The uncertainty regarding the manner of taxation of undisclosed income deposited in bank accounts as a result of demonetisation has been removed, due to the amendments to the tax laws approved by the Lok Sabha on 29 November 2016.
The amendments are in two parts, the first relating to amendment of the existing provisions of the income-tax Act, and the second relating to introduction of a new scheme, the Pradhan Mantri Garib Kalyan Yojana, 2016 (PMGKY).
Implications of declaring income under the PMGKY scheme
Under PMGKY, a person can make a declaration in respect of any undisclosed income in the form of cash or deposit with a specified entity, including banks and post offices, which is chargeable to tax for any year up to the financial year ending March 2017.
Such income is taxable on a gross basis, without any tax deduction, allowance or set off. The tax rate is 30% of the income, plus a surcharge of 9.9% of the income.
Apart from this, a penalty equal to 10% of the undisclosed income would be leviable, making the effective level of taxation 49.9%.
In addition, 25% of the income has to be deposited interest-free in the specified deposit scheme for a period of 4 years. If one assumes an interest rate of 8% pre-tax, which one could otherwise have earned, on a simple interest basis, the loss of post-tax interest over a period of 4 years on declaration of an income of Rs100 would be Rs5.16. The total effective cost under the scheme is therefore 55.06% of the income.
While the declaration has to be filed only after PMGKY comes into effect from a date to be notified, the declaration can be filed even in respect of deposits made in bank accounts prior to the date that PMGKY comes into force.
Implications of declaring Income without availing the PMGKY scheme
In the alternative, one may choose to go under the normal provisions of the income tax Act.
These have been amended to increase the flat rate of tax in respect of unexplained income, investments, money, valuables, and others, from 30% to 60%.
Besides, for the year ending 31 March 2017, there would now also be a surcharge of 25% of the tax, which amounts to 15% of the income.
Further, a taxpayer can now himself opt to treat such income as unexplained in his return of income, which so far could only be done by the tax officer.
A new penalty provision is also introduced, for levy of penalty of 10% of the tax (6% of the income), if such income is not offered to tax in the return of income.
Of course, the normal 3% education cess would also be applicable.
Therefore, if one does not opt for the PMGKY Scheme, and offers the hitherto undisclosed income to tax in one’s return of income for the current year, the effective rate of tax would be 77.25%.
In a case where such income is not included in the return, the effective cost would be 83.25%.
No penalty for misreporting of income would be levied, either under PMGKY or under the income tax Act.
Should you avail PMGKY or declare under provisions of income tax act
If one examines the two alternatives, it is evident that PMGKY is a superior alternative, as the effective cost in this is lesser than that under the income tax Act.
It is, therefore, likely that a large number of depositors of large denomination currency notes, who are unable to explain the source of such notes, will opt for the PMGKY.
This is definitely a smart move on the part of the government, as it provides tax evaders the escape route they were looking for, while at the same time ensures that they are taxed more heavily than regular taxpayers and those who have opted for the Income Declaration Scheme.
Further, a significant part of the black money unearthed from such tax evaders is made available to the government for anti-poverty and development programmes.
Of course, those depositors who are satisfactorily able to explain the source of their high denomination currency notes deposited in the bank, remain unaffected by such amendments, since such notes do not constitute their undisclosed income.
Historically, How have courts decided on tax disputes ?
Whether the explanation given as regards the source of the notes is satisfactory or not, is dependent on the facts of each case.
In the past, courts have adopted a common sense approach towards such cases, and looked at the preponderance of possibility as to whether the explanation given by a person can be accepted or not.
Far-fetched explanations regarding the source of such notes which are deposited may, therefore, not be accepted, unless one is able to substantiate these with supporting material and evidence.
Ultimately, each depositor needs to take a call as to whether he is in a position to substantiate the cash deposited, or whether he needs to take advantage of the PMGKY.
Gautam Nayak is a chartered accountant.