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Private Cos: Investors Must Reveal Source Of Funds


Also Read: Angel Investors Beware: Funding Startups Could be Classified as Income

Yet another amendment in the budget will open a can of worms, though this one might seem roughly acceptable, even if it is a big bother. In the Budget, another unnoticed clause requires an unlisted company to know the source of the funds of every single investment of each investor. The only exception is for money received through venture capital funds.

In the Finance Bill, you will see this clause (Search for “section 68” – it is item no. 22, on page 10)

In section 68 of the Income-tax Act, the following provisos shall be inserted with effect from the 1st day of April, 2013, namely:—
“Provided that where the assessee is a company, (not being a company in which the public are substantially interested) and the sum so credited consists of share application money, share capital, share premium or any such amount by whatever name called, any explanation offered by such assessee-company shall be deemed to be not satisfactory, unless—

(a) the person, being a resident in whose name such credit is recorded in the books of such
company also offers an explanation about the nature and source of such sum so credited; and

(b) such explanation in the opinion of the Assessing Officer aforesaid has been found to be

Provided further that nothing contained in the first proviso shall apply if the person, in whose
name the sum referred to therein is recorded, is a venture capital fund or a venture capital company as referred to in clause (23FB) of section 10.”.

Section 68 currently has only this inside: Where any sum is found credited in the books of an assessee maintained for any previous year, and the assessee offers no explanation about the nature and source thereof or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the sum so credited may be charged to income-tax as the income of the assessee of that previous year.

Let me put this in simple words:

If you have some money that you can’t explain how you got, we’ll assume it is income and tax you.

This is okay. If they find money in your house, or in your bank account, they can ask you where it came from, and you have to get your act together.

The new addition in this budget is:

Oh, if a company gets some money from any Indian resident investors as an equity investment of any sort, that investor needs to tell us how he got that money. If not, we’ll consider it income and tax that company.

This applies:

a) Only if you get investment from resident individuals or companies

b) If the money is in any kind of equity form (including convertible debt, preference shares or whatever). It might not apply to a loan (though I’m not sure about that).

c) Money received from VC funds (as registered with SEBI) will not have this restriction.

Why On Earth Does This Have To Be Done?

It seems too many scams are now happening through random privately owned entities, where the source of funds is unknown. From a DB Realty and the whole Raja scandal, to some smaller issues with Jagan Reddy’s companies, certain private companies have received some money from a resident investor for buying shares, but the source isn’t known.

This law means that the IT department will question the company on the source of such funds – that is, where did the investor get it from? If the investor isn’t able to provide an adequate explanation, the company will be taxed on the investment, assuming it is income.

What Does It Mean To Us?

If you are a startup founder, and you are looking for investment, please make sure you have a statement from each investor about the source of the funds he/she invests. I don’t know how this can be obtained, but the funds could be from accumulated reserves (typically this will need past tax return or a CA statement saying so), or from borrowings (for which there needs to be proof). Such statements should also be taken from the founders themselves.

If you are an angel investor or an LLP/company that buy stakes into other companies, then you need to be ready that if there is a request, you will need to produce proof of the “source” of your income. You may want to give a statement to the investor stating such sources, but more importantly, if there is a scrutiny, you will need to convince an assessing officer about the source of funds that you used to invest.

This can be painful, I agree. And a scrutiny is unlikely to be brought up just for the heck of it, because let’s face it, the IT department has bigger fish to fry. But startups, be ready; once in a while, the assessing officer might just want to abuse his power, and you have to be ready for such demands.

This is a cumbersome law, we have to be able to deal with such demands. Given the ability of our countrymen to create black money, the legitimate folks have to bear a little bit of the cost to control the menace. If we are willing to sign online petitions for Anna Hazare, this is the least we can do – agree to reveal the source of our funds.

The bad part: Obviously this clause can be abused. Say the assessing officer refuses to accept a valid source of funds and charges tax anyway: What then? Answer: You will have to go the legal route – there is a sequence of appeal in the legal system. Remember, the assessing officer loses something – from face to promotions – if a court finds that he was unnecessarily refusing a valid source. So they won’t summarily overrule sources. Too often, people get scared of courts and decide to agree to whatever the officers say, and tax officers use that fear to extract more. But if you are persistent, they’ll listen to you.

(While I know this has been addressed to startups, it applies to any private company that gets investment post March 31, 2012)


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