Section 68 Of Income Tax Act: Tax On Unexplained Cash

Unexplained cash credit, as defined under Section 68 of the Income Tax Act, refers to any income that is not adequately explained, or supported by documentary evidence. This section was put in place to ensure that taxpayers report and explain their income and income sources.

This article will provide a detailed analysis of the provisions, including their scope and implications. Whether you are a business owner or an individual requiring information on specific aspects, continue reading our post for helpful information on unexplained cash credit.

Background of Section 68: Unexplained Cash Credit 

This section was implemented to promote transparency in tax payments and reporting. The background of this clause is to ensure that individuals or entities declare their income accurately and pay applicable taxes on all income earned. It came into effect as a result of increased focus from the government on curbing instances of undeclared wealth. 

This section enables the tax department to take corrective measures on any information found to be incorrect or incomplete. It facilitates oversight of large cash infusions as a way to check and trace the source of such funds. Section 68 helps investigate sources of untaxed money and serves as a tool for compliance with taxation laws in India.

Analysis of Section 68: Unexplained Cash Credit

In a nutshell, the provisions address unexplained cash credit in the form of loans, advances, deposits, share capital etc.

Any income not reported for tax purposes and for which the taxpayer fails to properly explain the source and nature is called an unexplained cash credit. In addition, if the assessing officer is not satisfied with the explanation provided, then such a sum will be considered an unexplained cash credit. It will be subject to income tax for the financial year in which it was received.

To facilitate an easy understanding of each segment under Section 68, the provisions have been split up as below:

• A sum is credited to the taxpayer’s books.
• A sum was maintained for the previous financial year.
• The taxpayer is unable to provide any information on the nature of such a sum.
• The taxpayer is unable to provide any explanation about the source of such a sum.
• The explanation provided by the taxpayer does not satisfy the assessing officer.
• The sum credited is chargeable as income tax
• If the above provisions are satisfied, the sum is credited to the taxpayer’s income for the previous year. 

Unexplained Cash Credit: Special Provision for Corporate Taxpayers

Where the taxpayer is a company, any sum credited via share capital, share application money, share premium or any such arrangement will be deemed not satisfactory.

The only exception to the above-mentioned special provision is when:

• The person is a resident under whose name the credit is recorded in the company books.
• The taxpayer explains the source and nature of the sum credited, and this explanation is satisfactory to the assessing officer. 

In addition, the above rules will not apply if the person, in whose name the sum is recorded, is a venture capital fund or a venture capital company.

Closely held corporate taxpayers are provided special provisions to prevent tax avoidance. Companies may employ a technique of listing non-existent shareholders/third parties as having paid company shares. It is a method to conceal or park unaccounted money. This practice circumvents the stringent regulations imposed on widely held companies (a company in which the public is substantially interested).

The Objective of Section 68

The primary objective of this section was to address issues of tax evasion. People often adopt tax avoidance strategies to reduce tax outflow. This results in the accumulation of untaxed income, more commonly known as ‘black money.’ Over time, tax avoidance techniques have resulted in large amounts of untaxed cash in the hands of taxpayers.

Demonetisation and provisions like the Income Disclosure Scheme (IDS) are initiatives by the tax authorities to reduce black market activity. Additionally, with section 68, the government has taken steps to avoid tax evasion at its core. In a nutshell, it allows greater transparency in ensuring that all taxable incomes are accounted for accurately.

Applicability of Section 68: Unexplained Cash Credit

Below mentioned conditions necessitate the applicability of section 68: 

• The taxpayer has maintained books of record. These may include ledgers, cash books, day books, and other similar books. Loose sheets or unbound papers are not considered books of accounts.
• There has to be a sum credited in the books maintained by the taxpayer during the year. This section is inclusive of precious items like gold, in addition to cash.
• The taxpayer does not explain the nature and source of such credit or the explanation offered is not satisfactory in the opinion of the AO. As per the provisions, the taxpayer must provide adequate justification to satisfy the AO. Supporting documentation must be supplied, when requested, to demonstrate the unexplained cash credit included in their books of accounts. 
• If all the above conditions are met, the sum so credited will be taxed as income for the previous financial year.

Requirements to Preclude Section 68

In the case of unexplained cash credit, the taxpayer must prove that the funds were obtained through loans or credit from friends, family members, or private money lenders. In essence, they need to adhere to the following to avoid section 68:

• Identity of the creditor:
  The taxpayer can easily verify the identity of the creditor by providing the PAN or Aadhar card.
• The creditworthiness of the lender:
  A bank statement or a copy of the Income Tax Return (ITR) could be provided to demonstrate the financial capability of the lender.
• The authenticity of the transaction:
  The taxpayer can provide the source through which the funds have been received

 Key Features of Section 68

• The provisions of the Act make it mandatory for the taxpayer to explain the source of credits taken in the books of account.
• Under the rules of section 68, the taxpayer must produce evidence in the form of documentary proof or material facts to support the entries.
• Further to the section guidelines, any unexplained cash credit will be deemed as taxable income of the assessee and thus, charged to tax.
• The act also states that such unexplained cash credit will not only be taxed but the taxpayer may also be subject to penalty or prosecution.
• No penalty will impose if the assessee accounted for any unexplained income and paid the corresponding taxes due before the end of the financial year.

Tax Treatment of Unexplained Cash Credit

Section 68

This section imposes a tax on unexplained cash.

Tax u/s 115BBE (For income referred to in section 68)

The unexplained credits are subject to tax u/s 115BBE of the Income Tax Act, 1961 at the rate of 60% plus a surcharge at 25% and health and education cess at 4%. This totals an overall rate of 78%. The assessee will also not be eligible for any deduction of expenditure or allowance or offset of any loss under this act.

Penalty u/s 271AAC

Penalty u/s 271AAC will be levied if the assessee fails to report income as mentioned in section 68 or fails to pay due taxes on it. This will attract a penalty at 10% of the tax payable under clause (i) of sub-section (1) of section 115BBE.

Let us explain the above provisions with the help of an example:

Mr Z is a business person who received a sum of ₹ 5,00,000, recorded duly in his books. The AO served a notice inquiring why the payment was not added to his taxable income. Mr Z explained that he received the payment from his sister to support emergency business expansion plans. The AO asked him to furnish his sister’s ITR copy so that they could verify the source of the credit. Mr Z, however, does not furnish such information. The AO, therefore, categorised the payment under unexplained cash credits and added it back to the income of Mr Z.

Tax and Penalty on Mr Z

As per section 115BBE, tax will be levied at 60% + 25% Surcharge + 4% H&EC (Health and Education cess) = 78% on the deemed income u/s 68 of ₹5,00,000. This amounts to a tax burden of ₹3,90,000

In addition to the above, penalty u/s 271AAC would be calculated as

₹390000 (total tax payable) x 10% (penalty) = ₹39000

Hence, total tax and penalty work out to,

₹3,90,000 + ₹39000 = ₹4,29,000

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