No penalty for changing income head

A recent court ruling says that penalty can't be imposed on income whose classification has been changed during the course of assessment

The Income Tax Act states clearly that if a taxpayer does not disclose part or whole of his income, or provides inaccurate details of his income in his returns, he can be penalised. The penalty can be a minimum of 100 per cent to from a maximum of 300 per cent of the tax unpaid. These have been changed in the latest Budget. Penalty will now be levied at 50 per cent in case of under-reporting of income or 200 per cent in case of misreporting. But what happens if a taxpayer's income classification changes during the course of assessment? Can a tax officer levy a penalty even in such cases?

Penalty despite full disclosure
In a recent case that came up in the Bombay High Court, the taxpayer had disclosed all the income particulars while filing returns. However, during the course of assessment the tax officer changed the classification of a certain income. This led to an increase in the total taxable income.

The taxpayer had declared his total income at Rs 9.69 lakh. In his return, he also showed Rs 1.62 crore as long-term capital gain on sale of shares and claimed exemption under Section 10(38) of the Act. This section provides that any long-term capital gain on sale of equity shares held for a period of more than 12 months shall be exempt from tax.

During the course of assessment, the taxpayer filed a revised return of income wherein the amount of Rs 1.62 crore was offered as taxable income. While concluding the assessment proceedings, the tax officer also initiated penalty proceedings for claiming incorrect exemption. He imposed a penalty of Rs 55.79 lakh on the taxpayer for having concealed particulars of income and for furnishing inaccurate particulars thereof.

The case escalates
The taxpayer filed an appeal against the penalty order at the first appellate level. He pleaded that the penalty ought to be deleted on the ground that the amount of Rs 1.62 crore had been declared as capital gain in the original return of income. The first appellate authority accepted the taxpayer's claim and deleted the penalty.

It observed that sufficient evidence to conclude that the said amount can be attributed to long-term capital gain was produced before it during the course of proceedings. The taxpayer had produced broker notes, copy of balance sheet, copy of demat account, evidence of payment for shares, etc in support of his claim.

Not happy with the result, the tax officer filed an appeal with the second appellate authority. At this level too, the authority ordered the deletion of penalty by the tax officer and observed that the taxpayer had disclosed the income of Rs 1.62 crore in his returns but had claimed the same to be exempt. It also observed that if during the course of assessment proceedings, the tax officer changes the head of income, that should not attract a penalty. The order also noted that the taxpayer had agreed to offer the amount of Rs 1.62 crore as business income instead of long-term capital gain during the course of survey proceedings only to buy peace.

The tax department further filed an appeal against this order with the Bombay High Court. The tax officer argued that a change in head of income during assessment proceedings should attract a penalty if it has an impact on tax payable.

The officer said that the entire income of Rs 1.62 crore was claimed as exempt income. Only after the assessment the taxpayer agreed to file it as business income, thereby attracting tax at the applicable slab rate. Relying on a Supreme Court decision, the tax officer pressed that the taxpayer's defence of offering income for taxation to buy peace and avoid litigation was not sound.

DON’T GET CAUGHT ON THE WRONG FOOT

• The first mantra to avoid a penalty is to make full disclosure of your income
• Maintain proper documentation that can back the disclosures you have made
• Sometimes, during the course of assessment, the head under which an income is placed can be reclassified by tax officials
• If a tax officer imposes a penalty on such reclassified income, the order is unlikely to be upheld by tribunals and courts
• With the recent Budget introducing penalties for under-reporting and misreporting, taxpayers need to be even more watchful, as the rules are more complex now

Landmark ruling in favour of taxpayer
The high court, while dismissing the tax officer's argument, held that the taxpayer was under the bonafide belief that income from long-term capital gain is exempt from tax and had accordingly disclosed the said amount as tax-free income in his return of income. The court observed that all the lower appellate authorities had consistently concluded that the taxpayer had not concealed his income or filed inaccurate particulars attributable to capital gain in his return of income. It, therefore, found no reason to interfere with their decisions. The high court hence dismissed the case.

This decision serves an excellent precedent for cases of penalty levied on taxpayers even when they have provided complete disclosure of facts in their return of income and backed it with proper documents and basis for opinion. In the case, the noteworthy fact is that the taxpayer was absolved from paying penalty even though the said income was recharacterised from tax-free to taxable.

Penalty provisions are widely contested as tax officers have been found to levy penalty on additions made to income on the basis of change of opinion or re-classification of heads of income. With the change introduced by Budget 2016, penalty provisions have only become more complex. Taxpayers need to keep track of their income sources and ensure proper disclosure in returns.

In fact, recently the Mumbai bench of the Income-Tax Appellate Tribunal (ITAT) dismissed a penalty levied by income-tax officials for 'concealment of income' in the hands of a salaried employee.

The employee had enlisted the service of an online tax-return filing portal. While filing the returns, the portal committed a punching error, which resulted in under-reporting of salary income in the taxpayer's I-T return. Tax official took the view that this was an attempt to conceal income and imposed a penalty on the taxpayer.

The ITAT examined the fact of the case and dismissed the penalty on the ground that the assessee had no malafide intent to evade tax or claim refunds dubiously.

The writer is founder of Arvind Rao and Associates