Section 68 deals with unexplained cash credit. According to section 68 of the Income Tax Act of 1961, if any sum is found credited in an assessee’s books of accounts for any previous year, and the assessee could not provide any explanation about the source and nature of the sum, or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the sum may be charged to income-tax as the assessee’s previous year’s income.
As a result, Section 68 of the Income Tax Act expressly requires explanations as to the source and character of any cash credited to the assessee’s books.
History of Unexplained Cash Credit’s
- Salary, house property, business/profession income, capital gains, and income from other sources are the five types of income that are taxed. Except for capital gains, all of the income categories deal with revenue. The capital gains tax is concerned with the taxation of capital assets.
- The basic rule of income taxation is that unless specifically exempted, all income is taxed (i.e. made not taxable). Capital gains are not taxable unless they are brought into a specified tax category. Any income a taxpayer earns or receives must be reported to the IRS in the fiscal year in which it is earned or received.
- It is a well-known truth that people seek out and use tax evasion methods to reduce tax outflow, resulting in the amassing of black money. Given the improving economic situation throughout time, tax evasion tactics have also increased, owing to the large sums of money available to taxpayers.
- As a result, it is critical for the government to combat tax evasion and bring all of the money that has escaped taxation into the tax bracket. The government has lately implemented a number of policies, including demonetization and the Income Disclosure Scheme (IDS). Apart from the aforementioned steps, the Income Tax Act contains a number of provisions aimed at closing loopholes and tracking unexplained cash credits.
Section 68: Unexplained Cash Credit
What is ‘Unexplained Income’ as per Section 68 of the Income Tax Act?
- Unaccounted cash credit in the form of loans, advances, deposits, share capital, and other forms is traditionally dealt with under Section 68. Unexplained income or unexplained cash credit simply refers to any income or credit for which the Assessee has no valid explanations for the source or nature of the money and for which it was not disclosed for income tax purposes.
- Alternatively, if the Assessee provides an explanation but the Assessing Officer is not satisfied, the income will be treated as unexplained income and subject to income tax for the year in which it was received. Unless it is specifically exempted by tax regulations, all amounts credited to the taxpayer must be offered to tax. If the taxpayer does not offer such credit to tax, the taxpayer must explain why the credit is not being offered to tax and what the source of the credit is. Knowing the source of income is important since it may belong to a third party (i.e., someone other than the taxpayer) and may have to be taxed in their hands.
- It may have to be taxed in the hands of the third party since he may have diverted monies to the taxpayer in order to avoid paying taxes. As a result, if the following requirements are met, Section 68 considers any money credited in the books of a taxpayer in any financial year and not already offered to tax as income of the taxpayer for that financial year: The taxpayer does not explain the nature or source of the credit. In the opinion of the assessing officer, the taxpayer’s explanation of the nature and source of such credit is insufficient. Such credit is referred to as unexplained cash credit.
Special Provision for Corporate Taxpayers
- Any explanation provided by a closely held corporation (a company in which the general public has little or no interest) in relation to any sum credited as share application money, share capital, share premium, or any other amount shall be regarded unsatisfactory unless:
- The person whose name is on the books of such company provides an explanation of the nature and source of the money credited; and such an explanation, according to the assessing officer, is adequate.
- However, if the person in whose name the money is entered in the accounts of such firm is a venture capital fund or a venture capital company as defined in Section 10, the above-mentioned special provision will not apply.
- A special provision is designed for closely held corporate taxpayers to prevent tax evasion by companies that list the names of non-existing shareholders/third parties as having paid the company share related money, which is a mechanism for parking unaccounted money in companies that are not subject to the same stringent regulations as widely held companies.
Applicability of Section 68 of the Income Tax Act
Section 68 of the Income Tax Act of 1961 will apply in the following situations:
1) A payment is credited to the Assessee’s books and is subject to income tax.
2) The Assessee did keep books of accounts, such as ledgers, cash books, daybooks, and so on, as required by Section 2(12A).
3) The Assessee was unable to provide any information regarding the nature and source of these financial credits.
4) The Assessing Officer was not satisfied with the assessee’s explanation.
5) The money was not included in the Assessee’s total income for the preceding year.
6) The Assessee provided no documentary documentation to back up the amount credited to his books of account.
Key elements of Section 68 of Income Tax Act
Section 68 of the Income Tax Act of 1961 contains the following key elements:
The powers conferred on Section 68 of the Income Tax Act can only be used if the following three fundamental elements are present:
1. The existence of accounting books:
The first and most important requirement of Section 68 is that the Assessee keep books of accounts. Ledgers, Cash Books, Day Books, and other books are examples of books of accounts, but they do not contain loose sheets/unbound papers that are not bound to form a permanent book.
2. A cash credit in the Assessee’s books of accounts:
The second most important aspect of Section 68 is that there is a cash credit in the Assessee’s books of accounts. Because this part is comprehensive, other items such as gold and valuable items are included as credit entries. As a result, it is not restricted to cash and cash credits.
3. Assessee’s failure to provide sufficient and reasonable reasons:
The third critical aspect of Section 68 is the Assessee’s failure to provide sufficient and reasonable explanations to the Assessing Officer’s satisfaction.
If documentary evidence is required to support the cash credit in his books of accounts, the Assessee must submit it. However, failure to do so may result in the A.O. invoking Section 68.
Unexplained Cash Credit Taxability
Unexplained monetary credit is recognized as income in the year it is received, as previously stated. Unexplained cash credits are taxed at a flat rate of 60%, regardless of the tax bracket, and without any benefit of the basic exemption limit. A 25% surcharge is imposed, as well as a penalty of 6%. The overall tax rate is 83.25 percent (including cess).
There can be no deductions or allowances, and no loss can be offset against such an unexplained cash credit that is considered income. If an unexplained cash credit is already included in the return of income and the tax on it is paid on or before the end of the financial year, no penalty is imposed.
Important Points to Keep in Mind
- It is preferable to accept payments via account payee check or demand draught, as this allows the taxpayer to verify the payer’s identity.
- The assessing officer may request numerous details such as the mode of payment, the lender’s bank account documenting the transaction/cash flow statement, and so on. It’s a good idea to have the depositor’s address and PAN so you can get the relevant paperwork as needed.
- It is necessary to have ‘books’ in order to activate Section 68. Because loose sheets or scraps of paper can be easily separated and replaced, they are not considered books.
- The taxpayer’s books of accounts must contain unexplained cash credits.