Legal implications of deposit of Specified Bank Notes (SBNs) vis-à-vis Section 69A of the Income-tax Act, 1961
It has been considerable time since the demonetization of the earlier bank notes of denomination Rs.1,000/- and Rs.5,000/-, also referred to as the Specified Bank Notes (SBNs) was implemented by the Central Government by notification in the Official Gazette, pursuant to which instructions were issued by the Reserve Bank of India to the banks, but the event continues to be subject to scrutiny through the lens as the consequences of the event continue to be relevant till date. The events that followed have been the subject matter of extensive debate and discussion across the country, and beyond over the ensuing years. Though the ramifications of this arguably historic event are manifold, this article seeks to examine the legal implications, from a tax perspective, of transactions in Specified Bank Notes effected during the period intervening between the date of the gazette notification and the date after which the holding, receipt and transferring of such SBNs became altogether prohibited by operation of law. In particular, this exercise is aimed at understanding the applicability of Sec.69A of the Income-tax Act, 1961 dealing with Unexplained Money on such transactions.
The demonetization of Specified Bank Notes (SBNs) was implemented by the Central Government during the FY 2016-17, i.e. relevant to the Assessment Year 2017-18. In the year that followed, a number of cases were selected for scrutiny assessment by the issuance of notices under Sec.143(2) of the Income-tax Act, predominantly on the basis of information gathered during the Operation Clean Money (OCM) drive launched by the Income-tax Department for verification of large cash deposits made during the demonetization period. Such assessments in most cases culminated in orders under Sec.143(3) being framed wherein, presumably for lack of any other provision under the Income-tax Act to which recourse could be had, additions in respect of deposits of SBNs during the demonetization period were perfunctorily made by the assessing officers under Sec.69A of the Act as Unexplained Money, and brought to tax under Sec.115BBE, notwithstanding that in most cases, the essential ingredients for the invoking of Sec.69A, as expounded by various Courts, were conspicuously absent. Understandably, these assessment orders have been challenged in appeal across the country and are pending adjudication at various forums.
In terms of Gazette Notification No.2652 dated 08-11-2016 issued by the Government of India, bank notes of denominations of the existing series of the value of five hundred rupees and one thousand rupees, (hereinafter referred to as Specified Bank Notes) ceased to be legal tender to the extent specified in the Notification with effect from 09-11-2016. In terms of clause (2) of the said notification, the specified bank notes were permitted to be exchanged at any Issue Office of the Reserve Bank or any branch of a banking company, co-operative bank, corresponding new bank, subsidiary bank, regional rural bank and the State Bank of India as defined under the Banking Regulation Act, 1949 (10 of 1949) (hereinafter referred to as ‘banking company’ or ‘bank’), subject to certain conditions and limits that were specified in the said notification. New series of bank notes were thereafter issued and bank branches were designated as the primary agencies through which the members of public and other entities could exchange the Specified Bank Notes for Bank Notes in other valid denominations or depositing the Specified Bank Notes for crediting to their accounts, up to and including 30-12-2016. The said notification was issued by the Central Government in exercise of the powers conferred on it by the provisions of Sec.26(2) of the Reserve Bank of India Act, 1931 (“the RBI Act”) which reads as follows:
“(2) On recommendation of the Central Board the [Central Government] may, by notification in the Gazette of India, declare that, with effect from such date as may be specified in the notification, any series of bank notes of any denomination shall cease to be legal tender [save at such office or agency of the Bank and to such extent as may be specified in the notification]”
Pursuant to the said Gazette Notification issued by the Central Government, the Reserve Bank of India issued instructions to the Public Sector Banks/ Private Sector Banks / Foreign Banks/ Regional Rural Banks / Urban Cooperative Banks/ State Cooperative Banks vide Circular No.DCM (Plg) No.1226/10.27.00/2016-17 dated 08-11-2016 to give effect to the GOI Notification.
Thereafter, on 27-02-2017, Parliament enacted the Specified Bank Notes (Cessation of Liabilities) Act, 2017 which was deemed to have come into force on 31-12-2016. In terms of Sec.3 of the said Act, the specified bank notes which had ceased to be legal tender, in view of the Gazette Notification dated 08-11-2016 issued by the Government of India, would cease to be liabilities of the Reserve Bank under section 34 of the RBI Act and would further cease to have the guarantee of the Central Government under sub-section (1) of section 26 of the RBI Act on and from the appointed day, which was defined therein to be 31-12-2016. Sec.5 of the Act further prohibited any person from knowingly or voluntarily, holding, transferring or receiving and Specified Bank Notes on and from 31-12-2016, subject to certain exceptions.
It may therefore be understood that the Specified Bank Notes continued to be in circulation till 30-12-2016 for limited purposes, albeit without having the character of legal tender, but the holding, or transacting, receiving, transferring of such notes became illegal only on 31-12-2016. To understand the legality of accepting demonetized currency or Specified Bank Notes (SBNs) after 08-11-2016 but before 31-12-2016, we may do well to understand the concept of “legal tender”. “Legal tender” is not defined in the RBI Act or related legislations. “Legal tender” in common parlance may be understood to refer to money that may lawfully be used in settlement of debts or is a valid medium of payment recognized by law. “Tender” on the other hand is an offer duly made by one person to another of money, or the like, in discharge of a debt or a liability which fulfils the terms of the law and of the liability. A tender of a sum of money by a debtor and its acceptance by the creditor constitutes payment, thereby discharging the debtor from the debt and other obligations. The legal tender character of banknotes issued by the Reserve Bank of India is by virtue of the provisions of Sec.26(1) of the RBI Act, which reads as follows:
“(1) Subject to the provisions of sub-section (2), every bank note shall be legal tender at any place in [India] in payment or on account for the amount expressed therein and shall be guaranteed by the [Central Government].”
It is this legal tender character of the bank notes that was abrogated by the issuance of the notification by the Central Government in exercise of the powers conferred on it. Upon such abrogation, the notes ceased to be legal tender, but the Reserve Bank continued to be liable in respect of the Specified Bank Notes as Section 34 of the RBI Act continued to be in force. Accordingly, banks were allowed to accept such SBNs in the manner prescribed under the notification. The bank notes also continued to be guaranteed by the Central Government under Sec. 26(1) of the RBI Act. It was only upon the enactment of the Specified Bank Notes (Cessation of Liabilities) Act, 2017 and in terms of Sec. 3 thereof that there was a cessation of such liability and guarantee on and from the appointed date, i.e. 31-12-2016 in respect of the Specified Bank Notes. There was, however, no bar on the holding, receiving or transferring of the Specified Bank Notes till such enactment, as is evidenced by Sec.5 of the Specified Bank Notes (Cessation of Liabilities) Act, 2017, which on and from the appointed date, i.e. 31-12-2016, prohibited any person from knowingly or voluntarily, holding, transferring or receiving any Specified Bank Notes.
To better understand the legal implications of the manner in which demonetization was implemented and to draw a distinction between the ramifications of the Specified Bank Notes ceasing to be legal tender as opposed to the holding, receiving and transferring of such bank notes being prohibited altogether, we would do well to briefly advert to the earlier instances of demonetization during the years 1946 and 1978. On 12-01-1946, the High Denomination Bank Notes (Demonetization) Ordinance, 1946 was promulgated by the then Viceroy and Governor General of British India to provide for the demonetization of certain high denomination bank notes, to take effect immediately. Such ordinance provided that such high denomination notes would cease to be legal tender with immediate effect and also prohibited the receipt and transfer of such demonetized currency with immediate effect, as is evidenced by Sec.3 and Sec.4 of the said Ordinance which are extracted hereunder:
3) High Demonetization notes to cease to be legal tender: On the expiry of the 12th day of January 1946 of high demonetization bank notes shall, notwithstanding anything contained in Section 26 of the Reserve Bank of India Act, 1934 (11 of 1934) cease to be legal tender in payment or on account at any place in British India.
4) Prohibition of transfer and receipt of high demonetization bank notes: Save as provided by or under this ordinance, no person shall after the 12th day of January 1946 transferred to the possession of another person to receive into his possession from another person in high demonetization bank note.
It may therefore be noted that, in contrast to the demonetization of 2016, where the Specified Bank Notes merely ceased to be legal tender on and from 09-11-2016, but the prohibition on holding, receiving and transferring of such notes was deferred to 31-12-2016 onwards, under the 1946 Ordinance the cessation of the legal tender character of such notes and the prohibition on the transferring and receiving of the demonetized bank notes were enforced simultaneously and with immediate effect. Also apropos is the High Denomination Bank Notes (Demonetization) Act, 1978 which was enacted by Parliament 30th March, 1978 but was deemed to have come into force on 16th January, 1978 which contained identical provisions that provided for the cessation of the legal tender character of the demonetized bank notes and the prohibition on receipt and transfer of such notes. Section 3 and 4 of the High Denomination Bank Notes (Demonetization) Act, 1978 are extracted hereunder:
3. High denomination bank notes to cease to be legal tender.—On the expiry of the 16th day of January, 1978, all high denomination bank notes shall, notwithstanding anything contained in section 26 of the Reserve Bank of India Act, 1934 (2 of 1934), cease to be legal tender in payment or on account at any place.
4. Prohibition of transfer and receipt of high denomination bank notes.—Save as provided by or under this Act, no person shall, after the 16th day of January, 1978, transfer to the possession of another person or receive into his possession from another person any high denomination banknote.
The manner of implementation of the demonetization exercise is similar in the earlier two instances and therefore distinction between the earlier instances of demonetization and demonetization of 2016, and its implications need to be understood. The predominant difference is that unlike in the earlier instances, there was no prohibition on the holding or receiving or transferring of the demonetized currency with immediate effect and such prohibition was deferred till the appointed day under the Specified Bank Notes (Cessation of Liabilities) Act, 2017, i.e. 31-12-2016. This is further evident from the tone of the GOI gazette notification dated 08-11-2016, particularly paragraph (2) thereof, which is extracted hereunder (emphasis supplied):
2. The specified bank notes held by a person other than a banking company referred to in sub-paragraph (1) of paragraph 1 or Government Treasury may be exchanged at any Issue Office of the Reserve Bank or any branch bank referred to in sub-paragraph (1) of paragraph for a period up to and including the 30th December, 2016, subject to the following conditions, namely:—
The words “may be exchanged” used in the notification further indicate that there was no prohibition on transfer, and that the citizens were provided with the facility of exchanging the Specified Bank Notes, depositing them with banks, etc. The significance of transactions of transfer or acceptance of the specified bank notes after 8th November, 2016 but before 31-12-2016, therefore need to be understood. Upon the cessation of the legal character of the specified bank notes by virtue of the notification issued by the Central Government, the said specified bank notes were reduced to mere scraps of paper and therefore any transaction using such specified bank notes could not be said to be a payment but could only be regarded as barter. The recipient of such bank notes was entitled to deposit such specified bank notes into his bank accounts and therefore the receipt of such bank notes could be journalized in his books of accounts at a value that he would stand to derive upon deposit of such bank notes and into his bank account. In the absence of any prohibition on the receipt or transfer of such specified bank notes, the transaction of receipt cannot be assailed or tainted with illegality up to 31-12-2016. What therefore follows is that such specified bank notes could be accepted by a person in discharge of a debt and accordingly recorded in his books of accounts. It must also not be lost sight of that as the specified bank notes continued to be the liability of the Reserve Bank of India u/s. 34 of the RBI Act and carried the guarantee of the Central Government u/s. 26(1) of the RBI Act, the said specified bank notes carried value on the basis of which any transaction in the said Specified Bank Notes even after 08-11-2016 but before 31-12-2016 could be duly recorded in the books of the payer and the recipient. Assuming free consent, lawful object, competence of the contracting parties, and the fact that the consideration is lawful (not being declared as unlawful prohibited under any law), the requirements of Section 10 of the Indian Contract Act, 1872 are also met.
Consequently, there could have been no occasion for the Income-tax Department to contend that such acceptance and subsequent deposits of Specified Bank Notes during demonetization were illegal or unauthorized, and in any case could constitute no ground for invoking the provisions of Sec.69A of the Income-tax Act. In a case where books of accounts are maintained by the assessee, and such acceptance of SBNs are duly recorded therein, there could be no application of Sec.69A, as has been eminently upheld by decisions of various courts. The following decisions are relevant in this regard:
i) Chandigarh Bench of the ITAT in the case of M/s. Bhagwati Motors Vs. ITO (ITA No. 1084/CHD/2008)
ii) Ahmedabad Bench of the Income Tax Appellate Tribunal in the case of (ITO Vs. Nagardas Jashraj- 28 ITD 386 Ahd)
iii) Hon’ble Calcutta High Court in the case of Kantilal Chandulal & Co., Vs. Commissioner of Income Tax (136 ITR 889 (Cal))
iv) Mumbai Bench of the Income Tax Appellate Tribunal in Deputy Commissioner of Income Tax Vs. M/s. Karthik Construction Co., (ITA No. 2292/Mum./2016 and Income Tax Officer Vs. Shri. Parvez Mohammed Hussain Ghaswala in ITA 3318/Mum./2013)
To sum up, depending on the facts and circumstances of each case, a view may be taken that there was no bar to accept Specified Bank Notes during the demonetization period, so long as such receipts were duly recorded in the books of accounts of the taxpayer, and Sec.69A of the Act dealing with unexplained money could have no application. An authoritative judicial pronouncement expounding this view could go a long way in settling many tax disputes on this said issue which are pending at various forums.