By TIOL News Service

HYDERABAD, JAN 18, 2019: THE issue at hand before the bench is whether based on circumstantial evidence, the test of human probabilities can ordinarily be applied upon some business transactions. NO is the answer. The Tribunal also held that a company is a separate legal entity & whose legal rights cannot be infringed without any cogent evidence showing that such entity serves as a conduit for passing on benefits to interested shareholders.

Facts of the case

THE assessee-company, engaged in the manufacture & sale of Cement, filed returns for the relevant AY, declaring income of about Rs 2.91 crores, as income from other sources. On assessment, the AO noted that in the relevant AY, the assessee issued 0% convertible preferential shares with a face value of Rs 10/- per share and a premium of Rs 1,440/- per share in a private placement to three investor firms. The AO noted that these investments were not technical investments, but were arrangements between investors & directors to route funds through the assessee, since the directors were influential officials in the State Govt. The AO thus issued summons u/s 133(1) & statements of senior officials in the company were recorded. The AO then recorded incidences in which the investors benefited from the State Govt's policies & so treated them as income u/s 28(iv).

On appeal, the CIT(A) remanded the matter. Thereafter, the AO submitted remand report as well as some additional evidence. Then the CIT(A) proposed to assess the entire receipt of Rs 70.32 cr as income from other sources. It was also observed that the CIT(A) was vested with powers co-terminus with those of the AO, by virtue of which the CIT(A) could call for information or take cognizance of any information presented before him even if from the AO. On considering the information available, the CIT(A) confirmed the AO's findings. Considering the benefits passed on to the investors in the assessee-company, the CIT(A) noted there to be some connection between concessions received by the three investors from the State Govt and the investments in preferential share capital in the assessee-company. The CIT(A) found these to be part & parcel of one integrated plant for quid pro quo .

On appeal, the Tribunal held that,

++ ++ the AO & CIT(A) noted the timing of issue and allotment of shares with such huge share premium which aroused suspicion. Accordingly, AO issued summons to the investors and none of the investors had agreed that these were invested under any influence by the shareholder/directors. AO and CIT(A) has brought on record the incidences and circumstantial events to infer that these are quid-pro-quo arrangements between the investors and director of the company. The arrangement and circumstances leading to issue and allotment of shares may draw some doubts that certain benefits may have passed on to the directors. But the question is whether the directors/shareholders have really benefited with this arrangement and the assessee company was used as arrangement to pass on the benefit. The Revenue has to prove that the investors have passed on the benefit to the shareholders/directors through this arrangement by bringing cogent material. But the AO/CIT(A) has brought on record so many incidences and alleged benefits which were enjoyed by the investors from the Govt. of AP. But, what is important is that the funds were invested in the company and the company has demonstrated that it has treated the investment as part of share capital fund and also the share premium as part of capital reserve within the company as per the provisions of Companies Act. Since the assessee is artificial person created by the Statute, the legal entity cannot be trespassed, provided the authority has evidence to prove that this legal person was used to pass on the benefit to interested shareholders by lifting the corporate veil. In this case, no such evidence was brought on record rather circumstantial evidence and test of human probabilities were applied to convert the capital transaction as per Companies Act into revenue transaction under Income-tax Act;

++ the test of human probabilities cannot be applied when dealing with the business transaction, it has to be based on cogent material. Considering the whole situation, the AO/CIT(A) have restricted themselves by stopping the investigation based on circumstantial evidence and applying test of human probabilities. In order to lift the corporate veil for the purpose of determining whether any benefit is passed on to the shareholders/directors, they have to bring on record proper evidence/cogent material. Hence the AO must redo the assessment keeping in mind that no doubt the assessee has received this capital receipt and what circumstances which lead to investment is not important but whether the assessee company was used as a vehicle to pass on the benefit to shareholders/directors.

(See 2019-TIOL-184-ITAT-HYD)