It is proposed to amend the provisions of section 68 of the Act so as to provide that the nature and source of any sum, whether in form of loan or borrowing, or any other liability credited in the books of an assessee shall be treated as explained only if the source of funds is also explained in the hands of the creditor or entry provider.
However, this additional onus of proof of satisfactorily explaining the source in the hands of the creditor, would not apply if the creditor is a well-regulated entity, i.e., it is a Venture Capital Fund, Venture Capital Company registered with SEBI.
Finance Act 2012 had clarified that source of fund in the hands of shareholder is required to be explained. However loans and advances in other natures were not covered under the amendment in 2012.
Now, non-listed firms shall have to prove genuineness/ creditworthiness of the creditor in the case of any loan or borrowing. So the question is, can this hinder non-VC investments in start-ups?
Let us know more about the amendment by the Finance Bill 2022:
Conversion of black money through loans and advances has been a matter of concern for the income tax department since long. Almost every Income Tax Raids & Surveys have revealed the pernicious practice of conversion of unaccounted money through accommodation entry by way of loan or borrowing. Budget 2022 has proposed the most terrifying provision which will affect almost everybody in the business. More particularly, all those who are running business with borrowed funds would be worst affected by the new provision.
Let us try to understand the new amendment which though aimed at taxing the accommodation entries but would even affect the genuine transactions also:
With an aim to plug the loopholes & control the practice of accommodation entry, section 68 was incorporated in the Income Tax Law. It provides that where any sum is found to be credited in the books and the taxpayer fails to offer satisfactory explanation about the nature and source thereof then such amount can be treated as the income by the tax authorities. The onus of satisfactorily explaining such credits is on the person who has accepted the amount. This onus is normally discharged by the taxpayers by providing the identity (i.e., PAN and other relevant ID documents), creditworthiness (ITR, B/s, etc) & Genuineness (Transactions through Banking Channel, Agreement, etc) of the transactions. The courts have held that no addition u/s 68 could be done if the recipient has just provided the identity, creditworthiness and genuineness of the transactions. It was for the income tax authorities to prove otherwise. In general, the taxpayers were not required to prove the source of funds of the loan creditor in all the cases.
Way back in 2012, the scope of Section 68 was widened by providing that that if a closely held company receives any share application money or share capital or share premium or the like then such recipient company will be required to establish the source of source (that is, the source of the person who has given share application money was required to be proved by the company which has received the money). To some extent, the amendment was reasonable as the investment in ownership of the closely held companies is done by the known persons only. As a result, little higher onus was placed on such companies to not only establish the identity, creditworthiness & genuineness of the transaction but also the source of money in the hands of such shareholders or persons making payment towards shares.
Now, like in case of closely held companies receiving share application money, the scope has been widened to the loans, deposits and other liabilities received by any class of the taxpayers. The recipient will now be required to prove the source of the money of the lender. If such a person fails to offer an explanation or the explanation is not found to be satisfactory then the sum will be treated as income of the recipient.
Clause 17 of the explanatory memorandum to the Finance Bill-2022 explained at para.5 the purpose for which the amendment is proposed, as under:
“It is proposed to amend the provisions of section 68 of the Act so as to provide that the nature and source of any sum, whether in form of loan or borrowing, or any other liability credited in the books of an taxpayer shall be treated as explained only if the source of funds is also explained in the hands of the creditor or entry provider. However, this additional onus of proof of satisfactorily explaining the source in the hands of the creditor, would not apply if the creditor is a well-regulated entity, i.e., it is a Venture Capital Fund, Venture Capital Company registered with SEBI.”
Consequences of loan or borrowings being treated as income u/s 68:
a)If a person fails to prove the source of funds in the hands of the lender then such amount may be added to the income of the recipient as unexplained income.
b)Once such amount is deemed as income u/s 68, provisions of section 115BBE will apply which carry the effective tax rate of 78%. It is further subject to penalty u/s 271AAC which is 10% of the tax and will enhance gross tax liability to a minimum of 84% minimum.
The proposed provisions do not distinguish between secured loans and unsecured loans. It is also immaterial whether loans and borrowings are interest bearings or non-interest bearings. Most importantly, it doesn’t distinguish between genuine and non-genuine cases of loans and borrowings. Rather, the genuine loan or business transactions would be adversely affected. The loans transactions as is presently happening through finance/Hundi brokers would be very adversely affected by the new amendment wherein both the parties are unrelated to each other.
Normally, all the genuine loan transactions are done at the arm’s length & the lender is at a superior end whereas the borrower is at the lower end. Asking the documents of the lender by the borrower will be sensibly a tough task and appears to be little impractical. Amendment proposed u/s 68 has totally shifted the onus to prove the source of the source on the borrower. Tax authorities are more powerful as compared to the borrower and shifting the onus to prove the source of source would be like asking the taxmen to remain mere tax collectors rather than facilitators.