1. Introduction
The Peak Credit Theory, though not codified under the Income-tax Act, 1961, has evolved through judicial precedents and is widely recognized in income tax assessments and appellate proceedings. It is primarily invoked in cases involving unexplained cash credits or suspicious bank transactions assessed under Section 68 of the Act.
The essence of this theory lies in identifying the ownership of funds reflected through deposits and withdrawals in the assessee’s bank account. Rather than taxing each individual credit entry, the theory determines the peak or maximum unexplained balance after netting off deposits against corresponding withdrawals. This ensures that only the actual unaccounted income is taxed, thereby avoiding duplication or overstatement of taxable income.
2. Principle of Peak Credit Theory in Income Tax Assessment
The core of this principle lies in the ownership of funds deposited and/or withdrawn from the assessee’s bank account. It determines the highest balance in the account by adjusting deposits against withdrawals. Let’s understand through an example:
Suppose an assessee own an unaccounted amount of rupees one lakh and he start routing that money throughout the year, resulting in multiple deposits and withdrawals. According to the peak credit theory, the unaccounted money would still be considered as one lakh rupees, as at no given date should the balance in the account exceed that amount. The fresh credits are presumed to be sourced from earlier withdrawals.
In practice, if the assessee explains that the cash deposits or receipts are sourced from withdrawals made from the same account and requests the assessing officer to adjust deposits against withdrawals, the highest unexplained deposits would be treated as undisclosed income under Section 68. However, if the assessing officer can prove that a specific withdrawal is not available for redeposit, the benefit of the peak credit theory would not be applicable.
This principle is commonly used in cases where there are multiple transactions in the same account and when there is suspicion regarding the genuineness of the creditors involved. It aims to determine the maximum amount held by the assessee in the account of such non-genuine creditors at any given date. The acceptance of this plea is generally logical and acceptable unless there is evidence to show that a particular withdrawal could not have been available for subsequent deposit.
In the case of Bhagdev Roy v. Asstt. CIT [IT Appeal No. 832 (Kol.) of 2013, dated 31-3-2017] the ITAT bench of Kolkata observed that the principle of peak credit theory stems on the fundamental premise that the money deposited and/or withdrawn from the assessee’s bank account belongs to the assessee or in respect of which ownership vest in the assessee. So, in other words, ownership of the funds is the sine qua non for invoking the principle of peak credit and this particular principle of peak credit theory has been reiterated by the Hon’ble Allahabad High Court in the case of Bhaiyalal Shyam Behari v. CIT [2005] 276 ITR 38 wherein it was reiterated that for adjudicating upon the peak credit the factual foundation has to be led that the assessee has to own all cash credit entries in the books of account and only thereafter the question of peak credit can be raised.
3. How to Determine the Peak
To determine the peak credit of an accounting period, all cash deposits and withdrawals owned by the assessee as undisclosed income are arranged in chronological order. Balances are calculated for each deposit and withdrawal. The deposit in the first entry becomes the closing balance for that entry, which then becomes the opening balance for the second entry. The deposit or withdrawal of the second entry is adjusted to the opening balance, and the closing balance for the second entry is calculated. This process continues for subsequent entries. The highest closing balance among all entries, after adjusting for deposits and withdrawals, represents the peak credit for that accounting period.
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