Taxation of Unexplained Incomes

Background

To begin with, the unexplained income simply means any income for which assessee do not have valid explanation about the nature and / or source or the assessing officer is not satisfied with the explanation provided by the assessee.

Under the provisions of Income-tax Act, 1961 (the Act) broadly, the term ‘unexplained income’ is dealt with sections 68, 69, 69A, 69B, 69C and 69D as under.

As per the aforesaid sections, these amounts of unexplained income are by a fiction of law to be charged to income-tax as income of the assessee of the previous year in which the credit is reflected, investment is made or expenditure incurred. Accordingly, one could take a position that these amounts would be part of total income of the assessee and would be taxed at the rate applicable to the taxpayer or depending on its legal status. As a consequence, in case of individuals, HUF, etc., no tax was levied up to the basic exemption limit and even if such income was higher than basic exemption limit, it was getting taxed at the lower slab rate. Also, that expenditure incurred, if any, would be deductible and the losses for the year would be set off against such income.

The “White Paper on Black Money” presented in the Parliament on 16^th May 2012 was, inter-alia, concerned with the laundering of unaccounted money by taking advantage of basic exemption limit. Hence in order to curb this escape, section 115BBE has been introduced.

Object and purpose

The above stated position of taxing income of the nature referred to in the specified sections at the normal rate / applicable rate of income-tax on the total income of the assessee has been changed with effect from Assessment Year (AY) 2013-14. The Finance Minister in his budget speech, while introducing the Finance Bill, 2012 on 16^th March 2012, said as under:

“I propose a series of measures to deter the generation and use of unaccounted money. To this end, I propose ……….Taxation of unexplained money, credits, investments, expenditures, etc., at the highest rate of 30 per cent irrespective of the slab of income.“

Further, the reason and purpose of the provision of section 115BBE was explained by the Memorandum to the Finance Bill, 2012 as under:

“1) Under the existing provisions of the Income-tax Act, certain unexplained amounts are deemed as income under section 68, section 69, section 69A, section 69B, section 69C and section 69D of the Act and are subject to tax as per the tax rate applicable to the assessee. In case of individuals, HUF, etc., no tax is levied up to the basic exemption limit. Therefore, in these cases, no tax can be levied on these deemed income if the amount of such deemed income is less than the amount of basic exemption limit and even if it is higher, it is levied at the lower slab rate.

 2) In order to curb the practice of laundering of unaccounted money by taking advantage of basic exemption limit, it is proposed to tax the unexplained credits, money, investment, expenditure, etc., which has been deemed as income under section 68, section 69, section 69A, section 69B, section 69C or section 69D, at the rate of 30% (plus surcharge and cess as applicable). It is also proposed to provide that no deduction in respect of any expenditure or allowance shall be allowed to the assessee under any provision of the Act in computing deemed income under the said sections. This amendment will take effect from 1st April, 2013 and will, accordingly, apply in relation to the assessment year 2013-14 and subsequent assessment years.”

Thus, section 115BBE is designed to impose greater tax burden on the assessees who fail to explain the “nature and source” of their income, investments, expenses, etc. However, the substantive law dealing with provisions of sections 68, 69, 69A, 69B, 69C and 69D is unchanged and only the taxation mechanism on such unexplained income has been changed.

Accordingly, the Finance Act, 2012 has introduced the new section 115BBE to provide for the special rate of tax which will be applicable to income of the nature referred to in sections 68, 69, 69A, 69B, 69C and 69D.

The section has since its introduction by the Finance Act, 2012 w.e.f. AY 2013-14 been amended three times. The common point is that all three amendments are introduced at different point in times but all three amendments are applicable from AY 2017-18 onwards. Accordingly, the taxability as provided by section 115BBE gets divided in two parts as under.

• Taxability of undisclosed income from AY 2013-14 to AY 2016-17; and
• Taxability of undisclosed income from AY 2017-18 onwards.

Taxability of undisclosed income from AY 2013-14 to AY 2016-17

Let us first understand the taxability of undisclosed income from AY 2013-14 to AY 2016-17 which provides as under.

• Clause (a) of sub-section (1) of section 115BBE provides for tax at the rate of 30% on such undisclosed income covered by sections 68 to 69D (surcharge and cess are also applicable);
• Clause (b) of sub-section (1) of section 115BBE provides that while calculating income-tax, an assessee’s total income would be reduced by the income taxed under clause (a) and tax will be calculated on balance of income at the applicable tax rates depending on the legal status of taxpayer. The total tax liability will be the addition of tax calculated under clause (a) and clause (b).

The provisions of section 115BBE stated that the deemed income under section 68 to 69D is to be taxed at the rate of 30% (plus surcharge and cess as applicable). Therefore, from AY 2013-14 onwards, all the undisclosed income is taxed @ 30% (plus applicable surcharge and education cess) irrespective of the legal status of taxpayer viz. individual, company, firm, etc. In addition to tax @ 30%, surcharge and cess as is applicable is also required to be paid. Surcharge depends upon the legal status of the person and his total income e.g. Finance Act, 2016 provides that in case of an individual surcharge is payable @ 12% if his total income exceeds Rs.10 crores and not otherwise. In case of domestic companies, surcharge is payable @ 7% where total income exceeds Rs.1 crore but does not exceed Rs.10 crores and in case of domestic companies whose total income exceeds Rs.10 crores surcharge is payable @ 12%. Corresponding rates for foreign companies are 2% and 5%. Education Cess is payable @ 3%[1]. Thus, the tax incidence, for AY 2016-17, on the income of the nature referred to in specified sections was ranging from 30.90% to 34.608%.

[1] From AY 2019-20 onwards, Health & Education Cess is payable @ 4% as against 3% upto AY 2018-19

Thus, section 115BBE is designed to impose greater tax burden on the assessees who fail to explain the “nature and source” of their income, investments, expenses, etc. The real purpose of introducing this provision was to charge higher tax at the maximum marginal rate in respect of income / expenditure / investment on the assessee who fails to explain the nature and source of said income/expenditure/investment.

Sub-section (2) provides that notwithstanding anything contained in the Act, no deduction in respect of any expenditure or allowance shall be allowed to the assessee under any provisions of the Act in computing his income referred to in clause (a) of sub-section (1). Upto AY 2016-17 there is no prohibition on set off of loss although deduction in respect of any expenditure or allowance is not allowed. Further, the claim of deduction under Chapter VI-A is debatable and is not specifically restricted by sub-section (2) of section 115BBE of the Act.

Thus, the provisions of section 115BBE applies to all assessees –

• irrespective of the legal status i.e. it applies to individuals, HUFs, firms, LLP, co-operative society, AOP, BOI, political party, etc. ;
• irrespective of their residential status i.e. it applies to residents as well as non-residents
• including those covered by presumptive taxation under sections 44AD / 44ADA / 44AE
• it does not provide for minimum threshold limit i.e. it is applicable even to the smallest of amount of unexplained income if the amount is chargeable under the specified sections.

Taxability of undisclosed income from AY 2017-18 onwards

As mentioned above, there are three amendments applicable from AY 2017-18 onwards and all three amendments are made at different points in time. Let us analyse the three amendments in their respective order.

The 1^st amendment is by the Finance Act, 2016 with effect from AY 2017-18. In the said amendment, the Finance Act, 2016 has amended sub-section (2) to prohibit setting off of any loss against income of the nature referred to in specified sections 68 to 69D. Before this amendment, the deduction of any expenditure or allowance was not allowed against the undisclosed income forming part of sections 68 to 69D. Consequently, from AY 2017-18 onwards, current year and brought forward losses are also not allowed to be set-off against the undisclosed income covered within the ambit of section 115BBE of the Act. However, it may be noted that the said restriction of setting of losses does not apply to years prior to AY 2017-18.

The 2^nd amendment is by the Taxation Laws (Second Amendment) Act, 2016 w.e.f. 1.4.2017 i.e. AY 2017-18 onwards. The amendments made by the Taxation Laws (Second Amendment) Act, 2016 are drastic and has far reaching implications going forward.

Subsequent to demonetisation announced on 8^th November 2016, there were views expressed by professionals / peers that the undisclosed income held in the form of demonetised currency can be deposited in the bank and the said amount can be offered for taxation under specified sections. Consequently, tax on the said income may be paid under section 115BBE @ 30% plus applicable surcharge and cess and in which case, the person may not be subject to penalty.

It was with a view to prevent such practice and to overcome the views expressed, the amendments has been made to section 115BBE of the Act.

Chapter II of the Taxation Laws (Second Amendment) Act, 2016 amends existing provisions of sections 115BBE and also introduces a new section 271AAC in the Act.

The Statement of Objects & Reasons appended to the Taxation Laws (Second Amendment) Act, 2016, inter-alia states the object and purpose of introducing PMGKY as under –

“1. Evasion of taxes deprives the nation of critical resources which could enable the Government to undertake anti-poverty and development programmes. It also puts a disproportionate burden on the honest taxpayers who have to bear the brunt of higher taxes to make up for the revenue leakage. As a step forward to curb black money, bank notes of existing series of denomination of the value of five hundred rupees and one thousand rupees (hereinafter referred to as specified bank notes) issued by the Reserve Bank of India have been ceased to be legal tender with effect from 9th November, 2016.

2. Concerns have been raised that some of the existing provisions of the Income tax Act, 1961 could possibly be used for concealing black money. It is, therefore, important that the Government amends the Act to plug these loopholes as early as possible so as to prevent misuse of the provisions. The Taxation Laws (Second Amendment) Bill, 2016, proposes to make some changes in the Act to ensure that defaulting assessees are subjected to tax at a higher rate and stringent penalty provision.”

The President has given assent to the Taxation Laws (Second Amendment) Act, 2016 on 16 December 2016. Chapter III of the Taxation Laws (Second Amendment) Act, 2016 has amended the provisions of Finance Act, 2016 so as to provide the higher rate of surcharge on the tax amount relating to undisclosed income.

The original sub-section (1) as it stood for AY 2013-14 to AY 2016-17 and the amended sub-section (1) applicable with effect from AY 2017-18 are stated as under.

From AY 2013-14 to AY 2016-17

“Section 115BBE(1): Where the total income of an assessee includes any income referred to in section 68, section 69, section 69A, section 69B, section 69C or section 69D, the income-tax payable shall be the aggregate of

(a) the amount of income-tax calculated on income referred to in section 68, section 69, section 69A, section 69B, section 69C or section 69D , at the rate of thirty per cent; and

(b) the amount of income-tax with which the assessee would have been chargeable had his total income been reduced by the amount of income referred to in clause (a).”

From AY 2017-18 onwards

“Section 115BBE(1): Where the total income of an assessee,—

(a)  includes any income referred to in section 68, section 69, section 69A, section 69B, section 69C or section 69D and reflected in the return of income furnished under section 139; or

(b)  determined by the Assessing Officer includes any income referred to in section 68, section 69, section 69A, section 69B, section 69C or section 69D, if such income is not covered under clause (a), the income-tax payable shall be the aggregate of-

(i)  the amount of income-tax calculated on the income referred to in clause (a) and clause (b), at the rate of sixty per cent; and

(ii) the amount of income-tax with which the assessee would have been chargeable had his total income been reduced by the amount of income referred to in clause (i).”

The significant amendments made by the Taxation Laws (Second Amendment) Act, 2016 are as under.

• Earlier there was no bifurcation between the income declared by the assessee in its return of income and income determined by the Assessing Officer. However, the new section 115BBE(1) covers both the situation of income declared by the assessee in its return of income under clause (a) and income determined by the Assessing Officer under clause (b).
• Further, the rate of tax applicable on the income covered under clause (a) and clause (b) will be @ 60% (plus applicable surcharge and education cess) as against the earlier rate of 30% (plus applicable surcharge and education cess).
• The rate of surcharge in the pre-amended provisions was as applicable to the legal status of the assessee as mentioned aforesaid. However, Chapter III of the Taxation Laws (Second Amendment) Act, 2016, has amended the provisions of Finance Act, 2016 to provide for the surcharge of 25% on the tax amount i.e. 25% of tax rate of 60% being 15%.

The aforesaid amendments are effective from AY 2017-18 onwards. Accordingly, the income under specified sections for earlier years will continue to be governed by the pre-amended provisions irrespective of the fact that the assessments of such years are completed after the AY 2017-18. In this connection, one can rely upon the decisions of Jaipur Tribunal in the case of ACIT v. Sanjay Bairathi Gems Ltd – [2017] 84 taxmann.com 138 and ACIT v. Satish Kumar Agarwal – [2018] 96 taxmann.com 373.

Prior to the enactment of the Taxation Laws (Amendment Act), 2016 there could have been a question as to whether an assessee, on his own, could offer certain amounts for taxation under the provisions of sections 68, 69, 69A, 69B, 69C and 69D. It is now clear that items which could have been taxed by the provisions of sections 68 to 69D can also be offered for taxation by the assessee in his return of income by paying tax, on or before the end of the previous year, at the rates mentioned in section 115BBE.

Thus, the total incidence of tax in respect of income of the nature referred to in specified sections of 68 to 69D is 77.25% (60% + 15% surcharge + 2.25% education cess).

Since the amendment to section 115BBE made by the Taxation Laws (Second Amendment) Act, 2016 is effective from 1 April 2017, a question arises as to whether it is retroactive since it covers cases where income of the nature referred to in specified sections pertains to the period from 1 April 2016 to 8 November 2016. In other words, is the section applicable to acts done before its enactment.

A statute is retrospective when it takes away or impairs any vested right acquired under the existing laws, or creates a new obligation, or imposes a new duty, or attaches a new liability in respect of transactions or considerations already past. A substantive law determines the rights and liabilities of the parties concerned, whereas procedural laws govern the manner in which such rights or obligations are to be enforced or realized. A law applicable to the assessment is the law as it stands in the year of assessment and not that during the year in which the income was earned.

In this matter, the reference may be made to the Supreme Court decision in the case of CIT v. Scindia Steam Navigation Co. Ltd. [1961] 42 ITR 589 wherein it was held that total income has to be computed in accordance with the law existing as on 1^st day of the assessment year.

The rate of tax on income subjected to tax under section 115BBE of the Act is specified in the Act itself and not in the annual Finance Act. The Taxation Laws (Second Amendment) Act, 2016, inter alia, amended the provisions of section 115BBE of the Act so as to enhance the rate of tax from 30% to 60% and the same is effective from 1 April 2017 i.e. AY 2017-18 onwards and accordingly, it will apply to AY 2017-18 onwards.

Subsequently, section 115BBE of the Act is amended 3^rd time by the Finance Act, 2018 with retrospective effect from 1 April 2017.

Sub-section (2) of section 115BBE begins with a non-obstante clause and provides that no deduction in respect of any expenditure or allowance or set off of any loss shall be allowed to the assessee under any provision of this Act in computing his income referred to in clause (a) of sub-section (1). Thus, before the above amendment sub-section (2) by the Finance Act, 2018, it provided that no deduction in respect of any expenditure or allowance or set-off of any loss shall be allowed to the assessee under any provision of the Act in computing his income referred to in clause (a) of sub-section (1) which deals with unexplained income reflected in the return of income furnished under section 139.

In order to rationalize the provisions of section 115BBE, the amendment has been made in the said sub-section (2). Thereby, the provisions of sub-section (2) which restricts the deduction for any expenditure, allowance or set off of any loss are now applicable to the entire sub-section (1) i.e. whether undisclosed income is offered by the assessee in its return of income under clause (a) or determined by the Assessing Officer under clause (b).

Some of the other important points in section 115BBE are as under.

• It was debatable and continues to be a debatable question as to whether deductions under Chapter VI-A are allowable against such income.
• Clause (a) covers income referred to in specified sections which has been reflected in return of income furnished under section 139. Such income reflected in a belated return under section 139(4) or in a revised return furnished under section 139(5) would certainly be covered by clause (a).
• Pre-requisite for revising a return of income is “discovery” of omission or any wrong statement in the return of income filed by the assessee. Consequently, income covered by specified sections which is reflected in revised return after issue of notice by the AO may not be regarded being covered by clause (a).
• Return furnished under section 153A of the Act is regarded as if it is a return filed under section 139 of the Act and therefore it appears to be arguable proposition that a disclosure in the return filed under section 153A would be regarded as covered by clause (a). It could be debated as to whether a return filed under section 153C could be regarded as being covered by clause (a).
• However, income referred to in specified sections which has been reflected in returns furnished under section 148 will not be covered by clause (a) as the same is not furnished under section 139.

Penalty provisions under section 271AAC

The Taxation Laws (Second Amendment) Act, 2016 has inserted the provisions of section 271AAC to provide for the levy of penalty on the undisclosed income taxed in accordance with the provisions of section 115BBE of the Act.

Irrespective of whether the case of the assessee falls under clause (a) or clause (b) of section 115BBE(1), the rate of tax is 60% plus surcharge plus cess. However, the levy of penalty depends on whether the case of an assessee falls under clause (a) or clause (b) of 115BE(1).

The section 271AAC provides that penalty can be levied if the income assessed includes income of the nature referred to in specified sections and if the assessee has not included such income in his return of income or having included it in the return of income has failed to pay tax on such income before 31 March of the previous year. In other words, the penalty may not be levied under section 271AAC if the undisclosed income referred to in sections 68 to 69D are offered to tax in the return of income by the assessee suo-motto and the tax liability as provided in section 115BBE is paid on or before the end of the relevant previous year. Therefore, if 100% of the tax liability is not paid before 31 March of the previous year, the penalty may be applicable as provided in section 271AAC. However, there is no immunity from penalty if the undisclosed income is determined by the Assessing Officer.

The penalty is payable @ 10% on the basic tax rate of 60% (excluding surcharge and education cess). Accordingly, the penalty payable will be 6% under section 271AAC of the Act. If penalty under section 271AAC is also levied then the incidence of tax would be increased to 83.25% (60% + 15% surcharge + 2.25% education cess + 6% penalty).

Further, section 271AAC also provides that no penalty under the provisions of section 270A (Penalty for under-reporting and misreporting of income) shall be imposed upon the assessee. Also, section 271AAC further states that  the provisions of sections 274 and 275 i.e. for Procedures and Bar of limitation for imposing penalties, respectively, shall as far as may be, apply in relation to the penalty referred to in this section.

The other important points to be taken care if income relating to undisclosed income is offered to tax in the return of income by the assessee on its own are as under.

• Assessee will be liable to pay interest under section 234C of the Act, if assessee in his return of income declares income under specified sections but does not pay advance tax in accordance with the provisions of the Act.
• Belated returns will be subject to payment of interest under section 234A and default in payment of advance tax will trigger interest under section 234B.
• In a case where advance tax paid is more than 90% of the tax payable but less than 100% of the tax payable, interest under section 234B may not be leviable but the assessee will not be entitled to claim immunity from penalty.

Conclusion

To conclude, the unexplained income referred to in section 68 to 69D was taxed @30% plus applicable surcharge and cess under section 115BBE from AY 2013-14 to AY 2016-17. Thereafter, from AY 2017-18 onwards, the aforesaid income has been charged to tax @ 60% plus surcharge @25% plus education cess @ 3%, the effective tax rate comes to 77.25%. Also, the penalty under section 271AAC may be levied @ 10% of the basic tax amount chargeable under section 115BBE which would be 6% leading to effective tax rate of 83.25%. In order to avail benefit of immunity from penalty, the assesse may disclose the unexplained income referred to in aforesaid sections in his return of income and pay the full amount of tax under section 115BBE on or before end of the relevant previous year.

[1] From AY 2019-20 onwards, Health & Education Cess is payable @ 4% as against 3% upto AY 2018-19