Rationalisation Of Penalty Provisions Under The Income-tax Act 1961 As Per The Finance Bill, 2016

The Finance Bill 2016 proposes to make radical changes to the law relating to levy of penalty for concealment of income and furnishing of inaccurate particulars. Sections 270A and 270AA, which are intended to substitute section 271(1)(c), propose a levy of penalty for “under reporting of income” and “misreporting of income“. Shri. K. C. Singhal, former Vice President of the ITAT, has carefully analyzed the implications of the proposed amendments and explained the same with utmost clarity and with reference to practical examples

The levy of penalty for concealment or furnishing of inaccurate particulars of income under the existing provisions of Section 271(1)(c) of Income-tax Act 1961 has always been a matter of litigation between the revenue authorities and the taxpayers. The discretion regarding quantum of penalty led to corruption. The scope of such provisions was always a subject matter of litigation since tax authorities always levied the penalty whenever there was an addition or disallowance made by the assessing officer, may be because of pressure of higher authorities, even in cases where there was no prima facie case against the taxpayer. With a view to reduce the litigation and remove the discretion of tax authority, the Finance Bill, 2016 has proposed the insertion of new provisions in the form of new Sections 270A and 270AA in the Act which will replace the existing provisions of section 271(1)(c). The salient features of the new provisions are discussed below.

At the outset, it is clarified that the new provisions of sections 270A and 270AA will apply to cases pertaining to A.Yrs. 2017-18 onwards and existing provisions of section 271(1)(c) will continue to be applicable to all cases up to A.Yrs. 2016-17 which is apparent from the proposed insertion of sub-section 7 in section 271. Further, the proposed scheme will not be applicable to cases where assessment is made in pursuance of search u/s 132 in view of clause (e) of sub section (6) of Section 270A and consequently, in such cases, the penalty would be levied under the existing provisions of Section 271. It may also be noted that assessment made u/s. 153C is outside the scope of Section 271AAB and therefore in such cases, the penalty would, henceforth, be levied as per the new scheme.

Let us, first, have a look at the bare provisions of the scheme

Under the new scheme, the penalty matters are categorised in two parts — (1) under reporting of income and (2) misreporting of income. Under reported income has been defined in S. 270A(2) which is to be read with sub-section (6) while misreporting of income is defined in sub sections (8) & (9) of this section. With a view to remove the discretion of the Assessing Officer, it is proposed to impose fixed % of the amount of penalty under the new scheme. Hence, penalty for under reported income will be @ fixed rate of 50% of the tax payable on unreported income while it will be @ 200% of the tax payable on the misreported income as against 100% to 300% of concealed income under the existing provisions of section 271. This is a welcome step in the proposed legislation.

The under-reported income has been defined in sub-section (2) section 270A. According to this provision, a person shall be considered to have unreported his income where–

(a) The assessed income is greater than the income processed u/s 143(1)(a);

(b) The income assessed is greater than the maximum amount not chargeable to tax, where no return is filed by the assessee;

(c) Where the income reassessed is greater than the income assessed or reassessed immediately before such assessment;

(d) Where the deemed total income assessed or reassessed as per the provisions of Sections 115JB/115JC is greater than the deemed total income determined u/s. 143(1)(a);

(e) Where the deemed total income assessed under the provisions of sections 115JB/115JC is greater than the maximum amount not chargeable to tax, where no return is filed by the assessee;

(f) Where the income assessed or reassessed has the effect of reducing the loss or converting such loss into income.

However, in order to avoid litigation between the tax authorities and the taxpayers, the proposed Bill also provides for exclusion of certain amounts from the scope of the expression “Unreported income”. Such exclusions are enumerated in sub-section (6) which are narrated below—

(a) The additions or disallowances in respect of which assessee offers a bona fide explanation to the satisfaction of the tax authority and proves that he had disclosed all material facts to substantiate the explanation;

(b) The additions or disallowances determined on estimate basis, if the accounts maintained by assessee are correct and complete to the satisfaction of tax authority but the method employed is such that the income cannot properly be deduced there from;

(c) The additions or disallowances determined on estimate basis, where the assessee had, suo motu, made a lower amount of disallowance on the same issue in computation of income but had disclosed all material facts in respect of such additions or disallowances;

(d) The amount of addition made in conformity of arm’s length price determined by TPO if the assessee had maintained information and documents as prescribed u/s. 92D and declared the international transactions and disclosed all material facts relating to such transactions;

(e) The amount of undisclosed income referred to in section 271AAB.

The computation of unreported income is provided in sub section (3) in two parts. First part refers to the situation where the income is being assessed for the first time either u/s 143 or 147— (a) where the return is furnished, the unreported income will be the difference between the amount of income assessed and the amount of income determined u/s. 143(1)(a); (b) where no return is filed by the assessee, (i) in case of company, firm and local authority, it will be the entire income assessed and (ii) in case of other entities, it will be the difference between the income assessed and the maximum amount not chargeable to tax. Second part refers to the situation other than the one mentioned above. In such cases, it will be the difference between the amount of income reassessed and the amount of income assessed, reassessed or recomputed in a preceding order. Further, a proviso is added to such provisions which provides a formula for determining the unreported income where the income is assessed as per deeming provisions of sections 115JB/115JC.

Where, as a result of the assessment or reassessment, the loss returned by the assessee is reduced or converted into positive income, the unreported income will be the difference between the loss claimed and the income or loss as the case may be assessed or reassessed.

The expression “a preceding order” referred to earlier is explained to mean an order during the course of which penalty proceedings had been initiated.

Misreporting of income has been defined in sub-sections (8)&(9) of section 270A. Combined reading of these sub sections reveals that misreporting of income will be where under-reported income is because of following circumstances—-

(a) Misrepresentation or suppression of facts;

(b) Failure to record investments in the books of account;

(c) Claim of expenditure not substantiated by any evidence;

(d) Recording of false entry in the books of account;

(e) Failure to record any receipt in the books of account having a bearing on the total income;

(f) Failure to report any international transaction or deemed international transaction or any specified domestic transaction to which provisions of chapter X applies.

For the purpose of levy of penalty, the amount of tax payable on under reported income as per sub-section (10) shall be computed as under –

(a) Tax payable on such income as if it were the total income in case of company, firm or local authority; and

(b) At the rate of 30% of under-reported income, in any other case.

Sub-section (12) provides that such penalty shall be imposed by the tax authority by an order in writing.

Immunity from penalty and prosecution

Before analysing the entire scheme, it would be appropriate to refer to the provisions of section 270AA which provides for immunity from levy of penalty u/s. 270A and prosecution u/s. 276C. According to this scheme, an assessee shall be granted such immunity if following conditions are satisfied–

(a) Tax and interest payable as specified in the notice of demand in pursuance of order of assessment or reassessment has been paid within the time specified in such notice of demand; and

(b) No appeal is filed against the order of assessment or reassessment.

The procedure specified is simple which states that assessee is required to file an application in the prescribed form within one month from the end of the month in which such order of assessment or reassessment is received by the assessee. The Assessing Officer, if conditions fulfilled, shall grant immunity from imposition of penalty u/s. 270A and prosecution u/s. 276C provided the penalty is not initiated under the circumstances mentioned in sub section (9). The A.O. shall pass an order within one month from the end of the month in which such application is received.

In other words, such immunity is not available where either (i) penalty is initiated in respect of misreporting of income, or (ii) tax and interest as per demand notice is not paid within the time specified in the demand notice, or (iii) application is not made in the prescribed form within one month from the end of the month in which order of assessment or reassessment is received by the assessee.

If the A.O. decides to reject the application, he shall give an opportunity to the assessee of being heard before rejection.

Analysis

Let me, first, point out the distinction and similarity between the existing provisions and the new scheme–

• Under the existing provisions, the tax authority has to record his satisfaction in the assessment proceeding to the effect that assessee had concealed the particulars of income or furnished inaccurate particulars of income. Failure to record such satisfaction rendered the penalty order as nullity. Under the new scheme, there is no such statutory requirement. Mere initiation of penal proceeding would be sufficient which may be by issuing direction in the order or by issue of penalty notice.

• Under the existing provisions, the tax authority has to prove the fact that assessee has concealed the particulars of income or furnished the inaccurate particulars of income. Under the new scheme, there is no such requirement in case of under reporting of income since difference between the assessed income and income determined u/s. 143(1)(a) is presumed to be under-reporting of income or difference between the assessed income and maximum amount not chargeable to tax, where no return is filed by the assessee. 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). Further discussion is made at a later stage.

• Under the existing provisions, there is a discretion with the AO to impose penalty between 100% to 300% of the tax but under the new scheme, the AO has no such discretion. He is required to impose penalty at flat rate of 50% of tax payable on unreported income and 200% of tax payable on misreported income.

• Under the existing as well as new scheme, no penalty order can be passed without giving an opportunity of being heard in view of the provisions of Section 274.

• The limitation period specified in section 275 will apply to order passed under both the scheme.

• The right to appeal is available under Section 246A under both the scheme. Though there appears to be an inadvertent mistake in not making specific amendment in Section 246A but hopefully will be there in the said section. It may be pointed out that the existing clause (q) of Section 246A permits the right to appeal against any penalty order passed under any section falling under chapter XXI. Since penalty orders under the new provisions falls under chapter XXI, right to appeal is not lost even if no specific amendment is made in section 246A.

Whether penalty proceedings can be initiated after completion of assessment proceedings?

In my view, the answer is NO for the reason given hereafter.

• Though there is no specific provisions to this effect, the inference can be drawn from the Explanation below sub section(3) which refers to initiation of penalty under sub section(1) of section 270A.

• Since for availing the immunity u/s 270AA, the assessee is required to make an application within 30 days from the end of month in which the order of assessment is received, he must be aware from such order that penalty proceeding u/s 270A has been initiated or not.

• Further, immunity u/s 270AA is available only in case of under reporting of income. Hence, A.O must demonstrate whether penalty is initiated for under reporting of income or misreporting of income. This can be done only through initiating the same in the assessment order or by issuing the notice.

• Section 274 provides that no order of penalty can be passed without providing an opportunity of being heard to the assessee.

• Last but the most important reason is that section 275 provides the period of limitation. According to section 275(1)(c), no penalty order can be passed after the expiry of financial year in which the proceedings, in the course of which action for imposition for penalty has been initiated, are completed, OR 6 months from the end of the month in which action for imposition of penalty is initiated, whichever is later. Similar language is there in S, 275(1)(a). So, unless the penalty proceedings are initiated in the course of assessment proceedings, the period of limitation cannot be worked out.

It is the settled view that provisions should be interpreted in such a manner which makes the provisions workable rather than to frustrate. Therefore, in view of the reasons given above, it is opined that penalty proceedings must be initiated in the course of assessment proceedings itself.

How to compute the under reported income?

Though sub-section (2) defines the scope of the expression “under reported income”, sub section (3) provides the procedure for computing such income. It is explained as under –

(a) Where the income has been assessed for the first time in response to the return filed, it will mean the difference between the amount of income assessed and the amount of income determined u/s. 143(1)(a). Such assessment may be u/s. 143(3) or u/s. 147. Thus, under reported income would not include the amount of adjustment made in determining the income u/s. 143(1)(a). For example, assessee files a return declaring income of ₨ 10 lakhs but income is determined at ₨ 12 lakhs u/s 143(1)(a) and income is assessed at ₨ 13 lakhs u/s. 143(3)/147. In such case under reported income would be ₨ 1 lakh and not ₨ 3 lakh.

(b) Where no return is filed by the assessee, the computation is in two parts i.e. (i) where the assessee is a company, firm or local authority, it will mean the entire amount of income assessed and (ii) in case of other assessees, it will mean the difference between the amount of income assessed and the maximum amount not chargeable to tax.

(c) Where the income is assessed as a result of reassessment or re-computation (not being assessed for the first time), it will mean the difference between the amount of income re-assessed or re-computed and the amount of income assessed, re-assessed or re-computed in a preceding order. The preceding order has been defined as the order passed immediately preceding the order during the course of which penalty proceeding is initiated. Such preceding order may be as a result of assessment made u/s. 143 or 147 or as a result of directions of appellate/revisionary authority or Tribunal or Court as the case may be.

(d) Where the income is assessed by way of deemed assessment u/s. 115JB/115JC, it will mean the amount determined as per the formula given in the proviso to sub-section 3(ii) of Section 270A. This formula is similar to formula provided in the existing provisions of Explanation 4 to section 271(1)(c).

(e) Where as a result of assessment/reassessment, the loss is reduced or loss is converted into income, it will mean the difference between the amount of loss claimed by the assessee and the income or loss assessed or reassessed. For example, where returned loss is 15 lakhs assessed income is 5 lakhs, the unreported income will be 20 lakhs.

However, under reported income shall not include the amount of income referred to in sub- section (6) of this section.

What is the scope of sub section (6)?

This is an important aspect which needs to be elaborated. This sub section encompasses the circumstances where penalty in respect of under reporting of income cannot be levied. The income relatable to such circumstances shall be excluded from the computation of unreported income. Thus, it will reduce the litigation between the taxpayer and the revenue authorities. Such circumstances are discussed below—

(a) First situation is where any addition or disallowance is made by the A.O. but the assessee has offered an explanation which is bona fide to the satisfaction of tax authority AND has disclosed all the material facts to substantiate the explanation. For example, take a case of cash credit. If the assessee has furnished all material facts i.e. name and address of the creditor, his PAN, copy of ITR, ward where he is assessed, confirmation from creditor, copies of bank statement etc but the addition is made simply because the creditor could not be produced or not responded in response to summons. As per the judicial opinions, it cannot be said that explanation of assessee was not bona fide. Hence, it will not constitute under reporting of income since all material facts are disclosed. However, some litigation cannot be ruled out as the A.O may not be satisfied with the explanation of the assessee and in such cases the Appellate Authority/Tribunal is likely to accept the case of assessee in view of the settled legal position. There are various other situations which may fall under this category but all such cases cannot be discussed at this stage. It may be pointed out that this clause, being general one, will be applicable to any kind of addition or disallowance made by AO. Whether a case would fall under this category or not would depend on the facts of each case.

(b) Second situation is where the accounts of the assessee are correct and complete as per the accounting system but the method employed is such that income cannot properly be deduced there from and as a result thereof the addition is made on estimate basis. For example, GP rate is enhanced on estimate basis merely on the ground that it is lower than other assessees in the same trade or because of non maintenance of stock register etc. Such addition shall not be considered in computing the unreported income.

However, this category would not include where books of account are rejected on the ground that the same are not correct and complete to the satisfaction of A.O. For example, non-recording of purchase/sale; bogus purchases; under-recording of closing stock, manipulation in entries etc. In such cases, penalty can be levied.

(c) Third situation is where some disallowance is made by the assessee of his own but the A.O enhances the same on estimate basis provided all material facts are disclosed by the assessee. For example, some disallowance is made by the assessee u/s. 14A but the A.O, not being satisfied, enhances the same even though all material facts are disclosed by the assessee. In such cases, it will not amount to under reported income.

(d) Fourth situation is where the assessee had maintained information and documents prescribed under section 92D, disclosed the international transactions under chapter X and also disclosed all material facts relating to such transactions but addition is made in conformity with the arm’s length price determined by TPO. Thus merely because addition is made on the basis of TPO’s order, it will not amount to under reported income. This will really reduce the litigation.

(e) The last situation is where penalty is leviable u/s. 271AAB. S.271AAB applies where additions are made in case of a person in whose case search is initiated u/s. 132.

Scope of the expression “misreporting of income”

“Misreporting of income” is considered to be more stringent as compared to “under-reported income” since penalty in case of misreporting of income is to be imposed @ 200% of the tax payable as against 50% in case of under -reported income. It is to be noted that it is not an independent expression. 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.

Thus, in my opinion, the onus is on the revenue to prove that under reported income is in consequence of the circumstances mentioned in sub section (9). Let us have a look at these items—

• The first item in sub-section (9) is misrepresentation or suppression of fact which involves the element of mens rea i.e. the guilty mind on the part of assessee. This aspect will always be a subject matter of litigation.

• The second item is failure to record investment in the books of account while the fifth item refers to failure to record receipt in the books of account which has a bearing on the total income. Such facts can be proved by A.O just by referring to books of account of the assessee. But there may be cases where assessee does not make books of account even though such receipts are revenue receipts. For example, assessees falling u/s. 44AD or 44ADA are not required to maintain books of account. In such cases, this sub section would become inapplicable.

• Fourth item refers to recording of false entry in books of account. The word ‘false’ also involves mens rea on the part of assessee. Hence, onus will be on revenue to prove the mens rea on the part of assessee.

• The second item in the list refers to claim of assessee regarding expenditure not substantiated by any evidence. The word ‘any’ is important which can be read as no evidence. So, where evidence has been filed by the assessee, it will not be a case of misreporting of income merely because it is not believed by the tax authority. This aspect of the matter shall be a matter of litigation.

• The sixth and last item is failure to report international transaction or specified domestic transaction.

How the penalty is to be computed?

As already stated, sub-section (7) provides that penalty shall be computed @ 50% of the tax payable on under reported income AND 200% of tax payable in case of under reported income falling under sub-section (9) i.e. misreported income. Tax payable is to be computed as per the provisions of sub-section (10) of section 270A i.e. 30% of the under-reported income and not as per normal rate as per finance Act so far as assessees (other than company, firm and local authority) are concerned. In case of co., firm or local authority, it will be tax as if the under reported income would have been the total income. For example, an individual declaring income of ₨ 5 lakhs is assessed at ₨ 7 lakhs. In such case, under reported income would be ₨ 2 lakhs on which tax payable would be ₨ 60,000/-(30%) and penalty would be ₨ 30,000/-and if such income falls under subsection (9) then penalty would be ₨ 1,20,000/-. However, if such assessee had not filed the return at all for any reason then, under reported income will amount to ₨ 4.5 lakhs (Rs. 7 lakhs – ₨ lakhs) on which tax payable would be ₨ 1,35,000/-(30%) on which penalty would be ₨ 67,500/-and if such income falls under subsection (9) then penalty would be ₨ 2,70,000/-.

In my opinion, the provisions are too harsh and drastic in those cases where an assessee fails to file the return for bona fide reasons beyond his control. For example, a firm earned income of Rs. 50 lakhs during a year in respect of which TDS and advance tax are fully paid as per law. However, it fails to file the return due to bona fide unavoidable circumstances. The assessment is completed assessing the income at Rs. 52 lakhs even u/s. 144. In such case, the entire amount of Rs. 52 lakhs will be treated as under reported income as per sub section (3). The tax payable on such assessed income will be Rs. 15.60 lakhs on which penalty of Rs. 7.8 lakhs will be imposed even though the entire tax is already paid. On the contrary, had it filed the return, the under reported income would only be Rs. 2 lakhs on which tax payable would be Rs. 60,000/-only and penalty would be only Rs. 30,000/-.

Let us also take a case of an individual contractor whose total gross receipt is Rs. 1.5 crs on which tax is deducted u/s 194C which comes to Rs. 1.5 lakhs but fails to file the return for some bona fide unavoidable circumstances. The income is finally assessed at Rs. 15 lakhs

( ₨ 12 lakhs u/s. 44AD + ₨ 3 lakhs u/s. 69). The under reported income would be ₨ 12.5 lakhs (₨ 15 lakhs – ₨ 2.5 lakhs) on which tax payable would be ₨ 3.75 lakhs (being 30%) and consequently, penalty amount would be ₨ 1,87,500/-. Had he filed the return declaring income of ₨ 12 lakhs u/s 44AD, the under reported income would have been ₨ 3 lakhs only on which tax payable would have been only ₨ 90,000/- and penalty of ₨ 45,000/- only.

It appears that penalty, in such cases, is mainly for late filing of return rather than for under reported income. In my opinion, suitable amendment needs to be made in this behalf. In order to avoid hardship, the only option with the assessee is avail the immunity by paying tax and interest in accordance with the provisions of section 270AA.

Amendment in section 271AA

Sub section (2) has been inserted in this section. According to this amendment, if there is failure to furnish information and the document as required u/s. 92D(4) on the part of assessee then it shall be liable to pay penalty of ₨ 5 lakh.

So, the assessee has to be very careful in this regard.

Section 271AAB has also been amended which is applicable to search cases. According to the proposed amendment, the penalty leviable shall be fixed % i.e. 60% of the undisclosed income. thus the A.O. shall have no discretion.

Hope, the readers would be benefitted by the above write-up.

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