The unexpected announcement of demonetisation of the Rs. 1000 and Rs. 500 note (specified notes) with a caveat that the tax liability on concealed income would be 200% has created some bewilderment in the mind of an assessee under the Income Tax Act and this article is an attempt to clarify the issues involved.
The Rs. 500 and Rs. 1000 currency notes were denotified as legal tender w.e.f. 9-11-2016 and a notification was issued to this effect by the Ministry of Finance under section 26(2) of the Reserve Bank of India Act, 1934. The legal tender character of the notes and their cessation has been prescribed in Section 26 of Reserve Bank of India Act, 1934. The Central Government has issued the notification after receiving the recommendation from the Central Board of Directors of RBI.
B. Legality of demonetised notes as of now
The Attorney General informed the Supreme Court that the Central Government would bring a law to make it a punishable offence to possess or transfer the specified notes after 31-3-2017. Here it can be safely assumed that there is no legal bar in transferring demonetised notes from one person to another till 31-3-2017. Hence, one can receive a payment in demonetised notes till 31-3-2017 in satisfaction of a debt arising from an old transaction. One can also make a fresh transaction with a person who is willing to receive the specified notes as a consideration in discharge of an obligation.
This scheme of demonetisation is certainly not a scheme of amnesty as it was in the case of Income Disclosure Scheme (IDS). It is crystal clear that the Government has no intention to provide amnesty to black money holders. However, the legal position of the present scheme is not unambiguous.
Notification No. S.O. 3407(E) dated 8th November, 2016 issued by Ministry of Finance (Department of Economic Affairs) has declared that existing series of the Rs. 500 and Rs. 1000 notes shall cease to be legal tender but does not specify up to which date currencies can be deposited in RBI. Though, the P.M. had stated in his speech that the specified notes can be deposited in RBI up to 31-3-2017 with a supporting declaration, probably stating as to why deposit could not be made in a bank earlier.
The Government has also permitted certain entities to accept the Rs. 500 note up to 15-12-2016, while the Rs. 1000 note can only be deposited in the bank from 25.11.2016 onwards. Person having the specified notes can deposit them in their own bank accounts or authorise somebody to deposit in his account and an amount equivalent to these notes would be credited in the account by the bank. However, such deposit can be made only up to 30-12-2016 after which date, the specified notes can be deposited in specified offices of Reserve Bank of India as to be notified before 31-12-2016.
C. Why demonetisation?
The demonetisation scheme serves the following three main objectives: o To tackle counterfeit currency
o To strike at the root of terror funding
o To destroy black money
The demonetisation exercise is expected to bring a significant number of people into the formal economy due to compulsory usage of electronic mode of transaction. There will be long term benefit of demonetisation as large number of people will be attracted to digital payment mode. This move will also speed up financial inclusion, which will help both the private sector as well as the Government. Many merchants are also signing for digital payments. The Confederation of All India Traders has also welcomed increase in transaction limit on E-Wallets from Rs. 10, 000 to Rs. 20, 000 per month.
In this regard, it is to be noted that high denomination notes were demonetised in 1946 and 1978 too by Government of India through ordinances, which later became law. In both cases, there were specific provisions that no person, after the specified date, can transfer to another or receive from another any demonetised notes. However, in absence of a specific provision in the current instance, acknowledged by the Attorney General, there seems to be no apparent legal bar for a person transferring demonetised currency notes to another, if another person is willing to accept the same for any reason.
Unscrupulous persons have already attempted to use this window by depositing their black money in benami accounts. There are over 25 crores Jan Dhan Accounts which were opened for the poor. It has been observed that huge deposit to the tune of Rs. 65,000 crores have been made since demonetisation and one can estimate that total deposit in these accounts may swell beyond
Rs. 100,000 crores.
Another major difference between the earlier and current scheme, is that on earlier occasions, the person in possession of demonetised notes could exchange them for legal tender on specified dates. Also, while depositing these in his bank account, the person had to give a declaration as to how he acquired these notes. Further, the quantum of demonetised notes in earlier occasions was much smaller and the number of persons holding these notes was also small.
As in the current instance, the demonetised notes form 86% of the total currency notes in circulation by value, the Government plans to withdraw circulation of the currency notes over a period, given that such notes would be in possession of almost all the households. In the current scheme, a window has been provided to people who can deal with demonetised notes and deposit them with the banks for getting an equivalent amount credited in their accounts. No declaration has also been prescribed to accompany the deposit.
The Ministry of Finance notification has carved out exceptions for use of the currency notes at certain establishments for the specified period, now up to 15th December, 2016. Hence, depending on use, the currency notes can still be used as legal tender. Even otherwise, the demonetised notes are not simple scrap of paper as no mechanism has been prescribed to identify notes that were in possession of the depositor on 8th November and those which came in his possession thereafter. The demonetised notes, hence, continue to be valuable paper, which can, following the prescription in the notification, be converted into equivalent amount of legal money.
D. Accounting Implication of demonitisation
However, it is very important to understand that except for very limited purposes, the sovereign backing for the notes has ceased, in the sense that no one can insist on discharging an existing debt by paying through demonetized notes. Though, two parties can still contract for a barter transaction, using the demonetised notes as a valuable asset. A person can also agree to accept these notes in discharge of a debt.
A person can then validly enter a transaction in his books and deposit the demonetised currency notes in his bank account any time up to 30th December. The Attorney General has admitted in the Supreme Court that there is no legal bar in possessing and transferring the specified notes. He has promised that the Government will bring in a law prohibiting possession or transfer of such notes after 31.03.2017.
E. Benami Transactions (Prohibition) Amendment Act, 2016
Government has also announced that benami depositors will be prosecuted under the newly promulgated legislations “Benami Transactions (Prohibition) Amendment Act. 2016. Any property created through benami transactions will not only be confisticated but offender can be sent to jail.
The New Act which came into effect from November 1, 2016 prohibits benami transactions and provides for up to seven years of imprisonment apart from penalty for those indulging in such activities. Property includes Assets of any kind — movable, immovable, tangible, intangible, any right or interest, or legal documents and money in bank or in hand is also included. Benami Act is also applicable to Jan- Dhan Accounts.
(1) What constitutes Benami property? Property (except the following):
• Property held in the name of spouse or child for which the amount is paid out of known sources of income
• A joint property with brother, sister or other relatives for which the amount is paid out of known sources of income.
• Property held by someone in a fiduciary capacity; that is, transaction involving a trustee and a beneficiary.
This means, by law, if you buy a property in name of your parents that too can be declared as benami.
The person under whose name the property has been purchased is called the benamidar and the property so purchased is called the benami property. The person who finances the deal is the real owner. The property is held for the benefit (direct or indirect) of the person paying the amount.
F. Demonestisation and its income tax implications
Presently, around 92% of the Income Tax is collected in the form of TDS, TCS, and Advance Tax etc and only 8% of the total tax collection is done by the revenue authorities. The current demonetisation scheme would enhance the tax base and lead to better tax administration after successful implementation of this policy.
The general feeling amongst the assessees is that there would be a flat 200% penalty on income found to be concealed after the announcement of the demonetisation scheme. However, this is misconception that needs to be cleared. Penalty under the Income Tax Act, 1961 is governed by:
Section 270A of Income-tax Act, 1961, which stipulates the following:
– Power with tax authorities to impose penalty @ 50% in case of underreporting of income
– Power with tax authorities to impose penalty @ 200% if underreporting is as a consequence of misreporting of income
– However, assessee can make application u/s. 270AA and get immunity from paying penalty u/s. 270A, prosecution u/s. 276C & 276CC.
It was announced by the Government earlier that small deposits made in the banks by artisans, workers, housewives, etc. would not be questioned by the Income Tax Department since present exemption limit for Income Tax is Rs. 2.5 lakh.
There have been instances where people are using other persons’ bank accounts to convert their black money into new denomination notes, which has been mentioned above in case of Jan-Dhan Accounts. It is clarified that such tax evasion activities can be subjected to Income Tax and penalty imposed if established that the amount deposited in the account was not of the account holder but of somebody else. Also, the person who allows his or her account to be misused for this purpose can be prosecuted for abetment under Income-tax Act. However, genuine persons depositing their own household savings in cash into their bank accounts would not be questioned.
Modi Government had earlier assured that no retrospective amendments in the Act shall be advocated. Furthermore, retrospective amendment in penal provisions is not possible as Article 20(1) of the Indian Constitution explicitly prohibits it. However, higher rate of Income tax can be levied by Government – by amending section 2(1) of the Income-tax Act and Schedule of the Act. Following are the relevant case law that explain this position in law.
Hon’ble Apex Court in the case of W Ramnad Electric Distribution Co. Ltd. v. State of Madras AIR 1961 SC 1753 has held that penal statutes are generally considered prospective. Those penal statutes which create offences or which have the effect of increasing penalties for existing offences will only be prospective by the reason of constitutional restriction imposed article 20 of the Constitution of India. In the case of
Maruram v. UOI AIR 1980 SC 2147 it has been held that when an Act creates new offence it will bring into its fold those offenders which commit all ingredients of the offence after the Act comes into operation. In the case of
Pyare Lal v. M.D J& K Industries AIR 1989 SC 184 it is held that “it is the basic principle of natural justice that no one can be penalised on the ground of a conduct which was not penal on the day it was committed. In the case of
Narendra G. Goradia v. Commissioner of Income Tax, if the explanation shows that the receipt is not of income nature, the revenue cannot reject the explanation of the assessee to hold that it is income. In CIT v. Associated Transport Pvt. Ltd. Due to sufficient cash balance, the addition made on account of deposit of high denominations notes was held to be rightly deleted. The Apex Court in Bat
Velbai v. CIT  49 ITR 130 held that the crux of the matter is to explain or establish the source of the income or the receipt of money and not the source of the receipt of the high denomination currency notes.
In the case of Sumati Dayal v. Commissioner of Income Tax – 214 ITR 801 (SC) It has been held that in respect of cash credits, burden of proof is on the assessee to prove that amounts credited in the accounts did not represent income. The claim of winnings in races was false and what were passed off as such winnings really represented the appellant’s taxable income from some undisclosed sources. The Supreme Court also agreed that after considering the surrounding circumstances and applying the test of human probabilities the Commission had rightly concluded that the assessee’s claim about the amount being her winnings from races was not genuine.
G. What does this mean for an assessee?
In view of the above discussion it would become clear that if the deposit of specified notes are made by a person in his bank account and the same has been returned in the income as income assessable under the head “income from other sources” and on which income tax has been paid as per provision of section 115BBE, then no penalty under Section 271A would be leviable on such deposit as there will be no under reporting of the income in accordance with provision of sub section (2) of section 270A, which is condition precedent for levy of penalty under the provision of Section 270A(1).
Also, by way of abundant caution, before depositing cash into bank accounts, one should keep in mind that deposits should be based on income declared in earlier years. Undesirable increase in income is difficult to substantiate. Further, if assessee declares the deposits as business receipts, the reality of existence of business must exist.
[Source : Article published in the Souvenir of 19th National Convention held from 2nd to 4th December, 2016 at New Delhi]