The Income Tax (I-T) department, said industry circles, is dipping into the repository of data after all private firms were told to dematerialise shares by June 2025.
While stocks bought at less than the fair price would attract provisions under the direct tax laws and the Foreign Exchange Management Act, a steep premium could raise concerns related to money-laundering and fund round-tripping.
Over the past few weeks a slew of information has been sought from non-resident investors for securities purchased between 2019-20 and 2022-23.
“Persons receiving such notices should respond promptly and diligently, explain the entire transaction along with requisite documents around source of funds, valuation adopted including valuation reports obtained under applicable laws, reason for non-filing of tax returns, if asked,” said Ashish Mehta, partner at the law firm Khaitan & Co.
Non-residents with no earnings from India often skip filing I-T returns. Now, with ownership of demat shares they are drawing tax officials’ attention as a permanent account number (PAN) is required for opening demat accounts. In fact, some have been asked as to why they did not file ITRs.
“Earlier reopening notices were directly issued, and taxpayers would either have to go through the rigmarole of assessment proceedings or challenge such notices in court. However, presently the law, under Section 148A, requires tax officers to first issue a precursor to a reopening notice, seek taxpayers’ response, and then decide whether it is a fit case to reopen or not,” said Mehta.
Shares bought at less than the fair value could trigger a tax demand from investors, and abnormally high valuation spark suspicion that closely-held local companies were conduits to bring back undisclosed funds stashed abroad through irregular past transactions like under-invoicing of exports, over-invoicing of imports, or even sham imports.
According to Rajesh Shah, partner at Jayantilal Thakkar & Co, a CA firm specialising in tax and FEMA matters, “The department is thoroughly investigating the actual beneficial owners behind the investments, especially from the UAE and tax haven islands, where the valuation is high compared to the fair market value of the Indian company.”
Post share demat, it’s easier for the department to trace high-value transactions, he said. Unlisted companies failing to dematerialise stocks could be restricted from bonus issues or buybacks.
Some of the other queries and data sought by the department are: names, educational qualifications and residential status of directors; minutes of board meeting where the investment decision was taken as well as instances where the offshore company, say in Mauritius, had rejected any investment or disinvestment proposals; bank statements to prove the investors’ creditworthiness; relation of an NRI with the offshore investment vehicle etc.
“While investors are generally able to provide details relating to identity and valuation, establishing the source of funds continues to pose a challenge, particularly if it involves overseas pooling vehicles. The increasing emphasis by tax authorities on examining the ‘source of source’ is often impractical, given the large and diversified investor base of global funds. Sometimes well-established institutional investors may be subjected to scrutiny, resulting in hardship, unwarranted tax additions, and litigation. The department should calibrate their queries based on the nature and category of overseas investors, rather than relying on a standardized line of questioning,” said chartered accountant Ashish Karundia.