Income–Investment Mismatch Can Invite Tax Department Scrutiny

A woman who declared just Rs 4.81 lakh income in her Income Tax Return (ITR) faced a major tax setback after paying a Rs 50 lakh LIC premium, according to a recent media report. This made the Income Tax department look into her case. The matter eventually reached the Income Tax Appellate Tribunal (ITAT). In the end, the Rs lakh was added to her income, and that significantly increased her tax exposure.

Taxman Tracks Income–Investment Gaps

Indian tax authorities can easily identify mismatches between the income declared and the investment made in a year on the basis of data analytics and information reporting systems, which compare a taxpayer’s declared income with their financial transactions. “The tax department cross-verifies disclosures in income tax returns with third-party reporting under systems such as the Annual Information Statement (AIS) and Statement of Financial Transactions (SFT) maintained by the Income Tax Department of India,” says Mrugakshi Joshi, advocate, D.M. Harish & Co.

There could be a mismatch in the data submitted in the income tax return by the taxpayer and the data automatically captured in the Annual Information Statement and Form 26AS, which collates the data about tax deducted at source, tax collected at source, high-value transactions, etc., from various agencies like the banks, mutual funds, etc. In case there is any discrepancy in the data, it may trigger a scrutiny by the tax authorities. “It is noticed that typically scrutiny is triggered in the case of high-value transactions, where there is a likelihood of a large discrepancy in amounts reflected in tax returns and Form 26 AS, which might come under the notice of tax authorities,” says SR Patnaik, partner (head - taxation), Cyril Amarchand Mangaldas.

Maintain Records To Justify High-Value Investments

In order to justify large financial outflows and demonstrate legitimate sources for funding the same, the taxpayers should maintain the requisite documents that can provide the requisite clarity regarding the money trail, such as relevant bank statements, copies of investment statements, invoices, payment receipts, etc. “For proving legitimacy in case of bank or cash transactions, the taxpayer should maintain documents such as gift deeds, accounting entries of Hindu Undivided Family (HUF) or partnership firms, any contracts or loan agreements or sale deeds confirming such payments, tax deducted at source or tax collected at source (TDS/TCS) certificates, etc.," says Patnaik.

If taxpayers fail to explain the source of funds behind high-value investments in their response to the tax authorities’ scrutiny notice, tax authorities may suspect such transactions to be unexplained income or cash credits and could bring them to tax. “They may also impose an additional penalty if the taxpayer had failed to include such income in their tax returns,” says Patnaik.