Unexplained Capital Introduced By Partners Cannot Be Added

Unexplained Capital Introduced By Partners Cannot Be Added As Cash Credit Under Section 68 In Hands Of Partnership Firm

Unexplained Capital Introduced By Partners Cannot Be Added As Cash Credit Under Section 68 In Hands Of Partnership Firm

Issue

Whether an addition under Section 68 for unexplained cash credit can be made in the hands of a partnership firm when the Assessing Officer is dissatisfied with the source or creditworthiness of capital introduced by its partners.

Facts

Return & Scrutiny: For Assessment Year 2015-16, the assessee-firm (consisting of four partners) filed a NIL return of income, which was subsequently selected for scrutiny assessment.
Examination of Partner Capital: During assessment proceedings, the Assessing Officer (AO) examined the capital contributions introduced by the partners into the firm.
Addition u/s 68: Dissatisfied with the creditworthiness and source of funds regarding the capital introduced by two of the partners, the AO made an addition under Section 68 as unexplained cash credit directly in the hands of the assessee-firm.

Decision

Improper Tax Entity for Addition: In favor of Assessee. When partners introduce capital into a partnership firm, any failure or dissatisfaction regarding the creditworthiness or source of such funds cannot form the basis for an addition in the hands of the partnership firm.
Taxability Restricted to Partners: In favor of Assessee. The addition, if any, for unexplained capital contributions can only be considered and made in the individual assessments of the respective partners and not in the hands of the assessee-firm.

Key Takeaways

Scope of Section 68 for Capital Contributions: A partnership firm is not required to prove the source of the source regarding capital contributed by its partners once the entry is explained as partner’s capital.
Target of Assessees: If the Revenue doubts the financial capacity or genuine source of a partner’s contribution, any tax liability or unexplained cash credit addition u/s 68 must be pursued against the individual partner.
Distinct Legal Identity for Tax Assessments: The source of capital introduced by partners is treated as the partner’s liability to explain, preserving the distinction between firm capital additions and individual partner capacity.

IN THE ITAT RAIPUR BENCH

Galaxy Buildcon

Income-tax Officer

R.K. PANDA, Vice President
and Partha Sarathi Chaudhury, Judicial Member

IT Appeal No.284 (RPR) of 2026
[Assessment year 2015-16]

AUGUST 6, 2026

Sunil Kumar Agrawal, CA and Ms. Vidya Verma, Adv. for the Appellant. Piyush Tripathi, Sr. DR for the Respondent.

ORDER

R.K. Panda, Vice President.- This appeal filed by the assessee is directed against the order dated 30.01.2026 passed by the Ld.CIT(A), Raipur-3, relating to assessment year 2015-16.

2. There is a delay of 9 days in filing of this appeal for which the assessee has filed a condonation application along with an affidavit explaining the reasons for such delay. It has been explained that the father of the assessee was seriously ill for which the assessee was busy attending him and therefore could not file the appeal in time. Relying on various decisions the Ld. Counsel for the assessee submitted that delay in filing of the appeal should be condoned.

3. We have considered the contents of the condonation application filed by the assessee along with the affidavit and heard the Ld. Sr. DR. The Hon’ble Supreme Court in the case of Collector, Land Acquisition v. Mst. Katiji [1987] 167 ITR 471 (SC), has held that when substantial justice and technical considerations are pitted against each other, cause of substantial justice deserves to be preferred for the other side cannot claim to have vested right in injustice being done because of a non-deliberate delay. Refusing to condone delay can result in a meritorious matter being thrown out at the very threshold and cause of justice being defeated. As against this when delay is condoned the highest that can happen is that a cause would be decided on merits after hearing the parties.

4. We find recently the Hon’ble Supreme Court in the case of Inder Singh v. State of Madhya Pradesh 2025 LiveLaw (SC) 339 has held as under:

“14. There can be no quarrel on the settled principle of law that delay cannot be condoned without sufficient cause, but a major aspect which has to be kept in mind is that, if in a particular case, the merits have to be examined, it should not be scuttled merely on the basis of limitation.”

5. In the light of the above decisions of Hon’ble Supreme Court, the delay of 9 days in filing the appeal is condoned and the appeal is admitted for adjudication.

6. Although a number of grounds have been raised by the assessee, however, these all relate to the order of the Ld. CIT(A) in sustaining the addition of Rs.1,14,50,000/- made by the AO as unexplained cash credit under section 68 of the Act being the capital contribution by the partners in the assessee firm.

7. Facts of the case, in brief, are that the assessee is a partnership firm engaged in the business of construction. It filed its return of income on 22.03.2016 declaring total income at Rs.NIL. The case of the assessee was selected for scrutiny and notice under section 143(2) was issued and served on the assessee. Thereafter, notice under section 142(1) along with a questionnaire was issued in response to which, the assessee filed the requisite details. The AO, during the course of assessment proceedings noticed that the assessee firm was created on 31.10.2014 consisting of 4 partners who contributed their shares by introducing capital in the form of land or cash, the details of which are as under:

S. No.	Name of the partner	Total capital introduction claimed (Rs.)	Their shares
1.	Khushi Kundani	51 lakh	20.40%
2.	Liyakat Baig	2.17 crore	32.00%
3.	Vijay Nagpure	55 lakh	20.40%
4.	Sunil Sahu	58.33 lakh	27.20%
	Total	Rs.3,81,33,000/-	100%

8. He, therefore, asked the assessee to furnish the source of capital introduced by them with necessary evidence. After considering various replies given by the assessee, the AO accepted the capital contribution of Mr. Sunil Sahu at Rs.58.33 Lakhs and Mr. Vijay Nagpure at Rs.55 Lakhs. However, the capital contributed by Mr. Khushi Kundani at Rs.51 lakhs and Mr. Liyakat Baig at Rs.2.17 crores were not found to be satisfactory for the following reasons:

S.No.	Name of the partner	Total capital introduction claimed	Reason
1.	Khushi Kundani	51 lakh	On perusal of the bank statement of Khushi Kundani, it is seen that out of total amount of Rs. 51 lakhs, about Rs. 20 lakh have been invested after making immediate cash deposits in his bank account. Further, on perusal of balance sheet and Profit & loss statement of R.S. Automobile, the proprietarily concerns of the partner, for F.Y. 2013-14 and 2014-15, his creditworthiness is not found explained.
2.	Liyakat Baig	2.17 crore	Out of the total amount of Rs. 2.17 crore, a land whose value is taken at Rs. 1.47 crore. Further, an amount of Rs. 25 lakh have been introduced in cash and rest are transfer. On perusal of relevant return of Liyakat Baig, it is seen that he has not shown any amount under capital gain on account of the said introduction of land in the capital of the firm. No personal capital and balance sheet of the assessee has been furnished therefore the cash introduction of Rs. 25 lakh and transfer of Rs. 45 lakh are also remained unexplained especially when his last two years return were perused wherein one return of negative total income and other return of Rs. 2.84 lakh approx.

9. He, therefore, again asked the assessee to explain as to why the capital introduced by the above two partners should not be treated as unexplained cash credit under section 68 of the Act and accordingly be added to the total income of the assessee. After considering the explanation given by the assessee, the AO accepted the creditworthiness of Mr. Khushi Kundani to the extent of Rs.6,50,000/- and of Mr. Liyakat Baig to the extent of Rs.1.47 crores and made addition of the balance amount of Rs.1,14,50,000/- to the total income of the assessee by invoking the provision of section 68 of the Act. While doing so he held that the assessee firm failed to pass the test of creditworthiness and genuineness and therefore, it is the income of the assessee firm.

10. In appeal, the Ld. CIT(A) upheld the addition made by the AO by observing as under:

“Findings & Decisions: –

During the course of appeal proceedings, I have carefully perused the assessment order, statements recorded u/s 131 and the detailed submissions of the assessee. I find that the issue to be decided is whether the assessee-firm has discharged its onus u/s 68 of the Act, which requires proof of Identity of the creditor, Creditworthiness of the creditor and Genuineness of the transaction. Merely proving identity is not sufficient.

Capital introduced by Shri Liyakat Baig – Rs.70,00,000/-

During the course of appeal proceedings, on perusal of facts of the case I find that returned income of Shri Livakat Baig for A.Y. 2014-15 was only Rs.2,84,260/- and for A.Y. 2015-16 was (-) Rs.35,042/-which was negative. Out of Rs.70 lakh, Rs.25 lakh was introduced in cash and Rs.45 lakh through transfer, without proper source explanation. No personal balance sheet, capital account, or evidence of availability of funds was furnished. No evidence regarding sale or ownership of land worth Rs.1.47 crore was placed on record to establish overall financial capacity. Despite repeated opportunities, the source of funds remained unexplained. Most importantly, in his statement u/s 131 of the Act (answer of question no.8 of statement), Shri Liyakat Baig himself admitted inability to explain the source and voluntarily offered Rs.70 lakh as undisclosed income of the firm. Such admission has strong evidentiary value and was never retracted. Therefore, it is clear that creditworthiness and genuineness are not established.

Capital introduced by Shri Khushi Kundnani – Rs.44,50,000/-

During the course of appeal proceedings, on perusal of facts of the case I find that Shri Khushi Kundnani claimed source from his proprietorship concern M/s R.S. Automobiles. The capital in the said business was in negative, which itself shows lack of financial capacity. The balance sheet and P&L account were unaudited, inconsistent, and internally contradictory. Large investments and loans were shown without any details or supporting schedules. Unsecured loans of Rs.10 lakh, Rs.3 lakh, and Rs.10 lakh were not supported by ITRs of lenders, Bank statements of lenders, Proper confirmations, some confirmations were self-signed, without PAN, which makes them unreliable. The lenders had nil or insignificant income, clearly failing the test of creditworthiness and genuineness. Cash deposits of Rs.21.50 lakh were claimed from business receipts (R.S. Automobile), but Cash book was produced only for November month only. No evidence of real business activity was found. Sales shown were minimal and disproportionate. Even in the statement u/s 131, Shri Khushi Kundnani failed to satisfactorily explain the complete source despite sufficient time. Thus, the explanation is not supported by credible evidences. Assessee’s argument that capital was introduced before commencement of business is not acceptable because section 68 of the Act applies to any sum credited in the books, irrespective of commencement of business. The firm maintained books, recorded capital, and utilized funds for land purchase. The explanation of source is mandatory once credit appears in books. The judicial decisions relied upon by the assessee fact-specific and not applicable where creditworthiness is not proved and source remains unexplained and partners of firms themselves fail to justify funds. In the instant case, the facts clearly show failure to discharge statutory onus. The assessee has failed to establish creditworthiness and genuineness of capital introduced by Shri Liyakat Baig and Shri Khushi Kundnani. The Ld. AO has made the addition after detailed enquiry, recording statements, granting multiple opportunities, and relying on material evidence. Accordingly, the addition of Rs.1,14,50,000/-(Rs.70,00,000/- & Rs.44,50,000/-) u/s 68 of the Act is hereby confirmed and this ground of appeal is hereby dismissed.

11. Aggrieved by such order of the ld. CIT(A), the assessee is in appeal before the Tribunal.

12. The Ld. Counsel for the assessee relying on various decisions submitted that when the partners introduce capital in the partnership firm, and the AO has doubted the creditworthiness of the partners for introducing such capital, then addition, if any, can be made in the hands of the partners and not in the hands of the partnership firm. He submitted that the partners in the instant case have accepted the contribution of capital by furnishing various details. Relying on the following decisions, he submitted that no addition can be made in the hands of the partnership firm and addition, if any, can be made in the hands of the partners.

(i)

Durga Granites v. Asst. CIT [ITA No.30 OF 2023, dated 4-9-2023] (Telangana HC)

(ii)

Nova Medicare v. ITO (Telangana HC)

(iii)

Kesharwani Sheetalaya v. CIT (Allahabad) dated 24.04.2020.

(iv)Pr.

CIT v. Vaishnodevi Refoils & Solvex (Guj HC) dated 28.11.2017.

13. The Ld. Sr. DR on the other hand heavily relied on the orders of the AO and Ld. CIT(A).

14. We have heard the rival arguments made by both the sides, perused the orders of the Assessing Officer and Ld. CIT(A) and the paper book filed on behalf of the assessee. We have also considered the various decisions cited before us by the Ld. Counsel for the assessee. We find in the instant case, the AO made addition of Rs.1,14,50,000/- under section 68 of the Act on the ground that the source of capital introduced to the extent of Rs.44,50,000/- by Mr. Khushi Kundani and Rs.70,00,000/- by Mr. Liyakat Baig could not be explained properly and therefore it is the income of the firm. We find the Ld. CIT(A) upheld the addition made by the AO the reasons of which have already been reproduced in the preceding paragraphs. It is the submission of the Ld. Counsel for the assessee that when the partners introduce any capital in the partnership firm, even if the AO is not satisfied regarding the creditworthiness of the partners for introduction of such capital in the partnership firm, addition if any, can be made only in the hands of the partners and not in the hands of the partnership firm.

15. We find some force in the above argument of the Ld. Counsel for the assessee. We find, the Hon’ble Telangana High Court in the case of Durga Granite (supra), has held under:

“9. Having heard the contentions put forth on either side and on perusal of records, admittedly the appellant herein is a partnership firm. The return was filed by the appellant for the assessment year 2014-15. On 30.09.2014, upon limited scrutiny of the said return filed by the appellant, some discrepancy and mis-match was detected. The Assessing Officer in the course of the assessment, made an addition under Section 68 of the Act to the extent of Rs.2,71,00,000/- being the capital introduced by the partners. The Assessing Officer further made an addition an amount of Rs.54,50,207/- being the capital introduced by the partners which was paid back to the partners in the said year itself. The Assessing Officer subsequently disallowed the interest paid to the partners on the capital introduced by them. The appellant herein had offered his explanation, which the Assessing Officer did not accept the explanation and passed the assessment order.

10. The said assessment was subjected to challenge by the appellant before the CIT (Appeals). The said Appellate Authority i.e. the CIT (Appeals) vide order dated 30.06.2017 partly allowed the appeal of the appellant and rejected the assessment made by the appellant so far as the capital invested by the partners into the partnership firm. The CIT (Appeals) relied upon the judgement of this High Court in the case of the Commissioner of Income Tax v. M.Venkateshwar Rao and others 1. In the said judgement, the Division Bench of this Court had held that the partnership firm is not required to explain the sources of income of partners so far as the amount contributed by the partners towards the capital of the partnership firm.

11. Aggrieved by the aforesaid order of the CIT (Appeals) dated 30.06.2017, the respondent-Department had preferred the appeal before the Hon’ble ITAT, where the [2015] 370 ITR 212 (T&AP) case was registered as ITA No.1706/Hyd/2017. The Hon’ble ITAT had reversed the order of the CIT (Appeals) holding that the appellant has not been able to provide sufficient material to establish the source of income of the partners who had invested in the appellant’s partnership firm. Undoubtedly, from the pleadings it reflects that the stand of the appellant all along was that the investment to the partnership firm was contributed by the partners.

12. Now the only question that needs to be considered at this juncture, is that, in the event of the appellant’s partnership firm disclosing that it was the partners who had contributed in the capital, the source of income of the partners was to be explained by the partners themselves and not by the firm. In the case of M.Venkateshwar Rao, supra, the Division Bench of this Court in paragraph No.7 held as under:

“7. It is a matter of record that the respondent-firm comprises ten partners and each of them made contributions, be it in the form of cash or bank guarantees to be furnished to the Government, at the commencement of business. The returns submitted by the respondent-firm were processed, and the facts and figures furnished by it were accepted. However, the matter was reopened at a later point of time. The Assessing Officer treated the capital raised by the firm in the form of contributions made by the partners as income. This conclusion was arrived at on the ground that source of income for the partners was not explained. Learned counsel for the appellant placed reliance upon the judgment of the Patna High Court in CIT v. Anupam Udyog [1983] 142 ITR 133 (Pat). The Tribunal rested its conclusions upon the judgment of the Bombay High Court in Narayandas Kedarnath v. CIT [1952] 22 ITR 18 (Bom) and that of the Allahabad High Court in CIT v. Jaiswal Motor Finance [1983]141 ITR 706(AII).”

13. Recently, again the Division Bench of this Court in somewhat similar case between M/s. Nova Medicare versus The Income Tax Officer, decided on 15.02.2023, relying upon the decision of M.Venkateshwar Rao, supra, in paragraph No.15 held as under:

“Following and applying the aforesaid decision of this Court, Patna High Court in Anurag Rice Mills (supra) held that in such circumstances the unexplained cash credits would have to be assessed at the hands of the partners of the firm and not the firm itself. Such amounts could not have been treated as income of the firm by relying upon Section 68 of the Act.”

14. The Hon’ble Supreme Court of India also in the case of the Commissioner of Income Tax v. Lovely Exports (P) LTD 2 in a short judgment at paragraph No.2 held as under:

“Can the amount of share money be regarded as undisclosed income under section 68 of IT Act, 1961 ? We find no merit in this Special Leave Petition for the simple reason that if the share application money is received by the assessee company from alleged bogus shareholders, whose names are given to the AO, then the Department is free to proceed to reopen their individual assessments in accordance with law. Hence, we find no infirmity with the impugned judgment.”

15. The ratio laid down in the aforesaid three decisions clearly indicate that if in a proceeding under Section 68 of the Act, the assesse has been able to explain the sources of income, which in the instant case, the appellant had been stating that the capital investment made by the partners of the said firm is sufficient to meet the requirement under Section 68 of the Act. Thereafter, if at all, if the respondent- Department was not satisfied with the explanation, it was for them to have got it verified from the partners. Rather than still pursing the matter before the appellant’s partnership firm, which is otherwise impermissible in the light of the judgement referred to in the preceding paragraphs.

16. In the instant case also the appellant having said that the capital investment is that made by the partners. Applying the aforesaid judicial precedents, the burden now shifts upon the respondent-Department to get it counter verified from the partners from their books of accounts ascertaining whether such investments have been made or not. In the absence of such an enquiry/verification from the partners by the respondent-Department, the order of the Assessing Officer, as also the stand taken by the Hon’ble ITAT would not be sustainable and the same deserves to be and is accordingly set aside/quashed. The order passed by the CIT (Appeals) dated 30.06.2017 stands affirmed.”

16. We find the Hon’ble Telangana High Court in the case of Nova Medicare (supra), has held as under:

“14. After thorough consideration of all relevant aspects, we are of the view that issue raised in this appeal is squarely covered by M Venkateswara Rao (2015) (AP) which is binding on us. That was also a case where certain cash credits were advanced by the partners, which according to the Revenue authorities remained unexplained and accordingly were added to the income of the firm. In the facts of that case, this Court held as follows:

“6. It is a matter of record that the firm comprises of 10 partners and each of them made contributions, be it in the form of cash or bank guarantees to be furnished to the Govt, at the commencement of business. The returns submitted by the firm were processed, and the facts and figures furnished by it were accepted. However, the matter was reopened at a later point of time. The AO treated the capital raised by the firm in the form of contributions made by the partners as income. This conclusion was arrived at on the ground that source of income for the partners was not explained. Ld counsel for the appellant placed reliance upon Anupam Udyog (1983) (Patna HC). The Trib rested its conclusions upon Narayandas Kedarnath (1952) (Bom) and that of Jaiswal Motor Finance (1983) (All).

7. Sec 68 no doubt directs that if an assessee fails to explain the nature and source of credit entered in the books of account of any PY, the same can be treated as income. In this case, the amount, that is sought to be treated as income of the firm, is the contribution made by the partners, to the capital. In a way, the amount so contributed constitutes the very substratum for the business of the firm. It is difficult to treat the pooling of such capital, as credit. It is only when the entries are made during the course of business that can be subjected to scrutiny u/s68.

8. Even otherwise, it is evident that the respondent explained the amount of Rs.76,57,263 as the contribution from its partners. That must result in a situation, where sec68 can no longer be pressed into service.

However, in the name of causing verification u/s68, the AO has proceeded to identify the source for the respective partners, to make that contribution. Such an enquiry can, at the most be conducted against the individual partners. If the partner is an assessee, the concerned AO can require him to explain the source of the money contributed by him to the firm. If on the other hand, the partner is not an assessee, he can be required to file a return and explain the source. Undertaking of such an exercise, vis-a-vis the Part-firm itself, is impermissible in law. In the judgment relied upon by the appellant itself, the Patna HC held as under:

“If there are cash credits in the books of a firm in the accounts of the individual partners and it is found as a fact that cash was received by the firm from its partners, then in the absence of any material to indicate that they are the profits of the firm, they cannot be assessed in the hands of the firm, though they may be assessed in the hands of the individual partners. Cash credits in the individual accounts of members of a joint family with third party cannot be assessed as the income of the family unless the Department discharges the burden of proof to the contrary.”

9. Therefore, the view taken by the AO that the Part-firm must explain the source of income for the partners regarding the amount contributed by them towards capital of the firm cannot be sustained in law.”

15. Following and applying the aforesaid decision of this Court, Patna HC in Anurag Rice Mills (2016) (Pat HC) held that in such circumstances the unexplained cash credits would have to be assessed at the hands of the partners of the firm and not the firm itself. Such amounts could not have been treated as income of the firm by relying

16. In view of the above position, we answer the substantial questions of law in favour of the assessee and against the Revenue insofar the cash credits pertaining to the 2 partners of the appellantfirm i.e, Smt. K. Sujatha and Sri K.Prabhakar Reddy only are concerned.”

17. We find the Hon’ble Telangana High Court in the case of Vaishnodevi Refoils and Solvex (supra), has held as under:

“6. The assessee carried the matter in appeal before the CIT(A), who noted that from the audited balance-sheet of the partner in his books of accounts, the investments in the P-firm were duly reflected. Insofar as the source of capital contribution is concerned, the partner had his own capital, secured and unsecured loans besides liability. The AO had not given any adverse finding about the said sources and their genuineness. According to the CIT(A), in case the AO had any doubts about the credit worthiness of the partner, he could have referred the matter to the AO of the partner for making necessary verifications at his end. But no adverse inference could be drawn in the case of the assessee being the P-firm, for the capital introduced by the partner when the partner had confirmed the capital contribution.

7. In revenue’s appeal, the Tribunal placed reliance upon Pankaj Dyestuff Industries (2005) (Guj) for the proposition that no addition can be made with regard to the partner’s capital introduction in the hands of the Partnership Firm and dismissed the appeal.

8. In the facts of the present case, when the assessee has furnished the details with regard to the source of the capital introduced in the firm and the concerned partner had confirmed such contribution, the assessee had duly discharged the onus cast upon it. Therefore, if the AO was not convinced about the creditworthiness of the partner who had made the capital contribution, the inquiry had to be made at the end of the partner and not against the firm. The controversy involved in the present case, therefore, stands squarely covered by Pankaj Dyestuff Industries (2005) (Guj) dated 06.07.2005.”

18. We find when the Revenue challenged the decision of the Hon’ble Gujrat High Court in case of Vaishnodevo Refoils and Solvex (supra) by filing a SLP, reported in Pr. CIT v. Vaishnodevi Refoils & Solvex (SC), the Hon’ble SC dismissing the SLP by observing as under:

“HC in impugned order noted that amount received by assessee-firm had been duly reflected in books of account maintained by concerned partner and that assesse had furnished details with regard to source of capital introduced in firm and concerned partner had also confirmed such contribution and concluded that assessee-firm had duly discharged onus cast upon it. Further, court noted that if AO was not convinced about creditworthiness of partner who had made capital contribution, inquiry had to be made at end of partner and not against firm. Whether SLP against said decision was to be Dismissed-Held, Yes. (In favour of assessee).”

19. The various other decisions relied on by the Ld. Counsel of the assessee also support his case to the preposition that addition if any, can be made in the hands of the partners and not in the hands of the partnership firm once the partners admit that they contributed the capital in the partnership firm.

20. In view of the above discussion and relying on the decisions cited (supra), we hold that no addition can be made in the hands of the partnership firm towards capital introduced by the above two partners. Addition, if any, can be made only in the hands of the partners. We therefore, set aside the order of the Ld. CIT(A) and direct the AO to delete the addition made in the hands of the assessee firm. The appeal of the assessee is accordingly allowed.

21. The legal grounds were not pressed by the Ld. Counsel for the assessee for which the Ld. Sr.DR has no objection. Accordingly, these grounds are dismissed as “not pressed”.

22. In the result, the appeal filed by the assessee is allowed.