Peak Credit & telescoping theories in assessment proceedings under Income Tax

There may be some cases under Income Tax Assessment proceedings where there are a large number of unexplained credit and debit entries of a person standing in books of account of an assessee. In such case the AO may tend to add all the aggregate entries as unexplained income.

However, in such case if the assessee does not have any explanation for every credit or debit entry of a person, standing in his books of account then one of the most commonest defenses which an assessee may take is that, the entries should be so arranged in serial order, that a credit following a debit entry should be treated as referable to the latter to the extent possible and that, not the aggregate but only the ‘peak’ of the credits should be treated as unexplained.

Such an explanation is called as applying peak credit theory to the case of the assessee. It can be explained with the help of an example. Suppose there are credits in the assessee’s books in the account of A of Rs. 5000 on 1st day of October, 2010 and again on 5th November, 2010 there is credit of Rs. 5000, but there is debit entry by way of repayment of Rs. 5000 shown on 27th October, 2010, the explanation will be that the credit appearing on 5th November, 2010 has or could have come out of withdrawal / repayment on 27th October, 2010.

This plea is generally accepted as it is logical and acceptable(whether the creditor is a genuine or not), provided there is no material on record to show that a particular withdrawal/repayment has flown out of some other source or such withdrawal/repayment could not have been available on the date of the subsequent credit.

This peak theory is usually applied in cases when the unexplained credit and debit entries are standing in the same account of a person. However the peak credit theory may also be extended to the cases where the credits appear not in the same account but in the accounts of different persons.

Even if the genuineness of all such persons is disbelieved and all the credits appearing in the different accounts are held to be assessee’s own moneys, the assessee still will be entitled to a set off and a determination of the peak credit theory after arranging all the credits in chronological order.

It is to be noted hereby that the above propositions cannot be treated as propositions of law. These are only the inferences which can be drawn based upon the normal probabilities. These inferences can also be displaced by any material on record which may indicate to the contrary.

Thus before taking the plea of peak credit theory before the assessing officer, it is necessary to understand the facts of the case. The basic idea behind the peak credit theory is to avoid double addition and to bring only the actual income of the assessee to suffer tax, where there are large number of unexplained credit and debit entries. A bogus credit and debit may cancel out each other unless there are circumstances to indicate that withdrawal is utilized for purposes other than re-introduction.

The peak credit theory should normally be applied to non-genuine entries and not to genuine ones. Where there are many credits, all treated as non-genuine, withdrawal from one account should be treated as available for credit in another. In Bhaiyalal Shyam Behari v CIT (2005) 276 ITR 38 (All.) the High court upheld the view of the Tribunal that working of the peak should be confined to credits and withdrawals in accounts admittedly non-genuine.

As in case of large number of non-genuine credit and debit entries, peak theory may be applied, similarly, additions for low gross profits can be given credit against unapproved cash credits or unexplained expenditure or investment with similar set offs between additions and such practice is known as telescoping.

For example there may be a case where there is an unexplained income of an assessee in the first part of a year and also a corresponding unexplained investment of some what similar amount in the later part of the year, in such case unless there is evidence to the contrary, it may be treated that the unexplained investment has been made out of the unexplained income. Thus in such case instead of adding both unexplained income as well as unexplained investment to the income of the assessee, it would be wise to add one of them, as both represent only one income. This is called telescoping.

Telescoping theory may also extend to number of years income, where the unexplained income of previous year is being used in an unexplained investment in the subsequent year.

It should be kept in mind that both the theories of peak credit as well as telescoping should be applied with some degree of caution, because it is available only in such cases, where an earlier addition could be available for a later investment. If there is some intervening unrecorded expenditure in between such period then the theory of telescoping may not be available.

To conclude it is to be kept in mind that both the peak credit and telescoping theories have to be applied after appreciating the facts of each case and neither of the theory is readily available in every case as these are not the propositions of the law. The basic principle behind the theories is that there should not be overlapping additions and only the actual and real income of the assessee is taxed.