Unexplained Cash Credit (Section 68) – Tax Treatment of Cash Credits

Credit of any sum to the taxpayer requires to be offered to tax unless it is specifically exempted as per tax provisions. In case such credit is not offered to tax by the taxpayer. We will understand about unexplained cash credit in this article. 

Background of Unexplained Cash Credit

Income Tax is levied on five categories of income that are – salary, house property, business/profession income, capital gains and income from other sources. All the income categories deal with revenue income, except capital gains. Capital gains deal with tax on capital assets.

The basic rule of income tax levy is that all income is taxed unless specifically exempted (i.e. made not taxable). Capital income in general is not taxable unless specifically brought within tax bracket. Any income that is earned by a taxpayer is required to be offered to tax in the financial year in which it is earned/received.

It is a very well-known fact that people tend to find and adopt tax-evading measures to save tax outflow, which leads to the accumulation of black money. Considering the improved economic status over a period of time, tax evading measures have also been increasing, with huge cash available to taxpayers.

Thus, it becomes imperative for the Government to tackle such tax evasion and bring all the money into the tax bracket that has been/is escaping tax levy. The government recently has come up with various measures such as demonetisation, the Income Disclosure Scheme (IDS), etc. Apart from the aforesaid measures, the Income Tax Act has various provisions to plug loopholes and track unexplained cash credit, unexplained investments, etc.

Unexplained Cash Credit – Section 68 of Income Tax Act

Tax Implications of Unreported Credits:

Any income received by a taxpayer, including credits deposited in their accounts, should be declared for taxation unless specifically exempted by the law. Failure to do so necessitates an explanation from the taxpayer regarding the source and reason for non-reporting. This is crucial because the funds might belong to a third party and be subject to taxation in their hands.

Possible Tax Evasion and Section 68:

Sometimes, funds are diverted to a taxpayer by another person as a means of evading taxes. To address such scenarios, Section 68 deems any unreported sum credited to a taxpayer's account as taxable income under specific conditions:

• No Explanation Provided: If the taxpayer offers no explanation regarding the origin and nature of the credit.
• Unsatisfactory Explanation: If the explanation provided by the taxpayer is deemed unsatisfactory by the assessing officer.

By incorporating these conditions, Section 68 discourages tax evasion and ensures fairness in the system.

Such credit is referred to as unexplained cash credit.

Special Provision in Case of Corporate Taxpayers

Any explanation offered by closely held company (company in which public are not substantially interested)  with respect to any sum credited being share application money, share capital, share premium or any such amount shall be deemed to be unsatisfactory unless:

• Person in whose name such amount is recorded in the books of such company offers explanation about the nature and source of such sum credited; and
• Assessing officer is of the opinion that such explanation is satisfactory.

However, the above discussed special provision will not apply in case the person in whose name such amount is recorded in the books of such company is a venture capital fund or a venture capital company as per Section 10(23FB).

Special provision is designed for closely held corporate taxpayers in order to avoid any tax evasion by companies that show the names of non-existing shareholder/third party as having paid the company share related money which is a mechanism for parking unaccounted money in such companies which are not subject to stringent regulation under company law provisions as compared to widely held companies.

Taxability of Unexplained Cash Credit

As already mentioned unexplained cash credit is treated as income in the year in which it is received. Unexplained cash credits are taxed at flat rate of 60% without providing any benefit of basic exemption limit and irrespective of the tax slab. Surcharge is levied at 25% and Health & Education Cess @ 4%. The final tax rate comes to 78% (including cess).

No deduction/allowance is allowed and no loss can be set off against such unexplained cash credit which is considered as income. Penalty is not levied in case unexplained cash credit is already included in the return of income and tax on the same is paid on or before the end of financial year.

Key Points to be Noted

• It is advisable to accept payments through account payee cheque or demand draft which enables the taxpayer to know the identity of payer
• Assessing officer may ask for various details such as mode of payment, bank account of the lender evidencing the transaction/cash flow statement of the lender etc. It is advisable to collect address /PAN of the depositor in order to collate necessary documents as and when the need arises.
• Existence of ‘books’ is necessary to invoke Section 68. Loose sheets or scraps of paper cannot be termed as book as they can be easily detached and replaced.
• Books of accounts in which unexplained cash credit is found must be of the taxpayer.