Union Budget 2022 , which had the theme of digital embossed all over it, has received mixed response from the start-up community. While the capping of long term capital gain at 15 per cent is perceived to be a good move which will benefit the start-up founders, investors and ESOP holders, there is one amendment to the Section 68 of the Income Tax Act in the Finance Bill, 2022 which lays down additional compliance burden on start-ups to declare the source of funds “whether in the form of a loan or borrowing.” The amendment to the rule doesn’t apply to the venture capital fund/ company registered with the Securities Exchange Board of India (SEBI).
The borrower/ unregulated firms' nature or source of sum in the form of credit / liability will be deemed as explained if only the source of funds is explained. This, according to the legal experts, translates to the non-listed firms having to prove genuineness/ creditworthiness of the creditor. This assumes significance since many start-ups raise money from high-net worth individuals, and family offices from India and abroad. Darshan Bora, Partner, Economic Laws Practice said that Under Section 68 of the Income tax Act, the IT Department is empowered to impose tax on any amount credited in the account books if the recipient of credit is unable to satisfactorily explain the nature and source of such amount.
“The proposed amendment makes this provision more onerous. Once the proposed amendment is effective, in addition to the recipient of a loan or borrowing, even the lender may be called upon to provide justification about the nature and source of funds loaned by him,” Bora said.
“If the lender is unable to provide a satisfactory explanation, the amounts can be taxed as income in the hands of recipient of the loan. It will increase compliance burden on start-ups who receive loans or borrowings. This provision does not apply to amounts received from a venture capital fund or venture capital company. A similar provision has been existence for issuance of share capital and tax authorities have been imposing tax on share capital receipts, which has resulted in litigation in the past, “ he added. According to Paras Nath, Partner, Tax and regulatory Services, TR Chadha and CO LLP, this will also effectively address the concern of source of funding remaining unexamined. “There are numerous instances where the assessee receives money as loan, advance, share application money, etc. With respect to credit entries related to share application money, Finance Act 2012 clarified that source of fund in the hands of shareholder is also required to be explained. However, with regard to loans and advances in other natures were not covered under the referred clarification,” Nath said. “It has been held in various judicial pronouncements that to prove the genuineness of such loan and advances, the assessee needs to prove the identity and creditworthiness of the creditor. Accordingly, the assessees were shredding off the responsibility by merely providing the PAN and ITR of the lender to establish such credits (loans and advances, etc.) in the books,” he noted. “It was not always possible for the revenue to scrutinise the books of creditor with reference to such credit transactions due to multiple challenges such as difference of jurisdiction, inability to scrutinize due to different assessment years involved, etc. Hence, to strengthening the system and to verify the genuineness of source of funds received by the assessee, the proposed amendment in Section 68 now the assessee shall be required to prove the source of fund in the hands of creditor also,” he added.