Unexplained Cash Credits: Who bears the burden of proof?
Section 68 of the Income Tax Act, deals with unexplained credit whose nature and source cannot be satisfactorily explained by the assessee. Section 68 is an effective tool in the hands of the assessment authorities to prevent the conversion of black money into any other amount such as share premiums or share capital and escape tax assessment.
Typically, penny stocks, which are shares traded at very low prices are used to convert black money into white. Prices of such stocks are often artificially manipulated, in order to make a huge gain and evade long term capital gains tax. In order to check such illegal practices, the government amended Section 68 through the Finance Act, 2012 and added two provisos which now required the assessee to prove the source of the source of investment.
The question which arose was that how would the assessee discharge this onus of proving the `nature and source’ of the unexplained cash credit. The judiciary has extensively dealt with this question. We through this post, would discuss the findings of the courts with respect to the burden of proof on the assessee vis-à-vis unexplained cash credits and how does the assessee discharge the same.
Section 68, in simple words Cash Credits states:
- If the source of a sum of money credited to an assessee cannot be satisfactorily explained, then it is considered as taxable income for the previous year.
- If the money invested is by a venture capital company or satisfactorily explained by the creditor to the assessing officer then it is not taxable income.
The times and travels of the burden of proof
Simplifying the section does not mean that there is no ambiguity, the journey of the section through case laws provides an interesting insight on how the legal position has evolved.
Divine Leasing, Delhi High Court, (2006)
Decided in favour of the assessee, as the assessing officer failed to prove that the investor was not creditworthy after the assessee had provided the identity details.
Lovely Exports, SC (2008)
“Once the identity of the bogus investors is established the revenue department can re-open the assessment against these individuals.”
What this meant was that if the assessee provided the identity (name and PAN card details) of the investors, the burden of proof was on revenue. It would be their responsibility to assess the accounts of the identified investors and prove that the sum is undisclosed income.
Oasis Hospitalities Pvt. Ltd., Delhi HC (2011)
Nova Promoters and Finlease Pvt. Ltd, Delhi HC (2011)
Lovely exports ratio became diluted consequently, as many decisions were rendered by different courts, leaning towards the ICG test. This test required the assessee to prove not only the identity but also the creditworthiness of the investor and the genuineness of the transaction.
NRA Iron and Steel, SC, (2019)
The initial onus on the assessee is to prove
- the identity of the investor
- the creditworthiness of the investor
- the genuineness of the transaction.
- if the onus is not discharged to the satisfaction of the revenue authorities, then the said income can be added to taxable income as per section 68.
- revenue authorities need to investigate the identity and creditworthiness of the investor and genuineness of the transaction. If the identity and creditworthiness are doubtful, the transaction cannot be said to be genuine.
The tribunal ruled that mere showing of documents and paperwork by the assessee does not absolve the revenue authorities of their statutory obligation to verify the genuineness of such documents. The tribunal went ahead and laid down guidelines in the form of a fifteen-point questionnaire, which tax authorities should take into account while assessing the identity and creditworthiness of the investor and deciding the genuineness of the transaction. Some of these questions which assessing authorities need to ask inter alia include:
- Was the investor was known to the assessee?
- Was the transaction was entered through written documentation to protect the investment?
- Was the investor an angel investor?
- What was the mode by which the parties approached each other?
The tribunal stated that evidence pertaining to the source of the source was duly furnished, the case was thus distinguishable on facts from the NRA Iron and Steel decision. Hence, the NRA Iron and Steel decision is not a blanket rule but has to be applied keeping in view the facts and circumstances of each case.
In view of the aforementioned judicial decisions and section 68, it is a settled position now that the assessee needs to prove the identity and creditworthiness of the investor which once proved would prove the genuineness of the transaction. If the assessee fails to do so, then the assessing authorities may apply section 68. Moreover, assessing officers’ responsibility does not end if the assessee is able to show documentation to satisfy the ICG test. They need to independently assess the veracity of such documentation before they determine the applicability/inapplicability of section 68. Further, the assessee should also have a detailed explanation pertaining to the fifteen-point questionnaire as laid down by the ITAT Delhi in the APJ Construction decision.
The graphs below provide insight on a statistical level on how cases related unexplained cash credits fare at ITATs and High Court.
It is interesting to note that while 72% of all appeals at HCs are filed by revenue only 9% of revenue appeals result in the ITAT decision being overturned at HCs. 5% Appeals are dismissed for having no substantial question of law.
Unexplained cash credits and bogus investments have led to a steep rise in black money being converted to white. Section 68 was amended with a view to curb such practices. However, the provisos to section 68 are prospective in nature and do not apply to years prior to 2013. This is where the judiciary comes in. Decisions such as NRA Iron and Steel and APJ Construction have cast the net wide enough to prevent practices such as the conversion of unaccounted money into share premium or share capital amounts. Moreover, such scrutiny is enhanced when the shares are allotted through private placement. Revenue authorities need to examine the identity and creditworthiness of the investors independent of any documentation which the assessee may have produced, in order to establish a genuine transaction.