Demonetisation: Key tax aspects to keep in mind if you are depositing above Rs 2.5 lakh

The demonetisation of high denomination currency notes by scrapping 500 and 1,000 rupee notes by the Central government is widely seen as a masterstroke in an attempt to combat the menace of unaccounted money in India and to weed out counterfeited high denomination notes.

With individuals and other taxpayers now depositing cash (representing the old 500 and 1,000 rupee notes) in their bank accounts, it is important to take note of recent press statement issued by the Revenue Secretary. It has been reported that all cash deposits over and above Rs 2.5 lakh, between November 10th and December 30th, will be monitored by the Income Tax Department and will be matched by the past income tax returns of such depositors. It has also been clarified that in case of cash deposits above Rs 10 lakh, which are disproportionate or do not match with the depositor's tax returns, such deposits may be treated as 'tax evasion' and could, besides being subject to normal tax under the IT Act, attract a huge penalty of 200 per cent of the tax under the penal provisions of the Income-tax Act, 1961 ("IT Act").

It is important to note that although the IT Act does not provide any statutory threshold of Rs 2.5 lakh or Rs 10 lakh, for immunity from taxation in case of cash deposits; this should be seen as essentially a policy decision by the government to target only the large cash deposits and spare the sundry ones from scrutiny.

In the above context, some of the relevant provisions of the IT Act, such as those dealing with preventing tax evasion on account of unaccounted wealth, including penalty and prosecution may be relevant to note, which are briefly discussed in this article.

Section 68 of the IT Act prescribes that an item of receipt in the taxpayer's books of accounts, the nature and source of which cannot be explained by the taxpayer, is deemed to be the income of the taxpayer for such financial year. Section 69A of the IT Act contains similar 'anti-tax evasion' provisions and prescribes that any taxpayer who is found to be in the possession of any money, bullion, jewellery etc., which is unaccounted and the taxpayer is not able to justify the nature and source of the same, then such money or value of such bullion or jewellery etc. may be treated as the income of the taxpayer for such financial year. In the above cases, the income on account of the unexplained item of receipt or unaccounted money, jewellery etc, is taxed at a flat rate of 30 per cent (plus applicable surcharge and cess) under section 115BBE of the IT Act, with no deduction, whatsoever, of any expenditure or allowance or loss.

Besides tax, the tax defaulter may also be liable for penalty in terms of section 270A of the IT Act. Penalty in case of underreporting of income, which could be understood as the difference between returned and assessed income, is prescribed at the rate of 50 per cent of the tax payable on such underreported income. However, if the underreporting of income is on account of (a) misrepresentation or suppression of facts, or (b) failure to record investments in the books of accounts, or (c) failure to record any income receipt in the books of accounts, or (d) recording false entry in the books of accounts etc, the same is classified as 'misreporting of income', in which case, the penalty is prescribed at the rate of 200 per cent of the tax payable on such underreported income. In addition, the tax defaulter could also be prosecuted under section 276C of the IT Act for 'wilful attempt to evade tax', with imprisonment of 3 months to seven years (depending on the quantum of tax default) with fine.

Having analysed the legal position under the IT Act, the taxpayers/individuals planning to deposit large amount of cash in their bank accounts may be called upon to offer plausible explanations, supported by documentation/evidence, as to the nature and source of the income.

If the cash, which is deposited, is sought to be in the nature of current year's/prior years' drawings/savings, then the depositor should be able to substantiate the same with reference to current year's/past year's withdrawals. For other depositors, which would claim that the cash deposits represent their income from sales or professional receipts of the current financial year, they should be able to substantiate the same with reference to their tax returns, duly supported by adequate evidence such as maintenance of invoices, entries in stock register, details of vendors/customers, PAN details of the customers where it is statutorily required such as in the case of sale of goods or services exceeding Rs 2 lakh or payment to a hotel or restaurant exceeding Rs 50,000 etc.

The maintenance of above mentioned documentation is only indicative and while this will not mitigate tax exposure, it may certainly mitigate the penalty and prosecution exposure in respect of misreported income of prior years. Inability to justify may lead to the conclusion that the income pertains to prior years, following which additions may be made to the returned income of prior years, and subject to penalty levy of 200 per cent of the tax besides prosecution proceedings, in which case the total tax, penalty and interest under section 234B of the IT Act (at the rate of 1 per cent for every month on the default up to the date of assessment) could well exceed the total cash deposited by the depositor.

Amit Singhania is Partner, Shardul Amarchand Mangaldas & Co. Rahul Yadav, Senior Associate, also contributed to the article. Views expressed are personal