Section 115BBE of Income Tax Act, 1961: Is Penal Taxation a hindrance to Resolution of Disputes?
“Income tax returns are the most imaginative fiction being written today.”
Herman Wouk 
Probably the aforementioned quote by the American author has never been as relatable as it is in today’s time-space passageway. Sadly though, the absence of integrity with respect to income tax has forced governments to take make stern amendments to their taxation policies. Similarly, in India, to dissuade non – taxpayers and to tax “deemed unexplained income”, the government of India through the Finance Act, 2012, inserted Section 115BBE to the Income Tax Act, 1961 (hereinafter “the act”).
There exist multiple mooting questions revolving around Section 115BBE of the act, including but not limited to the constitutionality and applicability of the section vis-à-vis Article 14 of the Constitution, retrospective or prospective applicability of the section and the reasoning thereof, the question of excessive taxation etc. While the presence of the aforementioned concerns has been hinted through the course of this paper, primarily the author has highlighted the role of section 115BBE in prevention of settlements of disputes. Additionally, each section of the paper highlights a distinct timeline post the formulation of section 115BBE of the act along with the major problems stemming after each legal development with respect to the said section of the act.
Section 115BBE and its Amendments
Under the said section, a plane tax rate of 30 percent was to be imposed on individuals who willingly revealed such income under sections 68, 69, 69A, 69B, 69C or 69D or on income as learned by the assessing officer (hereinafter “AO”). Furthermore, Section 115BBE (2) of the act states that no expenditure or allowance was to be deducted from said incomes underlining that the assessees will not be in a position to request any deduction in order to lessen the said income. Nonetheless, the government was not careful enough to forbid set off of losses against the said incomes.
With the aim to stiffen the hold of Section 115BBE of the act on deemed unexplained income, the government, through Finance Act, 2016, amended section 115BBE(2). Under the said amendment, it was stated that set off of losses was not allowed against the incomes concerned. While the government hoped for a favorable response from the said amendment, there existed a not-so-bright side to it: Few overenthusiastic officers initiated the practice of retrospective application, i.e., rejecting set off of losses for assessment years before the amendment came to being.
For instance, in Vijaya Resorts v. Commissioner of Income Tax, the income tax department had stated that set off of a loss from assessment year 2013-14 against unexplained income was inappropriate. When the said assessment order was challenged, the judiciary pointed out that the amended section 115BBE (2) would be applicable from the first day of the fourth month of year 2017, i.e., 01/04/2017 and not before that. Thus, the assessment order of the income tax department was quashed and Vijaya Resorts were permitted to adjust the unabsorbed losses as per section 68 of the act.
To deal with the concern of AOs applying varying methods when dealing with set off of losses, around mid – 2019, the authorities stated that before the 2016 amendment, section 115BBE did not clarify that losses wouldn’t be set off against deemed unexplained income and thus, the provision would be applicable after the prescribed date, i.e., 1st day of the 4th month of 2017 (01/04/2017). The said issue would have never occurred and the judiciary wouldn’t have to contemplate over it if the drafters had been more diligent and sensitive. Nevertheless, in the author’s opinion, here, a debate which could’ve taken much longer stretch was dispelled with little harm.
The Aftermath of Demonetization
Following a sudden ban on currency of high denomination, it was evidently clear that dishonest entities were implementing suspicious and illegal methods to change their unreported black money into white. While certain individuals got around the law and illegally bartered their share of banned currency for currency of legal denomination, there were others who simply deposited the money in banks as unexplained income and paid thirty percent as income tax. This left the concerned parties who had horded black money with a share which in the government’s eye was more than fair. As per the aforementioned mechanism, even in an extreme case wherein there was no explanation behind the said income, the payment of tax at the rate of thirty percent against the income prevented the taxation authorities from performing a supplementary inspection.
The government did not waste much time in putting the blocks together. It was accepted that the current statute aided in the suppression of illegally horded money. Another amendment was proposed by the union. The primary aim of this bill was to do away with the ambiguities to avoid abuse of the law. In order to tax the deemed unexplained income at a greater percentage and to garner a stricter fiscal disadvantage, the percentage of tax was raised from 30% to 60% and a surcharge of 25% thereon was generated along with relevant Cess. These tax rates were applicable to both the situations: Individuals coming forward with unexplained income or unexplained income found at the time of assessment. Additionally, through the aforementioned amendment act, section 271AAC was inserted in the act. According to this provision, a penalty of 10% of tax outstanding on unexplained income as determined by the officer was to be paid by the assesse.
Ergo, following this amendment, in case any individual comes forth in unexplained income out of her or his own accord, she or he would still be mandated to compensate at sixty percent as tax along with a twenty five percent surcharge. This hindered the famous option of crediting illegal money in the form of high denomination currency notes into banks, showing the amount as unexplained income, rendering tax at a mere thirty percent and have the leftover seventy percent for oneself.
Post the aforementioned amendment, there was a slight distinction betwixt incomes brought forward by individuals of their accord and income identified by the AOs under the concerned sections of the act. Primarily, the former was taxed at the rate of 77.25 percent (60 percent tax on unexplained income, 25 percent surcharge and cess) and the latter was taxed at the rate of 83.25 percent (60 percent tax on unexplained income, 25 percent surcharge, cess and 10 percent penalty under section 271AAC of the act).
Unfortunately and against the government’s aims, the amendment failed to make considerable changes to the ongoing situation as the assessees managed to locate different loopholes and illicit methods to exchange black money for white money at a commission.
Tragically, the aim of amending ambiguities was not fulfilled appropriately but the tax rates for unexplained incomes was amplified tremendously. Ergo, the amendment had little to do with the supposed misapplication of the act that the amendment originally aimed to cater. Interestingly, the said amendment was implemented from the Fiscal Year 2016-17, i.e., retrospectively. Ergo, the increased tax rates were implemented to dates before demonetization took place. The period from 1st April to 8th November was also covered under the act even though demonetisation had not taken place then.
Thus, unexplained income (whether brought forward suo motu or assessed by the AO) which had nothing to do with hordes of currency of high denominations were put under the radar of the amendment. This amendment encompassed all incomes whose explanations were declined by the AO. These incomes came to include, inter alia, loans and donations. Ergo, the said amendment was questionable and acted in an ex post facto manner.
The Conundrum of Backdating
The word of law mandates that any act along with all its amendments as on the 1st of April of the fiscal year will govern assessment during the said fiscal year. Moreover, all the amendments that are brought forth after 1st of April of the financial year will not be applicable to assessment performed during that year. For instance, in Karimthauvi v. State of Kerala, the apex court of the country reiterated the aforementioned statement.
Regardless of the afore-stated judgment, the concerned amendment act acted retroactively and was made applicable to fiscal year in which it was proposed and affirmed. While the authority of the parliament to alter the tax laws and make them applicable in a backdated manner is not unprecedented, yet the said act is in clear violation of the values inscribed in the judgment of Karimtharuvi v. State of Kerala. Remarkably, the rationality and legitimacy of the concerned amendment was also taken up before the judiciary. Later, the bench of Rajasthan High Court instructed the concerned authorities to not take any measures that might harm the petitioner.
Assessments and High Denomination Notes
As per the regulations, the 31/12/2019 was the penultimate date for the closure of inspection and assessments for the fiscal year 2016-17. This was the year when high denomination notes were banned and a timeline was prescribed to credit the currency in banks. The Income Tax Return forms forwarded by the Central Board of Direct Taxes mandated individuals with unsubstantiated currency to provide details of currency credited to the bank during the aforementioned deposit time – passageway. By early 2017, the CBDT initiated programs to assess currency deposits of hefty amounts which were made during the aforementioned period. Consequently, over 18,00,000 entities were recognized and notified that the cash deposited by them was not in proportion to tax paid by them.
Following the same, numerous actions were taken by the taxation authorities to smoothen the process. All the instructions made or notifications circulated had the common objective of aiding AOs to finish assessments and deal with the problems arising from the irregular credit of high denomination currency. But, as per public review, due to the sheer quantum of assessments have not been fair or procedural.
Miserably, assessments which were started after demonetization were hurriedly in 2019. A shared complaint has been that at times, legitimate explanations and proofs provided by the assessees to authenticate the credit of high denomination notes have been disallowed without apt reasoning. Surprisingly, the principle of audi alteram partem was also compromised in many of these cases. Moreover, in certain other cases, deposits of high denomination notes made before demonetisation were treated same as that made after the note ban. Furthermore, in other cases, individuals dealing with assessment of sums transferred in cash stated that they had already replicated the cash in their income tax return and had already paid tax against the same but their clarifications were disregarded and no modification was made to the tax levied by the AOs. This amounted to double taxation and the said individuals paid tax at the rate of 105 percent comically.
Inter alia, the aforesaid issues finding their genesis in section 115BBE of the act paved way for a series of legal disputes and made sure that the settlement of disputes took more time than necessary.
The subject matter was analyzed by the Madras High Court strikingly in the case of Salem Chit Fund v Deputy Commissioner of Income Tax. In this case, the chit fund company contested the assessment performed by the income tax department vis-à-vis the cash credited by the company post demonetization. The chit fund company filed a writ petition and the court passed an order stating that:
The administration is rapidly moving towards E – Governance. Thus, the practice of assessment has also shifted online. While the court appreciated the government’s motives and the highlighted the necessity to hasten government procedures, the court highlighted that lack of human interactions can guide to wrong assessments, especially if AOs did not go for in – person explanations. Later, the court underlined the importance of written clarifications before an AO treats a cash transaction as irregular.
As per the court, the chit fund company had undoubtedly shown that the assessment done by the income tax department through the AO has stemmed into an untasteful end. While the respondent was not entirely wrong as dealing with unexplained money was its job, the principles of law were not upheld and thus a distorted result was brought up. The court further stated that the income tax authority’s order to mandate tax payment under section 115BBE, while relying on the case law: Banerjee v. Commissioner of Income Tax, was incorrect.
The judiciary further clarified that as the assessment mechanism does not comprise of in – person communication and relies solely on records, the assessment, in the given case, should have begun earlier and the proceedings were late in the situation. It was underlined that appropriate amount of time should be devoted to each assessment in order to make sure the result derived is definitive and in line with the characteristics of the business concerned. Here, there existed a big gap between the filing of IT return and beginning of the assessment which resulted in lack of time.
Moreover, the judges stated that the assessment mechanism in certain situations, for the sake of fairness and justice, mandates adequate discussion and exchange of information betwixt the tax authorities, the AO and the assessee.
The problem of extraordinary numbers
Petitions have been made in various courts against the assessments performed by the income tax department vis-à-vis the money credited in banks right after demonetisation. Specifically, a major issue has been the fact the rate of tax and the surcharge does not distinguish betwixt the transactions made in the form of unsubstantiated cash deposits or other forms of unexplained incomes.
Moreover, the 60% tax rate and 25% surcharge is applicable on cash credited post demonetization or before that. In the author’s opinion, it is absurd to treat a high denomination currency cash deposit before demonetisation same as one made after it. Similar penal taxation does not make much sense as there is a much higher chance of the latter being induced by malice when compared to the former.
Interestingly, some of these appeals have also been made with the appellate tribunal. Understandably, the appellate tribunal cannot diverge into the questions of legitimacy, validity or constitutionality of the amendment act of 2016. Thus, following the black word of law, it makes sense for the appellate tribunal to determine that as the concerned incomes fall under section 68, 69, 69A, 69B, 69C or 69D of the act, the applicability of the amendment to time before demonetization is acceptable. Ergo, the appellate tribunal, in all probability, would state that tax mandated under section 115BBE of the act.
Hence, a party undergoing grievance due to application of section 115BBE for cash deposit made before demonetization could reach out to the High Court and contest the amendment or the application of the amendment, as was done in Deepak v. Union of India.
The Scheme of Damage Control?
The Budget for the financial year 2020-21 saw a declaration for settlement of direct tax disputes. This scheme was based on the indirect tax dispute resolution scheme. This scheme helped the government and the individuals to resolve around 1.9 lakh cases.
The statute had the poetic touch oft taken up by the Modi government to make laws catchier. The act was named Income Tax Vivad se Vishwas Act, 2020. As per this act, disagreements or quarrels betwixt private entities and income tax authorities could be resolved if they were undecided on Thirty First day of January of the year 2020 (30/01/2020). The most important reason behind the genesis of this act is the fact that the government aims to settle the innumerable income tax disputes pending across the country at various levels. The government plans to gain mammoth revenue through resolutions of multitudes of cases, many of which revolve around the conundrum of section 115BBE of the act.
The caught up revenue is so significant to the authorities that that the officers were notified that their operation and execution with regard to the Vivad se Vishwas Act, 2020 will be utilized while deciding officers’ upcoming postings and appointments.
On the whole, the Vivad se Vishwas Act, 2020 will primarily aid with the resolution of disputes wherein assessment was done after demonetization vis – a – vis unexplained incomes and extraordinary tax charges as per section 115BBE of the act.
Regardless, following this act, the focus shifts on a different tangent: Will the assessees go for a resolution under the act? Generally, legal clashes involving taxes operate on a little portion of the quantum of tax levied. Additionally, efforts, wealth and hours spent on a dispute could be lesser than what an assessee might spend while resolving or after resolving the clash.
In the author’s opinion, there are certain questions which must be taken into account to better assess the practicality of the Vivad se Vishwa Act, 2020:
1. How likely is the taxpayer to be victorious against the taxation authority?
2. How beneficial is it for the taxpayer to resolve the issue?
An individual will be less motivated to resolve a clash if she or he thinks that there exists a decent possibility of her or him emerging victorious against the income tax authority. Moreover, he or she is less likely to resolve if there is a belief that the advantage of resolving the dispute if smaller when compared to the one wherein he goes for the appeal.
On a flip side, in case the taxpayer thinks that the possibility to win the dispute is scarce, she or he might wish to resolve the clash and do away with excessive penalty or criminal action.
The statistics, however, tilt in the favour of assessee or the taxpayer. For instance and as had been witnessed in cases settled, with respect to cash deposits amounting to deemed unexplained income during the demonetization phase, few taxpayers got the opportunity to explain or reason with the authorities. Many explanations were unreasonably rejected at that particular time – period. In such cases, the taxpayer is expected to go for a confrontation and have the assessment dismissed altogether.
While the AOs might wish to resolve the disputes through the Vivad se Vishwas scheme, the taxpayer might still wish to follow the legal battle at the hint of a win instead of a settlement through the aforementioned act. Inappropriate conclusions while determining taxable income derived from incorrect assessments have little standing in a court of law. And, anybody forcing a settlement might just strengthen the possibility of a mistake on the AOs’ part.
Another issue with settlement under the said scheme is that as per section 2(1)(j) read with section 3 of the Vivad se Vishwas Act, 2020, the assessee is mandated to pay 77.25 percent of the disputed tax. Contrary to the indirect tax dispute resolution scheme wherein the taxpayer has to pay only 40 to 70 percent of the disputed tax, the Vivad se Vishwas scheme gives pennies on the dollar.
The current legal mechanism evolving from section 115BBE of the act under which the taxpayers have been charged ridiculously, any capable legal counsel is to advise against resolution through the Vivad se Vishwas scheme. There exists a pretty high possibility that the appellate tribunal would amend the mistakes by the AO. The lack of culpability of the AOs despite multiple mistakes along with the difficulty to handle explosion of litigation by the government is probably going to highlight an administrative fiasco.
Given the extraordinary rates of taxes, even a single transaction wrongfully treated a deemed unexplained income would lead to the taxpayer continuing with litigation. Clearly, all the disputes will be considered on a case to case basis prior to the choice between settlement and litigation. Nonetheless, in the author’s opinion, the possibility of resolution of disputes comprising of assessment orders revolving around section 115BBE, is pretty low. This is definitive because blunder mistakes made by the AOs or infringement of principles of natural justice are major grounds for the taxpayers to win a dispute.
As the paper suggests, most of the difficulties related to the subject matter arise with AOs incompetence or haste. Ergo, it wouldn’t be an understatement to say that the actual problem with tax law is the concerned administration. As the government has failed to keep far – sighted goals, the country has recently witnessed amendments followed by further amendments for the sole purpose of “expressing the motive” of the previous laws. Section 115BBE, in the author’s opinion, is a classic example of inept drafting resulting in calling for explanations in the form of amendments.
Moreover, while the promotion of resolution of disputes by Vivad se Vishwas scheme and determining future postings by officer’s performance on the same is a step further for the government, getting the other side to the table needs to be deliberated upon. The government can mandate all pending disputes under the scheme but it will be of little avail as the actual issues rest in fortification. Appropriate penal taxation statutes, dedicated administration and implementation are prerequisites for any taxation system to prevail. Unfortunately, the trio isn’t to be found in the country as of today.
“Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism but peace, easy taxes, and a tolerable administration of justice: all the rest being brought about by the natural course of things.”
 Herman Wouk was an American author.
 The Income – Tax Act, 1961, § 68.
 The Income – Tax Act, 1961, § 69.
 The Income – Tax Act, 1961, § 69A.
 The Income – Tax Act, 1961, § 69B.
 The Income – Tax Act, 1961, § 69C.
 The Income – Tax Act, 1961, § 69D.
 The Income – Tax Act, 1961, § 115BBE (2).
 Ajay Kumar Srivastava, Understanding Applicability of Section 115BBE, December 09, 2019, available at https://taxguru.in/income-tax/understanding-applicability-section-115bbe.html (Last visited on February 19, 2021).
 The Finance Act, 2016.
 Shravan Belsare & Jinisha Motwani, Section 115BBE of Income Tax Act, 1961: Constitutional Validity, 2019 IJTL (Volume V).
 Vijaya Resorts v. Commissioner of Income Tax, CIT  419 ITR 322 (Ker.).
 The Income – Tax Act, 1961, § 68.
 Assistant Commissioner of Income Tax v. Bairathi Gems,  166 ITD 445 (Jaipur).
 Famina Knit v. Assistant Commissioner of Income Tax, , 176 ITD 246 (Chandigarh).
 Ministry of Finance, General Circular No. 11/ 2019 (Issued on June 19, 2019).
 Sudhir Mehta, Whether amended section 115BBE of Income Tax Act applicable retrospectively or prospectively?, October 29, 2020, available at https://taxguru.in/income-tax/amended-section-115bbe-income-tax-act-applicable-retrospectively-prospectively.html (Last visited on February 19, 2021).
 Livemint, Demonetisation and the fight against corruption, November 8, 2017, available at https://www.livemint.com/Opinion/sH5FSnXPkuAhknhzuPgH3M/Demonetisation-and-the-fight-against-black-money.html (Last visited on February 19, 2021).
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 Taxation Laws (Second Amendment) Bill, 2016.
 The Income – Tax Act, 1961, § 271AAC.
 Rahul Sarda, Section 115BBE and Demonetisation: Penal Taxation Impeding Settling of Disputes, available at https://itatonline.org/articles_new/section-115bbe-and-demonetisation-penal-taxation-impeding-settling-of-disputes/ (Last visited on February 19, 2021).
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 Karimthauvi v. State of Kerala,  60 ITR 262 (SC).
 The Taxation Laws (Second Amendment) Act, 2016.
 Supra Footnote 28.
 Deepak v. Union of India, Civil Writ Petition No. 3625/ 2020.
 Press Release, Press Information Bureau, January 31, 2017.
 Press Release, Reserve Bank of India, December 4, 2020.
 Supra Footnote 24.
 Mukesh Kabra, Analysis of Income Tax Assessment of demonetisation cases, January 19, 2020, available at https://taxguru.in/income-tax/income-tax-assessment-demonetisation-cases.html (Last visited on February 19, 2020).
 Salem Chit Fund v Deputy Commissioner of Income Tax,  114 taxmann.com 492 (Mad.).
 Banerjee v. Commissioner of Income Tax, 1964 AIR SC 697.
 Supra Footnote 11.
 Supra Footnote 31.
 Source: The Budget Speech for fiscal year 2020-21.
 Income Tax Vivad se Vishwas Act, 2020.
 Supra Footnote 43.
 Mayank Mohanka, Remembering Demonetisation on its Fourth Birth Anniversary!!!, November 8, 2020, available at https://taxguru.in/income-tax/operation-clean-money-ocm-demonetisation-cases-vivad-se-vishwas-scheme-2020.html.
 Source: India‘s Annual Economic Survey – 2018.
 Adam Smith was a Scottish Economist & Philosopher.