As a taxpayer to be on an income tax radar is the last thing that I expect in my life :). It is not the case that I am not paying my taxes honestly or has something to hide. To be fair and logical as a taxpayer, even though my slate is clean still, it is practically impossible for a taxpayer to explain each and every financial detail/transaction. To err is human and sometimes it is unintentional.
Before I proceed, let me clarify that all the details shared in this post are based on my personal understanding of the subject. It is my own interpretation that may or may not be right. Therefore, I am not claiming that what I am sharing is 100% correct but in my opinion, this is how things work.
As I shared in my post, 7 Types of Income Tax Notice that even an honest taxpayer gets scared once he receives income tax notice. The first reaction of the taxpayer is that now I am on income tax radar :). It is not the case always. Most of the times it is general query/clarification and that can be easily answered by the income taxpayer. In my opinion, if there is no major mismatch or discrepancy on your financial details then you are “honest taxpayer”. As I understand minor discrepancies are ignored by the income tax department.
Income Tax Department and the Technology
Gone are days when the AO (Assessing Officer) used to manually check each and every return. Today the department has access to all information related to the taxpayer. Thanks to PAN (Permanent Account Number). As I keep highlighting in my posts that the entire tax system is automated and on a click of the mouse the entire details are on a screen. At the same time as I understand Income tax department has complex algorithms based on data available in the system. It highlights any anomaly or mismatch or discrepancy in the taxpayer data. Any variance in this data may put you on income tax radar.
Now how it works, let’s take the example of one of the readers of this blog Mr. A from Gurgaon. He is an entrepreneur and from last 5 years, he is declaring an average income of Rs 10L in his return. He maintains 5 bank accounts and cumulative balance is around 54L in these accounts. He received income tax notice to explain the source of money in bank accounts. Reason being his last 5 years income as per ITR is 50L and during this period he deposited 54L in his bank accounts including 15L post demonetization. The big question is how he is managing household expenses :). Now he is on income tax radar. Prima facie 100% income was not declared. This was just one of the simplest examples. The algorithms of Income tax department are far more complex. Basically, these algorithms study the financial behavior of the taxpayer.
5 habits that may put taxpayer on Income Tax Radar
Before I share, let me share that as your credit behavior determines your credit score. Similarly, your financial behavior determines whether you are an honest income taxpayer or not. Any sudden change in financial behavior without a corresponding change in tax status may put you on income tax radar.
The following habits are more or less linked to your financial behavior. Some cases are specific in nature and cannot be generalized. I will explain the same with each point.
1. Sudden Withdrawals and Deposits in Bank Accounts:
In my opinion, this is one of the early and initial signs to put a person on income tax radar. To share a hypothetical example, I have a particular financial behavior that is linked to my income level (read: income tax status). In my bank accounts, there is an average monthly deposit of 1L and withdrawal of 70k towards household and other expenses. I save 30k per month that is national average savings rate. I declare annual income of approx 10L after availing various deductions. Till this point nothing suspicious in my case.
Assuming one fine day I deposited 10L in my bank account. There must be some reason for this deposit as it is not my normal financial behavior. Let say I received this money towards maturity of some investment or a gift from my parents i.e. amount is exempted. The algorithms of income tax department will check the money trail and if they will find the chain/link, the transaction will not be flagged. In case the money trail is untraceable and the taxpayer has not declared in ITR then the transaction will be flagged and I will be on income tax radar. Before any action, the IT department will wait for my income tax return i.e. how I declare this money. The same holds true for sudden withdrawals.
To summarize, if you carry out any high-value financial transactions then you should have valid and logical justification for the same. Here there is NO standard definition of high value. For a person filing an annual return of 50L, a transaction of 15L is a normal transaction but same transaction for a taxpayer filing annual return of 15L will be flagged in the system.
There is a famous saying for a particular community that if they have Rs 10 in their pocket, they pretend they have Rs 100 and spends Rs 1000. This is also called “show off” and may put you on income tax radar. There was a news report recently that only 24L taxpayer file an ITR declaring an income of more than 10L. At the same time, every year almost equivalent no of people buy a car :). The math’s doesn’t match.
Now you must be wondering how come, a person earning say 10L p.a. is spending 15L every year. One of the examples is of my friend. Her father is a doctor and she earns Rs 1L per month but spends average 1.5L per month. The deficit amount is paid by her father. Her father pays her credit card bill through CASH. Here, income tax department takes help of Annual Information Return. Though it is not a fool proof method but still any consistent behavior in this regard is captured by the system.
Now you must be wondering a father can gift to her daughter and there is NO gift tax. I agree but in this case, father and daughter will be on income tax radar to find out money trail. Based on my knowledge and understanding, in the majority of cases, these gifts are part of the black economy. The same thing happens and my friend was not able to explain the source of funds when she received income tax notice in this regard. The point I am trying to make is that you should have logical and reasonable justification to prove the source of funds. Any overspending will put you on income tax radar. You can overspend provided you can justify the money trail.
Another reason for income tax department to believe “overspending” is under-reporting of income. It is called the grey economy. I am earning 15L and spending the equivalent amount. Whereas i am declaring my income as 10L. Therefore, 5L will be overspending if we assume that i am correctly declaring my income in ITR.
The lifestyle of an individual should be in harmony with the income declared by the individual. How it works is, if an individual is earning 1L per month then it is assumed that on an average he must be spending around Rs 40k towards regular household expenses. Around 30% i.e. Rs 30k will be savings and balance Rs 30k must be spent towards school fees, healthcare, transportation, misc purchases etc. These figs may change but will not vary drastically.
Now you must have observed that these days schools ask for PAN no of the parent depositing the fees. Good schools in metro charge a min fee of Rs 15k per month per child. Here if 2 kids are going to the same school then monthly school fee is Rs 30k. In this case, income tax department can safely assume that monthly household income must be between Rs 1.5L to 1.75L. If there is any discrepancy or variance in ITR then the taxpayer will be on income tax radar.
Another important criterion to keep a tab on the taxpayer is foreign holidays and luxurious purchases. As I shared in my previous posts also that social media is one of the important media to keep a watch on the taxpayer. So be careful next time you post pics of your foreign tour or flash luxurious watch on social media accounts or platform. Don’t blame social media for you being on income tax radar :).
4. Sudden Change in Declared Income:
Until unless you have valid and logical reasoning explaining sudden increase/decrease in declared income like a job change or Job Loss. Any sudden change in declared income will put you on income tax radar. For example, I am filing an ITR of Rs 10L with a gradual increase of 10% to 20% increase every year. Suddenly next year, I declare my income as Rs 25L or Rs 4L. Therefore, any sharp increase or decrease in declared income is suspicious and will put you on income tax radar. Sometimes this is intentional and entrepreneurs adjust profit, loss, depreciation etc to tweak tax liabilities. In another instance, it might be based on the suggestion of a CA. Therefore, if you have a habit of declaring income with sharp variations then you should avoid the same.
In the business community, there is a popular joke that sudden decrease in declared income also means you found a good Chartered Accountant :). You may receive an enquiry from income tax department seeking clarification on the same.
5. Sharp Variance in Income Tax Records and Income Tax Return:
There is a very big misconception among taxpayers that they can hide or suppress any information from Income Tax department. If any details went unnoticed then it doesn’t mean that the taxpayer is smart enough to cheat the IT department. The fact of the matter is that the officials of the income tax department have limited bandwidth to scrutinize the ITR’s. Therefore, details went unnoticed. Be assured department has a detail of each and every penny.
The algorithms of income tax department always check for sharp variance in the records available with the income tax department and the details shared by the taxpayer through Income Tax return. Therefore if you have a habit to under-report income or other financial details in Income Tax Return then you should resist such practices. To avoid being on income tax radar you should provide correct and right information to the department else you may land in the tax trouble.
Words of Wisdom:
The only mantra to avoid tax hassles is to maintain 100% transparency. Please remember that small errors and omissions from taxpayer are always ignored by the income tax department provided they are unintentional. Moreover, the systems of the IT department are robust and intelligent enough to find out whether the errors and omissions are intentional or unintentional. Habitual tax evaders should beware and honest ones need not worry.
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