Introduction
The case of L.K.S. Bullion (Import and Export) Pvt. Ltd. v. The Income Tax Officer, (Bullion Case), brings to the forefront the issue where the Assessing Officer (AO) treated a certain amount as unexplained cash credit under the Income Tax Act (the Act) and added it to the assessee’s taxable income. Meanwhile, the assessee claimed that the amount in question reflected sales transactions that had already been documented, included in their books of accounts and taxed accordingly. The conundrum arose when the AO characterised the amount in question as an unexplained cash credit and added it to the assessee’s overall income for taxation purposes. However, at the end of this fiasco, the Income Tax Appellate Tribunal (ITAT) sided with the assessee and highlighted the principle that income that has already been taxed cannot be re-characterised and taxed under a different income tax provision.
Time and again it has been observed that lack of clear guidelines has given way to the tug-of-war between the tax department’s need to investigate and challenge transactions they suspect are not genuine and the taxpayer’s right to have their declared income accepted without recharacterization.
This article delves into the specifics of provisions of the Act which concerns unexplained cash credits and explores the judicial approach. Moving forward, the focus shifts to the concepts of ‘addition’ and ‘reassessment’, analysing apposite ITAT rulings and High Court judgments concerning the present issue. Lastly, a recommendation section follows proposing amendments to improve the application of these provisions.
Decoding ‘addition’ and ‘reassessment’
The intent of the provisions concerning cash credits under section 68 is to curb the spread of black money. If an assessee discovers a sum credited in his books and fails to explain the nature and source of the money, or if the assesse’s explanation is deemed unsatisfactory by the AO, the AO may tax the amount equal to the taxpayer’s income for that year. The basic text of Section 68 of the Act reveals three important ingredients: (i) the existence of books of account, (ii) credit entry, and (iii) the assessee’s failure to provide a reasonable explanation.
As per the judicial pronouncements, the initial onus rests on the assessee to establish cogent evidence of the genuineness of the transaction, and creditworthiness of the source of the transaction. The Supreme Court in CIT v. NRA Iron & Steel (P) Ltd., held that the assessee is mandated by law to establish the following to the satisfaction of the AO- (i) Proof of identity of the creditors, (ii) Capacity of creditors to advance money; and (iii) Genuineness of transaction. This stance was taken in the landmark case of Kale Khan Mohd. Hanif v. CIT and Roshan Di Hatti v. CIT, wherein the Supreme Court established that the onus of proving the sum of money credited to the assessee, is on the assessee itself. Furthermore, it was clarified that, post submission of documents substantiating identity, genuineness of the transaction, and creditworthiness, the burden shifts on the AO and he is obligated to conduct an inquiry before warranting any proceeding under section 68.
The ITAT ruled against considering declared sales as unexplained cash credits under Section 68, citing the Gujarat High Court’s ruling in CIT v. Vishal Export Overseas Ltd,where the assessee an export company, had declared certain sales which the AO deemed fictious and added back as unexplained cash credits. The key issue was whether declared sales, even if suspected to be bogus, could be subjected to the provisions of Section 68. Resultantly, it was held that once income has been offered for taxation and accepted, it cannot be simultaneously treated as unexplained cash credit, as this would amount to double taxation of the same income. This decision established the notion that income already subject to taxation cannot be re-taxed as unexplained cash credit, as this would result in double taxation. In the Bullion Case, the assessee presented extensive documentation in consonance with section 44AA of the Act, including sales invoices, registers, and bank statements, to demonstrate that the challenged amounts were sales profits that had already been reflected in their books and tax filings. The ITAT observed that the AO had not rejected the books of accounts or questioned the quantitative details of stock, implying implicit acceptance of the assessee’s records. This approach is consistent with the provisions of the Act and the general notion that, unless specifically denied, books of account should be given due weightage in tax procedures. Furthermore, the ITAT highlighted that once a prima facie justification for credits is presented, it is the tax department’s responsibility to disprove it with credible proof. The AO’s failure to offer conclusive evidence against the assessee’s explanations was a major reason for the ITAT’s decision to reverse the addition of INR. 1,92,29,000 made under Section 68 of the Act.
Moreover, in the present case, the AO relied on statements of individuals to make the said additions to the income of the assessee. The AO did not even provide the assessee an opportunity to cross-examine the individuals whose statements were relied upon for making the said additions as unexplained cash credits violating the principles of natural justice. Similarly, the High Court of Gujarat in the case of CIT v. Vishal Export Overseas Ltd upheld the principles of natural justice when the AO deemed the declared income of the assessee as unexplained cash credits, amounting to double taxation. To that effect, the Gauhati High Court in the case of Nemi Chand Kothari held that “assessee/borrower cannot be called upon to explain, much less prove the affairs of such third party, which he is not even supposed to know or about which he cannot be held to be accredited with any knowledge”, which factors in the application of Section 106 of the Indian Evidence Act 1872 (now Bhartiya Sakshya Adhiniyam 2023) concerning which the AO’s actions were ultra vires when he denied the opportunity to cross-examine a third party.
On the issue of reopening assessments under Section 148 of the Act, the ITAT sided with the AO’s decision. The ITAT specified that the “reason to believe” criteria for reopening does not obviate conclusive proof, but rather a reasonable cause to assume income has escaped assessment. This approach was clarified in Pushpak Bullion (P.) Ltd. v. Dy. CIT, in which reopening based on specific information from investigative authorities was found lawful. The ITAT contrasted this matter with Amar Jewellers Ltd. v. Dy. CIT, in which the reopening was reversed due to the AO’s failure to conduct independent verification. In the instance of the Bullion Case, the AO received specific information from the investigation and conducted preliminary inquiries, including examining bank statements for transactions between the assessee and M/s. Vishnu Trading Co. This approach brings forth that, while borrowed gratification alone is insufficient, reopening based on tangible, specific facts and some level of verification is acceptable.
Recommendation
In order to balance the interests of the tax authorities and taxpayers, amending section 148 of the Act to provide clearer guidelines on what constitutes “reason to believe” for reopening assessments could be a viable option. Addition of criteria wherein the AO needs to be satisfied with a “tangible material” before deciding upon the matter of reopening the assessment. If the said proceedings are initiated based on information received, then adjacently suitable thresholds for the quality and relevance of the information must be outlined clearly so that the misuse of discretion by the AO is minimized.
Mandating a preliminary inquiry process before the initiation of reassessment proceedings would protect both parties from unwanted litigation as it would provide the AO enough time to gather some tangible evidence warranting reassessment. For example, the amended section could state that “An assessing officer may issue a notice under this section when, based on specific and credible information from a reliable source, verified through preliminary inquiry, there is reasonable ground to believe that income exceeding [X amount] or [Y% of declared income] has escaped assessment.”
The words “in the opinion of the Assessing Officer”, give the AO a wide discretionary power to characterize any scrupulous or unscrupulous income as unexplained cash credits in the absence of any objective criteria. Section 68 allows the AO to render any unsubstantiated credits as unexplained cash credits provided, the assessee has failed to discharge his liability. But in various cases, the AO in the exercise of his discretion puts an undue burden on the assessees’. In light of such a predicament, a schematic interpretation must be given to the section wherein the AO must come to his conclusions based on ‘tangible materials’ which may warrant a case of income escapement.
To prevent the abuse of discretion, having a risk assessment framework would also mitigate the woes of the stakeholders. For instance, the inclusion of risk indicators like (i) Transaction size relative to the assessee’s normal business volume; (ii) Transactions with newly-incorporated entities or those with a history of non-compliance; (iv) Identifying unusual patterns in the timing or frequency of transactions; and (v) Transactions with parties in high-risk jurisdictions. To that effect establishing tiered scrutiny levels, wherein low-risk transactions might go under minimal review, medium-risk transactions could require additional documentation and high-risk transactions would be subject to detailed scrutiny and possible investigation. These measures could help narrow the discretionary powers of the AO under the Act.
Conclusion
The instant case highlights the complex interplay between all the concerned stakeholders. While the ITAT upheld the reopening of the assessment, its decision to delete the addition under Section 68 underscores the principle that income once offered for taxation cannot be subjected to double taxation in a different name vis-à-vis ‘unexplained cash credits’. Moving forward, this ruling inter alia underscores an indispensable need for refining the application of Section 68 and related provisions. An approach that balances the necessity of scrutiny and the rights of taxpayers must be factored into this evolving landscape ensuring fairness, transparency and efficiency. Ultimately, the goal should be to create a tax system that reduces unnecessary litigation and encourages compliance while maintaining transparency. In the ever-evolving landscape of business practices and economic trends, it is compulsory that tax laws and their application keep pace all the while maintaining the delicate balance between enforcement and fairness.
This Post is written by Kushagra Keshav 3rd Year student NLUO