MUMBAI: The income-tax department has threatened to freeze bank accounts of at least two of the 40 companies that had earlier been asked to explain premiums paid to them by foreign investors.

In both cases, the department has slapped a tax demand on the premiums by treating the money as "unexplained cash credits", and told the firms to pay up or face action, people with knowledge of the matter said. Sources said there were more such instances. Income tax isn't levied on inbound foreign direct investment and investors paying a premium isn't unusual in merger and acquisition deals. But the tax department sent notices to the 40 companies probably because it is suspecting some wrongdoing in those transactions, including disguising fee as investment to save tax, said people in the know.

Under Section 68 of the Income-Tax Act, an I-T officer can seek details when he suspects round-tripping or involvement of black money in a deal, said Sanjay Sanghvi, a legal expert and partner at Khaitan & Co. "Usually, an addition (tax demand) is not made where the details about the investor, including his identity, PAN and balance sheet in some cases is provided."

In the two transactions where the department has raised a demand, one was a private equity deal and in the other the investor was the parent of the local company. Both companies are likely to take the legal route against the tax authorities, people who are closely associated with the development at these companies, said on the condition that they and the companies aren't identified. "In our case, an investment was made from a parent company to its subsidiary," said one of them. ""The I-T has already made an addition and the company has approached the CIT (Commissioner of Income Tax). The company is also seeking legal opinion."

Under local rules, an unlisted Indian company must get its valuation done by an independent chartered accountant before it goes for an M&A deal. It cannot sell shares at a price below that value, a measure aimed at protecting the existing shareholders. In these 40 cases, the buyers have paid a premium, or more than the fair value. Tax experts said the premium that a buyer pays on the shares is a matter of commercial understanding and subject to exchange control.

"Often the assessment officer remains suspicious even when you provide him with all the details regarding the deal including the Sebi and RBI's approval," said a tax and legal expert involved in the second case where the authorities have made a tax demand. The tax department suspects that in some cases the companies that got the investment had provided certain services to their clients and, instead of paying a fee, the clients had routed the money as capital investment to save tax, said people.

Freezing accounts of taxpayers is not the right thing to do when the judicial process is underway. The tax department, which wants to crack down on money laundering through unexplained tax credits, should wait for the outcome. But courts and appellate tribunals also drag cases for years. The delays hurt both the taxpayers and the government. The need is to ensure a speedy dispute-resolution mechanism, and also consistent ruling by courts on similar cases.