The Hindu Business Line : Offering ‘income’ to buy peace of mind

The dilemma of when and how to offer income where two views are possible will get sorted out if the law on levy of penalty is tightened and made clearer.

R. Anand

What constitutes “income” is an issue not fully settled by the courts in India. The definition of ‘income’ contained in Section 2(24) of the Income-Tax Act is illustrative and not exhaustive. It has undergone several changes/amendments from 1961 to date and still no clarity has emerged on its import with reference to various transactions.

Income tax is a tax on ‘income’ and is not meant to be a tax on anything else. A further twist to the tale is that there is also confusion as to in whose hand a particular receipt is to be taxed.

An interesting issue with peculiar set of facts and circumstances came up for consideration before the Mumbai Tribunal in Srikant G. Shah vs Income-tax officer (2008 300 ITR AT 324 Mumbai).

Facts, decision

The assessee received amounts from his clients in his capacity as a solicitor for discharging the obligations of the clients. He claimed that the amounts received were only in the nature of deposits held by him on behalf of the clients and to be utilised only for discharging the obligations of the clients.

A separate bank account was maintained in respect of such deposits. On these deposits, interest was credited by the bank on accrual basis. However, such interest was not declared by the assessee in the original returns of income filed by him and was not offered to tax.

Admittedly, tax at source was deducted by the bank on such interest income and the bank also issued tax deducted at source certificate in the name of the assessee. Even though the assessee had not disclosed the interest income in the returns of income, he claimed credit for the tax deducted at source.

In the reassessment proceedings the assessee claimed that relevant interest income, which accrued on the account of the clients, was not assessable in his hands but nevertheless such income was offered for tax conditionally to avoid litigation with the clear understanding that no penalty or interest would be levied.

On the basis of these returns, the assessing officer (AO) completed the assessment, wherein the relevant interest income as declared by the assessee was brought to tax. Penalty proceedings were initiated under Section 271(1)(c) and interest under Sections 234A, 234B and 234C was levied.

Aggrieved by these orders, the assessee filed appeals before the Commissioner (Appeals), disputing these interest incomes being added to his income, even though the assessee himself had declared these incomes in the returns of income filed in response to notices issued under Section 148.

The Commissioner (Appeals) held that the interest income was not assessable but since the assessee had suo motu disclosed the income and paid self-assessment tax thereon, the tax could not be refunded.

The matter reached the Tribunal and the Tribunal held that the interest income could not be assessed in the hands of the solicitor.

The Bench reasoned that the monies had been received by the assessee in his capacity as a solicitor by way of deposits and to be utilised for meeting obligations of the clients.

These monies were put in a separate bank account and the interest accruing on this bank account and the interest accruing on this bank account was also apportioned by the assessee as liability payable to the clients. The amount was not assessable in the hands of the assessee.

The Assessing Officer (AO) was directed to withdraw the credit in respect of tax deducted at source allowed to the assessee for all the assessment years.

In effect, though the interest in question was offered to tax in the return of income, the Tribunal concluded that on that plank alone it would not give rise to income.

Fiduciary capacity

The key issue here is the solicitor had kept this amount on behalf of the client in a fiduciary capacity and, most importantly, the interest accruing in this deposit was treated as a liability due to the client. In which case why did the assessee offer the said interest to tax in the return filed pursuant to the reassessment proceedings? Today, most assesses face a Hobson’s choice. How does one insure himself against any penalty for so-called concealment?

In the case, the wordings in the covering letter convey the intention beyond doubt. The letter reads thus:

“However, to buy peace of mind and to avoid litigation, I am offering this income for the above mentioned assessment years with clear understanding that no penalty proceedings under Section 271 (1) (c) of Income-tax Act 1961, will be initiated and/or levied and no prosecution under the Income-tax Act 1961, will initiated. Thus, this offer is a conditional offer. You will also waive interest leviable under Sections 234B and 234C of the Income-tax Act, 1961.”

The department’s stand purely from a layman’s point of view is: If the assessee is sure that the interest is not his income why should he offer the same in the return of income.

After all, the basis of assessment is the return of income and if that is to be ignored to determine the ultimate tax liability where does one start the process of assessment?

Right to receive income is the tested principle of taxability of income is the hands of the recipient. When this right becomes vested in the assessee, it is said to accrue or arise to him (CIT vs Ashokbhai Chimanbhai — 1965 56 ITR 42 SC).

In the above situation, the solicitor did not have any right to the source leave alone to the income from the source. The only catch was that he had, albeit, conditionally offered it as income in the return of income.

Borderline cases, of what is income and what should be claimed as a deduction, are often debated in professional circles. Should such items be offered to tax in the return of income itself or in the covering letter?

Often, strategy and the needs of the situation overcome provisions of law in such matters. While transparency is a virtue, sometimes laying all the cards on the table can also boomerang.

The wordings in the covering letter and the intention of offering the interest as income was made clear and probably helped in convincing the Tribunal on the matter.

The entire problem revolves around the discretionary nature of levy of penalty. If this part of the law is tightened and made clearer, the dilemma of when and how to offer income where two views are possible will get sorted out. Till such time the debate will go on.

(The author is Partner, Global Tax and Advisory Services, Ernst & Young.)