Cash credit entries in books of a firm, in absence of material to indicate that they were its profits, could not be assessed in the hands of the firm
ABCAUS Case Law Citation:
ABCAUS 3304 (2020) (05) HC
Important case law relied upon by the parties:
Deputy Commissioner of Income Tax v Rohini Builders
CIT v. Jaiswal Motor Finance [1983] 141 ITR 706 (All)
Commissioner of Income Tax v Kishorilal Santoshilal
Abhyudaya Pharmaceuticals v Commissioner of Income Tax
Commissioner of Income Tax v Taj Borewells
Commissioner of Income Tax v Smt. P.K. Noorjahan
Commissioner of Income Tax v Burma Electro Corporation
Commissioner of Income Tax v Metachem Industries
Principal Commissioner of Income Tax (Central)-I v NRA Iron and Steel Private Limited
India Rice Mills v Commissioner of Income Tax
Commissioner of Income Tax, Allahabad v Jaiswal Motor Finance
Commissioner of Income Tax v P. Mohanakala
Commissioner of Income Tax, Lucknow v Kapur Borthers
In the instant case, the appellant assessee had filed the appeal to challenge the order of the Income Tax Appellate Tribunal (Tribunal/ITAT) in upholding the order of the Assessing Officer (AO) of making addition towards cash credit u/s 68 of the Income Tax Act, 1961 (the Act) in the hand of the firm.
The Tribunal had held that the assessee was not able to prove the source of income of partners who have made the deposit with the firm in their capital account therefore addition u/s 68 was justified.
The assessee was a partnership firm with sixteen partners engaged in the business of cold storage. For the relevant assessment year, the assessee filed a return of income which was selected for scrutiny and notices under Section 143(2)/142(1) of the Act were issued.
The Assessing Officer noted several credits in the names of the partners of the firm. The Assessing Officer held the credits as unproved and made an addition under Section 68 of the Act relying upon a decision of the jurisdictional High Court in a case where the assessee had entered deposits in the books of firm in the names of partners and upon the explanations for deposits being rejected the same were treated as income of the firm and not of the individual partners.
However, the CIT(A) partly allowed the appeal and the addition made u/s 68 of the Act was deleted. The deletion of the cash credits was made on the ground that the partners had shown agricultural income in their returns. It was taken note of that the partners were identifiable and separately assessed to tax and the firm had explained the source of investment as agricultural income of the partners, therefore, if at all additions were to be made, then the same had to be made in the hands of the partners and not in the hands of the firm.
However the Tribunal partly allowed the appeal filed by the Revenue and dismissed the cross-objections filed by the assessee. The Tribunal held that credits in the names of partners as agricultural income were not proved within the meaning of Section 68 and therefore the order of the Assessing Officer treating the same to be as the firm’s deemed income, was restored.
Before the Hon’ble High Court, the principal ground canvassed by the appellant assessee was that the partners having shown the agricultural income in their personal returns of the previous years, which had been accepted by the Revenue as such without any addition, and out of the said agricultural income the partners having made the deposits with the firm in their capital accounts, the appellant assessee had satisfied the conditions provided under Section 68 of the Act with regard to the identity and capacity of the depositors as well as genuineness of the transactions.
It was submitted that the only point which was required to be considered on the question of making addition under Section 68 of the Act in the hands of the firm was the nature and source of the transaction and the appellant assessee was not required to prove the source of the source.
The Revenue submitted that the credits having been found in the hands of the firm the onus was on the firm to prove the creditworthiness of the partners as well as genuineness of the transaction and no evidence having been given with regard to agricultural operations of the partners, the transactions in the books of the firm were rightly held to be not genuine and proved within the meaning of Section 68 and there was no infirmity in the order passed by the Tribunal.
The Hon’ble High Court observed that the conditions for the applicability of Section 68 are as follows-
(i) the existence of books of accounts made by the assessee itself;
(ii) a credit entry in the books of account; and
(iii) the absence of a satisfactory explanation by the assessee about the nature and source of the amount credited.
The requirement under the Section is that the assessee is to submit an explanation about the nature and source of the sum which has been credited. The explanation furnished by the assessee is to be satisfactory and the creditworthiness or financial strength of the creditor is to be proved by showing that it had sufficient balance in its accounts to explain the source and the credits in the books of accounts of the assessee. The assessee would be required to explain the source of credit in the books of accounts but not the source of the source i.e. source of the creditor. It is seen that although the requirement under Section 68 is that the Assessing Officer must be satisfied that the explanation offered by the assessee is genuine, but it is also provided that in the absence of a satisfactory explanation, the unexplained cash credit “may” be charged to income tax – therefore, the unsatisfactoriness of the explanation would not automatically result in deeming the amount credited in the books as income of the assessee.
Cash credit entries in books of a firm could not be added to its profit
The Hon’ble High Court noted the following important judgment in this respect:
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Unsatisfactoriness of the explanation would not automatically result in deeming the amount credited in the books as income of the assessee |
The phraseology of section 68 is clear. The Legislature has laid down that in the absence of a satisfactory explanation, the unexplained cash credit may be charged to income-tax as the income of the assessee of that previous year. In this case the legislative mandate is not in terms of the words “shall be charged to income-tax as the income of the assessee of that previous year”. The Supreme Court while interpreting similar phraseology used in section 69 has held that in creating the legal fiction the phraseology employs the word “may” and not “shall”. Thus the unsatisfactoriness of the explanation does not and need not automatically result in deeming the amount credited in the books as the income of the assessee as held by the Supreme Court |
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Question of addition under Section 68 in a case of capital introduced by the partners |
Section 68 is a charging section and also a deeming provision it was held that once the firm had offered explanation and established that the capital was contributed by the partners, the same could not be assessable in the hands of the firm |
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Addition under Section 68 |
the word “may” indicates that the intention of the legislature is to confer a discretion on the Assessing Officer in the matter of treating the source of investment or credit which had not been satisfactorily explained as income of an assessee, but it is not obligatory to treat such source as income in every case where the explanation offered was found to be not satisfactory |
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What is the true nature and scope of section 68 of the Act? When and in what circumstances section 68 of the Act come into play? |
The expression “the assessees offer no explanation” means where the assessees offer no proper, reasonable and acceptable explanation as regards the sums found credited in the books maintained by the assessees. It is true the opinion of the Assessing Officer for not accepting the explanation offered by the assessees as not satisfactory is required to be based on proper appreciation of material and other attending circumstances available on record. The opinion of the Assessing Officer is required to be formed objectively with reference to the material available on record. Application of mind is the sine qua non for forming the opinion. |
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Addition upheld |
Accordingly, we answer the question referred to us by holding that the cash credit entries standing in the names of the partners in the account books of the firm could validly be treated as the income of the firm from undisclosed sources. |
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Whether in a case where there are cash credit entries in the books of the assessee firm in which accounts of individual partners exist and it is found as a fact that the cash was received by the firm from its partners then in the absence of any material to indicate that there were profits of the firm, the sum so credited could be assessed in the hands of the firm?
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Held- if there are cash credit entries in the books of the firm in which the accounts of the individual partners exist and it is found as a fact that cash was received by the firm from its partners then in the absence of any material to indicate that they were profits of the firm, could not be assessed in the hands of the firm. |
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Burden of proof in respect of an addition under Section 68
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Held – where capital contributions are made by the partners prior to the commencement of the business by the assessee firm, it is for the partners to explain the source of such capital contribution and if they failed to discharge such onus then such capital contributions, although entered in the books of accounts of the assessee firm, cannot be regarded as income of the assessee firm but the same were to be added in hands of the partners. |
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Whether in a case where there was credit in the capital account of partners in books of the firm, addition thereof could be made in the hands of the firm or the same had to be considered in the hands of the partners |
Held-According to Section 68 the burden was on the assessee to satisfactorily explain the credit entry in the books of account of the previous year and in a case where satisfactory explanation had been given by establishing that the amount had been invested by a particular person, be he a partner or any individual then the burden of the assessee firm is discharged and the credit entry could not be treated to be income of the firm for the purposes of income tax. |
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whether in a case where there are cash credit entries in the books of the assessee firm in which accounts of individual partners exist and it is found as a fact that the cash was received by the firm from its partners then in the absence of any material to indicate that there were profits of the firm, the sum so credited could be assessed in the hands of the firm |
if there are cash credit entries in the books of the assessee firm in which accounts of an individual partner exists, and it is found as a fact that the cash was received by the firm from its partners then in the absence of any material to indicate that the same were profits of the firm, it could not be assessed in the hands of the firm |
The Hon’ble High Court stated that Section 68 requires the Assessing Officer to satisfy itself of the source of the credit and if during the course of enquiry undertaken, the entries are found to be not genuine then the sum represented by such credit entry is to be added as income of the assessee. The satisfaction of the Assessing Officer thus forms the basis for invocation of the provisions of Section 68. The satisfaction in this regard, however, must not be illusory or imaginary but is required to be based on the facts and the evidence and on the basis of a proper enquiry of the material before the Assessing Officer. The enquiry envisaged under the provision is to be reasonable and just.
Under Section 68, the onus is on the assessee to offer explanation where any sum is found credited in the books of account and where the assessee fails to prove to the satisfaction of the Assessing Officer, the source and nature of the amount of cash credits an inference may be drawn that the credit entries represent income taxable in the hands of the assessee. This does not however absolve the responsibility of the Assessing Officer to prove that the cash credits constitute the income of the assessee. The onus on the assessee has to be understood with reference to the facts of each case and if the prima facie inference on the basis of facts is that the assessee’s explanation is probable, the onus shifts to the Revenue. It has been consistently held that once the assessee has proved the identity of its creditors, the genuineness of the transactions and the creditworthiness of the creditors vis-a-vis the transactions which it had with the creditors, the burden stands discharged and the burden then shifts to the Revenue to show that the amount in question actually belong to, or was owned by the assessee himself.
The Hon’ble High Court stated that the question as to whether in a case where money has come from a partner, addition, if any, has to be made in the hands of the partner or of the firm came up for consideration by the Hon’ble Rajasthan High Court and referring to the language used under Section 68 and various authorities on the point it was held that in view of the language used under section 68 and the various decisions of different High Courts and the apex court, the following points are required to be noted:-
(i) that there is no distinction between the cash credit entry existing in the books of the firm whether it is of a partner or of a third party,
(ii) that the burden to prove the identity, capacity and genuineness has to be on the assessee,
(iii) if the cash credit is not satisfactorily explained the Income-tax Officer is justified to treat it as income from “undisclosed sources”,
(iv) the firm has to establish that the amount was actually given by the lender,
(v) the genuineness and regularity in the maintenance of the account has to be taken into consideration by the taxing authorities,
(vi) if the explanation is not supported by any documentary or other evidence, then the deeming fiction credited by section 68 can be invoked.
The Hon’ble High Court stated that in a case where a sum is credited in the books of account of a firm from a partner, the assessee firm could discharge its onus by proving three things: (i) identity of the creditor; (ii) creditworthiness of the creditor; and (iii) genuineness of transaction in question. Once the assessee proves all the three things its onus is discharged. It has also been consistently held that the assessee only needs to prove the source of credit entries and he is not required to prove the source of the source or the creditors’ credit. Where the integrity of the creditors is established and the entries are shown to be not fictitious, the burden would shift on the Revenue.
In the instant case, the Hon’ble High Court noted that the partners had shown the agricultural income in their personal returns of the past years which had been accepted by the department as such. The partners were all identifiable and separately assessed to tax. The source of investment having been explained, in the event the Assessing Officer was not satisfied the addition could have been considered in the hands of the partners and not in the hands of the firm. The burden of proving the source of the credits having been sufficiently explained the addition could not have been made in the hands of the firm in the facts of the case.
Accordingly, the Hon’ble High Court answered the questions of law in favour of the assessee and against the Revenue and the appeal was allowed.
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