Peak Credit in IT Assessment

Prabhat Nigam

28 Feb, 2022

During the time of Income Tax assessment, if the Assessment Officer discovers cash receipts or cash deposits in the bank account of the assessee and the assessee is not able to satisfactorily explain to the Assessment Officer then the assessee tries to explain that such cash deposits or part of them are made from the withdrawals from the same cash book or bank account and then request the Assessment Officer to adjust the deposits made against such withdrawals. The highest of such deposits were treated as an undisclosed income under section 68 of the Income Tax Act, 1961.

What is peak credit theory?

At the time of Income Tax assessment, the assessee wants to prevent any chances of double addition of his income and to bring forward only his true income for taxation purpose. This peak credit theory is applied where there are large numbers of unexplained credit and debit entries. The peak credit theory is applied to bogus entries and not to the genuine ones since the bogus credit and debit cancel out each other unless the circumstance depict that withdrawal is meant for purposes other than re-introduction.

However if the assessee admits that the cash deposits are genuine and not bogus, then he will not be able to claim the benefit under peak credit theory. [Bhaiyalal Shyam Behari vs Commissioner Of Income-Tax (2006) 202 CTR All 515]

If the Assessment Officer is able to prove that such withdrawal is not meant for redeposit purposes then also the assessee will not be able to claim the benefit under peak credit theory.

It must be noted that the benefit of peak credit theory is not limited to cash credit given to the assessee. Unaccounted cash can be introduced in the books of accounts both in the form of cash credit as well as trade credit and both are considered to be deemed income of the assesee. Both types of credit are assessee’s own money. Therefore, the benefit of peak credit theory would apply to trade credit too provided the assessee can prove it to be non-genuine.

In case where the Assessment Officer rejects the books of accounts and estimates the profits on the basis of such rejected books of accounts, then it will not be correct on the part of the Assessment Officer to estimate profits on the basis of rejected books of accounts. [Commissioner of Income Tax v K.M.N. Naidu 1996 221 ITR 451 Mad]

In case where the Assessment Officer has applied peak credit theory in the previous year and since then there has been no change in circumstances in the subsequent year, then peak theory can be applied in the subsequent year also. [Niteshkumar R.Dalwadi, Anand vs Department Of Income Tax on 11 February, 2014 ITA No. 53/Ahd/2013]

How is peak credit determined?

Following steps when followed in a chronological manner lead to determination of peak credit:

1. The process begins with placing in chronological order all the cash deposits and withdrawals owned by the assessee which he claims to be undisclosed.
2. The next step involves drawing the balances against each deposit and withdrawal.
3. The deposit made in the first entry then becomes closing balance in the first entry.
4. Thereafter, the closing balance then becomes opening balance for the second entry.
5. Then the deposit or withdrawal of the second entry shall be adjusted to the opening balance.
6. The closing balance is then adjusted against the second entry.
7. The chain repeats when the closing balance of the second entry becomes the opening balance for the third entry.

The highest closing balance drawn against any entry in the accounting period arising after adjustments made in the deposits or withdrawals becomes the peak in the accounting period. 

Adjustments that can be made to the peak credit

Once the determination of the Peak credit has been done, the next step is to make adjustments by the Assessment Officer in terms of opening balances, past capital, past savings, arithmetical mistakes, correct nature of entries, gifts etc.

Instances where Peak Credit can be denied

The assessee cannot take the benefit of peak credit theory if he has been withdrawing of cheques and it remains unexplained as to whom that withdrawn money gone.

In cases where both depositors are different and recipients are different other than the assessee, then the application of peak credit theory cannot be done. [Bhaiyalal Shyam Behari vs Commissioner Of Income-Tax (2006) 202 CTR All 515]

In cases where cash is deposited in the bank account^[1] and most of the withdrawals were done by inward clearing and very few instances of cash withdrawals exist, then peak theory cannot be applied in such cases. [ITO v Shivraj Mishrilal Bafna vs Assessee ITA No. 434/PN/2013]

In case where the assessee has been claiming to have genuine deposits and consequent withdrawals/payments to different people in the previous years, then in such a case the assessee will not be in a position to claim benefit of peak credit theory.

Conclusion

The highest available unexplained cash is termed as peak. In the concept of peak credit, if after the withdrawal of cash, it is not used elsewhere, then such cash can be considered for making deposits. The benefit of determining peak helps the assessee to reduce its taxable income. However, if the withdrawals made by the assessee are made through cheques and he is not able to prove that such withdrawals have come back to his account, then the assessee will not be able to claim the benefit of those withdrawals while explaining the deposits.

Read our Article:Section 194R of the Income Tax Act- Brief Analysis