Demonetisation – Some Tax Issues

Delegalisation of High Denomination Notes

On 8^th November, 2016, the Department of Economic
Affairs, Ministry of Finance, Government of India, issued a notification, SO No
3407(E) [F No 10/03/2016-Cy.I] exercising its powers u/s. 26(2) of the Reserve
Bank of India Act, 1934, notifying that bank notes (currency notes) of the
existing series of the value of Rs.500 and Rs.1,000 (referred to as “the
withdrawn bank notes”) would cease to be legal tender with effect from 9^th
November 2016 for transactions other than specified transactions. The
notification also provided a limit for exchange of such notes for any other
denomination notes having legal tender character, and also permitted deposit of
such notes in bank accounts before 30^th December 2016, after which
date such notes could be exchanged or deposited at specified offices of Reserve
Bank of India (RBI) or such other facility until a later date as may be
specified by RBI. As announced by the Prime Minister, this date is likely to be
31.3.2017.

Such an action, as stated in the notification, was actuated
by the facts that;

1.  fake currency notes of those denominations
were in circulation,

2.  high denomination notes were used for storage
of unaccounted wealth, and

3.  fake currency was being used for financing
subversive activities, such as drug trafficking and terrorism, causing damage
to the economy and security of the country.

Another Notification No. SO 3408(E) [F No 10/03/2016-Cy.I]
was issued on the same date, notifying that such withdrawn bank notes of Rs.500
and Rs.1,000 would not cease to be legal tender from 9^th to 11^th
November 2016 (later extended to 24^th November 2016 and further
extended to 15^th December 2016), in respect of certain transactions.
These transactions include payments to government hospitals and pharmacies in
government hospitals, for purchase of rail, public sector bus or public sector
airline tickets, purchases at consumer co-operative stores and milk booths
operating under Government authorisation, purchase of petrol, diesel and gas at
petrol pumps operating under PSU oil marketing companies, for payments at
crematoria and burial grounds, exchange for legal tender up to Rs.5,000 at
international airports by arriving and departing passengers and exchange by
foreign tourists of foreign exchange or such bank notes up to a value of
Rs.5,000. Some more permissible transactions were added later, such as payment
of electricity bills, payment of court fees, purchase of seeds, etc, and some
of the permissible transactions were modified from time to time. It also
permitted withdrawals from Automated Teller Machines (ATM) within the specified
limits.

On the same date, RBI issued a circular to all banks, specifying
the steps to be taken by them pursuant to such bank notes ceasing to be legal
tender, and giving formats of the request slip for exchange of the withdrawn
bank notes, and for reporting of details of exchanged bank notes. RBI also
issued FAQs on the subject. It has stated, inter alia, as under:

“1. Why is this scheme
introduced? The incidence of fake Indian currency notes in higher
denomination has increased. For ordinary persons, the fake notes look similar
to genuine notes, even though no security feature has been copied. The fake
notes are used for anti-national and illegal activities. High denomination
notes have been misused by terrorists and for hoarding black money. India
remains a cash based economy hence the circulation of Fake Indian Currency
Notes continues to be a menace. In order to contain the rising incidence of
fake notes and black money, the scheme to withdraw has been introduced.

2. What is this scheme?
The legal tender character of the existing bank notes in denominations of ?500
and ?1000 issued by the Reserve Bank of India till November 8, 2016
(hereinafter referred to as Specified Bank Notes) stands withdrawn. In
consequence thereof these Bank Notes cannot be used for transacting business
and/or store of value for future usage. The Specified Bank Notes can be
exchanged for value at any of the 19 offices of the Reserve Bank of India or at
any of the bank branches of commercial banks/ Regional Rural Banks/
Co-operative banks or at any Head Post Office or Sub-Post Office.”

Given the fact that bank notes of these denominations of
Rs.500 and Rs.1,000 constituted 86% of the value of all bank notes in
circulation in India, withdrawal of these bank notes affected almost every
person in India. Pursuant to such notifications, people rushed to exchange the
withdrawn bank notes and to deposit such withdrawn bank notes in their
accounts, as well as to make withdrawals from their bank accounts to meet their
daily expenses.

On account of such forced exchange and deposit of withdrawn
bank notes, various issues relating to taxation in such cases arose. In
particular, issues arose as to the rate of taxation, whether any penalty was
attracted, whether prosecution could be launched against such person, whether
there would be liability to MAT and interest u/s. 234C of the Act, whether
provisions of the BTPA, PMLA, FEMA were attracted, whether the declarant was
liable to Service tax and VAT, etc. 

Some of these issues get answered and addressed by the
amendments proposed in the Income Tax (Second Amendment) Bill, 2016, including
the Pradhan Mantri Garib Kalyan Yojana, 2016 (PMGKY), introduced in Parliament
on 28^th November 2016, and passed by the Lok Sabha on the next date
and received the assent of the President on 15^th December,
2016. 

In the statement of objects and reasons annexed to the bill,
it has been stated that changes are being made in the Act to ensure that the
defaulting assessees are subjected to tax at a higher rate and stringent
penalty provision. It further  states
that , in the wake of declaring specified bank notes as not legal tender, there
had 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 an 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 could be utilised for welfare schemes for the
poor. Therefore, an alternative scheme, namely, the Taxation and Investment
Regime for Pradhan Mantri Garib Kalyan Yojna, 2016 (PMGKY) is introduced.

The amendments and PMGKY, like any other legislation,   give rise to some more issues. The major
issues arising out of demonetisation in taxation keeping in mind the amended
law and PMGKY are sought to be discussed in this article.

The issue of validity of demonetization has been referred to
various courts including the Supreme Court. The courts have refused the request
for staying the operation of the notifications issued for demonetization. The
request for extending the time for deposit has also been refused. The courts in
the time to come would be required to address pertinent issues like validity of
the notification particularly in the context of article 14, 19 and 300A of the
Constitution of India, the vires of section 26(2) of the Reserve Bank of India
Act and the powers of the government to restrict the circulation, exchange and
withdrawals of the high denomination notes.

The demonetisation and the Taxation Laws (Second Amendment)
Act, 2016 raised several issues in taxation arising in the varied
circumstances. One of the possibilities is where the cash is deposited in the
bank out of cash on hand as on 08/11/2016 from known or unknown sources of
income or accumulation. Another is where cash has been deposited out of the
receipts on or after 09/11/2016.

In the latter case, the recipient is required to be a person
authorized to receive high denomination notes as per the notifications on or
after 09/11/2016. This permission to receive has ended on 15/12/2016. No person
is authorized to receive such notes thereafter. The person in possession of
such notes is left with no option but to deposit it with specified entities by
30/12/2016 failing which with the special officer of the RBI by 31/03/2017.

In cases of persons authorised to receive cash on or after
09/11/2016, an explanation about genuineness of receipts will be required to be
furnished with evidence of receipt to the satisfaction of the Assessing
Officer. Failure to do so may result in him being taxed as per the provisions
of amended section115BBE of the Income-tax Act.

A question may arise about the possibility of a person opting
for PMGKY in cases where he is in receipt of the currency without any authority
to do so; apparently there does not seem to be any express or implicit
restriction in PMGKY to prevent him from opting for the scheme irrespective of
his authority to receive high denomination notes, post 08/11/2016. The issue of
his authority or otherwise to receive currency will be resolved under the Reserve Bank of India Act and not under the Income Tax Act.

The earlier case of the deposit of cash out of the receipts
up to 08/11/2016 may be dealt with in any one of the following manners;

–   Possession explained out of income of the
year or accumulation over the years

–   Opting for PMGKY and declare the same and
regularise possession on payment of tax, surcharge and penalty and deposits

–  Includes the same in the total income in
filing the return of income for A.Y. 2017-18 and be taxed as per provisions of
the amended section115BBE of the Income-tax Act.

–   Does not include the same in the total
income.

Some of these possibilities are sought to be examined in
greater detail hereafter.

When a person deposits such withdrawn notes into his bank
account, there could be various situations under which this is done. If a
person is maintaining books of account, and after 8^th November 2016,
deposits or exchanges withdrawn bank notes equal to or less than the balance in
his cash book as of 8^th November 2016, there should be no tax
consequence, as disclosed amounts of cash in hand are being deposited pursuant
to the withdrawal of such notes. Such amount would not be taxable. This view is
supported by the decisions in the cases of Sri Ram Tandon vs. CIT (1961) 42
ITR 689 (All), Gur Prasad Hari Das vs. CIT (1963) 47 ITR 634 (All), Narendra G
Goradia vs. CIT (1998) 234 ITR 571 and Lalchand Bhagat Ambica Ram vs. CIT
(1957) 37 ITR 288 (SC).

In Narendra Goradia’s case, the Bombay High Court held that
where the assessee had sufficient cash balance, there was no requirement of law
to maintain details of receipts of currency notes of various denominations
received by the assessee and failure to furnish detailed particulars of source
of acquisition of high denomination notes could not result in an addition to
the income. A similar view was taken by the Supreme Court in the case of Mehta
Parikh & Co vs. CIT 30 ITR 181.

When books of account are not maintained by the depositor,
how does he prove that such cash deposit does not represent his undisclosed
income?

Consider a situation where the aggregate amount deposited in
a bank account is less than Rs. 2.50 lakh. Advertisements have been issued by
the Ministry of Finance, stating that deposits of up to Rs. 2.50 lakh will not
be reported to the Income Tax Department. This has been followed by amendments
to Rule 114B (which relates to compulsory quoting of PAN) and Rule 114E
[furnishing of annual information returns (AIR) in respect of specified
transactions], vide Income Tax (30^th Amendment) Rules, 2016,
Notification No. 104/2016, F.No.370142/32/2016-TPL dated 15^th November
2016.

Rule 114B, which applied to transactions of deposit of cash
exceeding Rs.50,000 in a bank or post office, has now been extended to deposits
aggregating to more than Rs.2.50 lakh during the period from 9^th
November to 30^th December 2016. A new requirement of furnishing
details through AIR by banks and post offices has been inserted in rule 114E,
requiring furnishing of details of cash deposits made during the period 9^th
November to 30^th December 2016, if such cash deposits amount to
Rs.12.50 lakh or more in a current account, or Rs.2.50 lakh or more in any
other account. It therefore appears that banks would not be required to furnish
details where a person deposits less than Rs.2.50 lakh in aggregate in a bank
during the period from 9^th November to 30^th December
2016. However, if the amount of deposit is Rs.2.50 lakh, there would be a
requirement to report in the AIR.

It needs to be kept in mind that mere non-reporting in the
AIR does not mean that the amount of deposits (though less than Rs.2.50 lakh)
is not taxable. Such deposits may escape taxation in the case of a person who
is not an assessee, and does not file his tax returns. However, if the
depositor is an assessee, who files his tax return, the position would be quite
different. If his income tax return is selected for scrutiny, and such deposits
come to the notice of the assessing officer, the depositor would necessarily
have to explain the source of such cash deposits, as in the case of any other
cash deposits which may otherwise have come to the notice of the assessing
officer. There is no exemption provided from such scrutiny.

Where the aggregate amount of cash deposits in a bank or post
office during the relevant period is Rs.2.50 lakh or more (or Rs.12.50 lakh or
more, as the case may be), such deposits would obviously be reported to the
Income Tax Department through an AIR, which has to be filed by 31st January
2017. The source of such deposits will have to be proven by the depositor, when
called upon to do so by the tax authorities.

The Bombay High Court, in the case of Gopaldas T Agarwal
vs. CIT 113 ITR 447, in the context of section 69B, has held that the
burden is always on the assessee, if an explanation is asked for by the taxing
authorities or the Tribunal, to indicate the source of acquisition of a
particular asset admittedly owned by the person concerned. It will depend upon
the facts of each case to decide what type of facts will be regarded as
sufficient to discharge such onus.

In Bai Velbai vs. CIT 49 ITR 130, the Supreme Court
considered a case where the assessee received certain amount by encashment of
high denomination notes. The ITO held that only part of the said sum could be
treated as savings of assessee and, therefore, assessed balance as income of
assessee from undisclosed sources. The Supreme Court, while allowing the
appeal, observed:

“Prima facie, the question
whether the amount in question came out of the saving or withdrawals made by
the appellant from her several businesses or was income from undisclosed
sources, would be a question of fact to be determined on a consideration of the
facts and circumstances proved or admitted in the case. A finding of fact does not alter its character as one of fact merely because it is itself an
inference from other basic facts.”

If books of account are not maintained, the following factors
would need to be considered in determining the reasonableness of such amount:

1.  Cash in hand as on 31^st March 2016
as declared in the return of income for assessment year 2016-17 (particularly
in Schedule AL or in Balance Sheet details filled in the return).

2.  Cash withdrawals from bank accounts during the
period from 1^st April 2016 to 8^th November 2016.

3.  Income received in cash during the period from
1st April 2016 to 8^th November 2016. It needs to be noted that with
effect from 1^st June 2016, the provisions of tax collection at
source u/s. 206C at 1% of the sale consideration are applicable to transactions
where the sale of goods or services in cash exceeds Rs.2,00,000. Besides, with
effect from 1^st April 2016, there is a requirement u/s. 114E of
furnishing AIR by any person liable for tax audit u/s. 44AB in respect of
receipt of cash payment exceeding Rs.2,00,000 for sale of goods or services.

4.  Any other cash receipts during the period from
1^st April 2016 to 8^th November 2016.

5.  Cash deposited in the bank during the period
from 1^st April 2016 to 8^th November 2016.

6.  Personal and other expenditure in cash of the
person and his family during the period from 1^st April 2016 to 8^th
November 2016. 

Ideally, a cash flow statement should be prepared to show the
cash in hand with the depositor as at 8^th November 2016. Reference
may be made to a decision of the Patna High Court in the case of Manindranath
Dash vs. CIT 27 ITR 522, where the Court held as under:

“The principle is well
established that if the assessee receives a certain amount in the course of the
accounting year, the burden of proof is upon the assessee to show that the item
of receipt is not of an income nature; and if the assessee fails to prove
positively the source and nature of the amount of the receipt, the revenue
authorities are entitled to draw an inference that the receipt is of an income
nature. The burden of proof in such a case is not upon the department but the
burden of proof is upon the assessee to show by sufficient material that the
item of receipt was not of an income character.

In the instant case it was
admitted that the assessee did not maintain any home chest account. It was
further admitted that he did not produce before the income-tax authorities
materials to show what was the disbursement for the various years. Unless the
assessee showed what the amount of disbursement was for the various years, it
was impossible to arrive at a finding that on the material date that is, on the
19-1-1946 the assessee had in his possession sufficient cash balance
representing the value of high denomination notes which were being encashed. It
was necessary that the assessee should have given further material to indicate
what was the disbursement out of the total income and satisfied the authorities
in that manner that on the material date the cash balance in his hand was not
less than the amount of Rs. 28,000 which was the value of the high denomination
notes. It was clear that the income-tax authorities were right in holding that
the assessee had failed to give sufficient explanation of the source and nature
of the high denomination notes which he encashed.

It was therefore, to be held
that the sum of Rs. 13,000 representing high denomination notes encashed on 19-1-1946, was income liable to income-tax.”

How does the depositor prove the reasonableness of the cash
in hand as of 8^th November 2016, where the depositor is covered by
the presumptive tax scheme u/s. 44AD, and therefore does not maintain books of
accounts? In such cases, the assessee would in any case be required to maintain
details of turnover, or may be required to maintain books of account under
other laws, such as indirect tax laws. The reasonableness would have to be
judged by the quantum of the turnover of the depositor, in particular, the
turnover in cash, and other cash expenses of the business. Wherever possible, a
cash flow statement should be prepared to prove the reasonableness of the cash
deposited.

If a person covered by section 44AD wishes to offer income
arising from unaccounted sales to tax, it first needs to be verified whether
his turnover would exceed the limits of section 44AD, after including such
unaccounted sales. If so, then normal computation provisions may apply. If his
turnover, after inclusion of such amount, does not exceed the limit u/s. 44AD,
then 8% of the turnover or the actual income, whichever is higher, needs to be
declared. The cash deposits need to be factored in while computing the actual
income for this purpose.

What would be the position of a housewife, who has saved
money out of money received from her husband for household expenses over the
years, and deposits such savings amount in her bank account? Would such deposit
be taxable? If so, in whose hands would it be taxable – of the housewife or her
husband? In such a case, the reasonableness of the amount would have to be
gauged from the quantum of monthly withdrawals for household cash expenses, and
the reasonableness of the period over which the amount is claimed to have been
served. The taxability, if at all, would have to be considered in the hands of
the husband.

In the case of ITO vs. R S Mathur (1982) 11 Taxman
24, the Patna bench of the Tribunal considered a case where the value of
high denomination notes encashed by the assessee’s wife, was included by the
ITO in the assessee’s assessment as income from undisclosed sources, rejecting
the explanation given by her that the notes were acquired out of savings
effected out of amounts given by her husband for household expenses. The
Tribunal held that the assessee was placed in high position and he was having
income from salary and interest. If the total earnings were taken into
consideration, the possibilities of saving to the extent of value of high
denomination note might not be ruled out. It therefore confirmed the deletion
of the addition.

If the depositor is unable to prove the reasonableness of the
cash deposited on the basis of the surrounding circumstances, and has not
offered such excess cash deposited as his income in his return of income, the
cash deposited in excess of the reasonable amount is liable to tax as his
income under the provisions of section 69A. Any amount taxed u/s. 69A is
taxable at an effective rate of 77.25% under the provisions of section 115BBE,
without any deduction in respect of any expenditure or allowance or set off of
any loss, as discussed above.

However, one also needs to keep in mind the common sense
approach adopted by the courts in similar cases in the past. The explanation
for such income needs to be credible and reasonable, given the facts and
circumstances. In this connection, a useful reference may be made to the
decision of the Supreme Court in the case of Sumati Dayal vs. CIT 214 ITR
801 (SC). In that case, the assessee claimed to have won 13 jackpots in
horse races during the year. The first jackpot was won on the first day that
she went to the races. The Supreme Court, while holding that it was possible
that the assessee had purchased the winning tickets in cash from the real
winner, and deciding against the assessee, observed:

“Apparent must be considered
real until it is shown that there are reasons to believe that the apparent is
not the real and that the taxing authorities are entitled to look into the
surrounding circumstances to find out the reality and the matter has to be
considered by applying the test of human probabilities.”

Would there be any other consequences if the amount deposited
is declared as business income of the year? One needs to keep in mind the
applicability of an indirect tax liability in respect of the amount of business
income declared, in the form of VAT, excise duty or service tax, depending on
the nature of business.

In case of a medical professional, one also needs to keep in
mind the requirement of keeping a register of patients. The fees indicated in
such register should match with the fees shown as income. Even for other
professionals, the details of the clients could be called for, for verification
of such details of cash alleged to have been received from clients.

Further, in a situation where the business or professional
income for assessment year 2017-18 is significantly higher than normal, and in
subsequent years, a normal lower income is declared, there is a high risk of a
detailed scrutiny in those subsequent years by the tax authorities to verify
whether the income disclosed in those years is correct or not, or has been
suppressed by the assessee. In particular, businesses or professions with large
cash receipts or large cash expenditures would be at higher risk of adjustments
to declared income in subsequent years.

Deposits out of Past Year’s Income or Additions

There may be cases wherein a person seeks to explain the
deposits in the bank by co-relating the deposits with the income of the past
years or out of the additions made in such years in assessing the total income.
In all such cases, the onus will be on the person depositing the money to
reasonably establish that the money so deposited represented the income of the
past years that had remained in cash and such cash was held in the High
Denomination Notes.

In such cases, the
possibility of a levy of penalty on application of Explanation 2 to section
271(1)(c) and/or section 270A(4) and (5) of the Act and now even section 271AAC
will also have to be considered. This is discussed later in this article. It is
seen that the Income Tax Department has issued notices u/s.133(6) for enquiring
into the source of deposits of the High Denomination Notes and in some cases
have carried out survey action u/s.133A. Many cases of search and seizure
action u/s.132 have also been reported. In all such cases, the issue of penalty
requires to be kept in mind. In ordinary circumstances, concealment or
misreporting is ascertained with reference to the Return of Income unless there
is a presumption running against the assesse. In cases of an enquiry u/s.133(6)
and survey u/s.133A, no such presumption is available for the year of notice or
action and, the liability to penalty will be solely determined with reference
to the income disclosed in the Return of Income. A presumption however, runs
against the assesse in cases of search and seizure u/s.132 by virtue of the
fiction available to the Revenue u/s.270AAB of the Act. To avoid the
application of the fiction and the consequential penalty, the person will have
to establish that the income and the consequential deposit thereof are duly
recorded in the books of account on the date of search.

Taxation of notes seized after 8^th November 2016

In a case where withdrawn currency notes are seized by the
tax authorities after 8^th November 2016 from an assessee who was in
possession of such notes as on 8^th November, 2016 , can the assessee
argue that since such withdrawn currency notes are not legal tender after 8^th
November 2016, they are not money or valuable article, and hence not
taxable u/s. 69A?

Support for this argument is sought to be drawn from the
decision of the Karnataka High Court in the case of CIT vs. Andhra Pradesh
Yarn Combines (P) Ltd 282 ITR 490. In this case, the High Court held as
under:

“The expression ‘money’ has
different shades of meaning. In the context of income-tax provisions, it can
only be a currency token, bank notes or other circulating medium in general
use, which has the representative value. Therefore, the currency notes on the
day when they were found to be in possession of the assessee should have had
the representative value, namely, it could be tendered as a money, which has
intrinsic value. In the instant case, the final Fact-finding authority, namely,
the Tribunal, after noticing the ordinance issued by the Central Government,
coupled with the fact of the RBI refusing to exchange the high denomination
notes when they were tendered for exchange, concluded that on the day, when the
assessee was found to be in possession of high denomination notes, they were
only scrap of paper and they could not be used as circulating medium in general
use as the representative value and, therefore, it could not be said that the
assessee was in possession of unexplained money. Therefore, the high
denomination notes which were in possession of the assessee could not be said
as ‘unexplained money’, which the assessee had not disclosed in its return of
income and, therefore, it would not warrant levy of penalty u/s. 271(1)(c).”

However, when one examines the facts of that case, the time
limit for exchanging these withdrawn notes with RBI had expired, and in fact,
RBI had refused to exchange the notes.

So far as the current position is concerned, the withdrawn
currency notes, though ceasing to be legal tender, continue to be legal tender
for the purpose of deposit with banks till 30^th December 2016, and
can thereafter be exchanged at notified offices of RBI up to 31^st March,
2017. It cannot therefore be said, till 31^st March, 2017 that the
withdrawn currency notes are not valuable, since they can be exchanged for
other currency notes up to 31^st March, 2017 at the Banks or the
Reserve Bank of India. Therefore, until such time as the option of exchange
exists, such withdrawn currency notes are a valuable thing, though maybe not
money and the provisions of section 69A would apply in cases where it is found
in a search action before 31^st March, 2017. The ratio of the
Karnataka High Court decision would apply only after the option of exchange
with RBI or with any other authority ceases to exist. The position however
could be different where the assessee is found to have received such notes on
or after 9^th November, 2016 even though he was not authorised to
receive such notes.

Taxation of Receipts of high denomination notes post
08.11.2016

Many businesses have received withdrawn currency notes after
8^th November 2016, as consideration for sale of goods or services,
or against payment of their outstanding dues, and subsequently deposited such
currency notes in their bank accounts. Can the businesses claim that the source
of deposit of the withdrawn currency notes was such subsequent sales, and that
therefore there is no undisclosed income?

Certain businesses, such as electricity companies, hospitals,
pharmacies, consumer co-operative stores, etc., were permitted to do so,
by specifically providing in a notification that the specified bank notes would
not cease to be legal tender up to a specified period, to the extent of certain
transactions specified in the notification. Such businesses can therefore
legitimately claim that the source of deposit of the withdrawn currency notes
by them in the bank account is on account of such sales or receipts.

The position is a little more complex when it comes to other
businesses not authorised to receive such currency. Attention is invited to the
demonetization of 1978 where besides providing that high denomination bank
notes of certain denominations would cease to be legal tender with effect from
16^th January 1978, section 4 of the High Denomination Bank Notes
(Demonetisation) Act, 1978 specifically provided that, save as otherwise
provided under that Act, no person could, after the 16^th day of
January 1978, transfer to the possession of another person or receive into his
possession from another person any high denomination bank note. The current
notification issued by the Ministry of Finance does not have a similar
provision apparently prohibiting transfer or receipt of withdrawn bank notes
after 8^th November, 2016 so that such notes cease to be a legal
tender. Instead the notification permits a few persons or businesses to receive
such currency and with that by implication provides that all other persons are
prohibited from receiving such currency.

Given the difference between the provisions of the 1978 law
and the 2016 notification, one view is that there is no prohibition of transfer
or receipt of the currency notes which have ceased to be legal tender, if both
the parties to the transaction are willing to transact in such notes. At best,
the recipient of the withdrawn bank notes can claim that the transaction is
void, since the consideration was illegal. As per this view, a business can
therefore transact in such notes, even after 8^th November 2016, and
deposit such notes in its bank account before 30^th December 2016.

Given the fact that such notes are no longer legal tender,
use of such notes in settlement of legal obligations is impermissible. This view
also draws support from section 23 of the Indian Contract Act, 1882. Section 23
of the Indian Contract Act reads as under: “23. What consideration and
objects are lawful, and what not. The consideration or object of an
agreement is lawful, unless it is forbidden by law; or is of such a nature
that, if permitted, it would defeat the provisions of any law; or is
fraudulent; or involves or implies, injury to the person or property of
another; or the Court regards it as immoral, or opposed to public policy. In
each of these cases, the consideration or object of an agreement is said to be
unlawful. Every agreement of which the object or consideration is unlawful is
void. 

The consideration of a contract to be settled by exchange of
withdrawn currency notes is opposed to public policy, and the consideration is
therefore unlawful, rendering the agreement as void. Further, under the current
demonetisation, by withdrawal of the currency notes as legal tender,
prohibition on their transfer should be implied. Therefore, one cannot claim
set off of such receipts against the deposit of the withdrawn currency notes.
This is also in accordance with the spirit of the action of withdrawal of the
legal tender status of these currency notes.

As far as the position in the Income-tax Act is concerned, it
is to be appreciated that as per one view discussed above, only a limited
number of persons are authorised to accept the high denomination notes, post
08.11.2016, besides the banks. All other persons are prohibited, expressly or
impliedly, to receive and accept such currencies as a medium of transaction. As
a direct off-shoot of this regulation, a person who has received such a
currency on or after 08.11.2016 is not entitled to deposit such a currency in
the bank. Please see Jayantilal Ratanchand Shah (supra) wherein the Apex
Court has held that the Reserve Bank of India was empowered to refuse to accept
the deposit of such notes. On failure to deposit, such a currency received
after 08.11.2016, loses its value and would have no economic worth. In the
circumstances, the person found in possession of such notes so received cannot
be taxed on the strength of its possession unless such currency is found to be
valuable. Please see the decision in the case of CIT vs. Andhra Pradesh Yarn
Combines (P) Ltd. 282 ITR 490 (Karn.).

Interesting issues may arise in a case of a sale of goods, on
or after 9.11.2016 against demonetised currency where he is not an authorised
person to receive such currency. In such a case, a question arises as to
whether the seller can be construed to have sold goods for no economic
consideration and can accordingly not be taxed on so called sale proceeds. If
so, the question will also then arise whether the purchaser of goods can be
subjected to tax u/s. 56(2)(vii) for having acquired the goods for inadequate
or no consideration, in such a case. The issue is likely to be a subject of
debate.

Trusts

The issue of deposits of High Denomination Notes by a
charitable trust and religious trust also requires consideration. A charitable
trust under the law of section 115BBC is liable to be taxed at the maximum
marginal rate in respect of anonymous donations. Such a trust would be required
to declare the identity of the donors to prevent the donation from being taxed u/s.
115BBC. Even in case of a religious trust, there will be an obligation to
establish that the donation in question was received by the trust on or before
08/11/2016.

In this connection, a decision of the Supreme Court in the
case of Jayantilal Ratanchand Shah vs. Reserve Bank of India, 1997 AIR 370,
in the context of the 1978 demonetisation is relevant. In this case, the
petitioner was the chairman of a society which was running a medical dispensary
at Surat. It was collecting funds to construct a public charitable Hospital,
and for that purpose, it had kept donation boxes at Surat and Bombay. On
demonetisation of 16^th January 1978, instructions were given to the
office bearers not to accept any deposit or allow anyone to deposit any high
denomination bank notes in the collection boxes after midnight of 16^th
January 1978. The collection box at Bombay was opened on 17^th
January 1978, and the high denomination bank notes of Rs. 22.11 lakh found in
that were deposited with State Bank of India for exchange. The collection boxes
at Surat were opened on 20^th January 1978, and were found to contain
Rs. 34.76 lakh in high denomination bank notes, which were also deposited with
State Bank of India for exchange.

State Bank of India refused to exchange the notes found in
the collection box at Surat on the ground that the Society had not explained
satisfactorily its failure to open the collection boxes immediately after the
issue of the ordinance, and that it had not been established that the notes had
reached the Society before demonetisation. The Central Government dismissed the
appeal again such rejection, pointing out that in the earlier year, the box
collection was only about Rs. 5,000 per month, and that the appellant had not
been able to prove that even in the past the trust was getting donations in
high denomination notes in the charity boxes and that this was a regular
feature.

The Supreme Court upheld the refusal to exchange the notes,
on the ground that the materials on record showed that the reasons which weighed
with the authorities to refuse payment to the Society in exchange of the high
denomination banknotes were cogent, and that the order was not perverse.

The Prohibition of Benami Transactions Act, 2016

The provisions of the Benami Transactions (Prohibitions)
Amendment Act, 2016 passed, on 10.8.2016, has been made effective from 1.11.
2016. Under this Act, holding of the property in the name of a person other
than the owner is an offence and the property so held is made liable to
confiscation and the owner of the property, in addition, is subjected to a fine
and punishment, too. Similarly, holding of the property in a fictitious name is
subjected to the same fate. This legislation should be a deterrent for the
persons holding properties including bank accounts in the name of a benamidar.
For example, deposits of magnitude in Jan Dhan Yojna Accounts. An exception has
been provided for the properties held in the name of a spouse or children,
amongst a few other exceptions. This law is administered by the Income tax
authorities.

The Government has also issued a press release dated 18^th
November 2016, clarifying that such tax evasion activities can be made subject
to income tax and penalty if it is established that the amount deposited in the
account was not of the account holder, but of somebody else. Also, as per the
press release, the person who allows his or her account to be misused for this
purpose can be prosecuted for abetment under the Income Tax Act.

Borrowing from Persons Depositing High Denomination Notes

A person borrowing funds from the person who has deposited
demonetised currency will have to satisfy the conditions of section 68 and the
lender may be required to explain his source of the deposits.

Prevention of Money Laundering Act

Use of any ‘proceeds of crime’, for depositing high
denomination notes, will expose a person to the stringent provisions of the
Prevention of Money Laundering Act. This Act covers various offences under 28
different statutes including economic laws like SEBI and SCRA. Any money
received in violation of the provisions of these enactments may be treated as
the ‘proceeds of crime’ and will be subjected to confiscation and fine and
imprisonment for the offender. Any person indulging in conversion of the
prohibited currency may be considered to have committed an offence under the
Indian Penal Code and may be held to be in possession of the proceeds of crime
and may attract punishment under the PMLA.

Non Resident and FATCA

Like other tax payers, a non-resident in possession of the
demonetised currency shall be eligible for depositing the same in the bank
account subject of course to the compliance of the provisions of FEMA. Such a
deposit may be required to be reported by the bank under FATCA.

Case of non- deposit of High Denomination Notes

A person not depositing the demonetised currency by the
prescribed date shall lose the money forever as his holding shall cease to have
any market value.

Pradhan Mantri Garib Kalyan Yojana, 2016

The Finance Act 2016 has been amended by the Taxation Laws
(Second Amendment) Act, 2016, by the insertion of Chapter IX-A and sections
199A to 199R, containing the Pradhan Mantri Garib Kalyan Yojana, 2016 (PMGKY or
‘Scheme’) which scheme has come into force from 17th December 2016. The Money
Bill introduced on 28/11/2016 received the President’s assent on 15^th
December 2016. In pursuance of the scheme, the Rules titled the Taxation and
Investment Regime For Pradhan Mantri Garib Kalyan Scheme Rules, 2016 have been
notified on 16/12/2016 under S.O. No. 4059(E) .

The scheme seeks to provide Taxation and Investment Regime
for PMGKY and introduce Pradhan Mantri Garib Kalyan Deposit Scheme (PMGKDS). A
statement dated 26/11/2016 by the Finance Minister explains the objects and
reasons behind introduction of scheme. It records that the scheme is introduced
on receipt of representations and suggestions from expert for stopping illegal
conversion of High Denomination Notes and to provide an opportunity to the tax
evaders to come clean on payment of taxes and to generate additional revenue
for government to be  utilised for
welfare activities and also for the use of funds in formal economy. The funds
to be deposited under PMGKDS are to be utilised for programmes of irrigation,
housing, toilets, infrastructure, primary education, health, livelihood,
justice and equity for poor.

The scheme is a code by itself and overrides the provisions
of the Income-tax Act, 1961 and any Finance Act. It shall come into force from
the date notified by the Central Government and shall remain in force till such
time is repealed by an Act of Parliament. It provides for filing of a
declaration by a person, latest by a date to be notified by the Central
Government (31^st March 2017), with the principal commissioner or
commissioner authorised to receive declaration under the notification issued by
the Central Government. The declaration is to be in the prescribed form and is
to be verified in the manner prescribed and signed by the person in accordance
with section 140 of the Income-tax Act. The rules prescribe the Form for
declaration (Form 1), besides for revision of the declaration, issue of a
certificate by the Commissioner (Form 2) and other related things.

Section 199B defines the terms Declarant, Income-tax Act, and
PMGKDS. The term not defined shall take meaning from the Income-tax Act, 1961.
To opt for the scheme is optional and is at the discretion of the person and is
not mandatory for a person to be covered by it. However, a person opting for
the scheme is assured of certain immunities. Any person, whether an individual
or not resident or not, is entitled to make a declaration under the
scheme. 

Under the scheme, a person can make a declaration as per
section 199C in respect of any income chargeable to tax for AY 2017-18 or an
earlier year, in the form of cash or deposit in an account with a specified
entity (which includes a bank, RBI, post office and any other notified entity).
Such income would be taxed without any deduction, allowance or set off of loss.
The tax payable would be 30% of the undisclosed income, plus a surcharge of 33%
of the tax, the total being 39.99% as per section 199D. Further, a penalty of
10% of the undisclosed income as per section 199E would be payable, the
effective payment of tax, surcharge and penalty being 49.9%. No education cess
would be payable. Such tax, surcharge and penalty is to be paid before filing
the declaration as per section 199H and is not refundable in terms of section
199K. Neither ‘income’ nor ‘undisclosed income’ is defined under Chapter IX-A.
While declaration is for income, charge of tax, etc is on undisclosed income.
Proof of payment is to be filed along with the declaration. Any failure to pay
tax, etc as prescribed would result in declaration to be treated as void and
shall be deemed never to have been filed as per section 199M. There is no provision for part payment, at present.

The scheme vide section199F requires making of a deposit of
25% of the undisclosed income as per section 199H declared in the Pradhan
Mantri Garib Kalyan Deposit Scheme, 2016, before making the declaration. The
deposit would be interest-free, and would be for a period of 4 years before
refund. If one takes the opportunity loss of interest on such deposit at 8% per
annum, the effective loss of interest on a pre-tax basis would be 8% of the
declared income over the period of 4 years, but would be about 5.2% on a
post-tax basis. This raises the effective cost under the scheme to 55.1%, as
against 77.25% payable otherwise under the Act. The scheme is therefore an
effective alternative to disclosure as income in the tax return of AY 2017-18.

Section 199-I provides that the amount of undisclosed income
declared in accordance with the scheme shall not be included in the total
income of the declarant for any assessment year under the Income-tax Act.
Further, section 199L provides that nothing contained in the declaration shall
be admissible in evidence against the declarant for the purpose of any
proceeding under any Act, other than the specified Acts in respect of which a
declaration cannot be made, even if such Act has a provision to the contrary.

A declaration in terms of section 199-O, cannot be made by a
person in respect of whom an order of detention has been made under COFEPOSA,
or by any person notified u/s. 3 of the Special Court (Trial of Offences
Relating to Transactions in Securities) Act, 1992. A declaration cannot be made
in relation to prosecution for any offence punishable under chapter IX or
chapter XVII of the Indian Penal Code, the Narcotic Drugs and Psychotropic
Substances Act, 1985, the Unlawful Activities (Prevention) Act, 1967, the
Prevention of Corruption Act, 1988, the Prohibition of Benami Property
Transactions Act, 1988 and the Prevention of Money Laundering Act, 2002. It
cannot be made in relation to any undisclosed foreign income and asset
chargeable to tax under the Black Money (Undisclosed Foreign Income and Assets)
and Imposition of Tax Act, 2015. Unlike under IDS, there is no prohibition on
making of a declaration for any year for which an assessment or reassessment
notice has been issued or in which a survey or search has taken place.

A declarant as per section 199J is not entitled to seek
reopening of any assessment or reassessment or to claim any set off or relief
in any appeal, reference or other proceeding in relation to any such assessment
or reassessment in respect of the undisclosed income which is declared under
the scheme. The tax, surcharge and penalty paid under the scheme is not refundable, section 199K.

Where a declaration has been made by misrepresentation or
suppression of facts or without payment of tax, surcharge or penalty, or
without making the deposit in the deposit scheme as required, such declaration
as per section 199M is void and is deemed never to have been made under the
scheme.

Section 199-I provides that the amount of undisclosed income,
declared in accordance with section 199C, shall not be included in the total
income of declarant for any assessment year under the Income-tax Act. The
income so declared is eligible for being excluded from the total income for any
assessment year. The immunity here is restricted to the total income of the
declarant and, unless otherwise clarified, will not extend to third parties.
This view is further confirmed by the express provisions of section 199P which
for the removal of doubts clarifies that nothing contained in the scheme shall
be constructed as conferring any benefit, concession or immunity on any person
other than the person making the declaration. The language of section 199-I is
clear enough to support the view that the income declared under PMGKY cannot be
included in the book profit for the purposes of levy of the minimum alternative
tax u/s. 115JB of the Income-tax Act, since such book profit is deemed to be
the total income. The language also supports the view that no penalty can be
levied or a prosecution can be launched under the Income Tax Act simply on the
basis of the income declared under the PMGKY. The provisions of sections 199D
and 199E specifically overrides the provisions of the Income-tax Act and also
of any Finance Act. No express provisions, as under the IDS, 2016, are
contained in PMGKY for conferring specific immunity from penalty or prosecution
under the Income-tax Act.

Another important immunity is provided vide section 199L
which expressly provides that anything contained in the declaration shall be
inadmissible in evidence against the declarant for the purpose of any
proceeding under any Act other than those listed in section 199-O. This is a
wide and sweeping immunity and shall help the declarant in keeping a safe
distance from any declaration based liability under any of the indirect tax
laws and also the civil laws. Denial of immunity for the statutes mentioned in
section 199-O is for the reason that the persons or the offences covered
therein are in any case made ineligible for making declaration of undisclosed
income under the scheme. Section 199L further confirms the understanding that
no penalty can be levied or prosecution be launched on the basis of the
declaration, alone.

A care has been taken u/s.199N to ensure the specific
application of sections 119, 138,159 to 180A and 189 of the Income Tax Act to
the declaration made under the scheme. This provision enables the continuity of
the proceedings by the subordinate authorities besides facilitating the making
and filing of declaration in specified cases of fiduciary relationships and
discontinued and dissolved entities. Application of section 138 shall enable
the authorities to restrict the sharing of information in their possession,
unless it is found to be in the public interest to do so.

The Central Government has been empowered vide section 199Q
to pass any order for removing the difficulty within a period of 2 years
provided such order is placed before each house of the Parliament.
Simultaneously the Board is empowered to make rules, by notification, for
carrying out the provisions of the scheme including for providing the form and
manner and verification of the declaration. Such rules when made are required
to be placed before each house of Parliament, while it is in session, for a
total period of 30 days.

The PMGKY contains many provisions similar to the Income
Disclosure Scheme, 2016 (IDS). There however are some important differences
between the PMGKY and IDS, some of which are listed here under:

–  An income or undisclosed income is not
defined under the PMGKY while under IDS it was specifically defined to include,
a) Income not declared in an return of income filed u/s. 139, b) An income not
included in the return of income furnished, c) An income that has escaped assessment

–  The aggregate rate of tax plus surcharge and
penalty is 49.9% under PMGKY against the aggregate of 45% under the IDS

–   The surcharge under the PMGKY is to be used
for the Kalyan of Garib while under the IDS, it is to be used for Kissan Kalyan

–   The penalty under PMGKY is levied on the
basis of undisclosed income while under the IDS it was levied on the basis of
tax excluding surcharge

–   Under the PMGKY an interest free deposit of
25% or more of undisclosed income is required to be made for a period of 4
years from the date of deposit while IDS did not contain any such provision

–  Under PMGKY the payment of taxes, etc is to
be made before filing the declaration, while under IDS such payment can be made
in 3 installments ending with 30.09.2017

–  Under PMGKY a declaration is rendered void in
cases of misrepresentation or suppression of facts while under IDS only
declaration by misrepresentation are rendered void

–   Under PMGKY a declaration made without
payment of tax, etc is void while under IDS the payment was to be made only on
demand by the Commissioner

–   Under PMGKY no specific immunities have been
conferred from levy of wealth tax, application of Benami Transaction Provisions
Act and penalty and prosecution under the Income Tax Act and the Wealth Tax Act
while IDS contains specific provisions to such effect

–   Under PMGKY a declaration is not possible in
cases of prosecution under the prohibition of Benami Property Transaction Act,
1988 and Prevention of Money Laundering Act, 2002 while under the IDS there is
no such provision to prevent a person making a declaration for prosecution
under said Acts

–  A person in receipt of any notices u/s.
143(2) or 142(1) or 148 or 153A of the Income Tax Act as also a person in
respect of whom a search or survey is carried out or requisition has been made
is not prohibited from making a declaration while under the IDS such a person
was prohibited from making a declaration

–   Under PMGKY a declaration is not admissible
as evidence under any Act other than a few specified Acts while under IDS such
a declaration is not admissible as evidence for imposition of a penalty and
prosecution under the Income-tax Act and Wealth Tax Act.

Given the similarity of the provisions to IDS, 2016 the
clarifications issued from time to time under IDS, to the extent that the
language is similar or identical, can perhaps be utilised for understanding
PMGKY as well.

While a declaration can be made only after commencement of
the scheme and the rules and forms have been notified, a declaration can be
made for any deposits or any cash for any assessment year up to assessment year
2017-18. Therefore, even in respect of cash deposits made before or after 8 November,
but prior to the scheme coming into force, a declaration can be made under the
scheme. 

A reading of the statement of objects and reasons leads a
reader to believe that the scheme has been introduced for the purposes of
giving an opportunity, to come clean, to persons who are in possession of the
high denomination notes, for which they do not have any satisfactory
explanation, at a cost which is higher than the cost of the regular tax.

The use of the terms ‘a declaration in respect of any
income, in the form of cash or deposit in an account maintained by a person
with a specified entity chargeable to tax’ in section 199C, where read in
the context of the statement of objects and reasons, means that it is such cash
or deposit held in the high denomination notes that qualifies for the
declaration under the scheme. The language of section 199C, though not
restricting the scope of a declaration to the high denomination notes, has to
be read in a manner that supports the objects and the reasons for introduction
of the PMGKY. Form no.1 and the contents thereon also supports this view. The
form prescribes for the declaration of the amount of cash and deposits with
specified entities. Even the Notification dt.19.12.2016 issued by the RBI
enabling the person to pay tax, etc. and make deposit under the scheme
by use of the high denomination notes, also supports this view. The other view
is that the meaning and the scope of above captioned words,  used in section 199C(1), should not be restricted
to the high denomination notes in as much as the language is clear and
unambiguous so as to include any cash or deposit of any denomination including
of the new currency. This view is further confirmed by the express provisions
of section 199C(1) which enables a declaration of income for any assessment
year commencing on or before 1^st April,2017. Obviously, a person
making a declaration for A.Y.2016-17 or earlier years cannot be holding the
declared income in cash since then and that too in the form of the high
denomination notes.

The language of section 199C makes it difficult for a
declarant wishing to come clean by declaring an unaccounted income which had
been used for payment of any expenditure, etc made at any time prior to the
date of commencement of the scheme; the payments might have been made in the
high denomination notes even after 08.11.2016 to authorised persons; even to
unauthorised persons, out of the unaccounted income held in the high
denomination note after 08.11.2016 and the declarant wishes to make a
declaration thereon irrespective of the legality of such payment. The question
also arises about the eligibility of the unauthorised recipient to declare cash
under the scheme and about the value of such cash.

In many a case of undisclosed income received up to
08.11.2016 in cash or by deposit, it is likely that such unaccounted income has
been utilised in acquiring some other asset or in advancing loan and is
therefore not in the form of cash or deposits as on the date of commencement of
the scheme.

The eligibility of such a person to make a declaration under
the scheme becomes contentious and debatable. This difficulty is further
confirmed by a reading of Form 1 which has no space for any such investments
and instead requires the declarant to specify the amount of cash and the
deposits, only. The above difficulties concerning the most important aspect of
declaration i.e. the scope of 
undisclosed income, is best resolved by the Government of India by issue
of appropriate clarification at the earliest.  

Section 115BBE and Amendment

Provisions and Scope

Section 115BBE was introduced by the Finance Act, 2012 w.e.f.
01.04.2013 and applied to assessment year 2013-14 and onwards. It was further
amended by the Finance Act, 2016. The section provided that;

–   in computing the total income of a person,
the income referred to in sections 68, 69, 69A, 69B, 69C and 69D (‘specified
income’) no deduction shall be allowed,

–   no set-off of loss shall be allowed against
the specified income,

–   the specified income so included in the total
income shall be taxed at the rate of thirty per cent, and

–   surcharge and the education cess, where
payable, shall be paid at the rate prescribed in the Finance Act of the
respective year.

No separate provisions were made for levy of penalty for the
specified income that are taxed at the rates prescribed u/s.115BBE of the Act.
Accordingly, penalty for concealment, etc where leviable, was leviable as per
section 271(1)(c) or section 270A, as the case may be. Likewise, no separate
provisions for prosecution were specifically prescribed for the specified
income and the provisions for initiating prosecution in regular course were
invoked, where applicable.

The provision did not enable an assessee to voluntarily
include the specified income in filing the return of income and pay tax
thereon.

A view has been prevailing for sometime, which view got
momentum in the wake of demonetisation, holding that an assessee can include an
amount in his total income without specifying the source of income or even the
head of income and voluntarily pay tax thereon; no penalty for concealment, etc
can be levied u/s. 270A of the Act; the provisions for prosecution were
inadequate for prosecuting such a person; such amount when included in the
return of income cannot be assessed u/s.68 to 69D of the Act and as such cannot
be taxed at the rates prescribed u/s.115BBE of the Act.

This view found a great favour with the tax experts during
the period commencing 9^th November, 2016, post demonetization. It
is/was believed that any assessee, relying on the view, can deposit the
demonetized currency and offer the amount as his income in filing the return of
income for the assessment year 2017-18 without attracting any penalty and/or
prosecution.

It appears that the Government could not but concur with the
view. Realizing the lacuna in the law, it has amended the provisions of section
115 BBE and simultaneously introduced section 271AAC w.e.f. 1^st April,
2017, vide enactment of the Taxation Laws (Second Amendment) Act, 2016 which
received the assent of the President of India on 15^th December,
2016. The objects and reasons for amending section 115BBE are found in the
paragraph 2 of the Statement dt. 26^th November, 2016 issued by Arun
Jaitley at the time of introducing the Bill. It reads as under; “concerns have
been raised that some of the existing provisions of the Income-tax Act, 1961
could possibly be used for concealing black money. It is, therefore, important
that, the Government amends the Act to plug these loopholes as early as
possible so as to prevent misuse of the provisions. The Taxation Laws (Second
Amendment) Bill, 2016, proposes to make some changes in the Act to ensure that
defaulting assessees are subjected to tax at a higher rate and stringent
penalty provisions.”

The    amendment      has 
the effect of substituting sub-section (1) of section 115BBE w.e.f
01.04.2016 and has application to A.Y 2017-18 and onwards. It inter alia ropes in, in its sweep, the
transactions from 1^st April, 2016 to 14^th December, 2016
and therefore has a retroactive if not retrospective effect.

The implication of amendment is that;

–   it applies to any assessee, resident or
otherwise,

–   it applies to assessment year 2017-18 and
onwards,

–   it enables an assessee to reflect the
specified income in filing the return of income,

–   it seeks to tax the specified income at the
rate of sixty per cent and included and reflected in the return of income
furnished u/s.139.

Simultaneously, section 2(9) of Chapter II of the Finance
Act, 2016 has been amended by inserting the Seventh proviso to provide for a
levy of surcharge at the rate of twenty five per cent of tax u/s.115BBE in
payment of advance tax. Education cess at the rate of three per cent will
continue to be levied.

The provision for taxing income at a flat rate, where it is
so assessed by the A.O as per sections 68 to 69D, are retained with the change
that the rates of tax would be sixty percent instead of thirty percent. No
deduction shall be allowed in computing such income and no set-off of loss will
be permissible in view of the provision of sub-section (2) of section 115BBE,
which are retained. No change is made in these provisions.

The amended section 115BBE, read with the Finance Act 2016 as
amended, now provides that, where an assessee, includes the specified income by
reflecting it in his return of income furnished u/s. 139, tax shall be payable
at 60% of such income, plus a surcharge of 25% of such tax (15% of income). The
effective tax rate, including 3% education cess, would therefore be 77.25%

The amendment of section 115BBE is neither restricted to the
high denomination notes nor to A.Y. 2017-18, only. It applies to even that part
of financial year 2016-17 consisting of the period during 01/04/2016 to
14/12/2016. It applies not only to deposits of withdrawn notes on or after
09.11.2016 but any such deposits during the current year, which an assessee has
no explanation for, and to all incomes covered by sections 68, 69, 69A, etc.
Therefore, the new rates of tax, surcharge and penalty would apply to items
such as loans treated as undisclosed cash credits, unexplained jewellery, etc.,
for assessment years 2017-18 and subsequent years.

The provision is wide enough to include a return of income
furnished u/s. 139(1), 139(3), 139(4), 139(4A), 139(4B), 139(4C) and 139(5). A
belated or a revised return can also enable an assessee to reflect the
specified income in his return of income. The option to reflect the specified
income in filing the return of income shall not be available in cases where
return is furnished in response to notice u/s. 142, or 148 or 153A of the Act.

In case the amount is not offered to tax in the return of
income, but the amount is added u/s. 68, 69A, etc by the Assessing Officer,
besides the tax, surcharge and cess of 77.25%, a penalty, at the rate of 10% of
the tax payable u/s. 115BBE(1)(i), would also be payable under the newly
inserted section 271AAC.

To include the specified income in total income is at the
discretion of the assessee. It is not mandatory for an assessee to do so and
pay tax voluntarily on such income. He may not do so where he is of a belief
that he will be able to explain to the satisfaction of the A.O that a
particular credit, money, investment, etc. does not represent any income.

Obviously, these provisions can apply only if the deposit is
in the nature of income, which is chargeable to tax. In other words, all such
deposits are not taxable. It is clear that such deposits can be regarded as
income only under certain circumstances.

Penalty u/s. 271AAC

Section 271AAC has been introduced simultaneously to provide for a levy of penalty at the rate of ten percent of the tax payable u/s.115BBE. The new section provides that;

–  income referred to in sections 68 to 69D
shall be liable to penalty on its determination as income,

–   penalty will be levied at the rate of ten
percent of the tax payable u/s.115BBE,

–  levy of penalty is at the discretion of the
A.O,

–  provisions of section 271AAC are applicable
for assessment year 2017-18, onwards,

–   the provisions override any provisions of the
Act other than the provisions of section 271AAB which deal with the levy of
penalty in search cases,

–   no penalty shall be levied u/s.270A in cases
where a penalty is levied u/s.271AAC,

–  provision of section 274 shall apply
requiring the A.O.to follow the procedure prescribed therein,

–  provision of section 275 shall apply
requiring the A.O to pass an order of penalty within the prescribed time,

–    importantly no penalty shall be levied where
an assessee has reflected the specified income in the return of income
furnished u/s.139 and has paid taxes on such income as per section 115BBE, on
or before the end of the relevant year,

–   provisions of section 273B are not
specifically made applicable to the case of an income assessed as per section
115BBE. The said section provides that no penalty shall be imposable on a
person where he proves that there was a reasonable cause for the failure for
which the penalty is sought to be levied. In view of the fact that the levy of
penalty u/s. 271AAC is discretionary, it appears that no penalty will be levied
in the presence of a reasonable cause, and

–   an assessee would not have the benefit of
waiver u/s. 270AA or 273A of the Income-tax Act.

Would the amount of such penalty be 6% of such income, or
7.725% of such income? The view that the amount of penalty would be 6%, draws
support from the fact that the reference in section 271AAC is to a specific
clause of the Act, namely section 115BBE(1)(a) where the rate of tax provided
for is flat 60%. Effective outgoing would be 83.25% in this case. The other
view is based on the fact that the term “tax” has been defined in section 2(43)
to mean tax chargeable under the provisions of the Act. Section 2 of the
Finance Act increases the amount of tax by a surcharge (which includes a cess),
but the nature of the entire amount remains a tax. Under this view, the tax
payable u/s. 115BBE(1)(i) is 77.25%, and therefore the penalty would be 10% of
this rate. Outgoing would be 84.97% in this case.

In the context of demonetisation, the applicability of the
above discussed provisions of section 115BBE and section 271AAC requires
consideration. As noted, the Government has introduced the provisions with the
object of plugging the loophole used for concealing black money and to prevent
misuse of the existing provisions. With this object in mind, an alternative has
been provided to the assesses to come clean, in cases where a declaration has
not been filed under PMGKY, by including the cash or deposits in the total
income and pay tax thereon by 31.03.2017 and reflect such income in furnishing
the return of income u/s. 139 of the Act.

The amended section 115BBE r.w.s. 271AAC surely provides a
way for the holders of unexplained high denomination notes to come clean
without penalty and prosecution on payment of taxes. No deposits are to be made
for any period as is required under the PMGKDS.

Strangely, any person is entitled to opt for being taxed as
per section 115BBE irrespective of the legality or otherwise of the source of
his income. Any of the persons, otherwise considered to be ineligible for
filing a declaration under the BMA 2015, IDS 2016 or PMGKY, 2016 can claim to
be taxed u/s. 115BBE without any limitation as to the nature and source of his
income. Again, the right to opt for section 115BBE is not limited by any
inquiry or investigation or the resulting detection, other than the one in
consequence of a search action u/s. 132 of the Act.

In many cases, one might find the rate of taxation u/s.
115BBE to be beneficial even where one were to take into consideration the
penalty u/s. 271AAC. The maximum rate together would be 84.97% and the minimum
would be 77.25%. Now in an ordinary case, this rate can be 102% of the income
(34% tax, etc plus 68% penalty) involving cases of misreporting otherwise
liable to a penalty at the rate of 200% of the tax sought to be evaded. This
surely is providing for a beneficial treatment to persons being taxed as per
section 115BBE.

Not all income is taxable u/s. 68 to Section 69D

If the value of such notes deposited exceeds the cash in hand
as per books of account as of 8^th November 2016, the difference
would be taxable as the income of the depositor. If the depositor on his own
offers the income to tax as his income, would tax be payable thereon at the
rate specified under the amended section 115BBE? Section 115BBE applies when
provisions of sections 68, 69, 69A, 69B, 69C or 69D are applicable.

If an assessee offers such amount to tax in his return of
income and pays tax thereon at normal rates of tax, but is unable to explain
the source of such income to the satisfaction of the assessing officer, can an
assessing officer invoke the provisions of section 68 or 69A read with section
115BBE, and levy the tax on such amount at the flat rate of 60% plus applicable
surcharge and cess? Do the provisions of section 68 or 69A, which deem certain
amounts to be income of the assessee, apply to amounts which have already been
disclosed as income of the assessee?

It needs to be emphasized that provisions of section 68 to
section 69D are apparently invoked in cases where an assessee is unable to
explain the source of a particular receipt, money, investment, expenditure, etc
or part thereof to the satisfaction of the Assessing Officer. These provisions
have no application in cases where an assessee has been able to explain the
source of his receipt, etc. and in such cases the income reflected in filing
the return of income shall not be taxed at 77.25% of such income.

Sections 68 and 69A create certain deeming fictions, whereby
certain amounts which are not considered as income by the assessee, are deemed
to be income of the assessee. A deeming fiction of income cannot apply to an
item which is already treated as income by the assessee himself. The question
of deeming an item to be income can only arise if the item is not otherwise an
income.

The Delhi High Court, in the case of DIT(E) vs. Keshav
Social and Charitable Foundation (2005) 278 ITR 152, considered a situation
where the assessee, a charitable trust, had disclosed donations received by it
as its income, and claimed exemption u/s. 11. The Assessing Officer, on finding
that the assessee was unable to satisfactorily explain the donations and the
donors were fictitious persons, held that the assessee had tried to introduce
unaccounted money in its books by way of donations and, therefore, the amount
was to be treated as cash credit u/s. 68. The Delhi High Court held that
section 68 did not apply, as the assessee had disclosed such donations as its
income.

This view is also supported by the income tax return forms,
where Schedule SI – Income Chargeable to Tax at Special Rates, does not include
section 1115BBE, though it includes section 115BB. In addition, a useful
reference may be made to Schedule OS, Entry 1(d) and Guidance (iii) thereto and
Instruction 7(ii)(29) appended to the Return of Income.

In our considered opinion, the language of the amended
provision of section 115BBE does not cover the case of a person declaring his
income voluntarily for explaining a deposit or cash on hand. The legislature,
for taxing a voluntarily declared income, is required to amend the provisions
of sections 68 to 69D so as to cover any income for which a satisfactory
explanation as to its source is not furnished by the assessee. It is only on
inclusion of such an income that the provisions of section 115BBE, can be made
applicable for taxing such income at the rate of 77.25%; till such time the
provisions of section 68 to section 69D are not amended, the issue in our
humble opinion would remain at the most debatable.

Other Important aspects

One needs to examine the following where an assessee includes
an income, otherwise unexplained, in filing his return of income and pays tax
as per section 115BBE of the Act.

–   Whether the specified income so offered for
tax as per section 115BBE will be accepted by the A.O. without any inquiry and
additions for the year or for any other year,

–   Whether any penalty be levied for tax on
additions,

–   Whether the person offering such income be
prosecuted under the Income-tax Act,

–   Whether there is any immunity from sharing
information with other authorities,

–  Whether there is any immunity from
applicability of provision of other laws including indirect tax laws,

–   Whether there is any saving from
applicability of the MAT, and

–   Whether a person can include the specified
income in the return of income even inquiry and investigation.

Estimation And Assumption; A person in cases where
income is offered under Return of Income voluntary offering to be covered by
amended section 115BBE for A.Y. 2017-18 onwards depositing the high
denomination notes should pass appropriate accounting entries in the book of
accounts maintained by him besides making appropriate noting in the bank slips.
Entries supporting the income, received in high denomination notes, would be
independent of the entries supporting the deposit of such high denomination
notes in the bank. In cases where these entries are found to be false, the
Assessing Officer would be entitled to reject the books of account and estimate
the income, on application of s.145 of the Act. Such a possibility is not
altogether ruled out. Even in cases where a person is unable to explain the
source of income or produce satisfactory evidences in support thereof, there
may be a possibility of estimation of income for preceding previous years.
Please see Anantharam Veerasinghaiah 123 ITR 457 (SC) wherein the Court
held that “There can be no escape from the proposition that the secret
profits or undisclosed income of an assessee earned in an earlier assessment
year may constitute a fund, even though concealed, from which the assessee may
draw subsequently for meeting expenditure or introducing amounts in his account
books. But it is quite another thing to say that any part of that fund must
necessarily be regarded as the source of unexplained expenditure incurred or of
cash credits recorded during a subsequent assessment year. The mere
availability of such a fund cannot, in all cases, imply that the assessee has
not earned further secret profits during the relevant assessment year. Neither
law nor human experience guarantees that an assessee who has been dishonest in
one assessment year is bound to be honest in a subsequent assessment year. It
is a matter for consideration by the taxing authority in each case whether the
unexplained cash deficits and the cash credits can be reasonably attributed to
a pre-existing fund of concealed profits or they are reasonably explained by
reference to concealed income earned in that very year. In each case, the true
nature of the cash deficit and the cash credit must be ascertained from an
overall consideration of the particular facts and circumstances of the case.
Evidence may exist to show that reliance cannot be placed completely on the
availability of a previously earned undisclosed income. A number of
circumstances of vital significance may point to the conclusion that the cash
deficit or cash credit cannot reasonably be related to the amount covered by
the intangible addition but must be regarded as pointing to the receipt of
undisclosed income earned during the assessment year under consideration. It is
open in to the revenue to rely on all the circumstances pointing to that
conclusion”.

Can an assessing officer question the year of taxability of
the income, and seek to tax the income in earlier years, on the ground that
based on the past years’ tax returns, it was impossible for the depositor to
have earned such a large amount within the short period of 7 months from 1^st
April to 8^th November 2016?

In Gordhandas Hargovandas vs. CIT 126 ITR 560, in the
context of section 69A, the Bombay High Court held that section 69A merely
gives statutory recognition to what one may call a commonsense approach. It
does not bring on the statute book any artificial rule of evidence, a presumption
or a legal fiction. It contains an approach which, if applied, to any
particular assessment cannot be regarded as contravening any principle of law
or any rule of evidence. In that case, there was no material on record to show
that the said amounts related to the income of the assessees for any earlier
year or any year other than the year under consideration. If there was no
material on record, then, the High Court held that the amounts which
represented the sale proceeds of the gold must be regarded as the assessee’s
income from undisclosed sources in the years in question, in as much as they
were introduced in the books at the relevant time. 

If the assessing officer contends that the income should not
be wholly added as income for a particular year, and that it should be spread
over or that it should be liable to be considered as income for another year,
the onus will be upon the assessing officer to point out the material or
circumstance which supports the argument. In the absence of any material or
circumstance, the income cannot be treated as the income of another year.

Further, in a situation where the business or professional
income for assessment year 2017-18 is significantly higher than normal, and in
subsequent years, a normal lower income is declared, there is a high risk of a
detailed scrutiny in those subsequent years by the tax authorities to verify
whether the income disclosed in those years is correct or not, or has been
suppressed by the assessee. In particular, businesses or professions with large
cash receipts or large cash expenditures would be at higher risk of adjustments
to declared income in subsequent years.

Penalty; Needless to say that in cases of estimation
of income, the difference between the returned income and the assessed income
may be exposed to the penalty unless it is established that no penalty shall be
levied in as much as neither there was any under reporting of the income by
virtue of clauses (b) and (c) of sub-section (6) of section 270A of the Act nor
there was an addition as that could be said to have been made u/s. 68 to 69D
read with section 115BBE so as to attract the penalty under newly introduced
section 271AAC of the Income-tax Act.

In cases wherein a person seeks to explain the deposits in
the bank by co-relating the deposits with the income of the past years or out
of the additions made in such years in assessing the total income, as discussed
earlier, the onus will be on the person depositing the money to reasonably
establish that the money so deposited represented the income of the past years
that had remained in cash and such cash was held in the high denomination
notes.

One will also have to examine the possibility of a levy of
penalty on application of Explanation 2 to section 271(1)(c) and/or section
270A(4) and (5) of the Act. A person, supporting the deposits on the basis of
additions made in the preceding previous years, would be exposed to penalty
under a deeming fiction of Explanation 2 to section 271(1)(c). The Explanation
provides that a penalty would be levied, in the year of addition, once a person
is found have correlated his deposit or investment in any other year with the
additions so made. Of course, no penalty would be levied second time in a case
where a penalty was already levied on the basis of addition made in the
preceding previous year. The provisions of sub-sections (4) and (5) of the
newly inserted section 270A will also have to be kept in mind, which
provisions, if not negotiated out of, may cause avoidable trouble for A.Y
2017-18 or thereafter, as well.

Can penalty be levied for concealment u/s. 270A, in a
situation where the assessee himself has disclosed such income in his return of
income but not u/s. 115 BBE? Penalty u/s. 270A is leviable if there is
under-reporting of income or misreporting of income. Section 270A(2) defines
what is under-reporting of income. A person is considered to have
under-reported his income, inter alia, if the income assessed is greater
than the income determined in the return processed u/s. 143(1)(a), or the
income assessed is greater than the maximum amount not chargeable to tax, in a
case where no return of income has been furnished. Therefore, where an item of
income is included in the return of income, such an item would also be part of
the income determined in the return processed u/s. 143(1)(a). When such item of
income is again assessed as part of the total income in an assessment u/s.
143(3), since the item of income is included in both the intimation u/s.
143(1)(a) as well as in the assessment order u/s. 143(3), it would not result
in a difference between the two incomes. Therefore, in effect, such income
reported in the return of income cannot be regarded as under-reporting of
income.

Section 270A(9) lists out cases of misreporting of income. It
includes, inter alia, misrepresentation or suppression of facts, failure
to record investments in the books of account, recording of any false entry in
the books of account, and failure to record any receipt in books of account
having a bearing on total income. However, sub-section (9) of section 270A
refers to sub-section (8) of the same section. It provides that the cases of
misreporting of income referred to in s/s. (8) shall be the following. If one
examines the provisions of s/s. (8), it provides that where under-reported
income is in consequence of any misreporting thereof by any person, the penalty
shall be equal to 200% of the amount of tax payable on underreported income.
Therefore, for an item to amount to misreporting of income, it has first to be
in the nature of under-reporting of income. It is only then that one can say
that it is a case of misreporting of income. Further, the computation of the
penalty would also fail if there is no under-reported income, since the penalty
is equal to 200% of the amount of tax payable on under-reported income.

From the above, it is clear that no penalty u/s. 270A can be
levied in a situation where the excess amount of withdrawn notes deposited into
a bank account are disclosed in the return of income filed for assessment year
2017-18 unless such amount is assessed to tax as per the provisions of sections
68 to 69 D, in which case the penalty will be leviable u/s. 271AAC, alone.

Prosecution; Doubts have been raised about the
possible application of the provisions of section 276C, section 277, section
277A and section 278 for initiating the prosecution in cases where an income is
included in the total income by filing ROI for A.Y 2017-18 for supporting the
deposit of the high denomination notes. The doubts arise in both the cases;
where return is filed in accordance with the provisions of section 115BBE or
where it is not so filed but in both the cases the income is included in the
total income in filing the return of income.

Section 276C deals with the offense of the willful attempt to
evade any tax, penalty or interest chargeable or imposable under the Act or
where he under reporting of income. This provision is independent of levy of
penalty. An Explanation to section 276C expands the scope of the provision to
cover the cases of a false entry or statement or omission to make an entry
besides causing circumstances for enabling evasion of tax. The person convicted
of offense in such a case is punishable with rigorous imprisonment for a term
ranging between 6 months to 7 years depending upon the quantum of evasion of
tax. In addition such a person is liable to a fine of an unspecified amount.
While the scope of the provision is wide so as to it cover a range of cases,
the provisions in our opinion would not be attracted in a case where the
assesse has included an income corresponding to the amount of deposit of High
Denomination Notes in filing the Return of Income in as much as no tax, etc.
could be said to have been evaded by him and in the absence of any evasion, the
provisions including the deeming fiction should fail to apply.

A person consciously making a statement, in any verification
or delivering an account which is false, is punishable u/s.277 for a term
ranging between 6 months to 7 years. In addition such a person is liable to
fine of an unspecified amount. This provision is not specifically made
independent of levy of penalty. The prosecution under clause (i) here (like
section 276C) is based on the quantum of the tax sought to be evaded. Hence in
cases where the assessee has included the income in the Return of Income and
paid tax thereon, there would not be any basis for initiating prosecution.
However, under cl. (ii) of section 277 a prosecution may still be possible for
the reason that the said clause permits the punishment independent of the
quantum of tax sought to be evaded. Needless to say that the burden of proof
for establishing the falsity of the statement, etc. shall always be on the
Revenue.

 Section 277A provides
for prosecuting a person who is found guilty of making an entry or a statement
which is false with the intent to enable other person to evade any tax, etc.
and on being proved guilty is liable for an imprisonment for a term ranging
between 3 months to 2 years. In addition, such a person is liable to fine of an
unspecified amount. This provision, unlike section 276C is not specifically
made independent of levy of penalty. Again the provision of section 277A is
related to the evasion of tax and in the absence of any evasion of tax, etc. in our opinion, the provisions might not apply unless the
Revenue establishes an evasion of tax by the other person.

Unlike section 276C, prosecution u/s. 277, 277A and 278 is
not specifically made without prejudice to levy of penalty. In the
circumstances, it may be possible to contend that a prosecution is not possible
in a case where no penalty is leviable under the Act. Please see the decision
of the Supreme Court in the case of K. C. Builders vs. ACIT, 265 ITR 562
(SC).

Abetting or inducing another person to make an account or a
statement or a declaration, relating to an income chargeable to tax, which is
false is liable for prosecution u/s.278 of the Act. Similarly, abetting a
person to commit an offense of willful evasion of tax, etc. u/s.276C is
also liable for prosecution u/s.278. In both the cases the punishment ranges
for a term of 6 months to 7 years. In addition such a person is liable to fine
of an unspecified amount. This provision, unlike section 276C is not
specifically made independent of levy of penalty. Once again the prosecution
under clause (i) here is based on the quantum of the tax sought to be evaded
and in cases where the assesse has included the income in the Return of Income
and paid tax thereon, in our opinion there would not be any basis for
initiating prosecution. However, under cl. (ii) of section 278 a prosecution
may still be possible for the reason that the said clause permits the
punishment independent of the quantum of tax sought to be evaded. Needless to say
that the burden of proof for establishing the falsity of the statement, etc.
shall always be on the Revenue. Section 138 protects a person for
confidentiality for the information declared in the Return of Income unless it
is in public interest to do so. Obviously, the protection here is not
comparable to the one available under IDS 1 and IDS 2.

Indirect tax laws and confidentiality: No immunity of
any nature is available under any of the other laws, including indirect tax
laws, in respect of the specified income. Neither is any special immunity
available for the confidentiality of the declaration other than the one
available u/s. 138 of the Income-tax Act.

MAT and High Denomination Notes: In case of a company,
the Income declared in the Return of Income for A.Y. 2017-18, representing the
demonetised currency, shall also be a part of the book profit and will be
subjected to MAT u/s. 115JB of the Act.

Enquiry and Investigations before filing Return of Income:
It is seen that the Income-tax Department has issued notices u/s.133(6) for
enquiring into the source of deposits of the High Denomination Notes and in
some cases have carried out survey action u/s.133A. A few cases of search and
seizure action u/s.132 have also been reported. In all such cases, the issue of
penalty u/s. 270A and for section 271AAC requires to be kept in mind. In
ordinary circumstances, concealment or misreporting is ascertained with
reference to the Return of Income unless there is a presumption running against
the assesse. In cases of an enquiry u/s.133(6) and survey u/s.133A, no such
presumption is available for the year of notice or action and, the liability to
penalty will be solely determined with reference to the income disclosed in the
Return of Income.