Income Tax

Tax Treatment of Unexplained Income

Tax Treatment of Unexplained Income

According to the basic rule of the Income Tax Act 1961, the assessee must pay tax on income except in cases it is specifically non-taxable. The income on which tax is levied is categorized under 5 heads, namely salary, house property, profession, business income, capital gains and income from other sources. These income categories, except capital gains, deal with revenue income, whereas capital gains deal with tax levied on capital assets.

However, any sum credited in the Books of Account that is not explained by the assessee or the explanation provided by the taxpayer is not satisfactory, as per the Assessing Officer, is known as unexplained income. The article discusses the Tax Treatment of Unexplained Income as per the Income Tax Act 1961[1].

Legal Provisions Pertaining to Unexplained Income

The legal provisions pertaining to unexplained income are provided under section 68 and 69 of the Income Tax Act 1961, which is enumerated below –

Section 68 – Cash Credits

According to this section, if the assessee fails to provide any explanation with respect to the nature and source of the income credited in the books of account may be charged to income tax as the income of the taxpayer of that year.

Conditions for Applicability of Section 68 

The following conditions must be satisfied in order to attract the applicability of Section 68 of the IT Act.

  • Maintenance of books of Account by the Assessee
  • Credited amount in the books of Account of the Assessee during the financial year.
  • Such credited amount is unexplained by the assessee, or the explanation is not satisfactory in the opinion of the Assessing Officer.
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Special Provisions in case of Corporate Assessee

Any explanation provided by a closely held company (a company in which the public is not substantially interested) pertaining to any sum credited being share capital, share application money, share premium, or any such amount shall be considered unsatisfactory until and unless.

  • The explanation is provided by the person in whose name the credited amount is recorded in the books of Account of the assessee.
  • The AO is satisfied with the explanation, so provided.

However, the above-discussed special provision will not apply in case the person in whose name such amount is recorded in the books of such company is a venture capital fund or a venture capital company as per Section 10(23FB).

Special provision is specially designed for closely held corporate taxpayers so as to avoid any tax evasion by companies that show the names of non-existing shareholders/third parties as having paid the company share-related money, which is a mechanism for unaccounted parking money in such companies which are not subject to stringent regulation under company law provisions as compared to widely held companies.

Section 69 – Unexplained Investments

This provision is similar to unexplained cash credits with the only difference that, in this case, cash credit is substituted by Investments. Simply put, if there existed any investments for which the assessee hasn’t provided any explanation or the explanation is not satisfactory as per the Assessing Officer, the investments shall be considered taxable income and shall be taxed in the financial yr in which the income is earned/received.  

69A- Unexplained money etc  

If the assessee owns any money, bullion, jewellery or other valuable article and such money, bullion, jewellery or valuable article which comes under the purview of the conditions mentioned in section 68 of the Act shall be deemed as a taxable income and taxed accordingly.

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69B- Amount of Investments, etc., not disclosed fully in books of Account

Where the assessee has made investments or owns any bullion, jewellery or another valuable article, and in any year, and it is found out by the Assessing Officer that the amount expended exceeds the amount recorded in respect of the same in the books of account of the assessee for any source of income, without any explanation provided in respect of the same by the assessee.

69C – Unexplained Expenditure, etc

If the expenditure incurred by the assessee remains unexplained, i.e. without or unsatisfactory explanation shall be deemed taxable by virtue of section 69C and won’t be permitted as a deduction under any head of income.

69D Amount borrowed or repaid on hundi

In the event of the amount being borrowed on a hundi from, or any amount due thereon has been repaid to, any person with any other mode other than an account payee cheque drawn on a bank, the repaid or borrowed amount shall be deemed to be the income of the person borrowing or repaying such amount. 

It would be considered as income for the year of borrowing and repaying as per the case.

However, it must be noted that if any amount borrowed on a hundi has been treated as income of any person by virtue of section 69D, then such person shall not be liable to be assessed again for the same amount on repayment thereof. The amount repaid shall include the interest paid on the amount borrowed.

According to the aforesaid sections, these amounts of unexplained income must be charged to income tax as income of the assessee of the PY in which the credit investment is made or expenditure incurred.

Accordingly, one could assume that these amounts would be part of the assessee’s total income and shall be taxed at the rate applicable to the assessee or depending on its legal status.

As a consequence, in the case of individuals, HUF, etc., no tax was levied up to the basic exemption limit, and even if such income was higher than the basic exemption limit, it was taxed at the lower slab rate. Also, that expenditure incurred, if any, shall be deductible, and the losses for the year shall be set off against such income.

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Tax Rates Applicable to the amount charged to tax by virtue of sections 68, 69, 69A, 69B, 69C and 69D

The tax rates were different from AY 2013-14 to AY 2016-17 and 17 -18 onwards, which have been discussed herein- under

AY 2013-14 to AY 2016-17

“According to Section 115BBE (1):

Where the assessee’s total income of includes any income referred to in section 68, – 69D, the income-tax payable shall be the aggregate of

(a) the amount of income tax calculated on income referred to in section 68 – 69D, at the rate of 30 per cent; and

(b) The amount of IT with which the assessee would have been chargeable if his total income had been reduced by the amount of income provided in clause (a)

AY 17-18 Onwards

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

  1. Income referred to in Section 68, – 69D and reflected in the ITR filed under Section 139; or
  2. Which is ascertained by the AO and inclusive of any income referred to in Section 68, – 69D if such incomes is not covered under clause (a).
  3. Such a tax rate of 60% will be further increased by a 25% surcharge 6% penalty, i.e., making the final tax to be 83.25% (including cess). However, such 6% penalty shall not be levied when the income under Sections 68, 69, etc., has been included in the ITR and has been paid on or prior to the end of the relevant previous year.
  4. No deduction in regard to any allowance or expenditure [or set off of any loss] would be permitted to the assessee in the computation of his income as provided under clause (a) of sub-section (1) of Section 115BBE.

Conclusion

The Income Tax Act clearly defines the tax treatment of unexplained income as provided u/s 68-69D, the criteria for its applicability, along with distinctly providing the treatment of such income for AY 2013-14 to AY 2016-17 and 2017-18 onwards, providing the much-needed clarity about the concept.

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