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Section 68: Tax Treatment of Unexplained Cash Credits
Section 68 of the Income Tax Act, 1961 is a significant clause that is intended to guarantee that people and corporations reveal their income and assets clearly and openly. To discourage tax avoidance, this particular section concentrates on mysterious cash credits discovered in a taxpayer's books of accounts.
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Comprehending Section 68:
When a certain amount of money is credited to a taxpayer's books of accounts without a clear justification based on the taxpayer's income or other acceptable sources, Section 68 comes into effect. These inexplicable credits are regarded as the taxpayer's income for that specific year under this provision. It puts the burden of proof on the taxpayer to show that the cash credit is real and not a covert source of income.
Applicability
A variety of monetary credits are covered under Section 68, including advances, deposits, gifts, and loans. It is important to remember that monetary credits that are already covered by other provisions of the Income Tax Act, such as Section 41 or Section 56(2), are not covered by this section.
Section 68 essentially serves as a tool to guarantee accountability and transparency in financial transactions by requiring taxpayers to provide explanations for any cash credits that can raise concerns about their authenticity or source.
So, breaking down Section 68 in simpler terms, we get:
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If a taxpayer receives money credited to their account, they are required to provide the Assessing Officer (AO) with a satisfactory explanation of the amount's origins.
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The taxpayer must provide evidence that the amount credited does not represent their income.
The catch is this:
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If the taxpayer fails to submit an explanation or the AO finds the explanation inadequate, the amount in issue can be regarded as income and be liable to taxes.
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To put it simply, Section 68 highlights how crucial it is to clearly explain any occasions in which money appears in a taxpayer's records in order to make sure it isn't seen as unreported income.
Corporate Taxpayers' Provision:
Regardless of the term used in the company's records, there is a special regulation involving certain quantities of money, such as share application money, share capital, share premium, or other amounts, in the case of tightly held firms (those in which the public isn't heavily engaged).
The situation is as follows:
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If a large amount is credited, it is immediately regarded as suspicious until the individual listed on the company's records satisfactorily explains the situation to the Assessing Officer.
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To satisfy the Assessing Officer, the corporation must first confirm the identification of the individual listed in its records and then demonstrate the kind and source of the money in that individual's possession.
Here's the exception, though:
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This clause does not apply if the credit is in a business that is categorized under Section 10(23FB) as a venture capital fund or venture capital company.
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To put it simply, this clause mandates that tightly owned businesses must openly justify and substantiate the accuracy of certain credited amounts unless they qualify for the designated venture capital entity exemption.
Reason for the Introduction of the Special Provision
The reason behind introducing this special provision for closely held corporate taxpayers is to tackle potential tax evasion by companies. There were instances where companies would falsely list names of shareholders or third parties that didn't actually exist. This tactic was used to show that these non-existing entities were contributing money to the company as part of share-related transactions. Essentially, it became a way to park unaccounted or undisclosed money within these companies.
To counter this, the proviso places the responsibility on closely held companies to prove the legitimacy of the money received as share application money, share capital, share premium, or any similar amount. The onus of proof lies with the company to demonstrate that the funds invested genuinely belong to the person listed as providing the money. Failure to provide such proof may result in the money being treated as taxable in the hands of the company, categorized as unexplained cash credit under Section 68. This provision acts as a safeguard to ensure transparency and authenticity in financial dealings, preventing misuse of the system for illegal activities such as tax evasion.
Requirements to Meet for Section 68 of the Income Tax Act of 1961 to Apply
For section 68 of the Income Tax Act to be applicable, two requirements must be met. These prerequisites are:
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The assessee must provide the books for every account.
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It is necessary to enter credit in the books.
Key Elements of Section 68 of the Income Tax Act:
This section revolves around three crucial components:
Maintenance of Accounting Books:
A taxpayer must maintain organized books of accounts, which can include ledgers, cash books, and daybooks. These records mustn't be loose or unbound, indicating they are meant to be permanent and reliable.
Money Credited in the Taxpayer's Books:
The heart of Section 68 is the presence of cash credit in the taxpayer's books of accounts. This isn't limited to just cash; it extends to other valuable items like gold. Essentially, any credit entry, whether in the form of money or valuable items, falls under the purview of this section.
Inability to Provide Adequate Explanation:
A significant aspect of this section is the requirement for the taxpayer to offer a reasonable and sufficient explanation regarding the nature and source of the cash credit in their account books. The Assessing Officer must be satisfied with these explanations. If the taxpayer fails to provide a satisfactory explanation, Section 68 comes into play.
In essence, Section 68 emphasizes the importance of maintaining accurate books of accounts and being able to provide clear and satisfactory explanations for any cash credits, ensuring transparency in financial dealings.
Section 68 Taxability of Unexplained Credits:
This is how Section 68's explanation of unexplained cash credits operates:
Section 115BBE Tax Rate:
Although the taxpayer claims unexplained cash credits on its income tax return, this still means that it faces a huge rate of 60% in terms of taxes plus a surcharge totaling to 25 percent; and top cess amounting to another percentage at least 4. Consequently, the effective tax rate is currently 78%.
Findings made by the Evaluating Officer:
In case of unexplained cash credits found throughout the assessment, taxpayer will be liable to pay 60% higher rate plus surcharge and cess retaining a whopping additional combined effective rate of 78%.
Penalties in accordance with 271AAC:
10% of the tax determined under Section 115BBE is the penalty levied under Section 271AAC. However, there is no penalty if the individual pays the tax before the end of the prior year and discloses this revenue in their tax return. The effective tax rate stays at 78% in these circumstances.
No Deductions or Allowance for Expenditure:
It's crucial to remember that under Section 68, no deductions or allowances for expenses are allowed from such presumed income. Losses are also not deductable from this considered income.
Therefore, the effective tax rate is 78% if the income from unexplained cash credits is declared on the income tax return submitted under Section 139. On the other hand, Section 271AAC imposes an 84% effective rate of penalty (i.e., 10% of the tax owed under Section 115BBE) if the income is not revealed. This highlights how crucial it is to disclose such revenue honestly in order to prevent further fines.
Example Illustrating Unexplained Cash Credit under Section 68:
Scenario: Let's consider a scenario where 100 individuals, residing in a community, deposited Rs 2,00,000 each in their bank accounts and issued a cheque of Rs 2,00,000 to a closely held company, ABC Pvt. Ltd., as share application money. Unfortunately, these individuals are unable to provide a satisfactory explanation to the assessing officer regarding the source of the Rs 2,00,000, or the explanation offered is deemed unsatisfactory.
Now, in accordance with the proviso of Section 68:
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If a closely held company, such as ABC Pvt. Ltd., receives a sum credited as share application money, share capital, or share premium (totaling Rs 2 crores in this case),
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The residents, in whose names the credits are recorded, fail to offer a suitable explanation about the nature and source of income (Rs 2,00,000),
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If the explanation provided by these residents is found unsatisfactory by the assessing officer,
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It leads to a deemed conclusion that the company's explanation regarding the credited sum (Rs 2 crores) is unsatisfactory. Consequently, Rs 2 crores is treated as income of the company under Section 68 as an unexplained credit.
As per Section 115BBE:
The company is liable to pay tax at a rate of 60%, along with a 25% surcharge and a 4% cess, resulting in an effective tax rate of 78% on the deemed income of Rs 2 crores. This amounts to Rs 1,56,00,000.
Additionally, under Section 271AAC:
The company incurs a penalty of 10% of the income tax, i.e., 10% of Rs 1,56,00,000, equaling Rs 15,60,000.
Impact on Residents:
The tax implications on the residents are as follows:
The residents lose the benefit of tax slabs on Rs 2,00,000, and the entire amount is taxed at a flat rate of 78%. Each resident is liable to pay a tax of Rs 1,56,000.
Additionally, a penalty of 10% of the tax payable under Section 115BBE, i.e., Rs 15,600, is imposed. However, this penalty is waived if the residents pay the tax of Rs 1,56,000 and include the Rs 2,00,000 in their income tax return before the end of the previous year.
Important Things to Keep in Mind About Section 68 of the Income Tax Act
Suggested Payment Options:
It is best to use account payee checks or demand drafts when receiving payments. These techniques help establish the payer's identity and source in addition to guaranteeing a traceable trail of transactions.
Keeping Accurate Records:
Taxpayers are required to keep correct and well-organized "books" of accounts in order to invoke Section 68. Since they are readily replaceable, loose sheets or fragments are not regarded as dependable. It is important to maintain organized, thorough records.
Who Owns the Accounts?
The taxpayer should be the owner of the book of accounts that contains any unexplained cash credit. This highlights how crucial it is to have precise and customized records.
Potential inquiries for the evaluating officer:
Possible Questions from the Assessing Officer:
During an assessment, an Assessing Officer may ask questions concerning a variety of topics, such as the lender's bank account, payment methods, and supporting documentation for the transaction or cash flow statement. Taxpayers should gather important data, such as the lender's address and PAN number, to be ready.
Essentially, in order to conform with Section 68, one must have complete and authentic books of accounts that are directly linked to the taxpayer in addition to collecting payments via traceable ways. One's ability to satisfy the criteria of this section may be further strengthened by being prepared to respond to inquiries from the Assessing Officer and by possessing the relevant data on the lender.
Conclusion
In conclusion, it can be stated that Section 68 of the Income Tax Act is an important tool for ensuring accountability and transparency in financial transactions. It concerns cases where a taxpayer’s books of accounts have monetary credits that are unexplained, and it is his or her duty to give an acceptable reason. This section is critical in curbing system abuse and tax evasion. In addition, the provision that is solely for taxpayers who are closely held corporations discourages the stashing of unreported funds in companies. It indicates how vital is to have viable books of accounts and clear explanations in order not to impose fines, high tax rates, or refusal for deductions. Alternatively, Section 68 stresses the importance of honesty as well as transparency in financial transactions aimed at ensuring compliance with the Income Tax Act and promoting a fair taxation system.
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Frequently Asked Questions
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What is the main purpose of Section 68 of the Income Tax Act?
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Section 68 aims to ensure individuals and corporations transparently disclose their income by addressing unexplained cash credits in their books of accounts, placing the responsibility on the taxpayer to prove the legitimacy of such credits.
Q
What types of monetary credits are covered under Section 68?
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Section 68 covers a range of credits, including advances, deposits, gifts, and loans. However, credits already covered by other provisions like Section 41 or Section 56(2) are not included.
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How does Section 68 impact corporate taxpayers?
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For closely held firms, Section 68 places the burden on them to prove the legitimacy of large credits, such as share application money, share capital, or share premium, by confirming the identity and demonstrating the source of the credited amounts.
Q
Why was the special provision introduced for closely held corporate taxpayers?
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The provision addresses potential tax evasion by requiring closely held companies to prove the legitimacy of funds received, preventing the misuse of listing non-existing entities as contributors to the company.
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What are the prerequisites for Section 68 to be applicable?
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To apply, the assessee must maintain proper books of accounts and credit entries in those books.
Prachi Jain
Chartered Accountant
Prachi Jain is a Chartered Accountant with a passion for simplifying finance and tax-related matters through her insightful and informative blogs. With a background in finance and a deep understanding of tax regulations, Prachi has established herself as a trusted source of financial wisdom. Prachi is committed to empowering her readers with the knowledge they need to make informed financial decisions. Her expertise and dedication shine through in every blog post, helping her audience navigate the intricacies of finance and taxes with confidence. Follow Prachi Jain's blog for practical insights and guidance on managing your finances effectively.
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