Neither a borrower, nor a lender be,” so goes the famous advice by Polonius to his son Laertes in William Shakespeare’s play Hamlet. This sage advice is, however, often ignored in today’s modern financial world, where there is no stigma attached to borrowing and people freely borrow. However, when it comes to borrowing from persons other than banks or finance companies, maybe even from friends and relatives, borrowers may do well to heed this old advice, given the income tax provisions relating to loans.
There is a provision of tax laws that provides that unexplained cash credits can be treated as the income of the recipient. The term “cash credits” would include loans that you may have taken. Therefore, under certain circumstances, the amount of loan that you may have taken can be added to your taxable income. These provisions were inserted to curb the practice of tax evaders converting their black money into white by taking bogus loans.
Proof of lender’s identity: Courts have held that for the purpose of explaining the loans that you have taken, you would need to prove the identity of the lender, the capacity of the lender to give you the loan and the fact that the amount paid to you is genuinely a loan. It is only then that such loan cannot be treated as an unexplained cash credit and will not be added to your income. If you are unable to prove either the identity of the lender, the capacity of the lender or the genuineness of the transaction, the amount of loan that you have taken can be treated as your income.
The identity of the lender can be proven either by furnishing his permanent account number or a copy of his passport, among other things. The genuineness of the transaction can be proven by furnishing a confirmation from the lender that he has given the amount to you as a loan. Normally, the difficult part is in proving the capacity of the lender to give you the amount involved, particularly if the amount is fairly large. Generally, a copy of income-tax returns of the lender, a certificate from bankers certifying his capability, a copy of his bank passbook or statement, or other similar documents should suffice. The practical difficulty often is that the lender is reluctant to share such personal and confidential documents with you, by mere reason of having given you a loan. In such circumstances, the alternative is to request the tax officer to issue a notice by way of summons to the lender, who would then file his documents directly with the tax officer.
Limit to borrowing cash: The other set of provisions that you need to be careful about are in relation to borrowing or repaying an amount exceeding Rs20,000 in cash. The law requires that all such loans are to be taken and repaid only by an account payee cheque or a demand draft. Not only that, if the value of the existing outstanding loans (with or without the incremental loan) exceeds Rs20,000, then no amount can be received or repaid in cash. The penalty for infringement of these provisions is an amount equal to the amount of the loan taken or repaid in violation of these provisions. A harsh penalty indeed. There is only one mitigating provision—where a person is able to prove that there was a valid and sufficient reason for taking or repaying the loan in cash, penalty cannot be charged.
There is no exemption even for loans between husband and wife, between brothers or sisters, or between parents and children. All such loans also have to be taken and repaid by an account payee cheque or a demand draft.
What’s an emergency? At times, a loan may need to be taken in cash on account of an emergency such as hospitalization. In such cases of emergency in life-and-death situations, the penal provisions would not apply as there certainly is a valid and sufficient reason for taking loans in cash. However, the difficulty arises in situations that you may regard as an emergency, but the tax officer doesn’t view it as an emergency. It is these situations which lead to unnecessary and unwanted litigation.
Cash limit absurdly low: The purpose behind introduction of these provisions was to prevent the practice of taxpayers justifying acquisition of certain undisclosed assets or incurring of certain undisclosed expenditure by claiming that these were acquired or met out of loans taken in cash from various people. While such provisions may, therefore, be justified to prevent tax evasion, the limit of Rs20,000 is absurd and ridiculously low and could apply even in seemingly innocuous day-to-day situations of many taxpayers. This limit was fixed about 20 years ago in 1989, and has remained unchanged since then. Based on the rate of inflation, the limit should currently be at least Rs1.25 lakh, if not more. The retention of this low limit unnecessarily places a large number of taxpayers at risk of being harassed by tax officers even in genuine cases.
Proposed limit not enough: Even under the Direct Taxes Code, the limit is being raised to just Rs50,000. Is it not high time for the government to fix a reasonable limit and ensure that the limit is indexed to inflation in the future so that small taxpayers do not unwittingly fall foul of the provisions of law?
Gautam Nayak is a chartered accountant.
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