Jigar M. Patel
International Tax Attorney
Section 68 of the Income-tax Act deals with the provisions of unexplained cash credits, which represent sums of money found credited in a taxpayer’s books of account, but which cannot be explained by him to the satisfaction of the tax authorities. The section empowers the tax authorities to treat any such unexplained credit as deemed income of the taxpayer.
When Section 68 gets triggered?
Section 68 is triggered when a taxpayer has a sum credited in his books of account for any previous year which is treated as unexplained. To ensure that credits to his account are not treated as his deemed income, the taxpayer must satisfactorily explain with supporting evidences the nature and source of such credit, the identity of the person providing the credit and his creditworthiness.
Key Amendment in 2022 – A Game Changer?
Prior to the amendment in this regard by the Finance Act 2022, the judicial decisions on the subject had consistently held that where the taxpayer had discharged his onus to prove the genuineness of the transaction and the identity and creditworthiness of the person, the tax department would not be justified in going beyond the above.
Effective from Financial Year 2022-23, a new proviso came to be introduced in Section 68 providing that for any sum credited in the books of a taxpayer, the explanation for such borrowing shall be considered satisfactory, only if the source of the funds in the hands of the creditor was also explained. Keeping this in view, a taxpayer borrowing any amount should be aware that the department may also question the source of the source in case of the person from whom such amount is borrowed.
The provisions of Section 68 would also stand attracted in the case of a private company in respect of share application money, share capital or share premium.
84% Burden of Tax & Penalty for Unexplained Cash Credits
When an amount is added to the taxpayer’s income under Section 68, it can have serious consequences. Under Section 115BBE, such deemed income is taxed at a flat rate of 60%, plus a surcharge of 25% on the tax and a 4% cess. This results in an effective tax burden of 78% of the amount of deemed income.
In addition to the above, a penalty of 10% of the tax payable under Section 115BBE, working out to 6% of the deemed income can also be imposed under Section 271AAC.
Practical Advice for Taxpayers
Section 68 serves as a strong deterrent against the laundering of unaccounted money through artificial entries in the books of accounts. To avoid the pitfalls of Section 68, a taxpayer should be equipped to prove not only the genuineness of the transaction and the identity of the creditor, but also his creditworthiness and source of the source for the borrowing.
It would also be prudent for taxpayers to maintain documentary evidence in regard to the above. As the tax regime becomes more data-driven and transparent, compliance with Section 68 is not just a legal necessity but a safeguard against severe tax consequences.
