Digital transactions: When can money transfers attract an income tax notice?

New Delhi: Money transfer has come a long way from cash to internet-based transactions as a result of the increasingly digital economy. People now have multiple channels to make payments and receive money, ranging from single-digit payments to large transactions.

People may choose Unified Payments Interface (UPI), National Electronic Funds Transfer (NEFT), Real Time Gross Settlement (RTGS), Immediate Payment Service (IMPS), and other channels to make routine or business transactions.

With new modes being introduced, new confusion may arise regarding the nature of these transactions and their tax implications.

Though such transactions may not necessarily be taxable, complications may, however, arise if the receiver is unable to explain the source of the money. This may happen when the transfers into a person's account in a year exceed the person's declared total income.

Therefore, even if the transactions are legitimate, the Income Tax Department may scrutinise them, even if the money is received as gifts from relatives, business receipts, or transactions made on others' behalf. The person has to be prepared to explain the source and reason for the money transferred into the account.

UPI is these days the most opted-for mode of digital transaction, and it does not have any transaction limit as per the Income Tax Act, which makes the nature and source of the transfer the reason for scrutiny.

The Statement of Financial Transactions (SFT) framework makes cash deposits of Rs 50 lakh and more in current accounts and Rs 10 lakh and more in savings accounts reportable. These thresholds do not apply to UPI, NEFT, RTGS, or IMPS transactions.

However, the frequency or amount transferred during digital transactions may come under the radar if the Income Tax Department detects unusual activity, even if no threshold exists.

It implies that even a small transaction can attract questions if the Income Tax Department suspects an illegitimate transaction. Thus, a small but suspicious deposit might have tax consequences just as a large-value transaction might.

Sometimes, confusion arises when a person uses the same account for personal and business purposes. It may happen that, despite a person's earnings being within the tax-exemption limit, they may receive a tax notice because the total amount of annual deposits made in the account crosses the threshold.

Similarly, a person who receives money on behalf of a family member or a friend may face scrutiny, even if the beneficiary is someone else. Transferring the received amount to someone else does not establish that the credit is legitimate or exempt from tax.

This happens because repeated deposits and transfers may resemble the activities of a money mule account. Therefore, it becomes necessary to keep records of these transactions ready to provide an adequate explanation regarding the nature of the transfer.