Unexplained Cash Credits and Cash Transactions

It is a well-known fact that people tend to find ways to evade tax and this leads to accumulation of black money. Government has to tackle such tax evasion tactics and bring all the money under its umbrella. The Indian Income Tax Act has various provisions to track unexplained cash credit and investments. Let’s explore in detail.

Background of Unexplained Cash Credit

Income Tax is levied on five categories of income: salary, house property, business/profession income, capital gains, and income from other sources. The Indian Income Tax has provisions to penalize tax evaders. The aforementioned categories except capital gains deal with revenue income, and one must pay taxes on them in the FY in which they are earned/received. Capital gains deal with tax on capital assets. 

The basic rule of the income tax levy is that all income is taxed unless specifically exempted (i.e. made not taxable). 

Unexplained Cash Credit – Section 68

Any money that is credited to the taxpayer will be eligible for taxation unless it is specifically exempted as per tax provisions. If such credit is not offered to tax by the taxpayer, he/she must explain the reason for it as well as cite the credit source. Knowing the source of income is relevant as the same might belong to a third person (i.e. a person other than the taxpayer) and might have to be taxed in the hands of such a third person.

It might have to be taxed in the hands of the third person as he might have diverted the funds to the taxpayer with the intention of evading taxes. Section 68 considers any sum credited in the books of taxpayers in a financial year and not already offered to tax as income of the taxpayer during such financial year, if the following conditions are satisfied:

• Taxpayer offers no explanation about the nature and source of such credit
• Explanation offered by a taxpayer about the nature and source of such credit is not satisfactory in the opinion of assessing officer.

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 an explanation about the nature and source of such sum credited
• Assessing officer is of the opinion that his/her explanation is satisfactory

However, the aforementioned special provision will not apply if 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 the Section 10(23FB).

Special provision is designed for closely held corporate taxpayers 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. This is a mechanism for parking unaccounted money in such companies, not subject to stringent regulation under company law provisions as compared to widely held companies.

Taxability of Unexplained Cash Credit

Under Section 115BBE of the Income Tax Act, 1961, Unexplained cash credit is treated as income and taxed at the rate of flat 60% with a 25% surcharge and 4% Health and Education Cess, making a total tax rate of 78%. This is calculated without providing any benefit of basic exemption limit. Furthermore, the taxpayer cannot claim any deduction for expenses or allowance, nor can they set off any loss against this tax.

Penalty is not levied if unexplained cash credit is already included in the return of income and tax on the same is paid on or before the end of the financial year. If the taxpayer fails to declare income as required under section 68 or appropriate taxes on this income, a penalty equal to 10% of the tax payable under the section 115BBE will be levied under section 271AAC of the Income Tax Act, 1961. 

Key Points to be Noted

• It is advisable to accept payments through an account payee cheque or demand draft, which enables the taxpayer to know the identity of the payer
• The 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 the address and/or PAN of the depositor in order to collate the necessary documents as and when the need arises.
• The 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.