Vide notification no. S.O. 3407(E) dated November 8, 2016,
Ministry of Finance (Department of Economic Affairs) has declared that existing
series of the value of RS.500 and RS.1000 (referred to as specified bank notes)
shall cease to be legal tender.

Among other things, it has been mentioned that specified
bank notes are used for storage of unaccounted wealth , therefore, Central
Government after due consideration to the recommendations of Central Board of
Directors of RBI has decided to implement the recommendations of the Board.

Thus, Central Government declared that specified bank notes
shall cease to be legal tender with effect from 9 November 2016 to the extent
specified in the notification which includes submission of return by every
banking company showing details of specified bank notes and remitting the same
to the Currency chest or branch of RBI.

The specified bank notes held by a person other than banking
company, can be exchanged at any issue office of RBI, Public sector Bank,
Private sector bank, foreign banks, regional rural banks, etc. for a period up
to and including 30 December 2016 subject to certain conditions specified in
the notification such as ceiling of exchange of Rs. 4000 (which has since been
amended twice) and one time maximum deposit of Rs. 50000 where KYC is not available,
etc.

Thus, on and with effect from 9 November no person can
accept the tender of specified notes, except those exempted by the Government.
The fall out of such notification and further instructions issued by the
central government from time to time, is that except in the circumstances
prescribed, specified bank notes would not be legal tender and any person who
does not have opening cash in hand on 9 November 2016 shall not be entitled to
credit any cash in his books of account by way of specified bank notes and the
deposit of these specified bank notes into the bank account has to be limited
only to the opening cash in hand as on 9 November.

Here it will be relevant to refer some case law which may
help to contest the addition, if any, proposed to be made by the department
despite having sufficient opening cash balance as on 9 November.

(a) In Narendra G. Goradia v. Commissioner of Income Tax 234
ITR 571 (BOM), where high denomination notes were deposited in the bank it was
held that what the assessee is required to prove in such cases is the source of
money and once he is successful in proving the same, he cannot be put to
further proof of acquisition of such amount in the currency notes of particular
denomination. If the explanation shows that the receipt is not of income
nature, the revenue cannot reject the explanation of the assessee to hold that
it is income.

(b) In CIT V. Associated Transport Pvt. Ltd. 212 ITR 417
(CAL), in view of sufficient cash balance, the addition made on account of
deposit of high denomination notes was held to be rightly deleted.

(c) In Commissioner of Income-tax v. Laxmandas Bhatiya 217
ITR 878 (MP) on the issue of addition made in respect of high denomination
notes held it to be rightly deleted. “The apex court in Bat Velbai V. CIT
(1963) 49 ITR 130 held that the crux of the matter is to explain or establish
the source of the income or the receipt of money and not the source of receipt
of the high denomination currency notes. The fact remains that the cash balance
of the assessee was sufficient to cover the value of high denomination notes.
This was a finding of fact which is not perverse and as such it did not give
rise to any question of law. In view of this, the Tribunal rightly rejected the
application for reference.”

(d) In Lakshmi Rice Mills v. Commissioner of Income-tax 97
ITR 258 (PAT) it was held that “It is a fundamental principle governing the
taxation of any undisclosed income or secreted profits that the income or the
profits as such must find sufficient explanation at the hands of the assessee.
If the balance at hand on the relevant date is sufficient to cover the value of
the high denomination notes subsequently demonetised and even more, in the
absence of any finding that the books of account of the assessee were not
genuine, the source of income is well disclosed and it cannot amount to any
secreted profits within the meaning of the law. What has to be disclosed and
established is the source of the income or the receipt of money, not the source
of the receipt of the high denomination notes which were legal tender at the
relevant time”.

The time window permitted for deposit of specified notes
into one’s own account is fixed by the central government as 30 December.
Statements are being issued by the income tax department to say that in case
specified notes deposited by any person in his bank account are unexplained,
they shall entail penalty of 200 per cent of the tax payable on such amount in
addition to levy of tax by treating the same as unexplained income under the
provisions of section(s) 68/69 etc of Income Tax Act 1961 (Act).

This has created a fear in the minds of general public.
Questions are being asked of consultants as to what would happen if they
deposit the specified noted into their bank accounts and department treats it
as unexplained income and what would be the consequences regarding levy of
concealment penalty and what precautions can be taken to avoid those penal
consequences if a person is ready to bear the tax and wants to avoid payment of
any penalty. An attempt is made to explain and to remove the doubts prevailing
in the minds of such persons.

Unexplained cash credits, investments and expenditure, etc.
are assessable under section(s) 68, 69, 69A, 69B and 690 of the Act. More or
less, all these section enable the assessing officer to make an addition in
case of unexplained cash credits, investments, money, investments which are not
fully disclosed in their books of accounts, unexplained expenditure and amount
borrowed or repaid on hundi, The amount added under these sections is treated
as income from other sources. The specified notes deposited in one’s bank
account on or after 9 November, unless supported by opening cash in hand, can
be treated by AO as unexplained amount to be assessable under these sections.

The fallout of such treatment would entail levy of income
tax thereon as per section 115BBE of the Act which is 30 per cent and is equal
to maximum marginal rate and mode of computation is prescribed in that section.
It is also provided in section 115BBE of the Act that no deduction against such
income can be allowed as an expenditure or allowance and no set-off of any loss
shall be allowed. Thus, if any such amount is added to the income of the
assessee the gross amount of such deposit etc. would be taxed at 30 per cent
plus surcharge, etc. and against such assessed sum no deduction or set off
would be available.

It may also be mentioned that opening cash balance as on 8
November may be subject to scrutiny by the department and precautions should to
taken to the extent these can be taken with regard to source and quantum
thereof as principle of preponderance of probabilities is not unknown to the
department and are now well established by the decision of the Apex court in
the case of CIT Vs. P.Mohankala (2007) 291 ITR 0278(SC). However, in cases of
unexplained deposits on which tax is already paid at the rate prescribed in
section 115BBE of the Act, the AO cannot do anything extra under the existing
provisions of the Act as what the AO could have done is already done by the
assessee.

Now a question arises whether a person who has deposited the
specified notes in his bank account, is unable to explain to the satisfaction
of Income Tax Authorities and is ready to declare the same in his return of
income as income assessable u/s 68 or any other sections discussed above which
is assessable as income from ‘other sources’ and tax has been paid at the
maximum marginal rate with surcharge without claiming any deduction then
whether he will be liable for concealment penalty u/s 270A of the Act which is
applicable for the financial year 2016-17 and AY 2017-18. To discuss this
aspect it will be necessary to examine the scheme of section 270A.

Section (270A)  has 12
sub-sections. Sub-section (1) authorises the authorities described therein to
direct any person who has under-reported his income to pay penalty in addition
to tax on the unreported income. Sub-section(2) describes the circumstances
under which a person can be considered to have under-reported his income.

Sub-section (3) describes the manner and mode of computing
under-reported Income. Sub-sections (4), (5) and (6) describe a situation where
any person who is claiming that source of any receipt, deposit or investment is
an amount added to the income or deducted while computing loss in the
assessment of such person in any year prior to assessment year in which such
receipt, deposit or investment appears(referred to as preceding year) and no
penalty was levied for such preceding year then the under reported income shall
include such amount as sufficient to cover such receipt, deposit or investment
and sub-section 5 describes the order in which the amount of income
under-reported for the preceding year is liable for penalty.

The provisions of sub-section (4) are subject to provisions
of sub-section(6) which describes the exclusion of amounts from under-reported
income which are: i) where IT authorities are satisfied that the explanation
offered by the assessee is bonafide and the assessee has disclosed all the
material facts to substantiate the explanation offered; ii) the addition
subject to under-reported income is determined on the basis of estimate in
which accounts are correct and complete to the satisfaction of IT authorities
described therein but the method employed is such that income cannot properly
be deducted there from; iii)where under reported-income is determined on the
basis of estimate and the assessee has returned its income on its own estimate
and assessee has disclosed all the facts and material to arrive at such
estimate; iv) where under-reported income is according to ALP determined by TPO
and the assessee had maintained information and documents as per section 92D
and hasdeclared the international transaction under chapter X and has also
disclosed all the material facts relating to the transaction and v) the amount
of undisclosed income liable for penalty u/s 271MB (penalty in search cases.)

Sub-section (7) says that the penalty leviable on
un-reported income determined in manner specified in sub-section (2) to (6)
will be a sum equal to 50% of the amount of tax payable on un-reported income.

Sub-section (8)prescribes that nothing contained in
sub-section (6) and (7) would be applicable in a case where under-reported
income is in consequence of any misreporting thereof by any person then the
amount of penalty leviable would be equal to 200% of the amount of tax payable
on unreported income.

Sub-section (9) explains what would be the cases of
misreporting of income on which penalty would be leviable as per sub-section
(8) which are as under:

a) misrepresentation and suppression of facts

b) failure to record investments in the books of account;

c) claim of expenditure not substantiated by any evidence;

d) recording of any false entry in the books of account;

e) failure to record any receipt in books of account having
a bearing on total income; and

f) failure to report any international transaction or any
transaction deemed to be an international transaction or any specified domestic
transaction, to which the provisions of Chapter X apply.

Sub-section (10) defines “tax payable” for the purpose of
computation of penalty in respect of unreported income leviable at the rates
described in subsection (7) and (8).

Sub-section (11) describes that where any addition or
disallowance has already been formed the basis of imposition of penalty in same
or any other A Y then the said person shall not be liable to pay penalty again
on that amount.

Sub-section (12) describes that penalty under this section
shall be imposed by an order in writing.

A combined reading of section 270A will give broader picture
that amount liable for concealment penalty would be in two broad categories.
First category is un-reported income as determined in accordance with
sub-section (2) from where the amount described in sub-section (6) are to be
excluded. Second category is under-reported income which is in consequence of
any misreporting as described in sub-section 7. In any case, it is essential
that penalty can be levied only if there is existence of un-reported income as
per sub-section (2). In absence of un-reported income, penalty cannot be levied
even if it is misreporting of income.

The above position is clear from the reading of sub-section
(1) and sub-section (8). Sub-section (1) is an enabling provision for an income
tax authority described therein to levy penalty and it speaks of levy of
penalty only in case of any person “who has under-reported his income”.
Sub-section (8) which describes levy of higher rate of penalty @ 200% of the
tax payable on under reported income will be applicable if under-reported
income is in consequence of any misreporting thereof.

Therefore, these provisions make it amply clear that unless
there is under-reporting of income, misreporting in itself would not result in
levy of penalty under section 270A. Sub-section (2) describes the circumstances
in which a person can be considered to have under-reported his income,

(a) If his income assessed is greater than the income
determined in the return processed u/s 143(1 )(a). It is a case where return of
income has been filed.

(b) In case where no return has been furnished, the income
assessed is more than the maximum amount not chargeable to tax.

(c) In case of re-assessment, if income reassessed is more
than the Income assessed or reassessed immediately before reassessment.

(d) (e) and (f) relate to cases where income is assessable
under the provisions of section(s)115JB or 115JC.

(g) where income assessed or reassessed has the effect of
reducing the loss or converting such loss into income.

The sum and substance of sub-section (2) is that to hold
existence of underreported income, the assessed or reassessed income, as the
case may be, should be more than the income returned or assessed earlier to
that. Unless, in the cases of returned income, the income assessed or
reassessed is more than the income returned, no case of under-reporting can be
made out by the department.

In view of above discussion it would become clear that if
the deposit of specified notes are made by a person in his bank account and the
same has been returned in the income as income assessable under the head
“income from other sources” and on which income tax has been paid as per
provision of section 115BBE, than no penalty under section 270A would be
leviable on such deposit as there will be no under-reporting of the income in
accordance with provision of sub-section (2) of section 270A.

The writer is an Advocate and a former Member (Judicial) of
the Income Tax Appellate Tribunal.