Analysis, Income Tax

Unexplained cash credits: 5 questions and their answers

Section 68 is one of the few sections in the Income Tax Act of 1961 which has largely remained unchanged. Apart from addition of provisos to cover corporate taxpayers, the purpose of the section has remained unchanged.

So what does section 68 say? Amounts credited to an assessee are taxable unless the Act has specifically created exemptions for it. To prevent tax evasion, it is crucial for the Revenue to know the source and nature of cash credits, as an assessee may try to escape taxation by using third parties. Any sum credited into the books of an assessee for any previous year, is to be treated as taxable in the hands of the assessee, if:

  • The assessee has no explanation as to the nature and source of the credit; OR
  • the Assessing Officer does not find the explanation satisfactory.

These unexplained cash credits involve different kinds of transactions, the nature of which varies significantly. Issues under section 68 are more factual, and some key ones are discussed below.

Can the Revenue look into the surrounding facts and circumstances to determine genuineness of a transaction?

Short answer: Yes

Sumati Dayal vs. Commissioner of Income Tax (Cited 1187+ times)

Supreme Court, decided on 28th March, 1995

Reasoning: The Supreme Court ruled in favour of the Revenue and held that the Department has the powers to look into the surrounding facts and circumstances to determine the correct narrative.  The matter should be looked considering the test of human probabilities.

In this case, the Court deemed that holding a winning ticket from horse races is not a satisfactory explanation given the fact that the assessee could not show any expenditure related to buying of tickets or travel expenses to different cities. Furthermore, the Supreme Court observed that one would not stop taking up activities yielding high returns merely because the income from it has become taxable which is what happened in the case of the assessee.

“There is no dispute that the amounts were received by the appellant from various race clubs on the basis of winning tickets presented by her. What is disputed is that they were really the winnings of the appellant from the races. This raises the question whether the apparent can be considered as real. As laid down by this Court, apparent must be considered real until it is shown that there are reasons to believe that the apparent is not the real and that the taxing authorities are entitled to look into the surrounding circumstances to find out the reality and the matter has to be considered by applying the test of human probabilities.”

Issue of notice to creditors u/s. 131: Is it sufficient to discharge onus of the assessee?

Short answer: Yes

Commissioner of Income Tax vs. Orissa Corporation (P) Ltd. (Cited: 621+ times)

Supreme Court, decided on 19th March, 1986

Reasoning: The Supreme Court sided with the assessee, observing that the lower courts were correct in holding that the finding of the courts, while considering the test of probabilities, should not be based on suspicions, conjectures and surmises, especially in the absence of evidence to the contrary. The Revenue cannot, by rejecting an explanation u/s. 68 unreasonably, turn evidence into no evidence.

The assessee had claimed that cash credits in his books were in the nature of loans from various creditors and he had produced letters as evidence to prove the same. The Court noted that merely because the creditors themselves could not be produced in front of the AO and the fact that hundi-racket exists does not mean that an adverse inference should be drawn that these cash credits amounted to undisclosed income.

“In this case, the assessee had given the names and addresses of the alleged creditors. It was in the knowledge of the Revenue that the said creditors were income tax assessees. Their index numbers were in the file of the Revenue. The Revenue, apart from issuing notices under s. 131 at the instance of the assessee, did not pursue the matter further. The Revenue did not examine the source of income of the said alleged creditors to find out whether they were creditworthy or were such who could advance the alleged loans. There was no effort made to pursue the so called alleged creditors. In those circumstances, the assessee could not do anything further. In the premises, if the Tribunal came to the conclusion that the assessee has discharged burden that lay on him, then it could not be said that such a conclusion was unreasonable or perverse or based on no evidence.”

Should the High Courts interfere when there is concurrent factual findings by the lower authorities?

Short answer: No

Commissioner of Income Tax vs. P. Mohanakala & Ors. (Cited: 570+ times)

Supreme Court, decided on 15th March, 2007

Reasoning: The Supreme Court overturned the decision of the Madras High Court and upheld the findings of the AO, CIT(A) and the Tribunal, noting that the High Court erred in accepting the appeal and the contentions of the assessee. For the Supreme Court, there was sufficient application of mind (supported using the test of human probabilities) by the lower authorities in reaching this conclusion and there was no reason to establish it as a finding based on conjectures, suspicion or surmises.

Based upon the statement of the donor and the surrounding circumstances also pointed to the fact that the transaction seemed more of a quid pro quo, which in all probability, meant that he was being compensated for his statement.

“The AO found that all the so called gifts came from Ariavan Thotan and Suprotoman. The assessees did not declare that they are the alias of Sampath Kumar. It is only an afterthought they have come forward with the said plea. The AO also found that the gifts were not real in nature. Various surroundings circumstances have been relied upon by the AO to reject the explanation offered by the assessees. The CIT(A) confirmed the findings and conclusion drawn by the AO. The Tribunal speaking through its Senior Vice President concurred with the findings of fact. The findings in our considered opinion are based on the material available on record and not on any conjectures and surmises. They are not imaginary as sought to be contended.”

Also Read: Judge analytics – PCIT vs. NRA Iron and steel

Investigating creditworthiness of share applicants: Does the burden lie with the Department?

Short answer: Yes

Commissioner of Income Tax vs. Divine Leasing & Finance Ltd. (Cited: 389+ times)

Delhi High Court, decided on 16th November, 2006

Reasoning: The Court ruled in favour of the assessee stating that the assessee had shown documentation (PAN card details, ITO ward no. etc.) of the share applicants and since the credits came by way of cheques (where the source and date of investment cannot be manipulated), the assessee has discharged their initial burden, to prima facie show the nature and source of such credits. At this point, the burden shifts to the Department to look into the creditworthiness of the share applicants. If no evidence contradicting assessee’s stand can be shown (be it lack of evidence or lack of action by the Assessing Officer), then the assessee has satisfied the requirement under section 68.

“In the case of a public issue, the company concerned cannot be expected to know every detail pertaining to the identity as well as financial worth of each of its subscribers. The company must, however, maintain and make available to the AO for his perusal, all the information contained in the statutory share application documents. In the case of private placement the legal regime would not be the same. A delicate balance must be maintained while walking the tightrope of ss. 68 and 69 of the IT Act. The burden of proof can seldom be discharged to the hilt by the assessee; if the AO harbours doubts of the legitimacy of any subscription he is empowered, nay dutybound, to carryout thorough investigations. But if the AO fails to unearth any wrong or illegal dealings, he cannot obdurately adhere to his suspicions and treat the subscribed capital as the undisclosed income of the company.”

Can penalty be directly imposed for ‘concealment of income’, when the assessee is unable to prove their explanation u/s. 68 read with Explanation 1 of s. 271(1)(c)?

Short answer: No

National Textiles vs. Commissioner of Income Tax (Cited: 298+ times)

Gujarat High Court, decided on 9th October, 2000

Reasoning: The High Court answered the reference in favour of the assessee. According to them, there are two conditions that must exist in order to levy penalty-

  • Existence of materials or circumstances which lead to the reasonable conclusion that the amount does represent the assessee’s income.
  • There must be conscious concealment or act of furnishing inaccurate particulars on part of the assessee.

When the cash credits are not explained sufficiently with evidence and documents, the department is justified in treating the same as income of the assessee but cannot impose penalty u/s. 271(1)(c) without making an effort to ensure that the claim for the genuineness of the transaction was false. Absence of proof acceptable to the Department cannot be treated the same as wilful default.

“In our opinion, therefore, even taking recourse to Expln. 1, same circumstances or state of evidence on which the cash credit were treated as income, could not by themselves justify imposition of penalty without anything more on record produced by the assessee or the Department.”

(Written by Ankit Sinha, Product Manager @ Riverus)

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