Credit in partner’s capital account for book entry adjustments can not be added u/s 68

Credit in assessee’s capital account consequent to book entry adjustments in the books of the partnership firm can not be added u/s 68 – ITAT

In a recent judgment, ITAT Mumbai has deleted addition under section 68 of the Income Tax Act holding that credit in the assessee’s capital account was only a consequential book entry arising from adjustments in the books of the partnership firm, the loan pertained to earlier years, and section 68 had no application to such a case.

ABCAUS Case Law Citation:
5021 (2026) (01) abcaus.in ITAT

The return of the respondent assessee was processed under section 143(1) of the Income Tax Act, 1961 (the Act). The case was selected for limited scrutiny under CASS on the issue of large increase in capital during the year.

During the course of assessment proceedings, the Assessing Officer noticed a substantial increase in the capital account of the assessee during the relevant previous year. In response to notices issued under section 142(1), the assessee explained that no fresh capital was introduced during the year and the increase in capital was on account of prior period adjustment.

It was explained that the adjustment arose from the assessee’s capital account in a partnership firm in which the assessee held 34 percent share. It was further explained that the partnership firm had written back an old unsecured loan, and corresponding credit was given to the partners’ capital accounts.

It was stated that the partnership firm had obtained an unsecured loan which had become time-barred under the Limitation Act and was written back unilaterally in the books of the firm. As a result, the assessee’s share of the loan was written back which after adjusting prior period losses and tax adjustments resulted in a net credit in her capital account.

Rejecting the explanation of the assessee, the Assessing Officer held that the increase in capital represented unexplained cash credit in the hands of the assessee. Accordingly, addition was made under section 68 and taxed under section 115BBE of the Act.

The CIT(A) deleted the addition made under section 68 r.w.s. 115BBE and allowed the assessee’s appeal.

The Tribunal noted that the undisputed factual position, as recorded both by the Assessing Officer and the CIT(A), was that the transaction in question pertained to the partnership firm, which had written back an old loan in its books, and the corresponding effect was given in the capital accounts of the partners in proportion to their profit-sharing ratio. The assessee did not receive any fresh funds during the year. The credit in the capital account was only a consequential book entry arising from adjustments in the firm’s accounts.

The Tribunal observed that the Hon’ble Supreme Court had categorically held that a firm is a distinct assessable unit, separate from its partners. Consequently, income which is assessable, if at all, in the hands of the firm cannot be brought to tax again in the hands of its partners merely because corresponding entries appear in the partners’ capital accounts.

The Tribunal further observed that Section 68 can be invoked only in respect of a sum credited in the books of the assessee in the relevant previous year. It is well settled that opening balances or credits pertaining to earlier years cannot be brought to tax under section 68 in a subsequent year. The CIT(A) had rightly relied on this settled principle and has correctly held that the impugned credit does not represent a fresh credit of the year under consideration.

The Tribunal opined that the assessee cannot be expected to produce complete particulars of a lender relating to a transaction undertaken more than ten years earlier, particularly when the law itself requires maintenance of records only for a limited period. In the absence of any tangible material brought on record by the Revenue to demonstrate that the loan was fictitious, the mere non-availability of certain particulars cannot justify the addition under section 68 of the Act.

The Tribunal further observed that the CIT(A) had held that the write-back of a time barred loan constitutes a capital receipt and that expiry of limitation does not extinguish the debt but merely bars its enforcement. The Revenue had not brought any material on record to demonstrate that the conditions of section 41(1) or section 28(iv) are satisfied in the facts of the present case. The Assessing Officer himself had made the addition under section 68, and not under section 41(1).

Accordingly, the Tribunal upheld the order of the CIT(A) and the grounds raised by the Revenue were dismissed.

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