Treatment of Cash Credit under Section 68 of Income Tax Act, 1961

Subject of cash credits has been a major area of litigation in taxation. The provision relating to cash credit, as in section 68, was provided for the first time in the Income Tax Act 1961 as there was no corresponding provision in the Income Tax Act 1922. Section 68 has been introduced in order to plug loopholes and in order to place certain situations beyond doubt even though there were judicial decisions covering some of the aspects. For example, even long prior to the introduction of s. 68 in the statute book, courts had held that where any amounts were found credited in the books of the assessee in the previous year and the assessee offered no explanation about the nature and source thereof or the explanation offered was, in the opinion of the ITO, not satisfactory, the sums so credited could be charged to income-tax as income of the assessee of a relevant previous year. Section 68 was inserted in the I.T. Act, 1961, only to provide statutory recognition to a principle which had been clearly enumerated in judicial decisions.

General Principles
The conditions for the applicability of s. 68 are:
I. The existence of books of accounts maintained by the assessee himself;
II. A credit entry in the books of account; and
III. The absence of a satisfactory explanation by the assessee about the nature and source of the sum credited.
I. The existence of books of accounts maintained by the assessee himself:
I.A. Assessee:
Examination of Section 68 of the Income-tax Act would show that in relation to the expression "books", the emphasis is on the word "assessee". In other words, such books have to be the books of the assessee himself and not of any other assessee. In Smt. Shanta Devi v. Commissioner of Income-tax the assessee maintained no books of account. The cash credit entry, of which the sum in question forms part, was found in the books of the account of the partnership firm which in its own right is an assessee. It was held that the books of account of the partnership firm cannot be considered as those of the individual assessee and, therefore, section 68 of the Income-tax Act would not be attracted to the case.

I.B. Existence of Books of Accounts is a condition precedent for s. 68:

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. The first condition necessary for invocation of the power is the existence of the books of account.

I.C. 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.

II. 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.

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

III. 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.

III. 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.

III. 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.

Presumptions
In S.N.Ganguly v.Commr.of Income-tax the Court held that there is no presumption in law that the amount standing in the name of the wife belongs to the husband. Unless there are some materials before the Income-tax Department to suggest that the amount standing in the name of wife really belonged to the assessee, there would be no justification on the part of the Income-tax authorities to tax this amount. The principle to be applied is that in the absence of evidence to the contrary, the money standing in the name of the wife must be presumed to belong to her, and an assessee cannot be taxed in respect of the amount standing in the name of the wife. The onus of proof in such a case will be not on the assessee but on the Income-tax Department to show by at least some material that the amount standing in the name of the wife does not belong to the wife but belongs to the assessee.

In Commissioner of Income-tax v. P. Darolia and Sons the Court held that it is a well-established principle that in respect of an amount of cash received during the accounting year the burden of proof is upon the assessee to show positively the source and nature of the receipt, and in the absence of an adequate explanation the Revenue authorities are entitled to draw the inference that the receipts are of an income nature and liable to be taxed. But there is no presumption in such a case that the cash receipt is income of the same business for which the assessee has kept regular business of account. The question is really a question of fact, to be decided upon the material furnished in each particular case. The cash receipt may be income either from the same business carried on by the assessee or from a different business.

In Lakshmichand Baijnath v. The Commissioner of Income-tax, West Bengal it was held that if there is no source of income other that business for which the assessee has maintained books which disclose cash credits, the presumption is that the cash credits represent income from the same business. Thus, in Commissioner of Income-tax v. Margaret's Hope Tea Co. Ltd. the cash credits appearing in the books of the assessee whose main activity was the cultivation, manufacture and sale of tea, was held to be treated as income of the assessee from its tea business.

In A.S. Swan Pillai v. CIT it was held that there is no presumption in favour of any illegality of a transaction. In fact, the presumption is the other way about. There must be evidence to show that the assessee did sell goods in excess of the legally fixed rates.

In Tolaram Daga v. CIT the court held that unchallenged account books are prima facie proof of the correctness of the entries made therein. Further, there is no presumption that the husband has the knowledge about the source of an income standing in the name of his wife.

Bibliography
Books
1.Kanga, Palkhivala and Vyas- The Law and Practice of Income Tax (Lexis Nexis, New Delhi, 9th edn., Vol. I, 2004)
2. Dr. Vinod K Singhania, Dr. Kapil Singhania, Taxmann's direct taxes: law and practice, (Taxmann Pub ications Pvt. Ltd., New Delhi, 2007)
Articles
1. Indu Patel & Usha Dalal, Advocates: Cash Credit-Section 68.
2. C.V. Kothari, Advocate: Cash Credit, Unexplained Investments, etc. and Provisions for Settlement of Cases.
3. Subramanian M, Advocate: Cash Credit, Partnership Firms and Disclosure Schemes.

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