Tax Treatment of Unexplained Transactions Including Cash credits

I. Introduction: Generally, Cash credit is a type of loan facility that allows a borrower to withdraw funds from a pre-approved credit limit...

I. Introduction:

Generally, Cash credit is a type of loan facility that allows a borrower to withdraw funds from a pre-approved credit limit. It is an important source of working capital for businesses and helps them to meet their short-term financial requirements. Cash credit is generally offered by banks and financial institutions against collateral security.

However, In the context of taxation, cash credit has a different meaning than its general definition. It refers to any sum found credited in the books of a taxpayer, for which the taxpayer does not provide an explanation about its nature and source or where the tax authorities are not satisfied with the explanation offered. Cash credit can be a significant source of income for businesses, and it is crucial to understand the tax treatment of cash credit under the Income Tax Act, 1961. 

In this blog, we will discuss various provisions related to the tax treatment of cash credit, including Section 68, 69, 69A, 69B, 69C, and 69D of the Income Tax Act. Section 68 of the Income Tax Act deals with the treatment of unexplained cash credits in the books of accounts of taxpayers. Additionally, sections 69, 69A, 69B, 69C, and 69D of the Act also deal with the tax treatment of various types of unexplained investments, expenditures, and assets.

It is important for taxpayers to understand the tax implications of cash credit and related transactions to avoid any adverse consequences from the Income Tax department. In this blog, we will discuss the tax treatment of cash credit and related provisions under the Income Tax Act, 1961.

Why It is Important To Understand these Sections?

​​Tax rates applicable to the amount charged to tax by virtue of sections 68, 69, 69A, 69B, 69C and 69D

​As per Section 115BBE of the Income Tax Act, 1961, the tax rate applicable to income charged under sections 68, 69, 69A, 69B, 69C, and 69D is 60%. This tax rate applies to income reflected in the return of income furnished under Section 139 or income determined by the Assessing Officer that is not covered under the first clause.

In addition to the 60% tax rate, a 25% surcharge and a 6% penalty are also applicable. Therefore, the final tax rate comes out to be 83.25%, including cess. However, the 6% penalty shall not be levied if the income under sections 68, 69, etc., has been included in the return of income and tax has been paid before the end of the relevant previous year.

It is important to note that no deduction in respect of any expenditure or allowance or set off of any loss shall be allowed to the assessee in computing his income referred to in clause (a) of sub-section (1) of Section 115BBE.

In summary, the tax rate applicable to income charged under sections 68, 69, 69A, 69B, 69C, and 69D is 60%, which is subject to a surcharge of 25% and a penalty of 6%. It is crucial to maintain proper documentation and records for cash credit transactions to avoid scrutiny by the tax authorities and being charged under these sections.

II. Section 68 of the Income Tax Act, 1961

Section 68 of the Income Tax Act, 1961, deals with the treatment of unexplained cash credit under the Act. It applies to any sum credited to a taxpayer's books for which the taxpayer has not provided an explanation regarding the nature and source of the amount or for which the tax authorities are not satisfied with the explanation provided.

The section lays down the following requirements for proving the source of cash credit:

• The taxpayer must be able to provide evidence that establishes the identity of the person or entity providing the cash credit.
• The taxpayer must provide a proper explanation of the nature and source of the cash credit.
• The taxpayer must establish the creditworthiness of the person or entity providing the cash credit.

If a taxpayer fails to provide a satisfactory explanation for the cash credit, the amount will be treated as taxable income under section 68. The taxpayer will be required to pay tax on the amount as well as a penalty of 100% of the tax payable on the unexplained cash credit.

For example, if a taxpayer's books show an unexplained cash credit of Rs. 10 lakhs, the taxpayer will have to provide evidence of the source of the credit, explain the nature of the credit, and establish the creditworthiness of the person providing the credit. If the taxpayer is unable to do so, the Rs. 10 lakhs will be treated as taxable income and the taxpayer will have to pay tax on the amount as well as a penalty of 100% of the tax payable on the unexplained cash credit.

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 the mode of payment, the bank account of the lender evidencing the transaction/cash flow statement of the lender, etc. It is advisable to collect the address /PAN of the depositor in order to collate 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 books as they can be easily detached and replaced.
• Books of accounts in which unexplained cash credit is found must be of the taxpayer

III. Other sections related to cash credit.

Section 69 unexplained investments

Section 69 of the Income Tax Act, 1961 deals with unexplained investments. This section is applicable if the Assessing Officer finds that there has been an investment made by the taxpayer, which is not explained by the taxpayer. The Assessing Officer can then treat the unexplained investment as the taxpayer's income and tax it accordingly.

Applicability of Section 69 to Cash Credit Transactions:

Section 69 can be invoked in case of unexplained investments made through cash credit transactions. For example, if a taxpayer shows an increase in investment in his books of account without being able to provide any credible explanation, then such an increase can be treated as unexplained investment and may attract the provisions of section 69.

Consequences of invoking Section 69 for Cash Credit:

If section 69 is invoked for cash credit transactions, the taxpayer will be required to prove the source of the cash credit. If the taxpayer fails to do so, the amount of cash credit may be added to his income and taxed accordingly. Additionally, penalties may also be imposed under section 271(1)(c) of the Income Tax Act, 1961 for concealing income or furnishing inaccurate particulars of income. The penalty may be levied at 100% to 300% of the tax sought to be evaded.

In conclusion, Section 69 of the Income Tax Act, 1961 serves as a powerful tool for the tax authorities to prevent tax evasion and ensure that the taxpayer is able to provide a credible explanation for the unexplained investments made through cash credit transactions. It is therefore advisable for taxpayers to maintain proper records and provide accurate and credible explanations for any cash credits received or investments made in their books of account to avoid any adverse consequences under section 69.

Section 69A Unexplained Money/assets

Section 69A of the Income Tax Act, 1961 is applicable when any sum of money, investment, or other asset is found to be in the possession of the taxpayer and the taxpayer fails to provide a satisfactory explanation regarding the nature and source of the sum or asset. This section is invoked when the Assessing Officer believes that the taxpayer's explanation is not credible and the amount or asset is unexplained.

Applicability of section 69A to cash credit transactions:

Section 69A can be invoked in cases of cash credit transactions where the taxpayer fails to provide a satisfactory explanation regarding the nature and source of the cash credit. If the Assessing Officer is not satisfied with the explanation provided by the taxpayer, he can invoke section 69A and treat the amount as unexplained money.

Example: Mr. A, a taxpayer, receives a cash credit of Rs. 10 lakhs in his bank account, which he cannot explain. The tax authorities invoke Section 69 and treat the unexplained cash credit as income of Mr. A for the relevant financial year.

Consequences of invoking section 69A for cash credit:

If section 69A is invoked for a cash credit transaction, the amount credited to the taxpayer's account will be treated as unexplained money and added to the taxpayer's income for the relevant assessment year. The taxpayer will be liable to pay tax on the added amount at the applicable rate along with interest and penalty, if any. Additionally, the taxpayer may also face prosecution under the Income Tax Act.

Section 69B Hundi

Section 69B of the Income Tax Act, 1961 deals with the amount borrowed or repaid on a hundi. A hundi is a financial instrument used in India as a means of making payments. It is a type of bill of exchange that is used primarily in trade transactions. Section 69B provides for the taxation of unexplained amounts borrowed or repaid on a hundi.

Applicability of section 69B to cash credit transactions:

If the taxpayer has an unexplained amount of money that was borrowed or repaid on a hundi, then section 69B of the Income Tax Act may be applicable. This means that the tax authorities can demand an explanation from the taxpayer regarding the source of the funds.

Example: Ms. B is found to be the owner of jewellery worth Rs. 20 lakhs, which she cannot explain. The tax authorities invoke Section 69A and treat the unexplained jewellery as income of Ms. B for the relevant financial year.

Consequences of invoking section 69B for cash credit:

If the tax authorities are not satisfied with the explanation provided by the taxpayer, then the unexplained amount may be treated as the taxpayer's income for the relevant assessment year. The taxpayer may be liable to pay tax on this income at the applicable rate, along with interest and penalties.

It is important for taxpayers to maintain proper records and documentation for all transactions involving hundis, as this can help them provide a satisfactory explanation to the tax authorities, if required. Failure to do so can lead to adverse consequences, including tax liabilities and penalties.

Section 69C unexplained expenditure

Section 69C of the Income Tax Act, 1961 deals with unexplained expenditure. This section is applicable when a taxpayer incurs an expense and is unable to provide a satisfactory explanation for the nature and source of such expenditure.

Applicability of Section 69C to Cash Credit Transactions:

Section 69C can also be invoked for cash credit transactions if the taxpayer is unable to provide a satisfactory explanation for the nature and source of the expenditure incurred from such cash credit.

Example: Mr. C borrows Rs. 5 lakhs on a hundi, which he cannot explain. The tax authorities invoke Section 69B and treat the unexplained borrowing as income of Mr. C for the relevant financial year.

Consequences of invoking Section 69C for Cash Credit:

If Section 69C is invoked for cash credit, the burden of proof lies with the taxpayer to explain the nature and source of the expenditure. If the taxpayer fails to provide a satisfactory explanation, the amount of the expenditure can be added to the taxpayer's income and taxed accordingly.

It is important for taxpayers to maintain proper records and documentation to support their expenditures, especially when it comes to cash credit transactions. This can help them provide a satisfactory explanation for the nature and source of the expenditure and avoid the consequences of invoking Section 69C. 

Example: Mr. D incurs an expenditure of Rs. 8 lakhs, which he cannot explain. The tax authorities invoke Section 69C and treat the unexplained expenditure as income of Mr. D for the relevant financial year.

Section 69D promissory note

Consequences of invoking Section 69D for Cash Credit:

If the tax authorities invoke section 69D for cash credit, the amount borrowed or repaid on a promissory note will be treated as unexplained income or investment. The amount will be added to the taxpayer's total income and taxed accordingly. In addition to this, a penalty of 100% to 300% of the tax amount may be levied under section 271AAA of the Income Tax Act, 1961, if it is found that the taxpayer has deliberately furnished inaccurate information or concealed income.

For example, if a taxpayer takes a loan of Rs. 10 lakhs from a person on a promissory note and is unable to explain the source of the funds, the amount of Rs. 10 lakhs will be added to the taxpayer's total income and taxed accordingly. If it is found that the taxpayer has deliberately furnished inaccurate information or concealed income, a penalty of 100% to 300% of the tax amount may be levied.

In conclusion, section 69D of the Income Tax Act, 1961 is an important provision related to cash credit transactions involving promissory notes. Taxpayers should ensure that they maintain proper records and provide satisfactory explanations for any unexplained funds borrowed or repaid on promissory notes to avoid adverse tax consequences.

IV Case laws related to cash credit.

Here's an explanation of the case laws related to cash credit transactions and their tax treatment:

CIT v. Divine Leasing & Finance Ltd.: In this case, the assessee had received certain amounts by way of cash credit entries in its books of accounts. The assessing officer had treated these amounts as unexplained cash credits under section 68 of the Income Tax Act, 1961. However, the CIT (Appeals) and the Tribunal had held that the assessee had provided sufficient explanation with regard to the source of these cash credits. The High Court held that the onus was on the assessee to prove the source of the cash credits and if the explanation was not satisfactory, the assessing officer was entitled to treat the same as unexplained cash credits.

Key takeaway: The onus is on the assessee to prove the source of cash credits, and if the explanation is not satisfactory, the assessing officer can treat them as unexplained cash credits.

Smt. Rajkumari Agarwal v. CIT: In this case, the assessee had received certain amounts by way of cash credit entries in her books of accounts. The assessing officer had treated these amounts as unexplained cash credits under section 68 of the Income Tax Act, 1961. The CIT (Appeals) and the Tribunal had held that the assessee had provided sufficient explanation with regard to the source of these cash credits. The High Court held that the assessing officer cannot disregard the evidence produced by the assessee, and if the explanation is found to be satisfactory, the cash credits cannot be treated as unexplained.

Key takeaway: The assessing officer cannot disregard the evidence produced by the assessee, and if the explanation is found to be satisfactory, the cash credits cannot be treated as unexplained.

CIT v. Sunil Kumar Agarwal: In this case, the assessee had received certain amounts by way of cash credit entries in his books of accounts. The assessing officer had treated these amounts as unexplained cash credits under section 68 of the Income Tax Act, 1961. The CIT (Appeals) and the Tribunal had held that the assessee had provided sufficient explanation with regard to the source of these cash credits. The High Court held that the Tribunal had erred in accepting the explanation of the assessee without examining the same in the light of the surrounding circumstances and other relevant material on record.

Key takeaway: The explanation provided by the assessee must be examined in the light of the surrounding circumstances and other relevant material on record.

CIT v. Lovely Exports Pvt. Ltd.: In this case, the assessee had introduced certain amounts in the form of share capital and share premium. The assessing officer had treated these amounts as unexplained cash credits under section 68 of the Income Tax Act, 1961. The CIT (Appeals) and the Tribunal had held that the assessee had provided sufficient explanation with regard to the source of these amounts. The High Court held that the explanation provided by the assessee was not satisfactory, and the assessing officer was justified in treating the amounts as unexplained cash credits.

Key takeaway: The explanation provided by the assessee must be satisfactory, and if it is not, the assessing officer can treat the amounts as unexplained cash credits.

Overall, the case laws related to cash credit transactions and their tax treatment highlight the importance of providing sufficient and satisfactory explanation with regard to the source of cash credits. If the explanation provided by the assessee is found to be satisfactory, the cash credits cannot be treated as unexplained. However, if the explanation is not satisfactory, the assessing officer can treat the cash credits as unexplained, which can have significant tax implications for the assessee.

V Conclusions

In conclusion, cash credit is a type of loan facility that allows a borrower to withdraw funds from a pre-approved credit limit. However, any sum found credited in the books of the taxpayer, for which he offers no explanation about the nature and source thereof or the tax authorities are not satisfied by the explanation offered by the taxpayer, is also termed as cash credit.

Under section 68 of the Income Tax Act, 1961, the taxpayer is required to prove the source of cash credit, failing which the sum credited may be added to the taxpayer's income and taxed accordingly. Additionally, sections 69, 69A, 69B, 69C, and 69D also provide for the tax treatment of various types of unexplained transactions, including cash credit transactions.

Proper documentation and record-keeping are critical for taxpayers to avoid scrutiny by tax authorities and demonstrate the source of cash credit. Failure to explain the source of cash credit can result in severe consequences, including additions to income and potential penalties.

In summary, it is essential for taxpayers to understand the tax treatment of cash credit under the Income Tax Act, maintain proper documentation and records, and seek professional assistance to avoid any adverse consequences.