ITAT Clarifies Treatment of FD Encashment in Tax Assessments
The Income Tax Appellate Tribunal (ITAT), Hyderabad bench, has issued a significant ruling clarifying how the encashment of fixed deposits (FDs) should be treated during tax assessments. The tribunal held that if an FD is created using funds already deposited in a bank account, its subsequent encashment cannot be treated as a fresh deposit for the purpose of adding unexplained money to income.
This decision addresses a common issue where Assessing Officers (AOs) may inadvertently or deliberately count the same funds twice: once when the initial deposit is made and again when the FD matures or is encashed.
The Case: Double-Counting of Rs 10 Lakh Deposit
The ruling stems from a case where the AO made an addition to the taxpayer's income by treating the maturity proceeds of an FD as a new, unexplained deposit. The taxpayer had deposited Rs 10 lakh in cash into their bank account in September 2020. Subsequently, on September 3, 2020, an FD of the same amount was created. This FD was encashed on November 2, 2020.
The AO calculated the total deposits in the bank account at Rs 32.50 lakh, effectively counting the Rs 10 lakh twice: once as the initial deposit and again as the FD encashment. The taxpayer had provided explanations for other deposits, including the sale of agricultural land and agricultural income. The first appellate authority, the CIT(A), accepted the explanation for Rs 20.85 lakh but sustained an addition of Rs 11.65 lakh, largely due to the FD encashment being treated as unexplained.
Tribunal’s Reasoning and Decision
The ITAT examined the facts and found that the Rs 10 lakh FD was created directly from the earlier bank deposit. Therefore, the encashment of this FD did not represent new money entering the taxpayer’s account. The tribunal noted that the AO’s calculation of total deposits was erroneous because it failed to account for the circular nature of the funds.
"Once the Assessing Officer has wrongly considered the total amount of deposit in the bank account on encashment of the fixed deposit then, this addition made by the Assessing Officer is also contrary to the facts and record. Accordingly, the same is deleted," the ITAT stated in its order.
Consequently, the tribunal deleted the remaining addition of Rs 11.65 lakh, ruling in favor of the taxpayer.
Expert Insight: Source of Funds Remains Critical
While this ruling is favorable for taxpayers, tax experts caution that it does not provide a blanket exemption for all FD encashments. Mihir Tanna, Associate Director at SK Patodia LLP, emphasized that the source of the money used to create the FD remains a critical factor.
"If the FD was created from an existing bank balance, and the source of that underlying bank balance itself cannot be satisfactorily explained, the department can consider the source of that money as unexplained credit and make an addition," Tanna said.
He further noted that if the creation of the FD was not recorded in the taxpayer’s books of account, or if no satisfactory explanation is provided for its nature and source, it could still be considered an unexplained investment.
Implications for Taxpayers
Taxpayers should ensure they maintain a clear and documented trail linking the original source of funds to the bank deposit and the subsequent FD. This includes bank statements showing the initial deposit, the FD creation, and the encashment, especially if these transactions occur within a short timeframe.
For substantial FDs, particularly those significantly higher than the income reported in the return, maintaining documentation of the source of funds—such as salary credits, business receipts, sale proceeds, gifts, or inheritances—is essential. A clear audit trail helps defend against allegations of unexplained money or investment.