Finance Bill, 2022 has amended the provisions of section 68 of the Income-tax Act, 1961 (‘Act’) to provide for disclosing the ‘source of source’ of loans and borrowings by the assessee and in case of failure to prove the ‘source of source’, the same will be taxed as undisclosed income.
Existing Provisions of Section 68
Section 68 of the Act provides that if any sum is found credited in the books of an assessee and such assessee either
(i) does not offer any explanation about nature and source of money; or
(ii) the explanation offered by the assessee is found to be not satisfactory by the Assessing Officer,
then, such amount can be taxed as income of the assessee.
The onus of satisfactorily explaining such credits remains on the person in whose books such sum is credited. If such person fails to offer an explanation or the explanation is not found to be satisfactory then the sum is added to the total income of the person.
Finance Act, 2012 has added the first proviso whereby it is provided that the nature and source share application money, share capital, share premium or any such amount by whatever name called, credited in the books of a closely held company shall be treated as explained only if the source of funds is also explained in the hands of the shareholder.
The second proviso states that the above shall not apply in the case of a Venture Capital Fund, Venture Capital Company registered with SEBI.
Proposed Amendment to section 68
Finance Bill, 2022 proposes to amend the provisions of section 68 to extend the provisions of the first proviso to section 68 to loans and borrowings. In other words, the proposed amendment seeks to explain the ‘source of source’ of funds in respect of loans and borrowings too, in addition to share capital.
For this purpose, Clause 17 of the Finance Bill, 2022 proposes to amend section 68 in the following manner:
Amendment of section 68.
17. In section 68 of the Income-tax Act, with effect from the 1st day of April, 2023––
(i) in the first proviso, for the words “Provided that”, the following shall be substituted, namely:––
“Provided that where the sum so credited consists of loan or borrowing or any such amount, by whatever name called, any explanation offered by such assessee shall be deemed to be not satisfactory, unless—
(a) the person in whose name such credit is recorded in the books of such assessee 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”;
(ii) in the second proviso,––
(a) for the words “Provided further”, the words “Provided also” shall be substituted;
(b) for the words “first proviso”, the words “first proviso or second proviso” shall be substituted.
Explaining the amended provisions
Clause 17 seeks to amend section 68 of the Income-tax Act relating to cash credits.
The provisions of the said section provide that where any sum is found to be 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.
It is proposed to insert a new proviso to the said section to provide that where the sum so credited consists of loan or borrowing or any such amount by whatever name called, any explanation offered by the assessee shall be deemed to be not satisfactory unless (a) the person in whose name such credit is recorded in the books of the assessee 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 and consequential amendments in the other provisos.
The first proviso would not apply if the creditor is a Venture Capital Fund or Venture Capital Company.
These amendments will take effect from 1st April, 2023, and will, accordingly, apply in relation to the assessment year 2023-2024 and subsequent assessment years.
Rearrangement of provisos
There has been a reshuffle in the numbering of the proviso to section 68. The existing first proviso will become the second proviso and the existing second proviso will be shifted as the third proviso. The new proviso is proposed to be inserted as the first proviso.
Stated Objectives for introducing the proposed amendment in section 68
The Memorandum states that the onus of satisfactorily explaining credits of any amount in the books of the assessee remains on the person in whose books such sum is credited.
If such person fails to offer an explanation or the explanation is not found to be satisfactory then the sum is added to the total income of the person.
Certain judicial pronouncements have created doubts about the onus of proof and the requirements of this section, particularly, in cases where the sum which is credited as loan or borrowing.
It is noticed that there is a pernicious practice of conversion of unaccounted money by crediting it to the books of assesses through a masquerade of loan or borrowing.
Unlike for share application or share capital or share premium of a closely held company (as amended by Finance Act, 2012), in case of loan or borrowing, the judicial decisions have held that only identity and creditworthiness of creditor and genuineness of transactions for explaining the credit in the books of account is sufficient, and the onus does not extend to explaining the source of funds in the hands of the creditor.
Hence, it is proposed to amend the provisions of section 68 of the Act so as to provide that the nature and source of any sum, whether in form of loan or borrowing, or any other liability credited in the books of an assessee shall be treated as explained only if the source of funds is also explained in the hands of the creditor or entry provider.
However, this additional onus of proof of satisfactorily explaining the source in the hands of the creditor, would not apply if the creditor is a well regulated entity, i.e., it is a Venture Capital Fund, Venture Capital Company registered with SEBI.
Analysis of the Amendment to section 68
Conversion of black money through share capital and loans and advances without paying the legitimate tax is rampant and the taxman always tried hard to curb those practices. In this process, section 68 was introduced and amended on many occassions to plug any loopholes to control these unwanted practices.
Finance Act, 2012 has already amended the provisions of section 68 to cast an onus on the assessee to prove the ‘source of the source’ of funds of share applicants in case of closely held companies.
However, in the case of loans and borrowings, there are no similar provisions and in the absence of such provisions, Courts have held that in the case of loans, the assessee needs to prove the identity of the creditor, creditworthiness and genuineness of the transaction and ‘source of source’ need not be proved by the assessee. Once the assessee establishes the identity, creditworthiness and genuineness, it becomes the duty of the income-tax authorities to conduct an enquiry to justify any additions in this regard.
The proposed amendment will overrule the decision of the Bombay High Court in the case of Gaurav Triyugi Singh vs. ITO [ITA No. 1750 of 2017] wherein it was held that the assessee was only required to explain the source of the credit. There was no requirement under the law to explain the source of the source.
Similar decisions were given in the case of PCIT vs. Veedhata Tower Pvt. Ltd.(2018) 403 ITR 415 (Bom)(HC) and Kumar Nirman and Nivesh Pvt. Ltd. v. ACIT (2020)425 ITR 486 (Karn)(HC ).
Thus from the above case laws, we can state that for the purpose of section 68 of the Act, for any cash credit appearing in the books of the assessee, the assessee is required to prove the following:
1. Identity of the creditor
The identity of the creditor can be proved by furnishing PAN and other relevant ID documents of the person from whom the loan is received.
2. Creditworthiness of the creditor
The assessee can prove the creditworthiness of the creditor by providing the bank statement, Balance Sheet, copy of ITR, etc.
3. Genuineness of the transaction
The source through which money is received, its utilization etc. proves the gennuiness of the transaction.
4. Source of the Source of funds
As per the above case laws, it is the duty of the revenue to prove the contention of the assessee wrong by making adequate inquiries. The assessee is not required to prove the source of the source of funds of the loan creditor.
With the proposed amendments in section 68, the initial onus shall lie on the assessee to prove the source of the source of funds received from the creditor.
Though the amendment appears to be a one-liner amendment, it has wide ramifications. The issues that may arise with the proposed amendment to section 68 are-
1. The proposed amendment covers every loan creditor in its ambit, unlike share capital. In the case of share capital, the source of the source of funds of the share applicants needs to be proved only in case of closely held companies. Hence widely held companies are outside the purview of this requirement.
There is no such relaxation or distinction provided for loans and borrowings. This will cover all type of loans taken from any person, be it Banks, NBFCs and other financial institutions, debentures and other securities, etc. Thus if a person takes loan from a bank then also he needs to prove the source of the fund of the bank from which it has taken the loan. There is no exclusion for loans taken from banks etc.
Though the memorandum states that the additional onus of proof of satisfactorily explaining the source in the hands of the creditor, would not apply if the creditor is a well-regulated entity, but as per the reshuffled third proviso, the regulated entity is limited to a Venture Capital Fund, Venture Capital Company registered with SEBI. It does not extend to entities regulated by RBI, etc.
2. The reach of the proposed amendments is so wide that even banks need to know the source of funds of the depositor. In the assessment of the banks, the ITO may ask the banks to prove the source of the source of the funds of the depositor.
3. Without any adequate safeguard to exclude genuine loan transactions, the proposed amendment will severely impact business transactions adversely. People will hesitate to take the loans from other persons with the fear that it may get disallowed in their hands and maybe assessed as undisclosed income. Conversely, people will also hesitate to give loans to other person as it needs to disclose their source of income all the time.
This is unlike share capital which is seen as an investment by the shareholders. In the case of loans and borrowings, the same is trading prudence which is repaid with interest after a certain period of time.
4. It also covers loans and borrowings taken from non-residents. It is hyper-technical to think that a resident is in a position to know the source of funds of the non-resident who resides outside the nation’s jurisdiction.
5. It does not distinguish between secured loans and unsecured loans. It is also immaterial whether loans and borrowings are interest bearings or non-interest bearings.
6. The additional onus of proving the source of funds of the loan creditor covers loan or borrowing or any such amount as per the wordings of the proposed amendment in section 68.
However, the memorandum states that the provisions shall apply to any sum, whether in form of loan or borrowing, or any other liability credited in the books of an assessee.
This creates a little bit of confusion about whether every liability is covered or only other liabilities in the nature of loans and borrowings are covered. On a literal interpretation of the proposed amendment, it shall cover only such amount which are in the nature of loan or borrowing. It does not extend to all the liabilities. Hence, trade creditors are excluded. Further, the liability for trade payables arises due to the purchase of goods or services and does not arise on account of receipt of money.
Now a question may arise whether ‘any such amount’ will cover advances or deposits. Normally, an advance is distinguished from a loan by the time period for which the amount is received, Advances are given for a shorter period and may be adjusted with other services or goods. It may or may not carry interest. A loan is repaid with interest after the stipulated period.
Consider a situation. A real estate developer has received booking amount as advance from his customers against sale of flats to them. This advance will remain in his books till he delivers the possession of the flats to the customers. In this case, if the proposed provisions are applicable, then the developer needs to ascertain the source of funds for each and every customer which is practically impossible to perform.
7. Though the proposed provisions do not distinguish between genuine and ingenuine cases of loans and borrowings, it is interesting to note that memorandum has used the term ‘entry operator’. The memorandum states that the nature and source of any sum, whether in form of loan or borrowing, or any other liability credited in the books of an assessee shall be treated as explained only if the source of funds is also explained in the hands of the creditor or entry provider.
The reference to the nature and source of the amount of loans and borrowings in the hands of the loan creditors who are entry operators are basically intended to be covered by these amendments. However, this is not suitably captured in the provisions.
Concluding Remarks
The provioisns of section 68 are introduced as a measure to prevent the generation and circulation of unaccounted money. It shall not disturb genuine business transactions. It would be better if the government comes out with clarifications to exclude genuine business transactions out of the rigorous proposed provisions of the additional burden of proving the source in the hands of the loan creditor.
Consequences of loan or borrowings being treated as undisclosed income under section 68
If a person fails to prove the source of funds in the hands of the loan creditor to the satisfaction of the Assessing Officer then such amount of loans or borrowings will be added to his total income as undisclosed income.
Once the loan amount is deemed to be undisclosed or unaccounted income under section 68, provisions of section 115BBE will apply.
Section 115BBE was introduced by the Finance Act, of 2012 in order to curb the practice of laundering unaccounted money by taking advantage of the basic exemption limit. This section was further substantially amended in 2016 by the Taxation Laws (Second Amendment) Act, 2016.
It is further provided that no deduction in respect of any expenditure or allowance shall be allowed to the assessee under any provision of the Act in computing deemed income under the said sections.
At present, the rate of tax under section 115BBE is 60% of the undisclosed income. The rate of tax shall be increased with a Surcharge of 25% irrespective of any level of income as per the seventh proviso to sub-section (8) of section 2 under Chapter-II of the Finance Bill, 2022.
Further, as per section 271AAC, a penalty of 10% of the tax under section 115BBE may be levied by the Assessing Officer.
After applying the Health & Education Cess of 4% on tax and surcharge, the effective rate of tax under section 115BBE for the addition of income under section 68 comes to 84%.
The amount of income-tax calculated on the income referred to in section 68, section 69, section 69A to section 69D at the rate of 60 per cent (plus surcharge @ 25% on such tax and cess of 4%). Thus effectively the rate comes to 78% if such income is reflected by the assessee himself in the return of income furnished under section 139. The penalty of 10% under section 271AAC is not leviable in this case.
Hence, if the assessee fails to prove the source of the fund of the loan creditor to the satisfaction of the AO, and the AO makes the addition under section 68, then he will be ready to pay a tax of 84% of the loan amount which he has taken from the creditor.
Indeed very harsh for genuine transactions, though deterrent for entry operators.
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