Budget 2022: Unexplained Borrowings To Face Tighter Tax Scrutiny

The Finance Bill, 2022 has placed additional onus on the taxpayer to prove unexplained cash credits.

The Income Tax Department head office in Mumbai. (Photograph: BloombergQuint)
The Income Tax Department head office in Mumbai. (Photograph: BloombergQuint)

A proposed amendment to the income tax law has the start up community perturbed.

Intended to be an anti-abuse provision, section 68 of the Income Tax Act deals with unexplained cash credit - the nature or source of which isn't satisfactorily explained by a taxpayer. Such amount is to be treated as the taxpayer's income. If the amount is in the form of share application money, share capital, share premium, taxpayers have the onus of explaining the nature and source to the satisfaction of the assessing officer.

Because of the way the section is worded, several tribunals have ruled that section 68 doesn't allow the tax department to examine source of source of non-share capital cases, for instance, the Delhi ITAT in Prem Anand's case.

This crippled the revenue department's ability to use section 68 in cases of loans and borrowings. Finance Bill, 2022 proposes to address this.

The proposed amendment says that in case of loans or borrowings or such amount credited in the books of any taxpayer, an additional onus will apply on taxpayer to explain the source of funds in the hands of the creditor. This will not apply if the lender is a well-regulated entity, for instance, a venture capital fund, registered with SEBI.

To reiterate, this onus always existed when a company raised share capital. It's also now been extended to debt borrowings. Which means, taxpayers will now have to prove the creditworthiness and genuineness of the lender. For instance, when a start-up raises seed capital, or takes an unsecured loan, borrows money for working capital requirements, it'll have to ask the lender for specific documents.

In share capital cases, taxpayers have sought to discharge this responsibility by furnishing the PAN card, income tax returns and bank statements of the entity investing the money.

But the department has all along argued that just because the money is coming via banking channels doesn't make it genuine - an argument that has been broadly rejected by courts. In addition, courts have also held that the taxpayer is not required to prove source of source, reiterated by the Delhi High Court as recently as last month in Agson Global Pvt.'s case.

Since the onus has now been extended to debt borrowings as well, experts apprehend the same approach from the department as seen in share capital cases, experts say.

In particular, start ups raising seed capital will be impacted and expected to find out and prove from where their creditor got its funds, Ashish Mehta, partner at Khaitan and Co., told BloombergQuint.

Going forward, assesses will be expected to do a reverse KYC of sorts on the source of lenders to obtain details so as to satisfy the tax authorities. This onerous task will hamper the intended standards for ease of doing business.
Ashish Mehta, Partner, Khaitan and Co.

The fear might not be unfounded.

In an interview with BloombergQuint, JB Mohapatra, chairman of the Central Board of Direct Taxes, reiterated the department's view to say that nature, source and legitimacy of a sum of money cannot be determined by looking at the first source.

Take it from me, the PAN or the balances in the bank account don't really conclusively prove that the remittance is from the right regular sources. We have to look at the second to the third to the fifteenth source, sometimes. This makes the life of a tax officer, who scrutinizes these entries to trace the source of the amount, very difficult. It is a very onerous task of going to the root of the real account.
JB Mohapatra, Chairman, CBDT

But where the department has taken the effort to prove a taxpayer otherwise, courts have upheld the use of Section 68.

For instance, in the case of NRA Iron & Steel Pvt., the apex court noted that the assessing officer's investigation revealed investor companies were non-existent, had filed returns for negligible taxable income, there was no explanation why the investor companies had applied for shares at a high premium, they weren't able to establish the source of funds etc.

And so, the apprehension isn't against genuine use of this anti-abuse provision. But additions which may be made by assessing officers without carrying out an independent enquiry to verify the genuineness of the lender.

The intent of the tax department is good. But, the new amendment may result in more taxpayers' knocking the doors of the courts and tribunals, Kumarmanglam Vijay, partner at J Sagar Associates, said. It adds to the difficulty of the businesses, who will have to go a step further to check the credentials of the lender. And given that parties are usually not keen to share business details with third parties, it may only spur further litigation for borrowers, Vijay opined.