Taxation Of High Value Currency Notes Demonetized

CA P. N. Shah, an eminent tax expert, has conducted a critical analysis of the Taxation (Second Amendment) Bill, 2016. He argues that while the Bill provides welcome clarity as to the taxation of, and the levy of penalty on, the deposit of unaccounted cash, declarants may face draconian consequences under the laws relating to Benami transactions, money laundering, foreign exchange etc. He urges the Government to issue appropriate clarifications so that all uncertainties are removed and demonetization becomes a rousing success

I. BACKGROUND:

1.1 On 8th November, 2016, the Central Government demonetized Rs. 500/1000 Currency Notes (Old Notes). New Currency Notes of Rs. 500/2000 have been issued to replace the old Currency Notes. Old Currency Notes of Rs. 500/1000 can be deposited in the bank account of the person holding such old notes between 10th November to 30th December, 2016. Once the old notes are deposited in the Bank Account of the person he will have to explain the source of such deposit to the Income tax Authorities during the course of his assessment proceedings. The Government has recognized in its public announcements that an Individual or HUF may be holding some such old notes out of their savings and kept them for household needs. Therefore, a public assurance has been given that the Income tax Department will not inquire about the source of such deposits if the total deposit during the above period is less than Rs. 2.5 lakhs.

1.2 After the above announcement for demonetization there was a public debate whether a person depositing old notes in his Bank if he is not able to explain the source of such deposit will be liable to pay any tax or penalty. Form the legal opinions of various counsels it was evident that if the assesse offered this deposit amount as Income from Other Sources in his return of income for the current year (A/Y:2017-18) and paid tax at applicable rate, no penalty under section 270A can be levied. This is because penalty u/s 270A can be levied only on un-reported income. If the income is offered in the return of income and tax is paid on such income no penalty can be levied as there will be no difference between assessed income and returned income.

1.3 It appears that the Government has accepted this view. It is recognized that large cash in the form of Old Notes is kept by some persons out of their unaccounted income and they should pay tax at higher rates and should also pay penalty when they make such unaccounted income official by depositing such cash in their Bank Accounts. To achieve this objective the Finance Minister introduced The Taxation (Second Amendment) Bill, 2016 in the Lok Sabha on 28th November, 2016. This Bill has been passed by the Lok Sabha, without any discussion on 29th November, 2016. The Bill after it is cleared by the Rajya Sabha and after the assent of the President will be brought into force from the current year. The provisions of this Amendment Act are very harsh. This Act also amends the Finance Act, 2016 and provides for an Income Declaration Scheme in the form of “Taxation and Investment Regime for Pradhan Mantri Garib Kalyan Yojna, 2016”. In this Article some important provisions of this Act and this Income Declaration Scheme are discussed.

1.4 In the Statement of Objects and Reasons, the Finance Minister has stated as under:-

“Evasion of taxes deprives the nation of critical resources which could enable the Government to undertake anti-poverty and development programmes. It also puts a disproportionate burden on the honest taxpayers who have to bear the brunt of higher taxes to make up for the revenue leakage. As a step forward to curb black money, bank notes of existing series of denomination of the value of five hundred rupees and one thousand rupees (hereinafter referred to as specified bank notes) issued by the Reserve Bank of India have been ceased to be legal tender with effect from the 9th November, 2016.

In the wake of declaring specified bank notes as not legal tender, there have been representations and suggestions from experts that instead of allowing people to find illegal ways of converting their black money into black again, the Government should give them and opportunity to pay taxes with heavy penalty and allow them to come clean so that not only the Government gets additional revenue for undertaking activities for the welfare of the poor but also the remaining part of the declared income legitimately comes into the formal economy. Thus, money coming from additional revenue as a result of the decision to ban Rs. 1000 and Rs. 500 notes can be utilized for welfare schemes for the poor.

Therefore, an alternative scheme namely, the “Taxation and Investment Regime for Pradhan Mantri Garib Kalyan Yojana, 3 2016” (PMGKY) is proposed to be provided in the Bill. The declarant under this regime shall be required to pay tax @30% of the undisclosed income and penalty @10% of the undisclosed income. Further, a surcharge to be called “Pradhan Mantri Garib Kalyan Cess” @ 33% of tax is also proposed to be levied. In addition to tax, surcharge and penalty, the declarant shall have to deposit 25% of undisclosed income in a Deposit Scheme to be notified by the Central Government in consultation with the Reserve Bank of India under the “Pradhan Mantri Garib Kalyan Deposit Scheme, 2016”. This amount is proposed to be utilized for programmes of irrigation, housing, toilets, infrastructure, primary education, primary health, livelihood, etc., so that there is justice and equality”

2. Taxation of unexplained Cash Credits, Investments etc. (Section 115BBE)

2.1 Section 115BBE of the Income tax Act deals with Rate of tax on income referred to in sections (i) 68 – Cash Credits, (ii) 69 – Unexplained Investments, (iii) 69A – Unexplained Money, bullion, jewellery or other valuable articles, (iv) 69B- Amount of Investments, jewellery etc. not fully disclosed, (v) 69C – Unexplained Expenditure and (vi) 69D – Amount borrowed or repaid on a Hundi in cash. This section was inserted by the Finance Act, 2012 w.e.f 1/4/2013. The Section provides that the rate of tax payable on addition made by the Assessing Officer (AO) under the above sections, if no satisfactory explanation for the above deposits/investments/expenditure etc. is furnished by the assessee, will be at a flat rate of 30% plus applicable surcharge and education cess. No deduction for any expenditure or allowance is allowable against such amount treated as income.

2.2 This section is now amended w.e.f 1/4/2017 (A/Y:2017-18) as under:-

(i) It is now provided that in respect of income referred to in Sections 68, 69, 69A, 69B, 69C or 69D which is offered for tax by the asseseee in the Return of Income filed u/s 139 the rate of tax on such income will be 60% plus applicable surcharge and education cess.

(ii) Further, in respect of the income referred to in Sections 68, 69, 69A, 69B, 69C or 69D is not offered for tax but is found by the AO and added 4 to the income of the assessee by the AO the rate of tax will be 60% plus applicable surcharge and education cess.

2.3 Section 2(9) of the Finance Act, 2016 dealing with Surcharge on Tax has also been amended w.e.f. A/Y: 2017-18. In the existing Section 2(9) it is provided that surcharge on tax on income added by the AO under Sections 68, 69, 69A, 69B, 69C or 69D will be payable at 15% of the tax if total income of an Individual, HUF, AOP, BOI, Firm etc. exceeds Rs. One Crore. In the case of Domestic Company the rate of surcharge is 7% of Tax if the total income is between Rs. 1 to 10 Cr. If total income of such a company is more than Rs. 10 Cr. the surcharge is 12% of the tax. For foreign companies the surcharge is 2% (where total income is between Rs. 1 Cr. and Rs. 10 Cr) and 5% (where total income is more than Rs. 10 Cr.)

2.4 By an amendment made in Section 2(9) of the Finance Act the rate of surcharge will now be 25% in respect of tax payable u/s 115BBE irrespective of the quantum of total income for A/Y:2017-18. This will mean that any income in the nature of cash credit, unexplained investments, unexplained expenditure etc. which is offered for taxation u/s 139 or which is added to declared income by the AO u/s 68, 69, 69A to 69D will now be taxable in the case of Individual, HUF, AOP, Firm, Company etc. at the rate of 60% (instead of 30% earlier) plus surcharge on tax at 25% of tax (i.e. 15%) even if the total income is less than Rs. 1 Crore. Besides the above, education cess at 3% of tax will also be payable.

2.5 It may be noted that if an Individual, HUF, AOP, Firm, Company etc. deposits old Rs. 500/1000 notes in his Bank A/c between 10/11/2016 and 30/12/2016 and he is not able to give satisfactory explanation for the source, he will have to pay tax at 75% (60%+15%) plus Education Cess even if this income is shown in the Return u/s 139 for A/Y:2017-18 and the total income of the assessee is less than Rs. 1 Crore. It is unfortunate that this Amendment Act nowhere provides that if the old notes deposited in the Bank during the above period are of the value below Rs. 2.5 lakhs, no tax will be payable. This means that the announcements by the Prime Minister, Finance Minister and others representing the Government that no enquiry will be made in respect of deposits upto Rs. 2.50 lacs have not been honoured by the Government while enacting this Amendment Act. If the Government desires to honour its 5 commitment in this regard, CBDT should now issue instructions to its officers that no addition u/s 68, 69, 69A to 69D will be made if old notes worth Rs. 2.5 lakhs or less are deposited by an Individual or HUF in the Bank during the above specified period.

3. Penalty in Search Cases (Section 271AAB):

3.1 Section 271AAB was inserted in the Income tax Act by the Finance Act, 2012 w.e.f 1/7/2012. Under this section penalty is leviable at the rate ranging from 10% to 90% of undisclosed income in cases where Search is initiated u/s 132 on or after 1/7/2012. By amendment of this section it is provided that the existing provisions of Section 271AAB (1) for levy of Penalty will apply only in respect of Search u/s 132 initiated between 1/7/2012 and the date on which the Amendment Act comes into force (Notified Date)

3.2 New Sub-Section (1A) is added in section 271AAB w.e.f. notified date to provide for levy of penalty at 30% of undisclosed income in cases where Search is initiated on or after the notified date. For this purpose the conditions are as under:

(i) The assesse admits such income u/s 132(4) and specifies the manner in which it was earned.

(ii) The assesse substantiates the manner in which such income was earned.

(iii) The assesse files the return including such income and pays tax and interest due before the specified date.

3.3 If the assesse does not comply with the above conditions the rate of penalty is 60% of undisclosed income. It may be noted that prior to this amendment the rates of penalty were 10% to 90% under specified circumstances.

4. Penalty on Cash Credits, Unexplained Investments etc. (New Section 271AAC)

4.1 New Section 271AAC is inserted by this Amendment Act w.ef. 1/4/2017 (A/Y:2017-18). This section provides for levy of penalty in respect of income 6 from cash credits, Unexplained Investments, Unexplained Expenditure etc. added by the A.O u/s 68, 69, 69A to 69D. This penalty is to be computed at the rate of 10% of the tax payable u/s 115BBE(1)(i). Since the tax payable u/s 115BBE(1)(i) is 60% of the income added by the AO under section 68, 69, 69A to 69D, the Penalty payable under this section will be 6% of the income added by the AO under the above sections. Thus the tax (including penalty) in such cases will be 83.25% (77.25%+6%).

4.2 It may be noted that no penalty under this new section will be payable if the assesse has declared the income referred to in sections 68, 69, 69A to 69D in his return of income u/s 139 and paid the tax due u/s 115BBE before the end of the relevant accounting year. In other words, if an assessee wants to declare the amount of old notes deposited in the bank during the specified period in his return of income u/s 139 for A/Y:2017-18, he should pay the tax at 75% (including Surcharge) and education cess on or before 31/3/2016. In this case the above penalty will not be levied.

4.3 It is also provided that in the above cases no penalty u/s 270A will be levied on the basis of under reported income. It is also provided that the procedure u/s 274 for levy of penalty and time limit u/s 275 will apply to levy of penalty u/s 271AAC.

5. Income Declaration Scheme No:2:

5.1 Income Declaration Scheme No:1: The Finance Act, 2016 enacted on 14/5/2016, contained “The Income Declaration Scheme, 2016”. This Scheme allowed any person to declare his undisclosed income (Indian assets, including cash) of earlier years during the period 1/6/2016 to 30/09/2016. Under this Scheme the declarant was required to file declaration about valuation of undisclosed Indian assets and pay tax of 45% (including surcharge and penalty) in instalments. It is stated that assets worth about 65000 Crores were disclosed under this scheme before 30/09/2016.

5.2 Income Declaration Scheme No:2: In order to give one more opportunity to persons holding old currency notes the present scheme to declare their undisclosed income held in cash is introduced, Sections 199A to 199R are inserted in the Finance Act, 2016. These Sections provide for a new Scheme called “Taxation and Investment Regime for Pradhan Mantri Garib Kalyan Scheme, 2016”. The provisions of this Scheme are on the same lines as the earlier Income Declaration Scheme, 2016, which ended on 30/09/2016. The Scheme will come into force on the appointed date and will come to end on the date to be notified. Some of the Important provisions of the Scheme are discussed below:-

5.3 Declaration under the Scheme: (i) Under Section 199C any person may make a declaration in the prescribed form during the period to be notified in respect of his income in the form of cash or deposit in any account maintained with a specified entity. Thus the benefit of this Scheme can be taken by an Individual, HUF, Firm, AOP, Company or any person whether Resident or Non-Resident. (ii) The income chargeable to tax under the Income tax can be declared under the Scheme if it related to period prior to 1/4/2016. No deduction for any expenditure, allowance, loss etc. can be claimed against such income. For this purpose the specified entity with which deposit is made means–

(a) Reserve Bank of India

(b) Any Scheduled Bank (including Co-operative Bank)

(c) Any Post Office

(d) Any other Entity notified by the Central Government.

(iii) The amount of Undisclosed Income declared in accordance with the Scheme shall not be included in the income of the declarant for any assessment year. In other words immunity is given under the Income tax Act and the Wealth Tax Act.

5.4 The Tax Payable: Sections 199D and 199E provide for payment of tax, cess, penalty etc. It is provided that the person making the Declaration u/s 199C shall have to 8 pay tax, cess and penalty i.e 49.90% of the income declared under the Scheme as under:

(i) 30% of Undisclosed income by way of tax

(ii) 33% of above tax (i.e. 9.9%) by way of Pradhan Mantri Garib Kalyan Cess.

(iii) 10% of undisclosed income by way of Penalty

5.5 Interest Free Deposit: The declarant under the Scheme has also to deposit 25% of the undisclosed income in the “Pradhan Mantri Garib Kalyan Deposit Scheme, 2016” as provided in Section 199F. This deposit will be for 4 years and no interest shall be paid to the declarant on this deposit.

5.6 Time for payment of Tax and Deposit (Section 199H)

The above Tax, Cess and Penalty is to be paid before filing the Declaration u/s 199C. Similarly, above Interest Free Deposit is to be made before filing the Declaration u/s 199C. The Declaration along with proof of payment of tax etc. and proof of deposit is to be filed before the due date which will be notified. Any amount of tax, cess or penalty paid under the scheme is not refundable.

5.7 Persons who cannot make a Declaration under the Scheme: Section 199-O provides that the following persons cannot make the Declaration under the above Scheme.

(i) Any person in respect of whom an order of detention has been made under the conservation of Foreign Exchange and Prevention of Smuggling Activities Act, 1974. Certain exceptions are provided in Section 199-O (a).

(ii) Any person in respect of whom prosecution for an offence punishable under Chapter IX or Chapter XVII of the Indian Penal Code, the Narcoitc Drugs and Psychotropic Substances Act, 1988, the Prohibition of Benami Property Transactions Act, 1988 9 and the Prevention of Money Laundering Act, 2002 has been launched.

(iii) Any person notified u/s 3 of the Special Court (Trial of Offence Relating to Transactions in Securities) Act, 1992.

(iv) The Scheme is not applicable to any undisclosed foreign income and asset which is chargeable to tax under the Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015.

5.8 Other Procedural Provisions: Sections 199G, 199J, 199L, 199M, 199N, 199P to 199R deal with certain procedural matters as under:-

(i) Person who can sign the declaration (Section 199G)

(ii) Undisclosed Income declared under the Scheme not to affect any concluded assessments (Section 199J)

(iii) Declaration not admissible as evidence in other proceedings (Section 199L)

(iv) Declaration will be treated as void if it is made by misrepresentation of facts (Section 199M)

(v) Provisions of Chapter XV, Sections 119, 138 and 189 of the Income tax Act to apply to proceedings under the Scheme (Section 199N).

(vi) Benefit, concession, immunity etc. udner the Scheme available to declarant only (Section 199P).

(vii) Central Government will have power to remove difficulties under the Scheme within 2 years (Section 199Q). (viii) Power to make Rules for administration of the Scheme given to Central Government (Section 199R). 10 6. General:

6.1 We should congratulate the Government for the bold step taken to demonetize old high value currency notes. This is a right step to deal with the problem of black money, corruption, fake currency in circulation etc. In the beginning persons with small holdings will have some difficulty in converting the old currency into new one. Taking into consideration the long term benefits which will accrue after the present conversion scheme is implemented, such difficulty in the initial period is worth suffering.

6.2 The Government recognized that the existing Income tax Act did not permit tax authorities to levy any penalty on persons who would convert large amount of black money through banking channel. Therefore, the present Amendment Act to amend the Income tax Act and the Finance Act has been passed. However, small income earners who had some high value notes kept at home out of their savings cannot be considered as holding their unaccounted black money. The Government had promised that if such persons deposit in their Bank Account amount upto Rs. 2.50 lakhs no enquiry will be made by the tax Department. This promise has not been honoured while passing this Amendment Act. It is, therefore, necessary that the CBDT issues a Circular to the officers not to raise any doubt if an assessee gives an explanation that amount upto Rs. 2.5 lakhs is deposited out of household savings.

6.3 The amendment in Section 115BBE punishes those assessees in whose cases additions are made for cash credits, unexplained investments, unexplained expenses etc. Tax rate is now increased from 30% to 60%. Further, there will be additional burden of 15% surcharge and 6% penalty. Such cases have no relationship with demonetization of high value currency. It is difficult to understand the reason for which such additional burden is put on such assessees.

6.4 The Income Disclosure Scheme No:2 is welcome. Persons holding unaccounted money in cash will take advantage of this scheme as the tax rate is 49.9% and 25% of the amount is blocked for 4 years in Interest Free Bonds. However, persons who decide to offer such amount in their Return of Income for the current year will be at disadvantage as they will have to pay tax, surcharge and education cess u/s 115BBE at 77.25% of such income. 11

6.5 It may be noted that under Income Declaration Scheme No:1 announced in May, 2016, immunity was granted from proceedings under the provisions of (i) Benami Transactions (Prohibition) Act, 1988, (ii) Foreign Exchange Management Act, (iii) Money Laundering Act, (iv) Indian Penal Code etc. There was also an assurance that the secrecy will be maintained about the contents of the Declaration under the Scheme. It is unfortunate that the present Scheme does not provide for such immunity or secrecy. Therefore, the assessees will have to be very careful while making the Declaration under the Scheme. They will have to consider the impact of such Declaration on the proceedings under Excise, Customs, Service tax, VAT, FEMA etc. before making Declaration under the present Scheme. 6.6 It appears that this Scheme as announced by the Government is with all good intention. It is advisable for the persons who hold unaccounted money in cash to come forward and take advantage of the Scheme and buy peace. Let us hope that this Scheme gets the desired response.

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