Creditworthiness of Creditor cannot be Denied merely due to Non-Filing of ITR: Patna HC deletes Addition u/s 68 [Read Order]

The Patna High Court, in its recent decision has held that creditworthiness of a creditor cannot be disbelieved merely because the creditor did not file an Income Tax Return ( ITR ) for the relevant assessment year.

In the matter of Rajnandani Projects Pvt. Ltd, the appellant challenged the final order of the Income Tax Appellate Tribunal ( ITAT ) challenging the confirmation of addition under Section 68 of the income tax act, 1961 which was deleted by the Commissioner of Income Tax (Appeals)[CIT(A)].

Justice Bibek Chaudhuri and Justice Dr. Anshuman noted that the assessee had produced confirmations, PAN details, bank statements, ledger accounts, and copies of the creditor’s ITRs for other assessment years, and that the transaction had been routed entirely through banking channels. Therefore the sources are established sufficiently as per the requirements of the law.

The counsel of the appellant submitted that the Tribunal erred in reversing the order of the Commissioner of Income Tax (Appeals) by placing undue emphasis on the fact that the creditor had not filed the return of income for the assessment year corresponding to the transaction.

It was argued that filing of return by the creditor for a particular year cannot be a determinative factor for the purpose of Section 68 of the Act when the identity and the banking trail of the transaction stand established.

According to the counsel of the appellant, the tribunal’s order suffers from an erroneous application of law and overlooks settled principles laid down by this Court.

However, the counsel for the income tax department supported the decision of the appellate tribunal. It said that the appellant has failed to discharge the statutory burden under

Section 68 of the Income Tax Act. The counsel added that had not produced a satisfactory and credible explanation regarding the nature and source of the credit.

The court observed that “Section 68 of the Act provides that where any sum is found credited in the books of an assessee and the explanation offered regarding the nature and source of such credit is not satisfactory, the sum may be treated as income of the assessee. The provision casts an initial burden upon the assessee to explain the credit. The extent and manner of discharge of such burden has been the subject of judicial interpretation, and the settled position is that the assessee is required to establish the identity of the creditor, the genuineness of the transaction, and the creditworthiness of the creditor.”

“The finding of lack of creditworthiness was primarily based on the absence of return of income filed by the creditor for the relevant year. While filing of return is a relevant circumstance, it cannot be the sole determinative factor, particularly when the transaction is routed through banking channels and the identity of the creditor is not in dispute” observed the bench.

The High Court further noted that the Tribunal’s approach required the assessee to prove the “source of the source,” which is not required under Section 68 unless supported by adverse material.

Adding to the observations, the court said that, if the department cannot believe the source established by the appellant then, it is the duty of revenue to investigate if the funds are from different sources.

The bench said that the assessee cannot be compelled to explain the origin of funds in the hands of a third party unless the material on record justifies such an enquiry. It was compelling the assessee to prove the financial capacity of the creditor beyond the documents submitted, which is not proper, observed the court.

Therefore, the court ruled in favour of the appellant - assessee. It restored the order of the CIT(A) and set aside the ITAT.

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