Consequent upon the boldest move of Hon’ble Prime Minister, Sh. Narendra Modi on November 8, 2016 to discontinue the than High Denomination Notes (OHD), people in possession of the OHD are compelled to deposit the same in bank account. This move, intends to get rid of Corruption, Black Money, Terrorism, eliminate counterfeit money and make people to pay taxes. Those who pay taxes in accordance with law in force and who have declared their black income under Income Disclosure Scheme are in a safe zone but this is not the case with the persons in possessions of black money. Their black money in the form of the OHD will either become scrap or they will have to deposit the same in Bank Account which will invite tax and penal consequences.
Though Income Tax Department through a series of press releases has warned regarding a levy of penalty at 200% of the tax amount in case where amount of deposit is not in line with the income returned however there is a loophole in the system.
Here in this article an attempt is made to discuss the loophole whether the current penal provisions be interpreted to cover that fact that if a person deposits the OHD in bank account and offers the same as Income u/s 68 by paying tax @ 30% u/s 115BBE, still will he be penalized u/s 270A on account of misreporting of income?
The Finance Act 2016 in order to rationalize and bring objectivity, certainty and clarity in the penalty provisions, replaced the existing section 271 of the Act and inserted a new section 270A of the Act for levy of penalty in cases of under reporting and misreporting of income.
The provisions of section 270A are inserted by the Finance Act 2016 w.e.f 1 April 2017 i.e (from FY 2016-17, AY 2017-18)
The provisions of section 271 are applicable up to AY 2016-17 (F Y 2015-16) as per sub-section (7) of section 271 inserted by Finance Act 2016.
The provisions of section 270A and section 270AA are applicable w.e.f AY 2017-18.
Under the provisions of section 271, the tax authority had to prove the fact that assessee has concealed the particulars of income or furnished the inaccurate particulars of income. However, under the new scheme (Sec. 270A), there is no such requirement in case of under reporting of income. It is because difference between the assessed income and returned income (Sec. 143(1)(a)) is presumed to be under-reporting of income ORdifference between the assessed income and maximum amount not chargeable to tax (where no return is filed by the assessee) is presumed to be under-reporting of income.
However, in case of misreporting of income, the tax authority will have to prove or demonstrate that case of assessee falls within the criteria mentioned in sub- Section(9).
Sub-section (1) of the new section 270A of the Act provides that the Assessing Officer, CIT (Appeals) or the Commissioner may direct that any person who has under-reported his income shall be liable to pay a penalty in addition to tax, if any, on the under-reported income. Thus, trigger point for applicability of penalty under section 270A of the Act is under-reporting of income.
Thus, in order to discuss applicability of penalty in cases where tax has been paid, it is important to first analyse what constitutes under-reporting of income.
Under-Reporting of Income
Sub-section 2 of section 270A of the Act provides that a person shall be considered to have under-reported his income, if, inter alia, the income assessed is greater than the income determined in the return processed under 143(1)(a) of the Act.
Thus, there shall be under-reporting of income only in cases where income assessed during the course of assessment proceedings would be greater than income determined in the return processed under section 143(1)(a) of the Act. Since, the income determined in the return processed under section 143(1)(a) of the Act in normal circumstances would be same as the income returned by a person, the penalty under section 270A of the Act can not be levied as it could be levied only when income assessed would be greater than income returned by the person. This position is further clarified by sub-section 3 of section 270A of the Act which provides for manner to calculate the under-reported income.
Rates of Penalty
Sub-section 7 of section 270A of the Act provides that the rate of penalty shall be 50% of the tax payable on under-reported income.
Further, sub-section 8 of section 270A of the Act provides in a case where under-reported income is in consequence of any misreporting thereof by any person, penalty levied shall be 200% of the tax payable on such under-reported income.
Thus, even for levy of penalty at 200% of the tax payable, it is important that the there must be an under-reported income which must be in consequence of misreporting.
Levy of penalty where tax has been duly paid
Combined reading of the sub sections (1), (2), (8) and (9) of section 270A reveals that misreporting of income will be only where there is under-reported income. A combined reading of sub-sections (8) & (9) shows that it is the under-reported income which is to be treated as misreporting of income if under-reported income is in consequence of items specified under subsection (9). So, firstly, under-reported income is to be computed and then A.O has to give a finding that such under-reported income is in consequence of the items specified under sub section (9). So, if any addition or disallowance does not fall within the scope of “under-reported income” then question of treating the same as misreporting of income does not arise.
If an assessee has declared any income in a particular AY and the AO feels that this is the income of some other AY or some other person, he has to prove. While if an assessee claims an expenditure then the burden is on the assessee to prove the evidences and also to prove that this is the expenditure of this year and incurred for the purpose of business.
As can be seen from above, for levy of penalty under section 270A of the Act, there must be under-reporting of income. Where there was no under-reporting of income, no penalty under section 270A (whether at 50% or 200%) could be levied.
Assume a person has unaccounted cash on which no tax was ever paid. Such a person deposits this unaccounted cash in his bank account after 9th November, 2016 and duly declares such additional income in his return of income for AY 2017-18. Tax at an appropriate rate is paid in full on such income for AY 2017-18.
Now, his income determined in the return processed under section 143(1)(a) of the Act would include this unaccounted cash income [assuming there is no other cause for variation under section 143(1)(a)]. When the case for AY 2017-18 would be picked up for scrutiny by income tax department, the Assessing Officer would not be able to make any addition on account of this cash deposited in bank account since the person would have already offered this income to tax in his return of income filed for AY 2017-18.
In such a scenario, the income assessed would not be greater than the income determined in the return processed under section 143(1)(a) of the Act (assuming there is no addition on any other account). Hence, in such cases, there would be no under-reported income. Thus, the basic condition for levying penalty under section 270A of the Act would not be triggered.
Reference is further drawn on Circular No.25 of 2016 dated June 30, 2016 issued by CBDT while providing clarifications on the Income Declaration Scheme, 2016 (‘IDS’). In question no. 9 of the circular, the CBDT dealt with the question regarding the advantages of the IDS where past undisclosed income is disclosed as current income in the return of income to be filed for AY 2017-18 in place of declaration under IDS. The answer of CBDT, inter alia, provided for the following:-
“If anyone attempts to disclose past undisclosed income in the current year, he will have to explain the source of income and substantiate the manner of earning the said income. In case of disclosure under the Scheme, there is no need to explain the source of income.”
Thus, it may be noted that where income is disclosed in return of income for AY 2017-18, the person making such disclosure would have to explain the source of income and substantiate the manner of earning the said income.
However, even where such person fails to offer the source of such cash deposit, the Assessing Office may only declare such cash deposits to be an unexplained income under section 68 of the Act on which no slab benefit (in case of individual/HUF) or any deduction would be eligible as per section 115BBE of the Act.
However, the Assessing Officer would not be able to make any addition on account of such cash deposit as income in respect thereof would already have been offered to tax. Thus, in the absence of any under-reported income, penalty under section 270A of the Act would not be levied.
Above interpretation of law may however not be accepted by the Government since it may defeat the objective of penalty provisions. It would also defeat the objective of Income Declaration Scheme wherein tax, interest and penalty on such cash deposit was required to be paid @45%. This situation may lead to intense litigation which may prohibit the citizens to make declaration of unaccounted income and payment of tax thereon, as the impact of 200% penalty would mean that the total tax and penalty would be more than 90% with additional fear of being prosecuted.
As per one estimate, total currency notes of Rs. 500 and Rs. 1000 in circulation was approximately of Rs. 14 lac Crores. Such currency notes are likely to be deposited by one or the other methods into the bank accounts by those holding them. In case legitimate method of declaring such amount as income and payment of taxes thereon is not available, people would tend to adopt dubious or undesirable methods and manners for deposit of such amount in the banks. In such a case, Government would not be able to collect its share of taxes and rather may find itself litigating with such kind of persons with no revenue collections.
Section 270A provides for the levy of penalty @200% in case of misreporting of income and @50% in case of under reporting of income. Therefore, to solve the above mentioned situation, it is suggested that Government may take a clear stand that such deposits would fall within the meaning of under reporting requiring levy of penalty @50% of the tax amount. That would mean that Government may get tax, surcharge and penalty to the extent of around 50% of cash deposited/income declared. By doing so, there would not be any inconsistency with the scheme of Income Declaration Scheme where the tax, interest and penalty was 45%. It would create win-win situation for everybody. If such clarification comes from the side of the Government, people may be tempted to declare such deposited cash as income rather than adopting dubious methods. It would bring revenue collection to the Government and capital formation for the banks with the least possibility of litigation.
The above mentioned legal position is my personal view based on reasons set out hereinabove. It is pertinent to mention that litigation on levy of penalty cannot be ruled out specifically in light of the fact that the CBDT has explicitly warned against declaration of past income in current year in its clarificatory circulars on Income Declaration Scheme, 2016. Hence, before resorting to declare previously undeclared money in current year, a person is advised to independently verify the legal position with his tax advisors.
I have complied this material based on the information available from public domain and views of various expert.