An earlier post highlighted the implications of the decision of the Supreme Court in Dharmendra Textiles (306 ITR) on penalty proceedings under the revenue laws, including the Income Tax Act. The Court there overruled its earlier decision in Dilip Shroff, and concluded that there is no requirement of mens rea in the case of penalty proceedings. Thus, it does not need to be shown that the assessee deliberately concealed income to avoid tax, as long as it is shown that some income escaped assessment.
This decision was widely perceived as being unduly harsh on assessees, by making penalty proceedings possible even in cases of innocent mistakes on the part of assessees. Not only did the decision mean that income inadvertently not declared by the assessee would result in penalty proceedings, but also resulted in the possibility that if deductions claimed by the assessee were subsequently disallowed, the amount of the disallowance would be subject to penalty. Given the complicated issues of law involved in the case of some deductions, this had the potential of resulting in grossly inequitable results.
It was this very issue that was considered recently by the Mumbai ITAT in ACIT v. VIP Industries. The case involved cross appeals from an order of the Commissioner of Income Tax (Appeals), the relevant one dealing with a deleted penalty. The assessee had claimed a 100% deduction for scientific research expenditure under section 35 of the Income Tax Act, and had included the cost of a car in the computing the amount of the deduction. The Assessing Officer had concluded that the car had not been used for scientific or research purposes, and thus disallowed the deduction to that extent. On this addition, a penalty had been imposed by him, which was deleted by the CIT(A).
In appeal before the ITAT, the Revenue placed reliance on the decision in Dharmendra Textiles, contending that penalty can be imposed even when income remains undisclosed without the conscious act of the assessee. However, the Tribunal rejected this contention, drawing a distinction between income which is not disclosed, and income which is declared to be tax-free. There are two ways in which the income declared by an assessee to be taxable can be lesser than that actually sought to be taxed by the AO. One is if the amount disclosed is lesser than the amount actually earned, and second is if the amount taxable is reduced by a deduction, which is subsequently disallowed. In the second case, the taxable income is increased not due to the discovery of undisclosed income, but because of a disallowed deduction. The Tribunal held that in such a case, since there is no ‘undisclosed’ income, the decision in Dharmendra Textiles could not be interpreted to require the imposition of a penalty.
While this part of the decision does seem to narrow the scope of Dharmendra Textiles, a closer reading also lends support to the possibility that this discussion of the Supreme Court decision is, in fact, obiter, and cannot really be said to be of much legal relevance. This is because in the portion of the judgment immediately preceding the discussion of Dharmendra Textiles, the tribunal examined in detail section 271 (dealing with penalty proceedings), and concluded that the explanation given by the assessee was sufficient for the purposes of section 271. Thus, even if the broad interpretation of Dharmendra Textiles was followed, it would have sufficed for the facts before the Tribunal. However, inspite of this red herring in the decision, the decision does provide a much needed rallying point for assessees seeking a way around the Apex Court dictum.