written by | June 1, 2022

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Table of content


Table of content

What is Cash Credit under Section 68?

Section 68 was created under the 1961 Income Tax Act. Its establishment was important to protect revenue interests. This was because the taxpayer was involved with tax fraud to steal tax. Over time, various changes were made to this section to increase its applicability and reveal the accommodation entries, cash credit entries, black money and other tax practices.

Taxpayers hide their income by diverting cash receipts to show them as unsecured loans or any other form in the books. This prevents the payment of tax on business receipts. This is tax theft, resulting in the loss of tax revenue for the Indian government.

Did You Know?

While cash credit is renewed every year in terms of a business, the access of the account holder to overdraft securities is reviewed yearly and might or might not be re-approved.

What Is Section 68 of the Income Tax Act?

The income tax act provides for the taxation of unaccounted sums. For instance, when an individual file his income tax return and avails of the tax slab benefits but cannot prove the source of the income, he may fall foul of section 68. In such a case, the Assessing Officer rejects the explanation as not satisfactory. 

He may even resort to litigation. But such actions will entail unnecessary litigation. Fortunately, there are some exceptions to this rule. Some itemised deductions will not raise the section 68 ceiling, including medical expenses and casualty losses. Similarly, investment interest will not raise the ceiling under section 68

This is especially helpful to those with low-targeted deductions and no deductions at all. Nonetheless, taxpayers should be aware of this provision before filing their taxes. Otherwise, it can result in a large tax adjustment.

The Act was introduced to stop the circulation of unaccounted money. It requires the source of funds to be satisfactorily explained and proved beyond a reasonable doubt. It will take effect on April 1, 2023, and will apply to assessment years 2023-24. The new section 68 rules were adopted by the Finance Act 2012.

  • To avoid paying taxes on a large amount of cash, it is important to understand the implications of section 68. For example:
  • The assessee cannot claim that the cash credit is purely a loan or a payment.
  • The assessee is obligated to prove the third-party lending position to satisfy the Income-tax Officer. Alternatively, the assessor may be able to claim the entire amount as income even if the cash credit did not accrue.

Also Read: What Is Section 193 in TDS?

Background of Unexplained Cash Credit

Income tax is a tax the central government assesses on income earned by individuals or businesses during a fiscal year. The government generates revenue from taxes. The government uses this revenue to provide healthcare, education, infrastructure development and subsidies for farmers/agriculture. It also helps fund other welfare programs.

There are two main types of taxes: 

Direct tax is a tax that is levied on income earned. Income tax is an example of a direct tax. The income slab rates that were applicable in the year of the income are used to calculate tax. 

People often adopt tax evasion measures to reduce tax outflow. This leads to the black cash. With huge amounts of cash at taxpayers' disposal, tax-evading has also increased due to an improved economic situation over time.

It is, therefore, imperative that the government tackles tax evasion and brings all money into the tax bracket that is avoiding tax levy. Recent measures taken by the government include Income Disclosure Scheme (IDS) and the great and historic "demonetisation". 

Unexplained Cash Credit (Section 68)

Suppose any amount is found to have been credited in books maintained by an assessee for any year. The assessee does not offer any explanation or reason that is satisfactory in his opinion. In that case, the amount so credited could be subject to income tax in the form of the income of that assessee in that year.

If the assessee is not a company, and the amount so credited includes share capital, share application cash, or share premium, then any explanation given by the assessee-company will be considered unsatisfactory, except

  • The person who is a resident and whose credit has been recorded in the company's books. Also, the explanation of the source and nature of the sum so credited. 
  • Such an explanation as the Assessing Officer has deemed satisfactory.  

The first provision is not applicable if the individual in whose name is recorded the sum is a venture fund or venture capital organisation, as defined in clause (23FB).

Special Provision in the Corporate Taxpayers Case

To avoid tax evasion, a special provision has been made for closely held corporations' taxpayers. Companies that list the names of nonexistent shareholders/third parties as having paid company share-related money can conceal unaccounted money. This is an alternative to companies that are subject to strict regulation under company law provisions.

In simple words, a closely held company shall explain why any amount credited to share application cash or share premium will be deemed unsatisfactory unless:

  • The person whose name is used to record such an amount in the records of the company gives explanations about the source and nature of the sum;  
  • The Assessing Officer is satisfied with the explanation.  

The above-mentioned special provision is not applicable if the individual in whose name the amount is noted in such company's books is a venture fund or venture capital organisation, according to Section 10(23FB).

Taxability of Unexplained Cash Credit

Unexplained cash credit is considered income for the year it is received. Also, Unexplained cash credits are subject to tax at a flat rate of @60%, without any benefit exemption limitations, and regardless of the tax slab. Also, surcharge @25%, penalty @6%. The final tax calculation will halt at @83.25%. It also includes cess.  

There is no deduction or allowance and no loss that can be offset against unexplained cash credit, which is income. Also, unexplained cash credit involved in the income return and tax paid before the end or beginning of the financial year does not attract a penalty.

Unexplained Tax Deduction on Cash Credits

Unexplained cash credits are subject to tax under 115BBE of Income Tax Act 1961 at the 60% higher rate surcharge plus cess, which is 78% without deductions. 

The main purpose of the similar provision is to impose higher tax rates than normal so that taxpayers don't hide their income. To ensure that the other assessee does not see the taxpayer hiding income, the tax rate was increased from 30%-60% to penalise tax evaders.

Section 68 of the Income Tax Act Is Applicable

Section 68 applied when the taxpayer maintained the books of accounts, and any amount revealed was credited to the books for the previous year. If the taxpayer does not provide an explanation for these cash credits, or if the taxpayer is unwilling to give it, the section will apply to the taxpayer. This section applies to all credit entries made in the taxpayer's books.

Also Read: The Income Tax Act, Section 206AB

Finance Bill, 2022

What does section 68 mean for masquerade loans and borrowings? It has been proposed to introduce a 'Clarificatory amendment' to the law to stop the dangerous practice of converting unaccounted money via crediting through a disguise of loan or borrowing. 

This will allow the nature and source for any sum, regardless of whether it is in loans or borrowings, to be treated as 'explained' if the creditor or provider of entry explains. The amendment proposed will be effective from April 1, 2023, and will apply to the assessment years 2023-24.

Conclusion

A top official recently assured that the proposed amendments were only anti-evasion measures targeted at tax evaders and will not harass genuine taxpayers. Section 68 plays a crucial role in determining 'revenue'. 

Individual assesses and companies will find it very difficult to engage in tax evasion. It is important to remember Nani Palkhivala's words. "If widespread tax evasion is occurring, it may prove more effective to look for the source in the tax system rather than the taxpayer." 

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FAQs

Q: Is it possible to resolve unexplained credit through the Vivaad SE Vishwas program?

Ans:

Yes. Promoters of companies that received notices u/s 68 during demonetisation may settle the litigation. This can be done through the Vivaad se Vishwas Scheme subject to the fulfilment of the terms of the scheme.

Q: What is an unexplained cash loan?

Ans:

If the assessee cannot explain the amount credited to his books, kept for previous years, or if the explanation offered is not satisfactory in the assessment officer's view, the amount so credited could be subject to income tax. This credit is known as unexplained credit.

Q: Is section 68 applicable only to cash transactions or all?

Ans:

Section 68 does not just apply to cash transactions but also to amounts received by cheques or drafts. Section 68 defines the following words: "any sum found credited to the books of assessee maintained for any prior year." This sum of money does not mean only cash transactions.

Q: What is section 68 of the Income Tax Act?

Ans:

According to section 68, if any amount was found credited in the taxpayer’s books, then for which the taxpayer did not explain the source, in the Assessing Officer’s opinion, they may face charges of income tax according to the taxpayer’s income in that year.

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