Levy of penalty in search cases

Introduction

1. In recent times it has been observed that a search and seizure operation invariably accompanies surrender of undisclosed income, the quantum of which is based on an assessment of the assets and papers found during the search. The amount surrendered in such cases is invariably arrived at based on an analysis and appraisal of the entire facts and circumstances of the search and invariably has some degree of estimation/approximation attached thereto. The question of levy of penalty on such undisclosed income surrendered is the subject matter of this article.

Penalties levied undisclosed income revealed in search cases between 1-6-2007 and 1-7-2012

2. The following two types of penalties can be levied in cases where a search is initiated on or after 1-6-2007, but before 1-7-2012:-

– penalty under section 271(1)(c) of the Income-tax Act, 1961 (hereinafter called “the Act”), read with theExplanation5A thereof;

– penalty under section 271AAA of the Act.
In case of search initiated on or after the 1st day of July, 2012, penalty is leviable u/s 271AAB of the Act. For the purpose of this article we shall limit ourselves to an analysis of Section 271AAA of the Act, since the same has been the subject matter of extensive administrative and legal debates recently consequent upon the finalization of assessments of searches conducted in the period from 1-6-2007 to 1-7-2012. However, academic purposes the provisions of Section 271(1)(c), read with the Explanation 5A thereto shall be discussed.

2.1 Penalty u/s 271(1)(c) read with Explanation 5A thereof – Penalty under section 271(1)(c) of the Act, read with the Explanation5A is leviable where undisclosed income for any previous year is found in case a search initiated on or after 1-6-2007 but the assessee has not filed the return for that previous year, although due date of filing has expired as per the Explanation 5A to section 271(1)(c) of the Act, where in the course of a search initiated under section 132 on or after 1-6-2007, the assessee is found to be the owner of –

(i) any money, bullion, jewellery or other valuable article or thing (hereinafter in thisExplanationreferred to as assets) and the assessee claims that such assets have been acquired by him by utilizing (wholly or in part ) his income for any previous year; or
(ii) any income based on any entry in any books of account or other documents or transactions and he claims that such entry in the books of account or other documents or transactions represents his income (wholly or in part) for any previous year, which has ended before the date of the search and the due date for filing the return of income for such year has expired and the assessee has not filed the return, then, notwithstanding that such income is declared by him in any return of income furnished on or after the date of the search, he shall, for the purposes of imposition of a penalty under section 271(1)(c) of the Act, be deemed to have concealed the particulars of his income or furnished inaccurate particulars of such income.
2.2 Penalty u/s. 271AAA – As per section 271AAA(1) of the Act, the Assessing Officer may, notwithstanding anything contained in any other provision of this Act, direct that, in a case where search has been initiated under section 132 on or after 1-6-2007 but before 1-7-2012, the assessee shall pay by way of penalty, in addition to tax, if any, payable by him, a sum computed at the rate of 10% of the undisclosed income of the specified previous year.

For this purpose ‘undisclosed income’ is defined to mean:-

(i) any income of the specified previous year represented either wholly or partly, by any money, bullion, jewellery or other valuable article or thing or any entry in the books of account or other documents or transactions found in the course of a search under section 132, which has –
(a) not been recorded on or before the date of search in the books of account or other documents maintained in the normal course relating to such previous year; or
(b) otherwise not been disclosed to the Chief Commissioner or Commissioner before the date of the search; or
(ii) any income of the specified previous year represented, either wholly or partly, by any entry in respect of an expense recorded in the books of account or other documents maintained in the normal course relating to the specified previous year which is found to be false and would not have been found to be so had the search not been conducted;
In addition, ‘specified previous year’ is defined to mean a previous year –

(i) which has ended before the date of search, but the date of filing the return of income under section 139(1) for such year has not expired before the date of search and the assessee has not furnished the return of income for the previous year before the said date; or
(ii) in which search was conducted.
However, sub-section (2) of section 271AAA of the Act relaxes the rigours of penalty in situations where:

(i) the assessee in the course of search, in a statement u/s 132(4) admits the undisclosed income and specifies the manner in which such income has been derived ;
(ii) substantiates the manner in which the undisclosed income has been derived; and
(iii) pays the tax together with interest, if any, in respect of the undisclosed income.
Further, as per section 271AAA(3) of the Act no penalty under the provisions of section 271(1)(c) of the Act shall be imposed upon the assessee in respect of the undisclosed income referred to in section 271AAA(1) of the Act.

Section 271AAA was inserted into the Income-tax Act, 1961 w.e.f 1.4.2007 as a replacement to the erstwhile Explanation 5 of section 271(1)(c) by the Finance Act, 2007. The scope and ambit of the same was explained and dealt by paragraph 68 of Circular No. 3 of 2008, dated 12-3-2008 issued by the Central Board of Direct Taxes as follows:-

“68.1 A new section 271AAA has also been inserted so as to provide that, in a case where search has been initiated under section 132 on or after 1st June, 2007, the assessee shall be liable to pay by way of penalty, in addition to tax, if any, payable by him, a sum computed at the rate of ten per cent of the undisclosed income of the specified previous year. However, provisions of this section shall not be applicable if the assessee – (i) in a statement under sub-section (4) of section 132 in the course of the search, admits the undisclosed income and specifies the manner in which such income has been derived; (ii) substantiates the manner in which the undisclosed income was derived; and (iii) pays the tax, together with interest, if any, in respect of the undisclosed income. It is further provided that no penalty under the provisions of clause (c) of sub-section (1) of section 271 shall be levied or imposed upon the assessee in respect of the undisclosed income referred to in this section. It is also provided that the provisions of section 274 and section 275 shall, so far as may be, apply in relation to the penalty leviable under the new section.

68.2 For the purposes of this section, undisclosed income has been defined to mean – (i) any income of the specified previous years represented, either wholly or partly, by any money, bullion, jewellery or other valuable article or thing or any entry in the books of account or other documents or transactions found in the course of a search under section 132, which has not been recorded on or before the date of search in the books of account or other documents maintained in the normal course relating to such previous year; or which has otherwise not been disclosed to the Chief Commissioner or Commissioner before the date of the search; or (ii) any income of the specified previous year represented, either wholly or partly, by any entry in respect of an expense recorded in the books of account or other documents maintained in the normal course relating to the specified previous year which is found to be false and would not have been found to be so had the search not been conducted.

68.3 For the purposes of this section, specified previous year has been defined, so as to mean the previous year-

(i) which has ended before the date of search, but the date of filing the return of income under sub-section (1) of section 139 for such year has not expired before the date of search and the assessee has not furnished the return of income for the previous year before the said date; or
(ii) in which search was conducted.
68.4 An appeal to the Commissioner against levy of penalty under the proposed new section 271AAA has also been provided.”

2.2-1 Section 271AAA as replacement for the earlier Explanation 5 to section 271(1)(c) – Section 271AAA of the Act is a replacement for the earlier Explanation 5 to Section 271(1)(c) incorporated into the Act by the Taxation Laws (Amendment) Act, 1984 w.e.f. 1-10-1984 which governed the issue of levy of penalty in cases of a search initiated u/s 132 prior to June 1, 2007 and which read as follows:-

“Explanation 5 – Where in the course of a (search initiated under section 132 before the 1st day of June, 2007), the assessee is found to be the owner of any money, bullion, jewellery or other valuable article or things (hereafter in this Explanation referred to as assets) and the assessee claims that such assets have been acquired by him by utilizing (wholly or in part) his income, –

(a) for any previous year which has ended before the date of the search, but the return of income for such year has not been furnished before the said date or, where such return has been furnished before the said date, such income has not been declared therein; or
(b) for any previous year which is to end on or after the date of search;
then, notwithstanding that such income is declared by him in any return of income furnished on or after the date of the search, he shall, for the purposes of imposition of a penalty under clause (c) of sub-section (1) of this section, be deemed to have concealed the particulars of his income or furnished inaccurate particulars of such income, unless: –

(1) such income is, or the transactions resulting in such income are recorded, –

(i) in a case falling under clause (a), before the date of the search; and
(ii) in a case falling under clause (b), on or before such date,
in the books of account, if any, maintained by him for any source of income or such income is otherwise disclosed to the Chief Commissioner or Commissioner before the said date; or

(2) he, in the course of the search, makes a statement under sub-section (4) of section 132 that any money, bullion, jewellery or other valuable article or thing found in his possession or under his control, has been acquired out of his income which has not been disclosed so far in his return of income to be furnished before the expiry of time specified in sub-section (1) of section 139, and also specifies in the statement the manner in which such income has been derived and pays the tax, together with interest, if any, in respect of such income.”

With regard to the conditions laid out in sub-section (2) of section 271AAA of the Act, while the issue of payment of tax and interest on the undisclosed income does not present any issues, the question of specifying and substantiating the manner in which the undisclosed income has been derived, can and has invariably led to litigation based on different perceptions and interpretation of the assessee and the Income-tax Department.

Judicial opinions in the context of Explanation 5 to section 271(1)(c)

3. Before proceedings further it would be relevant to overview the judicial opinion in the context of the Explanation 5 to Section 271(1)(c) of the Act, since the provisions and the underlying legislative intent and principles are similar, if not identical.

3.1 Case of CIT v. Radha Kishan Goel

(a) In the case ofCITvRadha Kishan Goel[2005] 278 ITR 454/[2006] 152 Taxman 290 (All.), the assessee had made surrender in his statement u/s 132(4) recorded during the course of search. Assessment was completed at an income of Rs. 24,43,980/- which included unexplained cash of Rs. 1,65,000/and unexplained jewellery of Rs. 22,63,557/-. Penalty was imposed for the manner in which unexplained cash and jewellery were derived, which was not disclosed in the statement recorded u/s 132(4). Levy of penalty was confirmed in first appeal but was deleted in second appeal by the ITAT. On these facts, the question before the Hon’ble Allahabad High Court was:
“Whether, on the facts and circumstances of the case, the Income-tax Appellate Tribunal was justified in holding that the conditions laid down inExplanation 5(2)to section 271(1)(c) were satisfied?”
(b) Considering clause (2) ofExplanation5 to section 271(1)(c) of the Act, the High Court upheld deletion of penalty with the following remarks:
“we are of the view that as per section 132(4) of the Act unless authorized officer puts a question with regard to the manner in which income has been derived, it is not expected from the person to make a statement in this regard and in case in the statement the manner in which the income has been derived has not been stated but has been stated subsequently, that amounts to the compliance with Explanation 5(2) of the Act. We are also of the opinion that in case there is nothing to the contrary in the statement recorded under section 132(4) of the Income-tax Act, in the absence of any specific statement about the manner in which such income has been derive, it can be inferred that such undisclosed income was derived, it can be inferred that such undisclosed income was derived from the business which he was carrying on or from other sources. The object of the provision is achieved by making the statement admitting the non-disclosure of money, bullion, jewellery, etc. Thus, we are of the opinion that much importance should not be attached to the statement about the manner in which such income has been derived. It can be inferred on the facts and circumstances of the case, in absence of anything to the contrary. Therefore, mere non-statement of the manner in which such income was derived would not makeExplanation5(2) inapplicable.”
3.2 Case of CIT v. Mahendra C. Shah – In CIT v Mahendra C. Shah [2008] 299 ITR 305/172 Taxman 58 (Guj.) the Hon’ble Gujarat High Court after taking into consideration the decision in the case of Radha Kishan Goel (supra) held as under :

“when the statement is being recorded by the authorized officer it is incumbent upon the authorized officer to explain the provisions of Explanation 5 in the entirety to the assessee concerned and the authorized officer cannot stop short at a particular stage so as to permit the Revenue to take advantage of such a lapse in the statement. The reason was not far to seek. In the first instance, the statement is being recorded in the question and answer form and there would be no occasion for an assessee to state and make averments in the exact format stipulated by the provisions considering the setting in which such statement is being recorded, as noted by Allahabad High Court in case of CIT vRadha Kishan Goel (supra)”

3.3 Case of Tavir Kumar Diamonds Ltd. v. ACIT [2009] 32 SOT 272 (Mum.) the assessee company , a member of ‘Tanvir Kumar’ Group, was carrying on the business of diamond trading and export. During the course of search u/s 132 at the office premises of the group, including that of the assessee-director of the assessee-company, who was also head of the group, made a statement u/s 132(4), whereby a surrender of Rs. 50 lakhs at the hands of the Assessee-company took place. In the statement u/s 132(4), it was stated that out of Rs. 3 Cr., Rs. 1.71 Cr. referred to discrepancies/excess/unreconciled stock of gold ornament jewellery valuables, etc. The balance of Rs. 1.29 Cr. was to cover any irregularity in normal books of account, including that part of the circulating capital which had not been explained to the satisfaction of the Assessing Officer which had been converted into stock/inventory and other current assets, etc. For the assessment year 2006-07, the assessee filed the return of income including the additional offer of Rs. 50 lakhs. The Assessing Officer completed the assessment accepting the additional income but imposed penalty u/s 271(1)(c) of the Act for the reason that in the statement made u/s 132(4), the Director had merely indicated the quantum of income to be offered and did not specify the manner in which that income was earned, the assessee was not entitled to exemption contemplated under section 5(2) to section 271(1)(c) of the Act. However, the Hon’ble Income Tax Appellate Tribunal deleted the penalty with the following remarks:

‘The issue is whether the assessee’s case satisfies the requirement of Explanation 5(2) so as to be excluded from the levy of penalty. The crux of the argument of the department and the first appellate authority is that the assessee has not specified in the statement “the manner in which such income has been derived” and, hence, the assessee is not entitled to the benefit of Explanation 5(2) to section 271(1)(c).’

3.3-1 In case of a search if assessee accepts undisclosed income and pays tax thereon penalty is not leviable – In case of a search, if the assessee accepts undisclosed income and pays tax on the same, penalty is not leviable. This is a benefit offered to the assessee. Therefore, this Explanation has to be interpreted in the manner to achieve the purpose and object of introducing this Explanation. The assessee is required to specify the manner in which such undisclosed income was derived. A broad description of the manner of earning has been explained by the assessee. We find that in the statement made under section 132(4), it has been clearly mentioned that the profits has arisen on account of discrepancy in the stock, possible discrepancy in the Explanation to circulating capital which might have been converted into stock. In our opinion this explanation is specific enough to satisfy the requirements of Explanation 5. It is not as if that the Assessing Officer has found any particular undisclosed income which, in his opinion, cannot be covered by the items/transaction given in the Explanation and, therefore, there is a doubt as to the source of undisclosed income offered by the assessee in the statement.

3.4 Case of DCIT v. Smt. Inderchand Surajmal Bothra – The above view also gets affirmed by the decision of the Pune Bench of the Hon’ble Income Tax Appellate Tribunal in the case of Dy. CIT v. Smt. Inderchand Surajmal Bothra (IT Appeal No. 139(PN) of 2010, dated 30-11-2011) wherein in the context of Explanation 5 to section 271 (1)(c) of the Act (the precursor to section 271 AAA), the Hon’ble Income Tax Appellate Tribunal had held as follows:-

“We have heard and considered the arguments advanced by the parties. Certain undisputed material facts are that when search u/s 132 of the Act was conducted on both group of cases on 22nd November, 2006, the time for filing of return of income u/s 139(1) for the A.Y. 2007-08 was still available. In the statements recorded u/s 132(4) of the Act, the assessee had declared additional income of Rs. 10,00,000/-, being income from water tanker supply business. In the return of income filed u/s 153A, the assessee declared the total income consisting of additional income of Rs. 10,00,000/- declared u/s 132(4) of the Act. The AO assessed the total income of the assessee for the A.Y. by accepting the income returned without making any addition. The AO levied the penalty stating that the assessee cannot be given benefit of Explanation 5 to Section 271(1)(c) of the Act as the clause (ii) of Explanation 5 to Section 271(1)(c) exempts only that part of the income from the penal provision, which is covered by statement u/s 132(4), where the assets have been acquired by the assessee out of his income which is not disclosed in the return of income to be furnished before the expiry of the time prescribed in section 139(1) and specified in the statement in the manner in which such income has been derived. We thus find that the AO has levied the penalty mainly with this allegation that the assessee has not specified in its statement u/s 132(4) the manner in which such income had been derived. We do not find substance in such view of the AO, since undisputedly, the additional income of Rs. 10,00,000/- was declared by the assessee in his statements u/s 132(4) of the Act and also offered the same to tax in its return of income filed u/s 139 of the Act. The Hon’ble Gujarat High Court in the case of CIT v. Mahendra C Shah [2008] 299 ITR 305, followed by the Ld. CIT(A), it has been held that it is not required to specify the manner in which the income was earned in respect of the amount offered to tax in the return of income filed pursuant to search action by paying taxes thereon for availing immunity from penalty under Explanation 5 to Section 271(1)(c) of the Act. The same decision has been relied upon by the Ld A.R. before us. Since the issue raised is fully covered by the decision of the Hon’ble Gujarat High Court in the case of CIT v. Mahendra C Shah (Supra) followed by the Ld. CIT(A), we are not inclined to interfere with the first appellate order in this regard. The same is upheld. The grounds are accordingly, rejected.”

3.4-1 The Unanimous opinion arising in the context of Explanation to section 271(1)(c) – It would be relevant to mention here that Explanation 5 to section 271(1)(c) of the Act provided that no penalty could be levied in respect of undisclosed income in a case where the appellant “specifies” the manner in which the income has been derived and pays the tax, together with interest or such income. As such, Explanation 5 to section 271(1)(c) and section 271AAA of the Act being pari materia, the decisions quoted hereinabove would apply with equal force in case of levy of penalty u/s 271AAA of the Act.

The unanimous opinion and conclusion arising out of the above judgments in the context of the Explanation 5 to Section 271(1)(c) of the Act is that where the amount surrendered is duly accepted, as such, by the various authorities and assessment is completed on that very basis leads to the distinct conclusion as to authentication, veracity and genuineness of the same and the issue of specifying the manner in which the income has been derived and substantiating the same gets answered in the affirmative.

In cases where the Income-tax Department, be it the Investigation Wing or the Assessing Officer, does not raise any query calling upon the Assessee to further specify and substantiate the manner of dealing with undisclosed income or after raising any query does not tinker with or amend the quantum thereof it cannot be said that the onus cast on an assessee u/s 271AAA of the Act has not been discharged. This would be true even where the quantum of undisclosed income surrendered is based on an approximation or an estimation, since allowance will have to be given to the fact that the income having been derived from undisclosed sources a degree of estimation is bound to arise therein.

3.5 Case of Pramod Kumar Jain v. Dy. CIT – Reference may also be made to the decision, dated 20-7-2012 of the Cuttack Bench of the Hon’ble Income-tax Appellate Tribunal in the case of Pramod Kumar Jain v. Dy. CIT [2013] 33 taxmann.com 651 (Cuttak-Trib.), Resources (P) Ltd v. Sambalpur c/o Sheri S. Agawam, Advocate, Hospital Road, Barger[(2013) 33 taxmann.com 651 (Cuttack-Trib.)] wherein it was held (following an earlier decision, dated 22-12-2011 of the same bench in Ashok Kumar Sharma v. Dy. CIT [2013] 33 taxmann.com 652(Cuttack -Trib.) that having accepted the surrendered income on the basis of returns filed by an assessee, satisfaction as to the specifying and substantiating the manner in which the same has been earned gets answered automatically. In this regard reference may be made to the following comments of the Hon’ble Income-Tax Appellate Tribunal:-

‘We have heard the rival contentions and perused the material available on record. On consideration of the facts and circumstances of the case, we are inclined to hold that no definition could be given to the “specified manner”, insofar as the very statement on oath u/s 132(4) specifies the manner on which the assessee is prepared to pay tax thereon. The inscribing in the books of account was taken care of by the assessee when he filed the returns in pursuance of notice u/s 153A accounting the assets. Therefore, the case laws cited at the Bar clearly indicate that the penalty is not automatic if one of the purported conditions is not fulfilled, although all the conditions have been agreed to of having fulfilled by the Assessing Officer insofar as the tax and interest have been recovered. Penalty has been levied after the tax has been recovered, therefore, answers the queries raised by the Learned DR for that the said provisions become redundant was not the intention of the legislation. The manner during the search operation, is noted by the search party which the Assessing Officer has acceded to. Therefore, following the decisions as relied upon by the learned counsel for the assessee, wherein the Tribunal was pleased to consider cancelling the penalty so levied are also applicable to the assessee’s case before us, insofar as there is no prescribed method to indicate the manner in which income was generated when the definition of “undisclosed income” has been defined in the Act itself when no income of the specified previous year represented “either wholly or partly” which onus lay upon the assessee stood discharged. In view of the above, we are of the considered view that the levy of penalty u/s 271AAA in the instant cases is not justified and, as such, we cancel the penalty so levied u/s 271AAA for the AYs under consideration in the case of respective assessees.’

3.6 Other relevant case laws – The above view also has been subsequently endorsed by the various Benches of the Hon’ble Income Tax Appellate Tribunal in the following cases:-

(i) Mothers Pride Education Personna (P.) Ltd.v.Dy. CIT[2011] 14 taxmann.com 177/48 SOT 24 (Delhi) (URO)
(ii) Sulochanadevi A. Agarwalv.DITITAppeal No. 1052(Ahd.) of 2012, dated 20-7-2012
(iii) Concrete Developersv.Asstt. CIT[2013] 34 taxmann.com 62 (Nagpur -Trib.)
(iv) Smt. Raj Rani GuptavDy. CIT[IT Appeal No. 3371(Delhi) of 2011, dated 30-3-2012]
3.7 The penal provisions embodied in section 271AAA – The penal provisions embodied in section 271AAA of the Act deal with question of levy of penalty consequent upon the amount surrendered during the course of a search u/s 132 and, as such, are required to be construed, interpreted and applied liberally. In fact, it has been held by the Hon’ble Income Tax Appellate Tribunal in different cases that the various conditions satisfied in Section 271AAA of the Act have to be given a wider and broader meaning and perspective. Even on the ground of payment of taxes the Hon’ble Income Tax Appellate Tribunal has held that in the absence of any specific provisions in the section taxes due on surrendered income can be paid at any time and not necessarily before the filing of the return. In this connection reference may be made to the following judgments:-

? Dy. CITv.Pioneer Online Ltd.[2012] 20 taxmann.com 668/52 SOT 94 (Kol.)
? Dy. CITv.Pioneer Marbles & Interiors (P) Ltd.[2012] 19 taxmann.com 301/50 SOT 571 (Kol.)
Conclusion

4. The prevailing judicial opinion seems to lead to the conclusion that in cases where the amount surrendered as undisclosed income is duly accepted (both with respect to the quantum and the manner in which the income had been earned) while framing the assessment and no further doubt or question arises in the minds of the authorities at any stage to question further the manner in which the income has been earned/derived and no need is felt for any further clarification or enquiries in this regard no penalty can be levied. Moreover, the issue also needs to be looked from a liberal view point, since in a search case, the question of specifying and substantiating the manner in which the undisclosed income has been derived can be somewhat general and omnibus and no precise calculations or computations can be done with reference thereto.

Of course, while a final decision on the issue would be awaited, till then litigations are only bound to multiply the prevailing consensus, based on the orders delivered by the Hon’ble Income Tax Appellate Tribunal, seems to call for the adoption of a liberal and broad-based approach.

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• DT – Secs. 132, 271, 271AAB and 271AAA.