Under the Income-tax Act, 1961, a taxpayer would file return based on certain tax positions. These positions would ordinarily be based on interpretation of the statute, judicial precedents, etc. Hence, the taxpayer, while filing the return, would typically make appropriate disclosures of the tax positions adopted either in the return of income itself/documents filed with the return of income and by way of notes to return of income.
In order to counter the tax evasiveness and discourage abuse of tax provisions by an assessee, the Act has embodied penalty provisions. One such provision is section 271(1) (c) that provides for penalty if the assessing officer (AO) is satisfied that:
• A person has concealed any particulars of income, or
• A person has furnished inaccurate particulars of such income
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While these disclosures of tax positions may seem enough, it is important to appreciate that almost every provision of the Act has been a subject matter of debate, interpretation and litigation—some in favour of the assessee and others in favour of the revenue authority.
If there is a disagreement between the AO and the tax payer with regard to the claim of certain tax incentives/interpretation of specific provision/allowability of particular expenditure, such claim/expenditure is disallowed by the AO and the income is accordingly recomputed.
The matter doesn’t stop here. It is further aggravated by imposing penalty on the ground that disallowance of expenditure/claim of assessee has resulted in assessee having concealed its particulars of income or furnished inaccurate particulars of such income in spite of the fact that appropriate disclosures were made by the taxpayer in its return of income and in the course of assessment proceedings.
There are a plethora of court decisions (including those of the Supreme Court) on the issue of circumstances under which penalty under section 271(1)(c) of the Act could be levied and interpreting the term “concealment” so as to attract penalty. Certain key guiding principles emerging out of these decisions are:
• There should be conscious and deliberate intent on the part of the assessee to hide or conceal the income so as to avoid the imposition of tax thereon, i.e. element of mens rea (guilty mind) is a must to levy penalty.
• Mere difference of opinion/taking a position contrary to the view taken by the AO cannot amount to the assessee company concealing facts material to the computation of income
• Rejection of the explanation/contention raised by the assessee company cannot lead to the conclusion that there has been any concealment of material facts
• Addition to income/rejection of claim for certain expenditure/disallowance of a debatable claim itself does not lead to an inference of concealment or furnishing of inaccurate particulars of income.
A two-member Supreme Court bench in the Dilip N Shroff case dated 18 May 2007 [291 ITR 519] has confirmed the above position that mens rea is an essential ingredient before the penalty can be imposed on an assessee.
However, in the case of UOI & Ors. v. Dharmendra Textile Processors & Ors. [306 ITR 277] dated 29 September, a three-member Supreme Court bench disapproved the decision in the Dilip Shroff case and held that mens rea is not an essential ingredient for imposing penalty. This has resulted in revenue authorities assuming that they have acquired further armoury in their hands to levy penalty on every addition/disallowance/rejection of claim as the tax department’s interpretation is that there is no longer any requirement to prove presence of mens rea on the part of the assessee to attract penalty.
The decision in the case of Dharmendra Textiles would have applicability to a limited set of facts and ordinarily not to each and every instance where an addition is made or a claim is rejected. Also, it seems that the Supreme Court in the Dharmendra Textiles case has not considered the decisions of three-member Supreme Court benches in certain earlier cases [Hindustan Steel Ltd v. State of Orissa [(1972) 83 ITR 27, D.M.Manasvi v. CIT (1972) 86 ITR 557, Anantharam Veerasinghaiah & Co v. CIT (1980) 123 ITR 457], which have also held that presence of wilful/conscious guilty intent i.e. mens rea of the taxpayer is a must to attract penalty. It has been held that where breach flows from a bona fide belief that the offender is not liable to act in a manner prescribed by the statute, penalty ought not be levied. This decision has held good the law for almost three decades.
The Mumbai tribunal in its decision in the case of Armour Chemicals Ltd v. ACIT [(2009) TIOL 204 ITAT] dated 27 January has held that since there were severe discrepancies in books of accounts of the assessee and the assessee had failed to reconcile these, this clearly showed wilful neglect and lack of bona fide.
Thus, in the said case, the Mumbai tribunal, relying on the ratio laid down by the Supreme Court in the Dharmendra Textile case, upheld the levy of penalty. However, the Mumbai tribunal in the same case also upheld the order of the CIT(A) for non levy of penalty in respect of disallowances. The rationale was the premise that penalty could not be levied on issues which are debatable in nature.
As it can be observed from this, even if the decision of the Supreme Court in the case of Dharmendra Textiles was to be applied, it would be applicable to particular facts of the case as opposed to application by the revenue authorities universally and generally.
Recently, the Mumbai tribunal, in another decision on 20 March in the case of VIP Industries Ltd v. ACIT [AIT-2009-122-ITAT], has held that penalty cannot be levied where there is a genuine difference of opinion between the assessee and the AO and the assessee has made a bona fide claim for deduction and disclosed all the necessary facts. The facts of the case were as follows:
VIP Industries Ltd (the assessee) made a claim for deduction under section 35 of the Act for research and development (R&D) expenses at 100% inter alia towards the cost of car purchased.
The assessee used the car for the purpose of business, which was related to its R&D activity. Further, the assessee had mentioned in Schedule 6 of the Tax Audit Report that the deduction was claimed on R&D expenses.
The AO added this amount and allowed depreciation at the rate of 20% by treating it as a car used for ordinary business purposes, not connected with scientific R&D activity; and the adjustment was confirmed by the Tribunal.
However, the penalty under section 271(1)(c) levied on this count by the AO was reversed by the commissioner of income-tax (appeals) CIT(A)”.
The revenue preferred an appeal before the tribunal against the order.
The assessee contended that CIT(A) was right in deleting the penalty as it had made full and proper disclosures in the return of income where it claimed deduction at the rate of 100% of the cost of the car. Further, the assessee submitted that the car was purchased and used in connection with the work relating to R&D.
The revenue authorities contended that the law governing the levy of penalty had changed drastically with the decision of the Supreme Court in the Dharmendra Textile case and penalty was sustainable even where the income remained undisclosed, with or without the conscious act of the assessee.
Hence, with the confirmation of the addition by the tribunal in the quantum proceedings, it has become crystal clear that the assessee had wrongly claimed the deduction for which the penalty must be imposed.
The tribunal held that the mere fact of confirmation of addition by the tribunal in quantum proceedings cannot, per se, lead to confirmation of levy of penalty. In the context of the Supreme Court decision in the Dharmendra Textile case, the tribunal held:
• The decision is confined to conclude that mens rea is not essential for invoking penalty provisions
• The intention of the Supreme Court is to cover those cases where the assessee earns income but unintentionally or inadvertently fails to disclose this in the return of income
• The Supreme Court has not held that in all cases where the addition is confirmed, the penalty shall mechanically follow.
• Simply because the AO does not accept the assessee’s claim in its entirety, it would not ipso facto (by that very fact) mean that the explanation offered by the assessee is not bona fide.
This decision is a welcome decision and clearly demolishes the revenue authorities’ view that every addition/disallowance would automatically give rise to penalty. The controversy created by the Supreme Court decision in the Dharmendra Textile case, which is sought to be applied against assessees for additions made in assessment, was anyway quite illogical; it can now further be countered by quoting the above decision of VIP Industries Ltd.
The stand of the revenue authorities that all additions are liable to penalty can create confusion and litigation. Hence, Central Board of Direct Taxes (CBDT) should come out promptly with a circular on imposition of penalties keeping the Dharmendra Textile last decision in perspective.
Ketan Dalal is executive director and Manish Desai is associate director, PricewaterhouseCoopers. Your comments and feedback are welcome at firstname.lastname@example.org