Background

The provisions of section 271(1)(c) of the Income-tax Act, 1961 (“the Act”) states that penalty shall be levied in case a person either “conceals the particulars of his income” or “furnishes inaccurate particulars of his income”.  Further, as a general practice, the reason for initiation of penalty proceedings should be clearly mentioned in the notice issued under section 271(1)(c) read with section 274 of the Act.  However, the tax officers in some cases either do not mention the reason for initiation of penalty proceedings or do not strike off the inappropriate reason.  Taxpayers contest such notices and request for annulling such notices and consequently request for annulling of penalty proceedings. 

Rulings on this aspect

The Karnataka High Court (“KHC”) in the case of CIT vs Manjunatha Cotton and Ginning Factory [TS-936-HC-2012(KAR)-O] had held that the notice under section 274 read with section 271(1)(c) of the Act need not explicitly mention the reason for initiation of penalty proceedings.  The KHC had held that if, during the course of the assessment proceedings, the tax officer has applied his mind and has recorded his satisfaction that the taxpayer has either concealed particulars of his income or furnished inaccurate particulars of income, non-mentioning of the specific reasons in the notice issued under section 274 of the Act for initiating the penalty proceedings will not vitiate the penalty levy under section 271(1)(c) of the Act.  In the case before the KHC, since such reasons were neither mentioned in the penalty initiation notice nor were clearly discernible from the assessment order where the taxable income was enhanced, the penalty levy was deleted for want of application of mind by the tax officer.  Revenue’s appeal against this KHC judgment before the Supreme Court came to be summarily rejected. 

The KHC had also noted the amendment to section 271 introduced by the Finance Act, 2008 (by way of introduction of sub-section (1B) to section 271) with retroactive effect from April 1, 1989.  As per this amendment, where there are certain additions made to the taxable income by the tax officer in the assessment order and if the assessment order contains a direction for initiation of penalty proceedings, then it will be deemed that the tax officer has recorded a satisfaction that it was a fit case for levy of penalty.  The KHC had interpreted the phrase “direction” in the context of this amendment and had held that a “direction” means that there should be a reasoned statement for directing levy of penalty and a mere statement of the tax officer in the assessment order to the effect that “penalty proceedings are being initiated separately” in the assessment order would not suffice the requirements of being a “direction”. 

The Bangalore bench of Income-tax Appellate Tribunal (“ITAT”) in a recent decision in the case of Jaysons Infrastructure India Private Limited vs ITO [TS-5873-ITAT-2017(BANGALORE)-O] had an opportunity to examine this aspect.  The taxpayer in the instant case filed nil return of income after claiming deduction under section 80-IA of the Act on certain infrastructure development income.  During the course of assessment proceedings and survey it was observed that the taxpayer was not rendering services covered under section 80-IA of the Act and therefore, the entire claim made was false.  This fact was admitted by the Director of the taxpayer company as well.  Based on this finding, the tax officer stated in the assessment order that “in view of the facts discussed above….penalty proceedings under section 271(1)(c)of the Act are initiated for furnishing inaccurate particulars of income”….  The tax officer consequently issued a notice under section 274 read with section 271(1)(c) of the Act but the reason for initiation of penalty proceedings was not clear.  Based on this the taxpayer did not respond to the penalty notice and tax officer levied a penalty of 100 percent of the tax amount.  Aggrieved by the penalty order, the taxpayer challenged the validity of the penalty order before the Commissioner of Income-tax (Appeals) [“CIT(A)”].  After placing reliance on the decision of the KHC in the case of CIT vs Manjunatha Cotton and Ginning Factory (supra), the CIT(A) ruled in favour of the revenue.  The CIT(A) mentioned that the tax officer had recorded the satisfaction in Pages 2 and 3 of the assessment order and initiated penalty proceedings for furnishing inaccurate particulars of income.  Accordingly, the penalty proceedings are valid.  Aggrieved, the taxpayer filed an appeal before the ITAT.  The ITAT after going through the facts of the case observed that the taxpayer had deliberately furnished inaccurate particulars of income and accepted the same during the course of the survey and was a fit case for initiation of penalty proceedings.  Also, it held that since the assessment order clearly mentioned the reason for initiation of penalty proceedings, not mentioning the reason in the penalty notice should not cause any prejudice to the taxpayer.  Therefore, it was held that the requirements of section 271(1)(c), as discussed by the KHC, were complied with in this case. 

The Mumbai bench of ITAT in a recent decision in the case of Mahesh M Gandhi vs ACIT [TS-5465-ITAT-2017(MUMBAI)-O] also dealt with this aspect.  The taxpayer had not offered Director’s fees and income from short term capital gains to tax in the return of income.  During the course of assessment proceedings when these incomes were picked up by the tax officer, the taxpayer admitted earning of the incomes and filed a revised computation of income.  Based on this finding, the tax officer mentioned in the assessment order that penalty proceedings under section 271(1)(c) of the Act will be initiated for furnishing of inaccurate particulars of income.  Subsequently the tax officer issued a notice under section 274 read with section 271(1)(c) of the Act wherein the reason for penalty was not mentioned.  The taxpayer filed an appeal before the CIT(A) which ruled in favour of the revenue.  The CIT(A) placed reliance on the decision of the KHC in the case of CIT vs Manjunatha Cotton and Ginning Factory (supra), the CIT(A) ruled in favour of the revenue.  Aggrieved the taxpayer preferred an appeal before the ITAT.  The ITAT after observing the facts of the case held that the tax officer had recorded satisfaction in the assessment order in relation to invoking penalty provisions.  The tax officer had applied his mind while detailing the reasons for initiation of penalty proceedings in the assessment order.  Accordingly, not mentioning the reasons in the penalty notice cannot invalidate the penalty proceedings. 

Conclusion

The above two ITAT rulings seem to be correct in light of the KHC judgment.  Considering the fact that the Supreme Court did not admit the appeal against the decision of the KHC in the case of CIT vs Manjunatha Cotton and Ginning Factory (supra), it can be stated that the law, as laid down by the KHC judgment, is clear on penalty proceedings under section 271(1)(c).  Mere fact that the penalty notice does not mention the reason for initiation of penalty proceedings cannot be a reason for invalidating the penalty proceedings, if the reasons for initiating the penalty are discernible from the assessment order.  If, based on a reading of the assessment order, one can say that the tax officer has come to a satisfaction that penalty proceedings are to be initiated, then it is sufficient enough compliance so as to not invalidate the penalty initiation for want of mentioning of specific reasons in the penalty notice.  Care should be taken to read the assessment order and penalty notice in conjunction while deciding whether a request should be made to invalidate penalty proceedings. 

It is notable that the penalty levy mechanism has undergone a substantive change with effect from Assessment Year 2017-18 and a new section 270A applies for levying penalty in cases of underreporting (50% of tax) and misreporting (200% of tax), as spelt out in the section.  Notably, section 270A(1) also requires the tax officer or the CIT(A) or CIT to give directions for levy of penalty in the principal proceedings, which gives rise to the penalty levy.  Therefore, the amendments made in section 271(1B) of the Act in so far as giving “directions” for penalty also finds place in the new penalty code, viz, section 270A of the Act.  In such a case, the principles of what is a “direction” and the requirements of recording of satisfaction in the principal proceedings necessitating a penalty levy, as spelt out by the KHC, will equally apply.  This requirement of “application of mind” is all the more important for levy of penalty under section 270A for the reason that an addition made to the taxable income in the assessment proceedings will not automatically constitute “underreporting” if the assesse has offered a bonafide explanation and disclosed all material facts in relation to the addition and the tax officer is satisfied with the said explanation and disclosures.