The officer says I have to prove where my lender got the money from. My loan was taken years ago. Does that requirement apply to my year at all?
It depends entirely on the year and on what the credit is. The main limb of s.68 has never asked for more than the nature and source of the sum credited in your books, which the courts read as identity, creditworthiness and genuineness. The source of the source is a statutory add-on, and it came in twice: the Finance Act 2012 imposed it on share application money, share capital and share premium in a company in which the public are not substantially interested, with effect from 1 April 2013 and so from assessment year 2013-14; the Finance Act 2022 extended it to any sum credited as a loan or borrowing, with effect from 1 April 2023 and so from assessment year 2023-24. Neither reaches a credit in the name of a venture capital fund or venture capital company referred to in s.10(23FB). For a loan credited in any year up to 2022-23 the statute does not require you to explain your lender's source, and anything the officer gets on that has to come from the case law, not from the provisos.
The main limb has not changed since 1961. 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 Assessing Officer, satisfactory, the sum so credited may be charged to income-tax as the income of the assessee of that previous year". Three things follow from the words. There must be books, and a sum found credited in them — that is what separates s.68 from ss.69 to 69D, which apply precisely because there is no entry. What you must explain is the nature of the credit and its source. And the test is the officer's opinion, which means it can be attacked as unreasonable but not as a matter of pure discretion.
The three-ingredient test is judicial gloss on those words, and it is the framework every assessment order uses. Identity means the creditor is a real and identifiable person. Creditworthiness means that person had the capacity to advance what he advanced. Genuineness means the transaction happened as described. The Supreme Court put the burden in those terms in PCIT v NRA Iron & Steel, holding that where share capital or premium is credited the assessee is under a legal obligation to prove the genuineness of the transaction, the identity of the creditors and the creditworthiness of the investors to the officer's satisfaction, and that the officer is in turn bound to investigate creditworthiness, verify identity and ask whether the entries are those of name-lenders. The practical point from that case is that money moving through a bank does not prove capacity: a statement showing a matching deposit immediately before the transfer proves the route, not the means.
Two older authorities are routinely cited for more than they decided, so read them before you rely on them. A. Govindarajulu Mudaliar v CIT is a decision against the assessee. The credits stood in a firm's books in his own name, he offered two explanations, both were disbelieved on evidence by three authorities, and the Court held it was then open to the officer to hold the amounts to be concealed income and refused to require the department to prove the source. The case establishes that an unexplained credit may be inferred to be income; it does not establish anything in your favour. Sumati Dayal v CIT is the same way round. It proceeds, adopting earlier authority, on the footing that once a credit is found in the books and the explanation is unsatisfactory there is prima facie evidence against the assessee — the receipt of the money — which if unrebutted may be used to hold the receipt to be of an income nature. It then holds that the authorities may look at the surrounding circumstances and apply the test of human probabilities: the apparent is to be treated as real only until there is reason to think otherwise. That formulation at paragraph 7 is the Court restating Durga Prasad More, and it was an appeal from a majority order of the Settlement Commission, which is why the language about non-interference is as strong as it is.
CIT v Lovely Exports is the taxpayer authority in this area and it is narrower than its reputation. It is a three-sentence order dismissing a special leave petition. What the order says is that if share application money is received from alleged bogus shareholders whose names are given to the Assessing Officer, the department is free to reopen those shareholders' individual assessments in accordance with law, and that on that footing there was no infirmity in the judgment under challenge. The proposition usually attributed to it — that the share money cannot be treated as the company's undisclosed income under s.68 — is not in the Court's order at all. It has been carried into later citations of the order, often with the words run on as though the Court had said them, and it is now quoted back from those. The order records no facts. The Delhi High Court has since treated it as affirming its own decision in the Divine Leasing line, which is the judgment it left undisturbed. Its reach has been cut from both directions: by NRA Iron & Steel on private placements, and by the Finance Act 2012 proviso, which reverses the allocation of burden the order rests on for exactly the companies it was invoked for.
The Finance Act 2012 is the first statutory source-of-source rule. It applies where the assessee is a company, not being a company in which the public are substantially interested, and the sum credited consists of share application money, share capital, share premium or any such amount by whatever name called. In that case the explanation "shall be deemed to be not satisfactory" unless the person, being a resident, in whose name the credit is recorded also offers an explanation about the nature and source of that sum, and the officer finds that explanation satisfactory. Four conditions therefore have to be met before it bites: a company, closely held, a credit of that description, and a resident in whose name the credit stands. The Memorandum to the Finance Bill 2012 states that the amendment takes effect from 1 April 2013 and applies from assessment year 2013-14 and subsequent years. It does not reach earlier years, and it does not reach a company in which the public are substantially interested, where Lovely Exports still has work to do.
The Finance Act 2022 is the second, and it is much wider. The amendment is clause 17 of the Finance Bill 2022, expressed to take effect from 1 April 2023, and it inserts a proviso that where the sum credited consists of "loan or borrowing or any such amount, by whatever name called", the explanation is deemed not to be satisfactory unless the person in whose name the credit is recorded also explains the nature and source of that sum and the officer finds that explanation satisfactory. Note what has gone. There is no requirement that the assessee be a company, no requirement that it be closely held, and no requirement that the lender be a resident. It reaches an individual, a firm, an HUF and a trust, and it reaches a non-resident lender. It applies from assessment year 2023-24 onwards. For any year up to 2022-23 there is no statutory source-of-source requirement for a loan at all.
Check the proviso numbering before you quote one, because the 2022 amendment changed it. The loans proviso was inserted as the new first proviso, so the share capital rule inserted in 2012 is now the second proviso, opening "Provided further that", and the carve-out is the third, opening "Provided also that". Anything written before April 2022 that calls the share capital rule "the proviso" or "the first proviso" is describing the earlier text. The carve-out itself reads: "Provided also that nothing contained in the first proviso or second proviso shall apply if the person, in whose name the sum referred to therein is recorded, is a venture capital fund or a venture capital company as referred to in clause (23FB) of section 10". It began life in 2012 covering only the share capital rule; the Finance Act 2022 widened it so that from assessment year 2023-24 a loan from such a fund or company is outside the source-of-source requirement as well. The carve-out is identity-based — it turns on who the person named in the credit is, not on what the credit is for. The Memorandum to the Finance Bill 2012 explains it as an exception for "a well regulated entity, i.e. a Venture Capital Fund, Venture Capital Company registered with the Securities Exchange Board of India (SEBI)", so registration is what it is built on; the definition itself sits in s.10(23FB) and has to be read there.
What the provisos do not do is set the depth of the enquiry. They attach the burden to "the person in whose name such credit is recorded" and stop there; nothing in either of them obliges you to explain that person's creditor. Whether an officer may go further in a year the provisos do not cover is a question the case law answers both ways, and the answer turns on the file rather than on a rule. Where the loan is an ordinary one from a real lender with his own funds, the line running from Nemi Chand Kothari confines your burden to the transaction between you and your creditor. Where the record shows the money arriving with the lender days before it left him, officers have been allowed to follow it. The library has a separate page on how far that enquiry can be pushed; what matters here is that for a pre-2023-24 loan the officer is arguing from case law, and you should make him say so.
Build the reply as an evidence file, credit by credit, against the three ingredients. Identity is addressed by PAN, the return acknowledgement, the constitution documents where the lender is an entity, and a confirmation signed by the lender — necessary, and not sufficient. Creditworthiness is addressed by the lender's own return, computation, capital account, audited accounts and a bank statement that shows the funds existed independently of the transfer to you, rather than appearing the day before it. Genuineness is addressed by the banking trail, the loan agreement or share application, interest paid, tax deducted on it, and the repayment record. Where the year attracts one of the provisos, add the lender's own explanation of where his money came from, in his words and signed by him, because the statute requires his explanation and not yours about him. If the officer relies on a statement or an investigation report about your lender, ask for a copy and for cross-examination before the addition is made.
The rate is why the characterisation fight is worth having. Income charged under ss.68, 69, 69A, 69B, 69C or 69D is taxed under s.115BBE. Sub-section (1) was substituted by the Taxation Laws (Second Amendment) Act 2016 with effect from 1 April 2017, so the rate is sixty per cent from assessment year 2017-18, with surcharge and cess on top. Section 115BBE(2) allows no deduction for any expenditure or allowance, and the bar on set off of any loss against that income was inserted by Act No. 28 of 2016, the Finance Act 2016, also with effect from 1 April 2017. Section 271AAC then adds a penalty of ten per cent of the tax so charged where the income was not offered in the return. So the same figure sustained as business income and sustained under s.68 are not the same outcome at all, and an argument that a receipt is recorded turnover is usually worth more than an argument about quantum.
Getting the year wrong here costs you the case twice over. If you concede a source-of-source requirement for a loan credited in assessment year 2020-21, you have conceded something the statute does not impose, and you have shifted the argument from what the officer must prove to what your lender's lender can produce. If you deny it for a loan credited in 2023-24, you are denying the plain words of the first proviso and you will lose the point with your credibility. The version of s.68 that governs is the version in force for the previous year in which the credit appears, and that has to be checked before anything else.
The Assessing Officer rejected my explanation for cash credits. Must he then prove where the money actually came from before taxing it?
Additions were made to my book profits in earlier years. Can I use that money to explain a cash credit or an unexplained payment in a later year?
I made unexplained investments after the close of my accounting year. Which year can the officer tax them in, and can he reopen an earlier year to do it?
A fixed deposit stands in the name of a partner's son and my firm used it as security for its overdraft. The Assessing Officer says the money is really the firm's concealed income. Who has to prove what?
The officer rejected my books, estimated my profits at a flat rate, and then also added an unexplained cash credit. Can he do both, and must he say what source the credit came from?
You have a document that says so. Does that settle it?
If the department doubts my shareholders, can it add the money to my income?
I gave the lenders' names, addresses and PAN and filed their confirmations, but I cannot produce them and the summonses came back unserved. Can the loans still be added under section 68?
Every page in this library links to what it was written from, so you can check it rather than take our word for it.
