What are the tax implications of depositing Rs 2,000 notes?

Indians have been panicking ever since it was reported that large cash deposits made during the phasing out of the Rs 2,000 notes would likely be notified by banks to the taxman, especially if the deposit is disproportionate to the income reported in the income tax return. 

But what does the fine print say?

After the RBI announced the withdrawal of Rs 2000 notes, the government declared that these notes would continue to be legal tender. The RBI has asked people to deposit or exchange these notes till September 30, 2023. There is no limit for depositing these notes in a bank account, but there is a limit of Rs 20,000 for exchange in one go.

Cash deposits in bank accounts have been subject to reporting requirements for a long time

While there is no cap on the number of Rs 2,000 notes that one can deposit in bank accounts, one should be aware of the Statement of Financial Transaction (SFT) rules. 

Cash deposits in bank accounts have been subject to reporting requirements for a long time, and this is not a new provision in the wake of the RBI’s decision to recall Rs 2,000 notes. This policy helps the government monitor any large-scale misuse of the country’s financial system. Consequently, in cases where significant cash deposits are made that are inconsistent with the person’s usual business operations, banks might report these transactions to the income tax department, which is also reflected in the depositor’s 26AS and Annual Information Statement.

“As per the existing norms, large cash deposits must be notified to the authorities. Banks in India are obligated to report cash deposits over a certain limit to the Income Tax Department. Currently, deposits over Rs 10 lakh for term and savings deposits and Rs 50 lakh for current account deposits in a financial year need to be reported by the banks to the tax authorities.

Let’s be clear, however, that this reporting protocol is not a new provision sparked by the RBI’s recent decision to recall Rs 2,000 notes. In fact, this system has had a long-established presence in our financial regulatory framework for a significant period. This is typically done to prevent money laundering and other illicit activities,” said CA Jay Desai.

The income tax department uses the SFT statement to check for discrepancies and can issue a notice to the depositor for clarification.

Point to note: The RBI has not mentioned any limit in depositing the withdrawn currency in bank accounts. However, individuals who exceed certain prescribed limits in their deposits may receive notices from the Income Tax Department. “Failing to satisfactorily explain the source of such cash deposits may result in tax at 60 per cent along with penalty. From a readiness standpoint, it is recommended that documentary evidence and records are kept ready justifying the source and availability of cash and matching such narrative with balance sheets and tax returns”, said Indruj Rai, Partner at Khaitan & Co.

How will your deposits be monitored?

While the exchange limit has been restricted to Rs 20,000 at a time, if you want to deposit Rs 2000 notes into the bank, you will have to furnish your PAN card if you are depositing cash more than Rs 50,000 in a bank account in a single day, according to Rule 114B of the Income Tax Act.

“With the PAN card details being provided with the deposit, the depositor or the account holder can be monitored,” said Anant Singh Ubeja, Senior Associate, SKV Law Offices.

So, does the act of depositing the note make it taxable?

“The depositing of a Rs 2000 note is not, in itself, a taxable event. The Rs 2000 note is legal tender and remains as such. Individuals have complete freedom to use such currency, and it’s unreasonable to assume that possessing even a single Rs 2000 note indicates the hoarding of black money. Therefore, the deposit of Rs 2000 notes does not, in itself, incur tax. There would be no tax obligations for genuine taxpayers depositing Rs 2000 notes into their bank. They typically hold only a limited quantity of such notes, so they can deposit them without any inconvenience or extra tax implications. However, you might receive a notice from the Income Tax department if large cash deposits, made during the period leading up to September 2023, do not align with your income sources or your business nature,” said Ankit Jain, Partner, Ved Jain & Associates.

How does one deposit Rs 2000 notes without inviting an income tax notice?

“Genuine cash deposits in Rs 2000 denominated notes, being made by the countrymen, in their bank accounts, can very well be explained either out of regular household savings, or out of earlier cash withdrawals, or out of cash gifts from blood relatives (with no limit) and others (with a limit of Rs 50,000) or as gifts received on marriage occasions, or as cash sales in case of the proprietor and other businesses, subject to such claims, being supported by authentic documentary evidence,” said Mayank Mohanka, Senior Partner in M/s S M Mohanka & Associates.

For instance, consider a retailer with an annual turnover of Rs 2 crore who routinely deposits Rs 10 lakh in cash every month. If this retailer were to deposit Rs 12 lakh in cash in a given month, it would not raise suspicion, as it aligns with the nature of their business. However, a different scenario unfolds if a salaried individual, earning Rs 25 lakh annually (all received through bank transfer), were to deposit Rs 6 lakh in cash all at once, explained Jain.

The government extensively employs data mining and analytics to identify potential tax evaders. In cases where substantial deposits do not corroborate with income sources or business nature, the tax authorities might likely issue a notice requiring an explanation of the source of cash deposits.

What about the tax implications for a businessman?

If any businessman is depositing notes, he may have to prove the source of funds. “Either his debtors have paid him, or he has made any cash sale; if he is making cash sales, it should be supported by an invoice. If he is registered under GST, he should issue an invoice charging GST. Similarly, if any household lady is depositing a Rs 2000 note, then she may need to declare the source of such a deposit. At present government has not issued any notification on the post effect of the deposit but any deposit that is unreasonable may need explanation in future,” said Bhagat.

Cash sales up to Rs 2 lakh from a person in a single day are allowed per Income Tax provisions.

“Once the businessman establishes the genuineness of cash sales in Rs 2000 notes, being done on or after May 19 and even after September 30, with all supporting documents like sales invoices, bank statements, confirmations from buyers, GST Returns, co-relation of such cash sales with purchases and stock etc., then the authenticity of making cash deposits out of such cash sales can’t be disregarded and rejected by the tax authorities, merely on account of variation in the ratio of cash sales in the current period with that of an earlier period. There can’t be a fixed sales pattern in any business,” said Mohanka.

Moreover, once a businessman has offered his cash sales as his business income, then again, taxing the cash deposits made out of his cash sales as unexplained cash credits amounts to double taxation, which is not permissible, explained Mohanka.

When can you get a notice from the income tax department?

According to the income tax guidelines, the financial activities of individuals may come under the purview of official scrutiny, specifically for those who deposit cash over the threshold of Rs 2.5 lakh. An elevated threshold applies to senior citizens, where cash deposits exceeding Rs 5 lakh may invoke scrutiny. Cash deposits within these limits might be typically exempt from scrutiny, assuming the money is justifiably sourced.

“The primary tax implication of depositing large amounts of cash into a bank account is the potential for it to be counted as income and thus become subject to income tax. If the depositor cannot adequately explain the source of the cash, the income tax department may treat it as’ income from other sources’ and tax it accordingly. If you deposit under Rs 2.5 lakh, there should typically be no scrutiny and you should be fine,” said Jay Desai.

What happens if you do get an I-T notice?

If you get an I-T notice, then the onus is on the taxpayer to establish the source of income and provide documentary evidence.

“In terms of Section 68 of the Income Tax Act, if large deposits are made without furnishing justification on the nature of such deposit in the Income Tax return, the same may be treated as unaccounted deposit. In such circumstances, the Income Tax Department may scrutinise the deposits which are suspicious in nature and may also issue notice to the depositor, thereby seeking justification for the such deposits,” said Anant Singh Ubeja, Senior Associate, SKV Law Offices.

No tax notice if…

CA Mahima Vachhrajani sums it up best: As per income tax guidelines, individuals who deposit cash above Rs 2.5 lakh and senior citizens who deposit cash above Rs 5 lakh may be scrutinised. Any amount within the specified limit of Rs 2.5 or 5 lakh will be excluded from scrutiny.

For businesses, cash sales up to Rs 2 lakh will not be scrutinised once the businessman establishes the genuineness of cash sales in Rs 2000 notes, with evidence like sales invoices, bank statements, confirmations from buyers etc.

The big hurdle and the loophole

There is no system in place to verify the total amount exchanged by an individual from different banks in a single day or the total amount they will exchange until September 30. “This poses a significant challenge for banks in managing the situation. However, if individuals provide their PAN (Permanent Account Number) during the exchange, the total amount exchanged can be determined at a later date,” said Muthiah Lakshmanan, CA, at M. Lakshman & CO.

Currently, even non-customers can exchange up to Rs 20,000 at a bank branch. “This may create an opportunity for individuals with black money to involve the general public as intermediaries for a commission,” he added.