Loans or Cash Credits as Deemed Income under Section 68: A Practical Perspective
By CA Naresh Jakhotia
When it comes to taxation, what’s not explained can become expensive. Section 68 of the Income Tax Act, 1961, is one such provision that often turns loans, gifts, or cash credits into “deemed income”-especially when the taxpayer fails to explain the source. While many taxpayers believe “loan lena koi gunah nahi hai” (taking a loan isn’t a crime), the Income Tax Department might just think otherwise if the paperwork isn’t airtight.
What is Section 68?
Section 68 applies when:
“Any sum is found credited in the books of an assessee for which no satisfactory explanation is offered about the nature and source of such credit.”
In simple terms, if you show money in your books (loans, gifts, share capital, etc.), and the Assessing Officer (AO) finds your explanation vague, you might be taxed on that amount as unexplained income–even if you never earned it.
Key Ingredients of Section 68:
- A credit entryin the books of accounts,
- Lack of explanationregarding the identity, creditworthiness of the lender, and genuineness of the transaction,
- Satisfaction (or dissatisfaction) of the AO.
Books of Accounts: What Counts and What Doesn’t
A major area of debate is: what qualifies as “books of accounts”? Courts have clarified that “books” must be maintained by the assessee-not third parties.
Diaries, rough pads, spiral notebooks, loose slips, or WhatsApp chats do not qualify. Regularly kept books such as:
- Ledger books,
- Cash books,
- Bank statements maintained by the assessee,
- Digital accounting systems (like Tally, ZohoBooks)
…are valid. These form the base for invoking Section 68. (CIT v. Neemat Ram Bhandari [2002] 125 Taxman 133 (All.)).
Judicial Approach: What the Courts Say
Several courts have addressed the applicability of Section 68 in loan-related matters. A few notable rulings include:
1. CIT v. Kamal Kumar Mishra[(2013) 33 com 301 (Lucknow – Trib.)]
Addition under section 68 justified when assessee failed to prove genuineness and creditworthiness of loan providers.
2. CIT v. Precision Finance Pvt. Ltd.[(1994) 208 ITR 465 (Cal.)]
Mere furnishing of PAN or confirmation letter is not enough-creditworthiness must be proved.
3. Anand Ram Raitani v. CIT[(1997) 223 ITR 544 (Gauhati)]
Identity and capacity of creditors and genuineness of transactions are essential to avoid Section 68 addition.
4. Sumati Dayal v. CIT[(1995) 214 ITR 801 (SC)]
Human probabilities are important-if the explanation is suspicious, the AO can reject it.
5. CIT v. Manju Ram Aggarwal[(2010) 189 Taxman 263 (All.)]
Share application money or unsecured loans must be backed by proper bank entries, ITR copies, and lender affidavits.
What About Bank Loans or Private Borrowings?
Whether the sum is shown as:
- Loan from relatives or friends,
- Gift from an NRI uncle,
- Share capital from a startup investor,
…the same three-fold test applies:
1. Identityof creditor/donor/investor,
2. Creditworthinessof that person/entity,
3. Genuinenessof the transaction.
Without documentary evidence (bank statements, ITRs of lender, agreement, repayment mode), even a real loan may be taxed.
Business Implication: A Word of Caution
For business owners, especially MSMEs and SMEs, Section 68 can become a major scrutiny trigger. During income tax assessments:
- Unsecured loans from friends or associates,
- Advances from customers without invoices,
- Capital introduced in cash by partners,
…can all be questioned. Even share capital received by companies (particularly penny stock transactions) is under heavy scanner post Demonetisation and various shell company crackdowns.
Not Just Books-Also Intent
Courts have also emphasized the motive behind credit entries. If it appears to be a colorable device to introduce black money or inflate net worth, the AO has enough ground to make additions under Section 68.
Notable Quote:
“It is not the form, but the substance of the transaction that matters.” – Income Tax Appellate Tribunal (ITAT)
How to Stay Compliant: Practical Tips
- Keep loan agreementsproperly executed on stamp paper,
- Ensure bank entriesreflect the inflow of funds,
- Collect PAN, Aadhaar, ITRcopies of lenders or donors,
- Record repayment schedule and interest (if any),
- Avoid cash transactionsbeyond ₹20,000 for loans,
- Maintain ledger balancesand audit trails.
Mistakes That Can Cost You
- Using bogus entries to boost balance sheet,
- Accepting or repaying loans in cash beyond permissible limits,
- Failing to verify creditworthiness of the lender,
- Relying solely on confirmations without backing.
Conclusion
Section 68 is a powerful tool in the hands of the Income Tax Department, but also a potential landmine for taxpayers. The key lies in documentation, consistency, and genuineness. If you can’t explain where the money came from, don’t be surprised if the taxman tells you where it’s going-to your taxable income!
Whether you’re a business owner, investor, or salaried individual borrowing from family-always remember: In tax matters, explanation is everything. A missing link in the financial trail could turn your loan into deemed income faster than you can say “assessment!”
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