CASH CREDITS

Cash Credits is dealt with under section 68 of The Income Tax Act 1961

Bare Act
Bare Act is reproduced as follows

“Where any sum is found credited in the books of an assessee maintained for any previous
year, and the assessee offers no explanation about the nature and source thereof or the
explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the
sum so credited may be charged to income-tax as the income of the assessee of that
previous year

Provided that where the assessee is a company (not being a company in which the public
are substantially interested), and the sum so credited consists of share application money,
share capital, share premium or any such amount by whatever name called, any explanation
offered by such assessee-company shall be deemed to be not satisfactory, unless—

(a) the person, being a resident in whose name such credit is recorded in the books of such
company also offers an explanation about the nature and source of such sum so credited;
and

(b) such explanation in the opinion of the Assessing Officer aforesaid has been found to be
satisfactory:

Provided further that nothing contained in the first proviso shall apply if the person, in whose
name the sum referred to therein is recorded, is a venture capital fund or a venture capital
company as referred to in clause (23FB) of section 10.”

Explanation of the above

As per section 68, any sum found credited in the books of a taxpayer, for which he offers no
explanation about the nature and source thereof or the explanation offered by him is not, in
the opinion of the Assessing Officer, satisfactory, may be charged to income-tax as the
income of the taxpayer of that year.
In case of a taxpayer being a closely held company (i.e., not being a company in which the
public are substantially interested), if the sum so credited consists of share application
money, share capital, share premium or any such amount by whatever name called, any
explanation offered by such company shall be deemed to be not satisfactory, unless:

(a) the person, being a resident in whose name such credit is recorded in the books of such
company, also offers an explanation about the nature and source of such sum so credited;
and

(b) such explanation in the opinion of the Assessing Officer has been found to be
satisfactory.

The above discussed provisions of share application money, share capital, etc., shall not
apply if the person, in whose name such sum is recorded, is a venture capital fund or a
venture capital company as referred to in section 10(23FB).

Conditions to be satisfied for applicability of section 68

Assessee has maintained 'books'

The first condition necessary for invocation of the power is the existence of the
books of account.
In Anand Ram Raitani v. Commissioner of Income-tax High Court Of Gauhati held
that under Section 68 of the Act where any sum is found credited in the books of an
assessee maintained for any previous year, and the assessee offers no explanation
about the nature and source thereof or the explanation offered by him is not, in the
opinion of the Assessing Officer, satisfactory, the sum so credited may be charged to
income-tax as the income of the assessee of that previous year. The Assessing
Officer before invoking the power under Section 68 of the Act must be satisfied that
there are books of account maintained by the assessee and the cash credit is
recorded in the said books of account and if the assessee fails to satisfy the
Assessing Officer, the said sum so credited has to be charged to income-tax as the
income of the assessee of that previous year. The existence of books of account is a
condition precedent for invoking of the power.

Books of Accounts of partnership firm and partners are different:

Section 68 applies where the books of the assessee show a cash credit entry. The term
“assessee” has been defined by Clause (7) of Section 2 to mean a person by whom any tax
or any other sum of money is payable under this Act. Section 2(31) defines the expression
“persons” to include an individual, a Hindu undivided family, a company, a firm or
association, etc. The I.T. Act makes a distinction between an individual as a person who is
liable as an assessee on the one hand and a firm on the other being as much an entity liable
to assessment independently of the individuals who may constitute its partners. When
Section 68 uses the term “books of an assessee”, it refers to the assessee whose books
show the cash credit entry. A partnership firm is an assessable entity distinct from the
individual partner. The books of account of a partnership cannot be treated as those of the
individual partner. And in the case of the firm, the books maintained by the firm should show
a cash credit entry and the firm’s explanation should be found unsatisfactory, then only
Section 68 will entitle the ITO to include the amount of the entry as the income of the
assessee-firm. The above position of law is enunciated from the principle that a partnership
firm is an assessable entity distinct from its individual partners constituting the firm.

A credit entry in the books of account is must

The provisions of sections 68 and 69 were introduced in order to check bogus entries which
are resorted to by firms in order to raise the corpus of the firm and the money which is being
invested may not come from a valid source. Both these Sections were engrafted so as to
raise a statutory presumption in the event of unsatisfactory explanation of those entries. This
was with a view to check the evil of illegal bogus entries. For the purpose of avoidance of
tax, certain black money of the firm is sought to be invested in the names of bogus persons
so as to convert it into white investment. Therefore, law has made such a strong presumption
so as to deter this kind of tendency. A close reading of both these Sections makes it clear
that in Section 68, there should be a credit entry in the books of account, whereas in Section
69, there may not be an entry in the books of account. This is a fundamental difference
between the two provisions. In the case of Section 69 only where investment has been made
but has not been satisfactorily explained, the income should be treated to be the income of
the assessee whereas in the case of Section 68, there should be a book entry and if that
book entry is not satisfactorily explained, then it should be treated as income of the
assessee. In Nanak Chandra Laxman Das v. CIT the Allahabad High Court has taken the
same view that: Where any sum is found credited in the books of the assessee, the initial
onus is on the assessee to offer an explanation of the nature and source of a cash credit. If
the explanation is not found satisfactory or reasonable, the Income-tax Officer can treat such
money as the assessee’s income from undisclosed sources. It is not necessary for the
Income-tax Officer to locate the exact source of the credits. The assessee can prove the
genuineness of the credits by establishing from some plausible evidence the identity of the
creditor and his creditworthiness. In CIT v. Kishorilal Santoshilal it was held that: In the case
of cash credits in the accounts of a firm (i) there is no distinction between the cash credit
entry existing in the books of the firm whether it is of a partner or of a third party; (ii) the
burden to prove the identity, capacity and genuineness is on the firm; (iii) if the cash credit
is not satisfactorily explained, the Income-tax Officer is justified to treat it as income from
undisclosed sources; (iv) the firm has to establish that the amount was actually given by the
lender; (v) the genuineness and regularity in the maintenance of accounts has to be taken
into consideration by the taxing authorities, and (vi) if the explanation is not supported by
any documentary or other evidence, then the deeming fiction created by Section 68 of the
Income-tax Act, 1961, can be invoked.

The absence of a satisfactory explanation by the assessee about the nature and source of
the sum credited.

A. Assessee can furnish alternative explanations:

Section 68 provides that where any sum is found credited in the books of an assessee
maintained for any previous year, and the assessee offers no explanation about the nature
and source thereof or the explanation offered by him is not, in the opinion of the ITO,
satisfactory, the sum so credited may be charged to income-tax as the income of the
assessee of that previous year. The section, on a proper construction, does not debar the
assessee from offering alternative explanations and if either of them is accepted, the cash
credit cannot be charged as the income of the assessee. Therefore, an assessee can furnish
alternative explanations, and if any one of them is accepted, the cash credit cannot be
charged as the income of the assessee.

B. Assessing Officer “must” be satisfied:

The section requires that the assessing officer must be satisfied that the explanation offered
by the assessee is genuine. Section 68 of the Act does not stop at advancing of explanation
about the nature and source of any sum found credited in the books by the assessee; the
Assessing Officer is also required to be satisfied that the explanation offered by the
assessee is acceptable and/or in other words, genuine. When the law has given to the
Assessing Officer discretion and it is his satisfaction upon which genuineness has to be
decided, his inference on the basis of the facts is a finding of fact. In CIT v. Daulat Ram
Rawatmull, the Supreme Court held that the fact that the depositor had not been able to give
a satisfactory explanation regarding the source of deposit would not be decisive even of the
matters as to whether the depositor was or was not the owner of the amount, that a person
could still be held to be the owner of a sum of money even though the explanation furnished
by him regarding the source of that money was found to be incorrect, and that from the
simple fact that the explanation regarding the source of the money had been found to be
false, it would be a remote and farfetched conclusion to hold that the money belonged to the
assessee.

C. Unexplained cash credit “may” be charged to income-tax:

The section requires that the assessing officer must be satisfied that the explanation offered
by the assessee is genuine; but it also provides that in the absence of a satisfactory
explanation, the unexplained cash credit “may” be charged to income tax- therefore, the
unsatisfactory explanation does not automatically result in deeming the amount credited in
the books as income of the assessee. The phraseology of section 68 is clear. The
Legislature has laid down that in the absence of a satisfactory explanation, the unexplained
cash credit may be charged to income-tax as the income of the assessee of that previous
year. The legislative mandate is not in terms of the words “shall be charged to income-tax
as the income of the assessee of that previous year”. In CIT v. Smt. P. K. Noorjahan, the
Supreme Court while interpreting similar phraseology used in section 69 has held that in
creating the legal fiction the phraseology employs the word “may” and not “shall”. Thus the
unsatisfactoriness of the explanation does not and need not automatically result in deeming
the amount credited in the books as the income of the assessee. Therefore, according to
Section 68, the first burden is on the assessee to satisfactorily explain the credit entry in the
books of account of the previous year. If the explanation given by the assessee is
satisfactory, then that entry will not be charged with the income of the previous year of the
assessee. In case the explanation offered by the assessee is not satisfactory or the source
offered by the assessee-firm is not satisfactory, then in that case, the amount should be
taken to be the income of the assessee.

Burden of Proof and Extent of Onus:

Onus on assessee to prove the source and nature of receipt: The onus of proving the
source of a sum of money found to have been received by an assessee is on him. If he
disputes the liability for tax, it is for him to show either that the receipt was not income or
that if it was, it was exempt from taxation under the provisions of the Act. In the absence of
such proof, the Revenue is entitled to treat it as tax able income. In A. Govindarajulu
Mudaliar v. CIT the Court came to the conclusion that: “There is ample authority for the
position that where an assessee fails to prove satisfactorily the source and nature of certain
amount of cash received during the accounting year, the Income-tax Officer is entitled to
draw the inference that the receipt are of an assessable nature.” In Kale Khan Mohammad
Hanif v. Commissioner of Income-tax the Supreme Court, in answering the question
“Whether the burden of proving the source of the cash credit is on the assessee” observed
that: “It is well established that the onus of proving the source of a sum of money found to
have been received by the assessee is on him. If he disputes liability for tax it is for him to
show either that the receipt was not income or that if it was, it was exempt from taxation
under the provisions of the Act. In the absence of such proof, the Income-tax Officer is
entitled to treat to as taxable income.”

Shifting of onus to the department: The language of section 68 shows that it is general in
nature and applies to all credit entries in whomsoever name they may stand, that is, whether
in the name of the assessee or a third party. This section has, therefore, removed the
distinction which was drawn in some decisions between the credits held in the name of the
assessee and those held in the name of a third party. Under Section 68 now the assessee
has to prove that such third party was in a position to lend such sums and that he did, in
fact, so lend to the assessee in order to satisfy the Income-tax Officer that the credits shown
in the account books were genuine. This section has laid the onus of proof on the assessee.
In Orient Trading Co. Ltd. v. Commissioner of Income-tax one of the questions referred to
the Bombay High Court was whether there was any material before the Tribunal to hold that
a sum standing in the books of the assessee to the credit of a third party belonged to the
assessee. The Bombay High Court discussed the nature and significance of cash credits in
such cases and observed as follows: When cash credits appear in the accounts of an
assessee, whether in his own name or in the name of third parties, the Income-tax Officer is
entitled to satisfy himself as to the true nature and source of the amounts entered therein,
and if after investigation or inquiry he is satisfied that there is no satisfactory explanation as
to the said entries, he would be entitled to regard them as representing the undisclosed
income of the assessee. When these credit entries stand in the name of the assessee
himself, the burden is undoubtedly on him to prove satisfactorily the nature and source of
these entries and to show that they do not constitute a part of his business income liable to
tax. When, however, entries stand, not in the assessee’s own name, but in the name of third
parties, there has been some divergence of opinion expressed as to the question of the
burden of proof. The Income-tax Officer’s rejection not of the explanation of the assessee,
but of the explanation regarding the source of income of the depositors, cannot by itself lead
to any inference regarding the non-genuine or fictitious character of the entries in the
assessee’s books of account. Treatment of Explanation by the assessee. The length of time
taken after assessee is called upon to explain a cash credit is also a relevant factor in
considering whether the evidence produced is satisfactory. Inability of the department to
verify the explanation offered by the assessee is not a sufficient cause for rejection of the
explanation. At the same time, it is not correct to say that the AO is not entitled to reject the
explanation without some other positive evidence falsifying the assessee’s case. The true
test is that, while the AO is not bound to accept as true any possible explanation which the
assessee may put forth, he cannot also arbitrarily reject the assessee’s explanation. Section
68 of the Act does not stop at advancing of explanation about the nature and source of any
sum found credited in the books by the assessee; the Assessing Officer is also required to
be satisfied that the explanation offered by the assessee is acceptable and/or in other words,
genuine.

Rejection of explanation by the AO:

In Sona Electric Co. v. Commissioner of Income-tax, the Court held that the section makes
it clear that the entry can be rejected if the explanation offered by the assessee can be
rejected by the ITO on cogent grounds. When such grounds are themselves based on no
evidence, the question of presumption does not arise. However, it was not open to the
Assessing Officer to merely surmise that it would not be probable for the assessee to keep
the amount unutilised for a period of two years. The AO ought to have given an opportunity
to the assessee to substantiate his assertion.
Result of Rejection of Assessee’s Explanation:
In K.S. Kannan Kunhi v. Commissioner of Income-tax it was held that it is not the law that,
when once the explanation is rejected, it automatically follows that the receipts are income.
Whether an explanation is acceptable, and if not, whether it should be inferred that the
receipts constitute income, are different aspects of the same question. Both these aspects
are interrelated, and the question whether such receipts constitute income or not has to be
decided on a consideration of all the relevant facts and circumstances of the case. It is quite
legitimate in the case of an assessee who is known to be carrying on several activities of an
income-earning character or who can reasonably be found to be involved in such activities,
to draw the inference that the amounts found with him constitute income from undisclosed
sources, in the absence of satisfactory explanation regarding their source. Such an
inference should not be readily made in the case of a person, who has no known business
or other source of income, or who cannot even be reasonably suspected as engaged in any
income-earning activities. In the latter case, there must be more substantial reasons to reject
the assessee’s explanation, and draw the inference that the amounts found with him
constitute income.

Tax Implications

Tax rates to be applied and other provisions are laid down in S 115BBE of The Income Tax
Act 1961.

As per Section 115BBE, income tax shall be calculated at 60% where the total income of
assessee includes following income:

a) Income referred to in Section 68, Section 69, Section 69A, Section 69B, Section 69C or
Section 69D and reflected in the return of income furnished under Section 139; or

b) Which is determined by the Assessing Officer and includes any income referred to in
Section 68, Section 69, Section 69A, Section 69B, Section 69C or Section 69D, if such
income is not covered under clause (a).

Such tax rate of 60% will be further increased by 25% surcharge, 6% penalty, i.e., the final
tax rate comes out to be 83.25% (including cess). Provided that such 6% penalty shall not
be levied when the income under Section 68, 69, etc., has been included in return of income
and tax has been paid on or before the end of relevant previous year.
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.