source of Source” Debate

Prior to Finance Act 2012, assessees were not required to explain the investor’s source (Veedhata Towers, Bom HC 2018). Post 2012, the first proviso to Section 68 mandates such explanation where the creditor is a company. Yet, judicial application remains cautious, recognising prospective effect (Mamta Gold, ITAT Mum 2019).[12]

5. Analytical Synthesis of Key Precedents

5.1 NRA Iron & Steel (2019, SC)

The Supreme Court upheld addition of ₹17.6 crore where investor entities lacked capacity and were non-existent at given addresses. The Court underscored that routing funds through banking channels does not ipso facto establish genuineness.[13]

5.2 Nova Promoters (2012, Del HC)

Relying on Investigation Wing findings of accommodation entry operators, the Court reinstated additions despite affidavits and PAN details, emphasising the qualitative assessment of evidence.[14]

5.3 Divine Leasing (2006, Del HC)

While deleting additions, the Court articulated the modern burden-shifting framework, but left scope for additions where AO gathers contrary evidence.[15]

5.4 Nipun Builders (2011, ITAT)

The Tribunal, after extensive evaluation of documents and absent contrary evidence, deleted additions, reiterating that suspicion cannot replace proof.[16]

6. Interplay with Company Law and Securities Regulation

Although income-tax proceedings focus on taxability, the Companies Act 2013 (e.g., Sections 42 & 62 on private placement and preferential allotment) and SEBI regulations (e.g., PFUTP Regulations, 2003) address corporate governance and investor protection. The Pyramid Saimira matter (2013, SC) illustrates SEBI’s competence to penalise fraudulent financial statements, complementing tax scrutiny.[17]

7. Policy Considerations

7.1 Balancing Capital Mobilisation and Tax Integrity

Excessively stringent standards may stifle genuine capital formation, particularly for start-ups reliant on angel investments at high premiums. Conversely, laxity facilitates money-laundering. A calibrated approach—robust AO training in forensic accounting and technology-aided verification (e-PAN, MCA-21 cross-linking)—is imperative.

7.2 Need for Consistency

Divergent outcomes for similarly situated assessees undermine certainty. Issuance of CBDT circulars consolidating jurisprudential principles, coupled with uniform standard operating procedures for enquiries into share capital, could mitigate arbitrariness.

8. Conclusion

The jurisprudence on bogus share capital has matured from a shareholder-centric to a substance-over-form doctrine. While Stellar Investment once offered a shield, subsequent rulings—culminating in NRA Iron & Steel—affirm that the corporate veil will not shelter colourable devices. Yet, courts remain vigilant against revenue overreach grounded in mere suspicion. The operative equilibrium demands diligent documentation by assessees and evidence-based investigation by the Revenue. Legislative refinements (e.g., the 2012 proviso to Section 68) and technological synergy between tax and corporate regulators promise further alignment of tax enforcement with the legitimate needs of capital markets.

Footnotes

  1. See Commissioner of Income-Tax v. Divine Leasing & Finance Ltd., (2006) 299 ITR 268 (Del).
  2. Inserted by Finance Act 2012, w.e.f. 1 April 2013; cf. Mamta Gold (P) Ltd., ITAT Mumbai, 2019.
  3. Commissioner of Income-Tax v. Sophia Finance Ltd., 1993 SCC OnLine Del 445 (FB).
  4. Commissioner of Income-Tax v. Stellar Investment Ltd., 1991 SCC OnLine Del 243.
  5. Commissioner of Income-Tax v. Lovely Exports (P) Ltd., (2008) 299 ITR 268 (SC).
  6. Sophia Finance, supra.
  7. Principal CIT v. NDR Promoters (P) Ltd., 2019 SCC OnLine Del 6599; PCIT (Central)-1 v. NRA Iron & Steel (P) Ltd., (2019) 103 taxmann.com 48 (SC).
  8. CIT v. Nipun Builders & Developers (P) Ltd., 2011 SCC OnLine ITAT 5488; PCIT (1) Indore v. Chain House International (P) Ltd., 2018 (ITAT Indore).
  9. Principal CIT v. Best Infrastructure (India) (P) Ltd., 2017 SCC OnLine Del 9591; Onassis Axles (P) Ltd. v. CIT, (2014) SCC OnLine Del.
  10. See documentary list cited in Divine Leasing, supra, and Nipun Builders, supra.
  11. NRA Iron & Steel, supra.
  12. PCIT v. Veedhata Tower (P) Ltd., (2018) Bom HC; Mamta Gold, supra.
  13. NRA Iron & Steel, supra.
  14. CIT v. Nova Promoters & Finlease (P) Ltd., 2012 SCC OnLine Del 969.
  15. Divine Leasing, supra.
  16. Nipun Builders, supra.
  17. N. Narayanan v. Adjudicating Officer, SEBI, (2013) SCC OnLine SC 770.