Tax Rate on Unexplained Income: 30% Under Section 195 of the Income Tax Act 2025

Under section 195 of the Income Tax Act 2025, unexplained income is taxed at a flat 30%. It covers the five deemed-income heads in sections 102 to 106: unexplained credits, investment, assets, expenditure, and amounts borrowed or repaid in a prohibited mode. The rate was 60% in the Act as first enacted and was replaced by 30% with effect from 1 April 2026 by the Finance Act, 2026. No deduction for expenditure or allowance, and no set-off of loss, is allowed against this income (section 195(2)).

This guide explains what the 30% applies to, how the tax is calculated alongside your normal income, and what you can and cannot reduce. Every figure comes from the Act as amended by the Finance Act, 2026. The examples use tax year 2026-27. This is information, not tax advice.

Which income does the 30% rate apply to?

Section 195(1) applies to income referred to in sections 102, 103, 104, 105 or 106. These are cases where the law treats a sum as your income because you could not explain it satisfactorily.

Section	Head	What is treated as income
102	Unexplained credits	A sum credited in your books, where you give no explanation of its nature and source, or the Assessing Officer (AO) finds the explanation unsatisfactory
103	Unexplained investment	An investment not recorded in your books, or the excess over the recorded amount, without a satisfactory explanation
104	Unexplained asset	An asset not recorded in your books, or the excess of the amount spent on it over the recorded amount. "Asset" includes money, bullion, jewellery, virtual digital asset or other valuable article (section 104(2))
105	Unexplained expenditure	Expenditure, or part of it, whose source you do not explain satisfactorily
106	Amount borrowed or repaid by negotiable instrument, hundi, etc.	An amount (with interest) borrowed or repaid through a negotiable instrument or hundi other than an account payee cheque, or any mode the Board specifies

For the detail of each head, see our guide to unexplained cash credits, investment and assets under the Income Tax Act 2025.

Does section 195 apply only when the AO finds the income?

No. It applies in two situations:

• Clause (a): your return of income, furnished under section 263, itself includes such income. If you disclose an unexplained credit in your return, it is taxed at 30%.
• Clause (b): the income is determined by the AO and is not already covered by clause (a).

The rate is the same either way. Whether you declare it or the AO adds it, section 195 taxes it at 30% and section 195(2) blocks deductions against it.

How is the total tax worked out?

Section 195(1) splits your total income into two parts and adds the tax on each:

1. Tax on the unexplained income at 30% (clause (i)).
2. Tax on the rest of your income at the normal rates, as if your total income were reduced by the unexplained income (clause (ii)).

The Act's text sets only these two parts. It does not mention surcharge, cess or interest, so the figures below are the tax under section 195 before any of those.

What can you deduct or set off against unexplained income?

Nothing. Section 195(2) says that, irrespective of anything else in the Act, no deduction for any expenditure or allowance, and no set-off of any loss, is allowed in computing income referred to in section 195(1)(a) and (b). Section 105(2) adds that unexplained expenditure treated as income cannot be claimed as a deduction either.

Your other, explained income is still computed as usual. Expenses and losses that belong to it still reduce it. They just cannot be used to shrink the unexplained portion.

Is there a penalty on top of the 30% tax?

It can be. Section 439 lets the Competent Authority impose a penalty for under-reported income, payable in addition to tax. The basic penalty is 50% of the tax payable on the under-reported income (section 439(9)). Where the under-reporting is misreporting, the penalty is 200% of that tax (section 439(10)). Section 439(11)(g) lists income referred to in section 195(1)(b), meaning income determined by the AO, as a case of misreporting. Income you declare yourself in the return falls under clause (a), not (b). Whether a penalty is actually levied depends on the facts and the proceedings.

Worked example 1: unexplained credit found in the books

Assumptions: tax year 2026-27. Ravi runs a small trading business. The AO finds a Rs 5,00,000 credit in his books, and his explanation is not satisfactory (section 102(1)(b)). His other income, after all permitted deductions, is Rs 12,00,000, and the tax on it at normal rates works out to Rs 80,000. The Rs 80,000 is an assumed figure to keep the example short; compute yours from the rates that apply to you.

Step	Working	Amount (Rs)
1. Unexplained income	Credit under section 102	5,00,000
2. Tax at 30% (clause (i))	5,00,000 x 30%	1,50,000
3. Tax on the rest (clause (ii))	Assumed, on Rs 12,00,000	80,000
4. Total tax under section 195	1,50,000 + 80,000	2,30,000

Worked example 2: losses and expenses cannot reduce the 30% part

Assumptions: tax year 2026-27. Meena has business profit of Rs 9,00,000 and a house property loss of Rs 1,00,000. The AO adds Rs 4,00,000 as unexplained expenditure under section 105. The tax on her normal income is assumed to be Rs 40,000 (illustrative only).

Step	Working	Amount (Rs)
1. Normal income	9,00,000 less house property loss 1,00,000 (permitted against normal income)	8,00,000
2. Unexplained income	Section 105 addition. The house property loss cannot be set off against it (section 195(2))	4,00,000
3. Tax at 30% on step 2	4,00,000 x 30%	1,20,000
4. Tax on step 1	Assumed	40,000
5. Total tax under section 195	1,20,000 + 40,000	1,60,000

If the loss could have been set off against the unexplained income, the 30% tax would have been on Rs 3,00,000 instead. Section 195(2) closes that route.

Real-life example 1: a loan from a friend with no paper trail

Sunil, a proprietor, shows a Rs 3,00,000 "loan from a friend" in his books. During assessment the AO asks the friend to explain the source. The friend does not respond, so under section 102(2) Sunil's explanation is deemed not satisfactory. The Rs 3,00,000 becomes his income for the year and is taxed at 30% under section 195, with no deduction available.

Real-life example 2: a repayment in cash through a hundi

Anita repays a business loan, with interest, through a hundi instead of an account payee cheque. Under section 106(1), the amount repaid, including the interest, is deemed to be her income for the year of repayment. Section 195 taxes it at 30%. Section 106(2) says a person whose borrowing has been taxed this way is not assessed again on repayment of that same amount under that sub-section.

Quick reference

Point	Rule	Where
Rate on unexplained income	30% (earlier 60%, replaced from 1 April 2026)	Section 195(1)(i)
Rest of income	Taxed at normal rates on total income reduced by the unexplained income	Section 195(1)(ii)
Declared in return	Covered, if reflected in the return under section 263	Section 195(1)(a)
Found by the AO	Covered, if not already in the return	Section 195(1)(b)
Deduction of expenditure or allowance	Not allowed	Section 195(2)
Set-off of loss	Not allowed	Section 195(2)

Common mistakes

• Treating the 30% as a penalty on top of normal tax. It is the rate of tax on that income. The rest of your income is taxed separately at normal rates.
• Setting a current-year loss against the unexplained amount. Section 195(2) bars it.
• Claiming the unexplained expenditure as a business expense. Section 105(2) and section 195(2) both bar it.
• Assuming a disclosure in the return gets a lower rate. Section 195(1)(a) taxes it at the same 30% as an AO addition.
• Relying on the old 60% figure. The Finance Act, 2026 substituted 30% with effect from 1 April 2026.
• Leaving a related lender out of the explanation. For loans and borrowings, section 102(2) deems your explanation unsatisfactory unless the person in whose name the credit is recorded also explains it and the AO finds that explanation satisfactory. Section 102(3) applies the same test to share capital, share premium and similar credits in a company that is not one in which the public are substantially interested (the person must be a resident). Section 102(4) exempts venture capital funds and companies.

How CA firms can keep clients out of this

Most unexplained credit cases begin with a missing document: a loan confirmation, a source for a cash deposit, an investment not in the books. A CA firm that keeps a per-client checklist of such documents can raise the gaps before the return is filed. Finexo's practice management software can track those document requests and reminders across your client list. It does not decide how any item is treated under the Act.

Where this is in the Act

• Section 195: tax on income referred to in sections 102 to 106
• Section 102: unexplained credits
• Section 103: unexplained investment
• Section 104: unexplained asset
• Section 105: unexplained expenditure
• Section 106: amount borrowed or repaid through negotiable instrument, hundi, etc.
• Section 263: return of income
• Section 439: penalty for under-reporting and misreporting

Related: TDS on rent under the Income Tax Act 2025.