>>CASH CREDIT, UNEXPLAINED INVESTMENTS, ETC.

CASH CREDITS UNDER INCOME TAX ACT AND FEMA

Paresh P. Shah
Chartered Accountant

If a cash credit or investment, etc. in foreign exchange is treated as unexplained under Income Tax Act, whether there would be any penal consequence unclear FEMA? This & other questions regarding foreign exchange transactions have been answered in the present article. 

1. Background

Cash credits and other unexplained items under the Income Tax Act, 1961 are governed by provisions of sections 68, 69, 69A, 69B & 69C of the Income Tax Act, 1961 (the Act) and various Judicial pronouncements in relation to such credits and other items. However, such credits in the books of account are also governed by the provisions of Foreign Exchange Management Act, 1999 (FEMA).

Under FEMA, varying nature of credits are governed by one or more notifications, which may or may not have any impact as to what the Income Tax Act Authority has to infer / has inferred on inquiry of such credits or otherwise. Therefore, attempt has been made in this article to compare the provisions relating to cash credits, with those under FEMA with or without any correlation with tax laws. This is due to the fact that the objectives of two statutes are significantly different, that of Income Tax as to tax the chargeable income of the assessee and of FEMA is to conserve and manage the foreign exchange resources of the country.

2. Introduction

Cash credits, unexplained money, investment and expenditure are governed by sections 68 & 69 of the Act, and provides for computation of deemed Income, if assessee is unable to substantiate the source of such credits or as the case may be of investments, money or expenditure. There may or may not be any implications under FEMA, as to whether such credit is assessed as income of the assessee, or not.

Scope of FEMA concerning cash credits transactions may be considered to be of wider impact, since it is not only applicable to transactions in India, but also applies to transactions outside India, between Resident and Non-Resident either in Indian currency or foreign currency.

It may be pertinent to note that

1. the provisions of FEMA may not be applicable to

   1. a transaction of Loan / Deposits, Lending & Borrowings and investment between two Residents,

   2. possession of money not being foreign currency by residents,

   3. a transaction of gift between two residents,

   4. an expenditure by residents in Indian currency,

therefore the discussion on various issues of this article may not be applicable to above transactions.

2. It is possible that the transactions of cash credits, etc., which are found unexplained resulting in deemed Income in the hands of assessee, may carried out in accordance with the provisions of FEMA or may not have been.

The notifications under FEMA cover various types of transactions, however, for the purposes of this article we shall consider transactions as mentioned under with respective notifications under FEMA. Scheme of FEMA requires to carry out the transaction either without any reference to Reserve Bank of India / Central Government if it is within the guidelines of automatic route or it may require to file some declarations and or informations to the ADs / RBI or it requires prior approval of the respective authorities.

The above transactions entered into between the residents and non residents may have been carried out with permission or in accordance with the provisions of the respective notification which may be by declaration or without declaration or with prior approval as the case may be under FEMA.

Under I.T. Act, unexplained transaction of cash credit is considered as income, under FEMA penal provisions are provided under section 13 which reads as under.

Penalties

Section 13 (1). If any person contravenes any provision of this Act, or contravenes any rule, regulation, notification, direction or order issued in exercise of the powers under this Act, or contravenes any condition subject to which an authorisation is issued by the Reserve Bank, he shall, upon adjudication, be liable to a penalty up to thrice the sum involved in such contravention where such amount is quantifiable, or up to two lakh rupees where the amount is not quantifiable, and where such contravention is a continuing one, further penalty which may extend to five thousand rupees for every day after the first day during which the contravention continues.

(2) Any adjudication authority adjudging any contravention under sub-section (1), may, if he thinks fit in addition to any penalty which he may impose for such contravention direct that any currency, security or any other money or property in respect of which the contravention has taken place shall be confiscated to the Central Government and further direct that the foreign exchange holdings, if any of the persons committing the contraventions or any part thereof, shall be brought back into India or shall be retained outside India in accordance with the directions made in this behalf.

Explanation. — For the purposes of this sub-section, "property" in respect of which contravention has taken place, shall include—

1. deposits in a bank, where the said property is converted into such deposits;

2. Indian currency, where the said property is converted into that currency; and

3. any other property, which has resulted out of the conversion of that property".

Also there are provisions of prosecution, if penalty is not paid and Appeal provisions under FEMA.

Thus, on comparison, one would find that penal provisions under FEMA are initiated only if the transactions are not carried out in accordance with the provisions and penalty are quantified, which includes confiscation of assets / property acquired in contravention of the provisions.

3. Borrowings and lending

The provisions of FEMA requires proper documentation as to the identity of creditor and genuinity, however, it does not require to establish the prima facie credit worthiness or capacity as required u / s. 68 of the I.T. Act. Normally, Reserve Bank approves the transaction without further inquiry on the subject, unless it comes to its notice that deposits or lending by non residents to residents is not a genuine transaction or deposits in foreign currency by Residents either in India or abroad is in contravention of any of the provisions of FEMA.

The transactions covered by section 68 of the Act contemplates cash credit recorded in the books of account. Penal provisions under FEMA shall be invoked only if (a) the transactions are carried out in contravention of the respective provisions of the FEMA (b) there is a positive evidence under Income Tax Act, 1961 which can trigger action under FEMA. Thus if a transaction of borrowing is carried out in accordance with the provisions of FEMA i.e., in accordance with notifications (1), (3) & (4) of FEMA and assessment of Income under section 68 of the Income Tax Act, 1961, is made without any further evidence as to the genuinity of the transaction, then in most of such cases action may not be possible under FEMA.

However, some of the transaction of Cash Credit recorded in the books of account may have implications under FEMA. In C.P. Devasay vs. Director of Enforcement (Appeal No. 632 of 1986 decided on 3-5-88), the appellant received Rs. 1 lakh by bank draft from a person in India on the instructions of the appellant’s non-resident son. In reply to the show-cause notice issued for contravention of section 9(1)(b) of FERA, the appellant submitted, among others, that his son would normally have remitted the amount from abroad which was required by the appellant to purchase a car which he needed for health reasons. But as his son could not arrange immediate remittance, he had asked a person in India to give the amount to the appellant. Thus, there was not compensatory payment involved.

The Board held that even though no compensatory payment was involved and the amount was received from a resident person by bank draft, the contravention of section 9(1)(b) was proved.

Similarly, in P. Mohammed Koya Haji vs. Directorate of Enforcement (46 Taxman 87), two letters were seized by the Enforcement Officers from the appellant’s premises. In his statement, the appellant explained that he had received two sums of Rs. 10,000 and Rs. 3,000 on the instruction of non-residents through their relations for construction of their houses. The adjudicating officer imposed penalty for contravention of section 5(1)(aa) [corresponding to section 9(1)(b)] for the appellant’s having received money by order of non-residents. On appeal, the appellant argued that there was no evidence to show as to how the said two amounts had come to India and that it was conceivable that the persons themselves might have handed over the money while in India. The FERA Board held that the letters seized from the appellant clearly showed that the amounts were remitted to him by non-residents and consequently contravention was established.

In the cases cited above, it would be noted that there may not be any consequence under section 68 of the Income-tax Act 1961. Also language of section 9(1)(b) of FERA must be distinguished from that of section 3 of the FEMA in order to comprehend the various situations of breach.

4. Realisation, repatriation and surrender of foreign currency under FEMA

If a Resident Indian acquires Foreign Exchange abroad during his visit or otherwise, he is required to surrender the same within seven days from the date of receipt. It does not matter whether such resident Indian offers the same as income or not under the Act.

Similarly, a Resident Indian is permitted to buy the Foreign Exchange as per the provisions of the current account transactions Rules / Regulations under section 5 of the FEMA. Also he is required to surrender the foreign currency in excess of US$ 2,000 / - within ninety days, except that travellers cheques may be retained for the period of 180 days irrespective of the limits.

Thus, Resident Indian may acquire the Foreign Exchange out of funds which may be held to be unexplained cash credit or money u / s 68 of the Act. However, if these are acquired in accordance with the provisions of the FEMA and foreign exchange is surrendered as per above provisions, there are no penal consequences under FEMA.

Also there are no penal consequences, if freely acquired foreign currency income or any other receipt is surrendered to the Authorised dealer within stipulated time despite the fact whether receipt is offered for tax or not. Similarly, if foreign currency is retained by the residents, within the limits laid down under FEMA, there are no penal consequences under FEMA irrespective of the fact that position may be different under the I.T. Act. However, there will certainly be the assessment of income as per the provisions of the section 68 / 69 of the Act in case such currency / etc are not recorded in the books of the account or the source of acquisition is not explained.

5. Investment

Investment in foreign currency by residents is governed by notification nos. 19 & 10 of the FEMA. There are various prescribed methods under FEMA by which an investment can be made by the resident applicant. These are like :–

1. Purchasing foreign exchange from ADs.
2. Out of the foreign currency balance held in EEFC A / c.
3. Out of the RFC A / c.
4. Applying proceeds of ADR / GDR to acquire foreign security.

Similarly non-residents can invest in India under the portfolio scheme as well as Direct Investment scheme in accordance with Notification No. 20 of FEMA.

It is provided u / s. 69 of the I.T. Act that if the Investment made by the assessee is not recorded in his books of account, same will be considered as income of the assessee. This will even include investments which are established to have been made by the assessee, whether in his own name or on someone else’s name.

Investment made abroad by the Resident Indian, as per the notification No. 10 and / or 19 of FEMA, has to be one of which is recorded in the books of account of the assessee and therefore there may not be any consequences under FEMA and or under the I. T. Act. However, if investment is found to be made in foreign currency by the assessee, which is not recorded in the books of account or invested in third party’s name, penal provisions under FEMA shall be attracted, if it is discovered that such foreign investment is made otherwise than as per any of the approved methods or that such investment is made by contravention of foreign exchange regulations,

1. through compensatory payments which is in contravention of section 3 of the FEMA, or

2. the income earned by residents is invested abroad without first repatriating it to India and surrendered to ADs as required under the regulation governing repatriation and surrender of foreign exchange in India, or

3. Investment in foreign currency / security in someone else‘s name, however investment made by resident Indian, etc.

Normally action under FEMA / FERA by enforcement directorate will be initiated when penalty proceedings are initiated under Income Tax Act, in a relevant case of resultant violation under FEMA and vice versa.

6. Gift

6.1 The Finance (No. 2) Act, 1998, has amended the charging section 3 of the Gift-tax Act by inserting sub-section 3 with effect from 1st day of October, 1998, which reads as under :

"(3) Notwithstanding anything contained in sub-section (2), the provisions of this Act shall cease to apply and shall have no effect whatsoever in respect of any gift made on or after the 1st day of October, 1998."

As the gift tax has ceased to apply, some of the assessees are under the impression that the tax authorities cannot ask questions in respect of foreign gift. The said impression is not correct.

6.2 Mere receipt of amount shown as gift whether received in foreign exchange or Indian currency would not be sufficient to relieve recipient of gift from burden of establishing identity, financial capacity of donor and genuineness of gifts. The donee would have to furnish necessary evidence such as the income earned by the donor, capacity of the donor, financial status at the time of making the gift, complete address of the donor. It would be further necessary to explain the circumstances under which the gift was made so as to prove the genuineness of gifts.

A transaction of gift between Residents and Non-Residents has come to focus on number of occasions, and it is attempted to consider the transaction as unexplained credit, under section 68 of the Act, by holding the view that such donor either does not have enough capacity or it is not a bona fide credit.

In one of the interesting case of CIT vs. Mrs. Sunila Vachani 184 ITR 121, (Delhi) it was held by the honourable Court that unless it is proved that it is the assessee’s own money which has been routed via Gift, it cannot be treated as income u / s. 68. It was held that even though it may be surprising as to how large sums of money are received by a family in India by way of Gifts from strangers from abroad, unless there is something more tangible than suspicion, it will be difficult to regard the moneys received in India from abroad as representing the income of the assessee in India. However, the Delhi Tribunal in D.C. Rastagi (HUF) vs. ACIT 57 ITD 295, after considering the Delhi High Court decision supra, have held that the onus lies on the assessee to establish identity, capacity of donor and genuineness of transaction. Mere fact of receipt of money in foreign exchange would not relieve the burden cast upon the assessee. The Hon’ble Mumbai Tribunal in P.M. Mehta vs. ITO in ITA No. 136 / Bom / 86 Order dated 27-8-1987, (BCAJ 1987 page 655) have laid down the precise limits of the powers of the Assessing Officer and the burden of proof which the assessee is required to discharge for proving the Foreign gifts. According to the Tribunal, the Assessing Officer is not justified in making a roving inquiry into the entire financial affairs of the donors relating to several years. However, the Assessing Officer is justified in making an enquiry into the question whether the amount which is said to have been gifted really belonged to the donor and whether the amount has, in fact, been gifted to the donee. For that purpose, the Assessing Officer is entitled to ascertain as to whether the donor on the date of the alleged gift has a particular amount to his credit in his account in the bank and whether from that amount the gift has been made. The Assessing Officer is entitled to make investigation to rule out the possibility of the assessee’s own money being deposited in the bank account of the donors and being returned to the assessee.

In recent years, the tax authorities in India are applying the ratio of judgment of Supreme Court in the case of Sumati Dayal vs. CIT 214 ITR 801 (SC) wherein the court upheld the decision of the assessing officer taxing the receipt as income from undisclosed source u / s. 68, although the assessee has shown the same as winning from lottery very frequently. Therefore, if an assessee is very frequently receiving the gifts from persons other than relatives, the Assessing Officer may try to apply the ratio of Supreme Court judgment. Hence while accepting the gift, the donee will have to keep minimum information like – address of donor, confirmation from donor, financial capacity of donor, bank statement of donor of the relevant year of gift, etc. If the donor is assessed to tax, certificate from the Chartered Accountant or Tax Consultant of respective country may be advisable.

In the circumstances as mentioned above of non bona fide transaction of Gift between Resident and Non Resident, donee must keep proper records otherwise same can be treated as compensatory payments, violative of Section 3 of the FEMA.

7. Sale of gold and silver by Non Resident Indians – Taxation

Any person who are citizen of India and person of Indian origin returning to India after having stayed abroad for more than six months can import gold not exceeding 10 kg., on payment of duty @ 400 rupees for 10 gm and silver not exceeding 100 kg.@ duty of Rs. 500 per kg with certain conditions. The Custom Authorities cannot ask the source of acquisition of gold or silver, however, when the sale consideration is deposited in the banks, the tax authorities can ask the assessee to explain the source of investment. If the source are not satisfactorily explained, the same can be assessed under section 69 of the Income Tax Act. Rafique Abdul Hamid Kokani vs. ITO, ITA No. 85 / M / 96 Bench ‘A’ dated 9th March, 1999.

If the source is established to be not out of the legitimate income earned abroad, but out of compensatory payments, then proceedings can be initiated under FEMA for violations of provisions of section 3.

8. Unexplained expenditure

In case of understatement of cost of investment or understatement of the expenditure incurred by the assessee, if it is established that such cost is understated or expenditure is incurred by the assessee, same shall be treated as income under section 69B of the I.T. Act. Similarly under FEMA, if Resident Indian has incurred expenditure in foreign currency, out of undisclosed sources, penal provisions under FEMA shall apply.

9. Conclusion

It would be interesting to note that, the violations under FEMA / FERA are normally centered around and on account of

1. The compensatory transactions; i.e., transaction is squared up by exchanging the currencies, or

2. The acquired exchange is not surrendered in time or retained beyond the permitted period for which it could be retained or the legitimate foreign exchange belonging to the Country is not brought into India either as income or otherwise.

However under Income Tax Act, 1961 addition is made as deemed income and penal provisions are attracted, if credit is unexplained and money / foreign exchange or investment are not recorded in the books of account. In case of investments and expenditure, even if they are understated, additions to Income may be made.

Thus each and every consequences under sections 68 to 69Cof the Income Tax Act, 1961 may not automatically lead to penal consequences under the FEMA and the vice versa.

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