A recent post by a chartered accountant discussing a credit card related income tax notice has stirred considerable discussion online. The case involves a taxpayer who incurred credit card spendings of over Rs 50 lakh but had not filed any income tax returns. On examination, it emerged that the taxpayer was using his credit card to pay expenses on behalf of friends, popularly known as card rotation to accumulate rewards on those transactions.
When such substantial payments with no corresponding income reported were detected by the income tax system, the system flagged the mismatch for further investigation. The Income- Tax (I-T) department proceeded to issue a demand notice, treating the expenditure as unexplained.
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In fact, demand notices arising from credit card payments are becoming common. While rewards redeemed as purchase discounts generally do not attract tax, cashback or rewards converted into monetary value may become taxable if their total value exceeds Rs 50,000 in a year.
During scrutiny proceedings, submitting detailed credit card statements can inadvertently reveal large cashbacks, leading to further additions if they cross the threshold.
Card payments
Under Section 285BA of the Income-tax Act (ITA), financial institutions are required to report high-value financial transactions exceeding Rs 10 lakh annually to the I-T department. The department receives information on credit card payments and not credit card spendings. Even if a taxpayer pays for a friend’s expenses, the payment is mapped to the taxpayer’s PAN and is presumed to be their expenditure unless proven otherwise. When credit card payments appear disproportionate to the income declared, the tax department will invoke Section 69C, which deals with unexplained expenditure.
Under this provision, any expenditure for which the taxpayer offers no satisfactory explanation regarding the source of funds may be treated as income and taxed at applicable slab rate of the taxpayer. Once additions are made under Section 69C, relief rarely comes at the initial levels of assessment. Most such cases see resolution only at the tribunal stage, making it essential for taxpayers to prevent these mismatches.
To defend against additions, the taxpayer must maintain a clear and complete audit trail linking each credit card payment to the source of funds used. If reimbursement of payments is accepted in cash, the primary link in the audit trail breaks, making it difficult to establish the source of funds. However, the audit trail alone is not adequate. Amounts exceeding Rs 50,000 received from other than specified family members may be treated as taxable gifts. Therefore, someone paying for a friend’s purchases must be able to demonstrate, not merely state, that the payment was made on the friend’s behalf and not for themselves.
This typically requires invoices in the friend’s name, bank transfers matching the exact amounts, and communication acknowledging reimbursement.
