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October 12, 2022

Tribunal sets aside an amount of Rs. 115 Cr. related to share premiums received from foreign investors

by CA Shivam Jaiswal in Income Tax, Legal Court Judgement

Tribunal sets aside an amount of Rs. 115 Cr. related to share premiums received from foreign investors

Facts and Issues of the Case

The main grievance of the assessee is against the action of the Ld. CIT(A) confirming of addition of Rs.115,56,95,385/- under Section 68 of the Income Tax Act, 1961.

The facts of the case are that, the assessee company had filed its return of income on 30.10.2018 declaring total loss of Rs.41,85,61,758/-. Later, the case of the assessee was selected for scrutiny under the CASS in which one of the parameters was fresh issue of share capital during the year under consideration. Before the AO[NFAC], the assessee vide submission dated 08-12-2020 had furnished the details of the shareholders to whom shares were issued along with the relevant valuation report. Vide notice dated 06-04-2021, the AO, NFAC proposed a draft assessment order, wherein it observed that merely because the assessee had filed all primary evidences regarding the investors, it could not be said that the onus stood discharged u/s 68 of the Act. The AO noted that, the losses incurred by the company had increased over the years in contradiction to the valuation reports furnished by the Chartered Accountants, and therefore according to them, the share premium charged upon issuance of shares was unreasonable. Relying on the decision of the Hon’ble Supreme Court in the case of Pr. CIT Vs NRA Iron & Steel Pvt Ltd, the NFAC proposed to add back Rs.115,56,95,385/- under Section 68 of the Act. In response the assessee furnished its rebuttal/submission vide letter dated 12-04-2021. It explained that, the assessee company was a start-up promoted by Mr Anuj Raykan, with the intent to Make-in-India fresh health beverages/juices using cold-pressed technology. It was brought to the notice of the AO that this idea was supported by marquee PE investors such as Sequoia Capital, Saama Capital, DCGP Consumer Partners, who had invested with the assessee. It was also explained that the entire closing amount of Rs.115,56,95,385/- was not received in the relevant year, but it comprised of opening balance of Rs.63,32,28,987/- and fresh share premium of Rs.52,24,66,399/- received during the year. Accordingly, the opening figure of Rs.63,32,28,987/- was claimed to be not amenable to Section 68 of the Act.

Before the AO, the assessee had furnished the brief background of the PE investors, M/s Sequoia Capital India Investments IV and Saama Capital III Ltd along with their financial statements. Copies of the relevant Foreign Inward Remittance Certificates (‘FIRCs’) were furnished before the NFAC. The PAN Card, GBL License, Certificate of Conversion and financial statements of M/s Sequoia Capital India Investments IV was also placed on record. In relation to Saama Capital III Ltd, the assessee had furnished copy of its PAN card, financial statements, Tax Residency Certificate, GBL License and Certificate of Incorporation. It was pointed out that the share premium to the tune of Rs.48,21,36,180/- were received from reputed foreign investors, after complying with the foreign investment procedure laid down by Reserve Bank of India and therefore, according to the assessee, the initial onus laid down u/s 68 of the Act stood discharged. The assessee further stated that, these investors are reputed foreign entities over whom it does not exercise influence so as to compel them to furnish their confidential documents such as IT returns, bank statements, etc. The assessee therefore requested the AO to exercise the statutory powers vested in him and call for the necessary documents from these investors for verification. Qua the investment of Rs.85,588/- made by the founder- promoter, Mr. Anuj Rakyan, the assessee had furnished his ITR, financial statements and bank statement, as sought for by the NFAC.

In respect of Ms. J. Fernandez, it was explained that there was no actual cash inflow from her. The assessee had engaged the services of Ms. J. Fernandez as a celebrity endorser for their products for which it had entered into a Service Agreement dated 10-03-2018. In terms of thereof, Ms. J. Fernandez was allotted 13,992 shares in lieu of the services offered by her, for which a Supplementary Agreement was executed on the same date. It was thus contended that these shares were issued for consideration other than cash, for which relevant ROC filings were also furnished before the AO/NFAC. The assessee thus submitted that Section 68 could not be applied, since there was no cash credit in the books of accounts.

In view of the above, the assessee thus claimed that it had proved the identity of all five investors, their creditworthiness and also the genuineness of the transactions. The assessee also requested for an opportunity of video conference hearing from the AO/NFAC, which was granted on 21-04-2021 at 4 PM. The assessee filed another rejoinder on 22-04-2021 wherein it reiterated the above set out facts and prayed that no addition ought to be made u/s 68 of the Act. The AO/NFAC however did not agree with the submissions of the assessee. According to AO/NFAC, the valuation reports furnished by the assessee were not reliable as the financials of the company did not justify the high valuations arrived at by the Chartered Accountant. The AO/NFAC observed that the huge share premium received from foreign investors was ‘hawala’ and that provisions of Black Money Act were applicable. Referring to the decision of Hon’ble Supreme Court in the case of Pr.CIT Vs NRA Iron & Steel Pvt Ltd (supra), the AO added the closing balance of share premium of Rs.115,56,95,385/- as unexplained cash credit u/s 68 of the Act.

He submitted that, the assessee was a new-age start-up company which had the expertise/know-how to produce healthy fruit juices without adding any preservatives, which was being marketed under the brand “Raw-Press”. According to the Shri Mistry, like any other start-up, the assessee required financial support to gain foothold in the market for which it sought funding from private equity investors. Having regard to the future projections, brand valuation etc., it was pointed out that three Foreign investors agreed to fund and invest in assessee company. According to the Ld. Counsel, these Foreign Direct Investment (FDI) were raised from globally reputed investors like M/s. Sequoia Capital India Investments-IV , M/s. Saama Capital III Ltd. M/s. DSG Comsumerts Partner II . It was pointed out by the Ld. Senior Counsel that the assessee had received the fund from these three foreign investors in the earlier AYs 2016-17 & 2017-18 as well. In those years also, these investors were allotted shares on substantial premium. Taking us through the relevant notices/enquiries made by the Revenue u/s 142(1) of the Act, the ld. Senior counsel showed us that the identity and creditworthiness of these foreign investors and genuineness of the transactions with them, had already been accepted by the Department in earlier AYs 2016-17 & 2017-18.. He submitted that all these three foreign investors had infused additional equity funding into the assessee during the relevant year. The Ld. Senior Counsel submitted that the prices at which the shares were issued were in conformity with the valuation report obtained from Chartered Accountant under the Discounted Cash Flow Method (‘DCF Method’) as set out in Rule 11UA, as it stood then, in AY 2018-19. Even otherwise, inviting our attention to the provisions of Section 56(2)(viib) of the Act, he contended that the valuation guidelines did not apply to shares issued by private companies to non-residents. The Ld. counsel also pointed out that, the AO/NFAC was unable to pin point any defect or infirmity in the valuation exercise, calculation, methodology followed by the Chartered Accountant to determine the value of the shares. He submitted that the AO/NFAC had simply rejected the valuation on whimsical reasoning. The Ld. counsel pointed out that the assessee had furnished the following documents in support of the share premium received from the existing foreign shareholders:

Name and address of shareholders;

Copies of their PAN Cards;

Copies of the Financial Statements;

Brief profile of the foreign investors and the assets being managed by them;

Copy of Global Business License of both foreign investors;

Copy of Tax Residency Certificate of Saama Capital;

Copy of FIRC issued by RBI; and

Copy of FC-GPR submitted in relation to receipt of foreign investments

Taking us through the above documents, he brought to our notice that from perusal of the balance-sheets of the  M/s Sequoia Capital India Investments-IV, it was evident that it had assets worth US $ 952 Million which is US $211 crores which comes to approximate Rs.1700 crores and that only Rs.24 crores has been invested in the assessee company. Likewise, he drew our attention to the balance-sheet of the M/s. Saama Capital III Ltd. which had assets to the tune of US $ 62 million and they invested in assessee’s company only to the tune of Rs.11 crores, which also fully tallied with their accounts. He further submitted that both these foreign PE investors held Category-I Global Business License issued by the Financial Services Commission under the laws of Mauritius under the Financial Services Act. He thus contended that the Ld. CIT(A)’s observation rejecting these documents as fake papers was patently perverse and misleading. He contended that, if the lower authorities were not satisfied with the above documents or wanted to make further enquiries, then nothing prevented them to make direct enquiries from the investors or through the appropriate channel. Rather than using the statutory powers vested in them, the lower authorities shifted the entire burden onto the assessee, particularly when the assessee had categorically submitted that it did not have the IT returns or bank statements of the foreign investors. He submitted that such arbitrariness of the lower authorities was totally unjustified.

To further buttress his contentions and show the ignorant attitude of the lower authorities, the Ld. Sr. counsel submitted that, the not only the AO/NFAC but even the Ld. CIT(A) had simply ignored the material fact that the sum of Rs.115,56,95,385/- comprised of opening balance of share premium of Rs.63,32,28,987/- which clearly could not be assessed to tax u/s 68 of the Act in the relevant year. He also pointed out that, nothing amiss was brought on record, in relation to the share premium received from founder-promoter Mr. Anuj Rakyan whose complete details, including bank statements, IT return etc. were furnished both before the NFAC and Ld. CIT(A). Taking us through the orders of lower authorities, the Ld. Sr. counsel showed that no allegation was made against the shareholder Mr. Anuj Rakyan, but still the premium received from him was added u/s 68 of the Act. In respect of the share premium of Rs.4,02,44,630/- relatable to the shares allotted to Ms. Fernandez, he pointed out that the Ld. CIT(A) was in agreement that, no sum whatsoever was received from her in as much as the shares had been allotted in lieu of the services rendered by her to the company as a celebrity endorser, but the Ld. CIT(A) had still confirmed the premium of Rs.4,02,44,630/- relatable to her as unexplained cash credit u/s 68 of the Act, which according to the Ld. Sr. counsel was impermissible in law and against Rule of Law.

It was brought to our notice that, the assessee company had taken the services of Ms. Fernandez who was an actress to be the brand ambassador and promote/advertise the company’s product “Raw Press”. The Ld. Sr. counsel submitted that, she is still the brand ambassador of the company and she regularly features in the print as well as electronics advertisements and also take part in the promotion/marketing campaign of its product. For rendering the aforesaid that services, an agreement was signed between her and the assessee company wherein the consideration was fixed at Rs.4.02 crores and in lieu thereof shares of that value (on premium) was allotted to her. It was also brought to our notice that the Ld. CIT(A)’s aspersion regarding the reasonability of such an arrangement was unfounded as the agreement explicitly contained an exit clause in terms of which if she intended to off-load the shares at any later date, then the assessee would buy back the shares from her, thus protecting her interest.

Per contra, the Ld. CIT-DR appearing on behalf of the Revenue supported the order of the lower authorities. Referring to a newspaper article, he submitted that M/s. Sequoia Capital was being investigated for funding a start-up company which had suffered heavy losses and therefore according to him, the observations of the AO/NFAC that these funds may be ‘hawala’ could not be brushed aside. He also wondered as to why these investors would infuse such huge monies into loss making start-ups. So according to Ld. CIT-DR, the investments made by the foreign entities in assessee company was indeed doubtful. He thus contended that he Ld. CIT(A) has rightly confirmed the action of AO, which does not require any interference from our side.

In the rejoinder the Ld. Sr. Counsel submitted that the allegations made by the Ld. CIT-DR were based on surmises and conjectures. He submitted that the AO/NFAC had loosely used the expression ‘hawala’ in the assessment order which was also wrongly reiterated by Ld. CIT(A) as well as the Ld. CIT-DR, without bringing on record even a single iota of evidence to back such serious allegation. He pointed out that usage of such term was uncalled for as such allegations are serious and that the lower authorities ought to have desisted from using this expression, particularly when nothing was brought on record to suggest the same. He strongly argued that these casual remarks of the Revenue would shake the confidence of the foreign investors in the Indian start-up ecosystem and the ‘Make-in- India’ initiative. Such high-handed and excessive attitude of the lower authorities, according to Ld. Sr. counsel, ought to be deprecated and he thus urged that the additions made u/s 68 of the Act be deleted.

Observation by the Court

The court had heard both the parties and perused the material on record and it is noted that the issue for our consideration is whether the addition made u/s 68 of the Act was right or erroneous. Before adverting to the facts of the case, it would be relevant to reproduce the provisions of Section 68 of the Act.

The phraseology of Section 68 of the Act is clear. The Legislature has laid down that in the absence of a satisfactory explanation regarding any sum which is found credited in the books of an assessee during the previous year, such unexplained cash credit may be charged to income- tax as the income of the assessee of that previous year. In this case, the Legislative mandate is not in terms of the word ‘shall’ be charged to income-tax as the income of the assessee of that previous year. The Hon’ble Supreme Court while interpreting similar phraseology used in Section 69 of the Act has held that in creating the legal fiction, the phraseology used therein employs the word “may” and not “shall”. Thus, the un-satisfactoriness of the explanation does not and need not automatically result in deeming the amount credited in the books as the income of the assessee as also held by the Supreme Court .

The said provision casts the initial burden to prove the nature of credit on the recipient i.e. the assessee. There is a marked distinction between ‘onus of proof’ and ‘burden of proof’. The ‘burden of proof’ lies on a person who has to prove a fact initially and if he fails to prove it, when asked to do so by the AO, then AO can draw adverse inference against the assessee u/s 68 of the Act. But if the assessee discharges its burden/obligation and prove the nature & source of the credit entries to AO’s satisfaction, then the ‘onus of proof’ shifts on the AO. However, for the purposes of Section 68 of the Act, the ‘burden to proof’ begins with the assessee and once the assessee submits evidence in support of the credit and makes out a prima facie case, then the ‘onus of proof’ shifts to the Revenue. Such shifting of ‘onus’ is a continuous process in the evaluation of evidence. If the evidence on record weighs in favour of the assessee or that the explanation put forth cannot be said to be completely unsatisfactory, then the onus cast upon the assessee u/s 68 of the Act can be said to have been discharged. In view of the foregoing, the court  are of the considered view that the initial burden on the assessee was only to substantiate the source of its share premium in as much as the identity and creditworthiness of the investors along with the genuineness of the transaction.

The proviso to Section 68 of the Act, which was inserted by the Finance Act, 2012 is noted to be applicable to persons who are residents, who are further required to substantiate the ‘source of source’ of funds. This additional burden cast upon by the proviso is noted to be not applicable to non-resident investors.

Having regard to the above legal position, the court  now advert to facts of the case. It is noted that during the year, the company had received share premium of Rs.52,24,66,398/- from five (5) shareholders, out of which four (4) were existing shareholders who had infused capital in earlier years as well and the remaining one (1) was a new shareholder but to her the shares were issued in discharge of her consideration for rendering of services. From the material on record, it is clearly discernible that the impugned addition of Rs.115,56,95,385/- comprises of opening balance of share premium of Rs.63,32,28,987/- brought forward from earlier years. Reading of Section 68 of the Act, as reproduced above, makes its clear that the provision applies to any sum which is found credited in the books of an assessee during the previous year for which no explanation has been furnished or explanation furnished is found to be false. The court  find merit in the submissions of the Ld. Sr. counsel that the opening balance of share premium of Rs.63,32,28,987/- represented monies received in earlier years and not in the relevant FY 2017-18 and therefore Section 68 had no application in relation thereto. Further, as pointed out to us, the share premium received in earlier AYs 2016-17 & 2017-18 has already been examined and verified in the income-tax assessments framed u/s 143(3) of the Act and the explanation furnished by the assessee has been accepted. The court  thus agree that the addition made by the lower authorities to the extent of Rs.63,32,28,987/- u/s 68 of the Act in AY 2018-19 was unjustified. Although this particular aspect had been pointed out by the assessee both before the AO/NFAC as well as the Ld. CIT(A), it is noted that both the authorities failed to examine the same and brushed it aside without assigning any reason whatsoever. Such action of the lower authorities cannot be countenanced.

Coming to the share premium of Rs.52,24,66,398/- received during the year, it is noted that sum to the extent of Rs.48,21,36,180/- was received from existing foreign shareholders, M/s Sequoia, M/s Saama & M/s. DGSP whose identity and creditworthiness and genuineness of the transactions, is noted to have been accepted by the Revenue in earlier AYs 2016-17 & 2017-18. The assessee is a start-up company promoted by Mr Anuj Raykan, with the intent to Make-in- India fresh health beverages/juices using cold-pressed technology under the brand name ‘Raw Pressery’. The idea found support from foreign PE investors who infused capital into the entity through successive rounds of funding. In relation to the share premium received during the relevant year, it is noted that the assessee had furnished the relevant foreign inward remittance certificates, FC-GPRs etc. in support of the foreign investment received in accordance with the regulations of Reserve Bank of India. These investors are noted to be of repute holding Category-I Global License issued under the laws of Mauritius. Their financial statements also show that they had sufficient funds to make investment in the capital of the assessee. The assessee had also provided the PAN details of these foreign investors. It is noted that although the AO had also called for the income-tax returns and bank statements of these investors but the assessee expressed its inability to furnish the same. It was pointed out to AO/NFAC that the assessee was a start-up company which had raised funds from these global PE investors and therefore it did not exercise such influence over them to insist them to furnish their internal confidential documents such as income-tax returns, bank statements etc. Having provided their PAN details, addresses, tax residence status, the assessee had requested both before the AO/NFAC and the Ld. CIT(A) to make direct enquiries from these investors. We thus note that, although the assessee had furnished the primary evidences in support of the share premium received from these foreign investors, the lower authorities chose to sit back with folded hands till the assessee exhausted all the evidence in his possession and then merely reject the same without conducting any inquiry or verification whatsoever. Such in-action/omission on the part of lower authorities cannot be accepted.

The court  find merit in the contention of the Ld. Sr. counsel that, the lower authorities should have desisted from using the expression ‘hawala’ when no such case was made out by them. It is noted that such an expression has been used whimsically by the AO/NFAC, which has been surprisingly endorsed by the Ld. CIT(A) without any corroborative evidence. The Ld. CIT(A) is noted to have gone a step ahead and simply branded the documents of the foreign investors as ‘fake’, which according to us, was also unwarranted. The lower authorities ought to have borne in mind that, the public at large and also the foreign investors who are looking at India as an attractive investment destination, have great faith and confidence in the justness of the decision making process which has serious civil consequences. The Faceless Assessment Scheme and the Taxpayer’ Charter which was introduced on 13-8-2020 was to ease the compliance burden, to increase fairness and objectivity in the assessment process and to ensure fair, courteous and reasonable treatment to the taxpayer. The motive was to provide non-intrusive and non-adversarial tax ecosystem, having minimum government and maximum governance through a simplified tax system. In the case at hand, we however note that, both the lower authorities have clearly failed in their duties set out in their respective Schemes/Charters.

On perusal of the Faceless Assessment Scheme, 2019, it is noted that the Assessment Unit of the NFAC could very well have referred the enquiry/verification into the foreign investors to their Technical Unit, which as per Rule 4(v) of the Faceless Assessment Scheme had been set-up to facilitate the conduct of e-assessment, for performing the function of providing technical assistance which includes any assistance or advice on legal, accounting, forensic, information technology, valuation, transfer pricing, data analytics, management or any other technical matter, which may be required in a particular case.

In view of the above, if the NFAC harbored even a remote suspicion regarding the foreign investors, it ought to have made appropriate independent enquiry through proper channel, rather than simply rejecting the documents furnished by the assessee, more so when, even the assessee had required the AO/NFAC to make such enquiries in order to allay their suspicion. This in-action on the part of the NFAC and thereafter making the impugned addition u/s 68 of the Act, cannot be countenanced. Even the Ld. CIT(A) is noted to be empowered under the Faceless Appeal Scheme, to obtain a report of the Assessing Officer either directly or through the NFAC, on grounds of appeal or information, document or evidence furnished by the assessee or he could have also requested the NFAC, for making further inquiries under sub-section (4) of section 250 of the Act and submit a report thereof. The Ld. CIT(A) is also noted to have failed in his duties as a quasi-judicial authority. His action of terming the investment as ‘hawala’ and documents as ‘fake’, without making any enquiries whatsoever, is deprecated.

In view of the above, the reliance placed by the lower authorities on the judgment of the Hon’ble Apex Court in the case of Pr.CIT vs. NRA Iron & Steel (P) Ltd (supra) is found to be misplaced in as much as in that case [NRA] the shareholders were found to be untraceable even after making field enquiries. In the case at hand, it is evident from the material on record, that neither the AO/NFAC nor the CIT(A) took any effort whatsoever to enquire into the creditworthiness of these foreign shareholders and the genuineness of the transactions. Rather, we find that the assessment was framed in the most arbitrary manner by blatantly ignoring glaring material facts and evidences placed by the assessee. As far as the news article regarding M/s Sequoia Capital referred to by the Ld. CIT-DR is concerned, we find it to be based on irrelevant considerations/hear-say, in as much as it has no bearing on the facts of the present case.

Now, coming to the allegation of the AO that share premium being significantly higher than the intrinsic worth/fair value of the equity shares, it is noted that the assessee has supported the valuation with a certificate issued by a chartered accountant using DCF method which is one of approved method as prescribed by RBI. The tax-payer while issuing shares to non-resident investors create an foreign obligation for India in favour of third country. Accordingly, in terms of the RBI/FEMA requirements, the tax-payers are required to issue shares for a consideration which has to be necessarily be equal to or higher than the fair value, arrived at by such approved method. Reason being, the tax-payer should not create an foreign obligation for India in favour of third country at a consideration which is below fair value of shares. Thus, to plug this loss to India, FEMA/RBI stipulate that issue price of shares should be equal to or more than fair value arrived at by approved method viz. DCF. Hence, even going by AO/NFAC’s analogy that the price at which shares were issued to foreign investors was higher than fair value of shares, according to us, such issuance of shares at a value higher was in compliance with the FEMA/RBI regulations. It is noted that, the RBI has not disputed the fair value of shares, which was supported by CA Certificate using DCF method, and filed along with the Form FC-GPR through the authorized banker. As far as the provisions of Section 56(2)(viib) r.w.s 2(24)(xvi) of the 1961 Act is concerned, it is noted that the said provision is relevant for issuance of shares to residents while in the instant case, undisputedly these shares were issued by the assessee to non-residents. The said section 56(2)(viib) r.w.s. 2(24)(xvi) of the 1961 Act have not been made applicable to the shares issued to non-residents mainly to encourage foreign investments.

As regards the share premium received from Mr. Anuj Rakyan, we note that none of the lower authorities have given any reason or basis for adding the same u/s 68 of the Act. The material placed before us shows that, Mr. Anuj Rakyan is the founder-promoter of the assessee. Copies of his financial statements, income-tax return, bank statements etc. in support of the shares subscribed by him during the relevant year were placed both before the NFAC and Ld. CIT(A). None of them have pointed out any defect or infirmity therein. The shares were issued to him at the same price at which they were issued to the foreign investors. These contemporaneous facts supports the arguments of the Ld. Sr. counsel that the assessment was framed by AO/NFAC by placing blinkers on their eyes and ignoring the material placed before them.

In respect of the share premium of Rs.4,02,44,630/- pertaining to Ms. Fernandez, it is an admitted factual position that she did not actually pay any amount to the company. Rather, it was the assessee which had engaged her as a celebrity endorser, for which her consideration was fixed at Rs.4.02 crores. Instead of paying the same, the assessee had allotted equity shares to her at a premium, which is evidenced by the agreement dated 10-03-2018. Prima facie therefore, the court find substance in the assessee’s contention that Section 68 of the Act did not have any application on these given facts. Instead of doing so, the AO/NFAC mechanically added this share premium as well u/s 68 of the Act, which according to us, was unjustified.

In view of our above discussions and findings, and having regard to the entire conspectus of the facts of the case, the court  set aside the impugned order of the Ld. CIT(A) confirming the addition of Rs.115,56,95,386/- made u/s 68 of the Act .

Conclusion

The appeal of the assessee is partly allowed by the court for statistical purpose.

Raw-Pressery-Private-Limited-Vs-ACIT-ITAT-Mumbai

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