For generations, corrupt politicians and bureaucrats [both integral part of the ruling establishment] and dubious industrialists and businessmen have indulged in generation of ‘black money’ – euphemism for the money that goes ‘unaccounted’.
In a quid pro quo, corrupt politicians and bureaucrats take bribe in lieu of granting favor to industrialists and businessmen in project approvals and enabling them escape payment of tax on their income and wealth. The former also siphon-off funds meant for disbursement to the poor under welfare schemes.
The bribe money, embezzled/misappropriated funds and cash going off the taxman’s radar constitute ‘unaccounted’ or black money. Apart from investing in conventional modes such as gold, jewellary, real estate etc or stashing abroad, money launderers have also sought to camouflage such cash in forms whereby it seemingly acquires a greater degree of legitimacy and respectability.
A modus operandi commonly employed for this purpose is to transfer the unaccounted cash to paper firms [entities which are not into any business and are contemplated with the sole intent of creating accommodation entries] who invest or lend the funds back to the company owned by the launderer.
Invariably, the money comes back as share capital/premium [for instance, a share with face value of Rs 10/- is bought for Rs 1000/-]. The investment is made mostly through private placement of shares to avoid coming under the glare of the market regulator viz. Securities Exchange Board of India [SEBI]. The investment in shares being risk capital, the money launderer need not pay back.
These dubious practices had been going on for decades with full support and abetment by successive governments. This was not unexpected especially when we consider the fact that none other than the rulers themselves [read: corrupt politicians and bureaucrats] were the beneficiaries of such game plan.
In those times, investors buying shares of companies [with not so good track record or so called fly-by-night entities] at premium 100 times the face value of a share were common knowledge. This defies common sense. No one [in his senses] would ever invest his hard earned savings in an avenue where he can never hope to get back; forget earning a decent return which is a rational expectation.
But, those investments were not genuine; that money [albeit black] belonged to the launderer and came back to him from paper firms as part of former’s orchestrated game plan to hoodwink the law enforcers. What prevented the Income-Tax [IT] department and other state agencies from taking cognizance and act?
Such a scenario should have prompted the market regulator to proceed against the investee company [which received the mammoth share premium]. Furthermore, IT was fully justified in collecting tax on the premium amount as income in the hands of the company. But, the subsisting eco-system did not favor the taxman.
For instance, in the dispute between the IT department and NRA Iron & Steel Pvt Ltd, a Delhi-based company which had issued shares to 19 entities, appellate authorities right up to the high court had refused to buy the taxman argument. This was despite extensive probe carried out by the I-T leading to question marks on the genuineness of investor firms. The probe showed that the investors had either given incorrect address, or failed to justify their investments, or did not respond to queries.
The amendment to Section 68 of the IT Act [1961] dealing with share capital effective from assessment year 2013 -14 put the onus of proving the genuineness of the investment on investors. Indeed, as the investigation by the department showed, they could not come clean. Yet, the judicious authorities remained un-fazed.
Only now, in a ruling delivered on March 5, 2019, the Supreme Court [SC] has held “if the taxman can back up its claim with sufficient investigation and the company receiving funds as share capital fails to prove the genuineness of the deal and creditworthiness of the investor, the company will have to pay tax on the amount”. It further observed “The lower appellate authorities appear to have ignored the detailed findings of the tax assessing officer from the field inquiry and investigations carried out by his office.”
The apex court order is a shot in the arm for the IT department who should now go hammer and tongs after all such cases, subject both the investee company and the investors to rigorous examination and scrutiny to build up a strong case and get the sanction/approval of the judicial authorities. The present dispensation – led by Modi who has zero tolerance for corruption and black money – provides the ideal setting for the agencies to act forcefully and decisively.
For checking the genuineness of the transactions and creditworthiness of investors, the department can now go much beyond merely looking at PAN of investors, proof of address, tax returns, and routing investment through a bank. The focus should be on determining whether the investors really have the capacity to generate the kind of surplus to support the investment on the intended scale.
In cases where, the investee company has raised share capital via private placement, as rightly emphasized by the SC, the department should put greater focus on the investee as the information is within the personal knowledge of the latter.
The pronouncement of the apex court may also have a bearing on the ongoing disputes between startup companies and the tax department on the price actually paid by investors vis-à-vis their fair value. Seeing the excessive premium in several cases, the department suspected whether or not the unaccounted cash was being funneled into these entities. Accordingly, tax notices were sent.
Following resistance from several quarters, the government seems to have mellowed down and ruled out precipitate action even in cases where notices have already been served. However, there is urgent need for careful scrutiny to identify cases of money laundering followed by appropriate action.
To conclude, if agencies can block the share premium route for laundering black money, this will deal a body blow to the corrupt as without safe outlet, they won’t have incentive to generate it.