The judgement of the Supreme Court in Price Waterhouse Coopers vs. CIT makes for startling reading and leads to unsatisfactory consequences. An assessee caught red-handed trying to smuggle in an untenable claim for deduction is able to escape penalty u/s 271(1)(c) for concealment/ filing inaccurate particulars of income by putting on a sheepish face and pleading that the untenable claim was because of some confusion at his end.
What makes the situation worse is that the assessee concerned is not some ignorant person unaware of the legal provisions but a professional firm of Chartered Accountants who get paid heavy fees for being auditors
and tax experts.
I put the blame for this fiasco on the totally inept handling of the case by the department. The matter was not presented in the proper perspective nor were the statutory provisions explained.
First, lets’ understand the facts. The Tax Audit Report (obviously prepared by another firm of Chartered Accountants) clearly declared that an amount of Rs. 40 lakhs debited to the P&L A/c was not allowable as a deduction u/s 40A(7). All that a person preparing the computation of income has to do is to scan the TAR to identify the issues red-flagged by the tax auditor and disallow it.
The person who prepared the computation lost sight of it.
The partner who signed the return is supposed to be a vigilant auditor. Even he lost sight of something so obvious. Maybe he had more pressing things on his mind.
Doesn’t matter. It can happen to the best of us. But when a notice of reassessment u/s 148 came; surely that would have warranted a second and closer look at the return that was furnished to see if there was something wrong somewhere.
How could the same return that was filed earlier be filed again in response to the s. 148 notice? Was everybody still in a stupor? Nobody bothered to cross check the computation and the Tax Audit Report? Is this not the height of incompetence and carelessness?
Not surprisingly, the assessee’s plea met with no sympathy at the lower levels. The High Court sternly observed that a well known and reputed firm of Chartered Accountants could not afford to behave in such an irresponsible manner and get away with it. "The assessee has failed to discharge its strict liability to furnish their true and correct particulars of accounts while filing the return" the Court solemnly observed.
The assessee’s defense before the Apex Court was as facile as it can get.
The first defense was that its partner who signed the return had "proceeded on the basis that the return was correctly drawn up and so did not notice the discrepancy between the Tax Audit Report and the return of income". Who asked this worthy gentleman to "proceed on the basis that the return was correctly drawn up"? He is an auditor – always supposed to sniffing for trouble like a watchdog or a blood hound. He is not paid to assume that everything is hunky dory.
The second defense was that the assessee had over 1000 employees and a separate accounts department and that there was "some confusion" in the person who prepared the computation.
Surprisingly, both these facile arguments met with the Court’s approval. Worse, the Court virtually made excuses for the assessee. Yes, so what if the assessee is a reputed firm and has great expertise. It is entitled to make a "silly mistake". The assessee had "disclosed" the factum of disallowance in the TAR so there is the question of the assessee being guilty of concealment or filing inaccurate particulars of income. The assessee had committed a "human error" that "all of us are prone to make", the Court added magnanimously.
But wait! What about when the notice for reassessment came and you were asked to file a return of income. Didn’t anybody bother to open the file and see if there is something wrong somewhere? How could you have dared to file the same return a second time and repeat the claim for a wrong deduction? Is this also a "silly mistake"?
Nobody bothered to ask the Question. Neither the department nor the learned Judges.
Also, to justify the judgement, the learned Judges observed that the facts of the case were “rather peculiar and somewhat unique“. I don’t see what is “peculiar” or “unique” about an assessee forgetting to make a disallowance. It happens day-in and day-out. They also made something out of the fact that “even the AO made a mistake in overlooking the contents of the Tax Audit Report“. This, again, is an irrelevant consideration. How does the AO’s omission justify the assessee’s negligence? Also, the AO did notice it the second time when he issued the s. 148 notice. The assessee still overlooked it. So, what is to be made of it?
Anyway, so it is that the law has been laid down that it does not matter how careless or negligent or irresponsible you are whilst filing your return. If you can somehow manage to give the wrong claim the label of "human error/ silly mistake", you can go scot free.
Now, there are two things wrong with the judgement.
The first is that the department did not point out the deeming provision in Explanation 1 to s. 271(1)(c) which reads as follows:
Courts have considered Explanation 1 to s. 271(1)(c) in a number of judgements and the consensus is that the "explanation" for the wrong claim should be a plausible one. Any and every explanation cannot be accepted as being "bona fide" (see CIT v. Mussadi Lal Ram Bharose 165 ITR 14 (SC)).
Now, what is contemplated by Explanation 1 to s. 271(1)(c) is an "explanation" on the "merits" of the claim for deduction. If that explanation has some merit, then, even if one does not agree with that explanation, you can say that it is a bona fide explanation and so penalty cannot be levied. But, if the explanation is ex-facie bogus, then, even if there is no concealment of income or furnishing of inaccurate particulars, penalty is still attracted.
This is exemplified in the judgement in CIT vs. Escort Finance Ltd 328 ITR 44 (Del). The assessee, a finance company claimed deduction u/s 35D even though that deduction is available only to an "industrial undertaking". The claim was disclosed in the Tax Audit Report. To prove that its claim was "bona fide", the assessee obtained the opinion of a Chartered Accountant. However, the Court rejected the argument of "bona fide" by pointing out that when it was clear to even a layman that there was no scope for getting a deduction, it was not understood how a Chartered Accountants who is supposed to be an expert in tax laws could give such an opinion. The assessee’s claim was held to be false and as liable for penalty despite due disclosure and a so-called opinion of a CA.
Now, in the present case, the assessee did not even have a fig leaf of an explanation to defend its claim. It straightaway admitted that it was wrong and blamed the whole thing on carelessness on his part.
So, how are the ingredients of Explanation 1 to s. 271(1)(c) satisfied? Is it now the law that a plea of carelessness/ negligence/ mistake will suffice to constitute a "bona fide" explanation?
Secondly, the Court’s attention was not drawn to the fact that penalty was intended to be a deterrent to prevent an assessee being casual about his responsibility to make a full and true disclosure of income.
This is particularly relevant in the present legislative scheme in which the assessees are trusted to do the right thing and a bulk of the returns are not picked up for scrutiny. If there is no deterrent, what is to prevent the assessee from "taking a chance"?
Now, lets see how the law laid down in Price Water House Coopers can be abused. Suppose you have incurred expenditure that you know is not deductible. Instead of straight away disallowing it and paying up the tax thereon, why not try your luck and take a chance without any incremental cost or risk. Here’s what you have to do:
(i) Make sure that the expenditure is prominently displayed in the P&L A/c and there is a reference to it in the audited accounts and the tax auditors’ report;
(ii) In the computation of income, "forget" to disallow the expenditure;
(iii) If your luck holds and the return gets processed u/s 143(1) and there is no scrutiny assessment, you are on velvet;
(iv) If your luck runs out and the AO hauls you up by the collar, just put up a sheepish face and say "Sorry Sir, I forgot. There was some confusion. I made a "silly mistake". Please forgive me".
That’s it. Even in the worst case scenario that you are caught red handed, you are only liable to pay the tax on the amount. No risk of penalty because you have "disclosed" in the accounts and audit report the fact that the expenditure is not allowable and only committed a "silly mistake".
So, why bother being honest & straightforward when there is such a premium on carelessness/ dishonesty?
What makes the situation worse is that the assessee concerned is not some ignorant person unaware of the legal provisions but a professional firm of Chartered Accountants who get paid heavy fees for being auditors
and tax experts.
I put the blame for this fiasco on the totally inept handling of the case by the department. The matter was not presented in the proper perspective nor were the statutory provisions explained.
First, lets’ understand the facts. The Tax Audit Report (obviously prepared by another firm of Chartered Accountants) clearly declared that an amount of Rs. 40 lakhs debited to the P&L A/c was not allowable as a deduction u/s 40A(7). All that a person preparing the computation of income has to do is to scan the TAR to identify the issues red-flagged by the tax auditor and disallow it.
The person who prepared the computation lost sight of it.
The partner who signed the return is supposed to be a vigilant auditor. Even he lost sight of something so obvious. Maybe he had more pressing things on his mind.
Doesn’t matter. It can happen to the best of us. But when a notice of reassessment u/s 148 came; surely that would have warranted a second and closer look at the return that was furnished to see if there was something wrong somewhere.
How could the same return that was filed earlier be filed again in response to the s. 148 notice? Was everybody still in a stupor? Nobody bothered to cross check the computation and the Tax Audit Report? Is this not the height of incompetence and carelessness?
Not surprisingly, the assessee’s plea met with no sympathy at the lower levels. The High Court sternly observed that a well known and reputed firm of Chartered Accountants could not afford to behave in such an irresponsible manner and get away with it. "The assessee has failed to discharge its strict liability to furnish their true and correct particulars of accounts while filing the return" the Court solemnly observed.
The assessee’s defense before the Apex Court was as facile as it can get.
The first defense was that its partner who signed the return had "proceeded on the basis that the return was correctly drawn up and so did not notice the discrepancy between the Tax Audit Report and the return of income". Who asked this worthy gentleman to "proceed on the basis that the return was correctly drawn up"? He is an auditor – always supposed to sniffing for trouble like a watchdog or a blood hound. He is not paid to assume that everything is hunky dory.
The second defense was that the assessee had over 1000 employees and a separate accounts department and that there was "some confusion" in the person who prepared the computation.
Surprisingly, both these facile arguments met with the Court’s approval. Worse, the Court virtually made excuses for the assessee. Yes, so what if the assessee is a reputed firm and has great expertise. It is entitled to make a "silly mistake". The assessee had "disclosed" the factum of disallowance in the TAR so there is the question of the assessee being guilty of concealment or filing inaccurate particulars of income. The assessee had committed a "human error" that "all of us are prone to make", the Court added magnanimously.
But wait! What about when the notice for reassessment came and you were asked to file a return of income. Didn’t anybody bother to open the file and see if there is something wrong somewhere? How could you have dared to file the same return a second time and repeat the claim for a wrong deduction? Is this also a "silly mistake"?
Nobody bothered to ask the Question. Neither the department nor the learned Judges.
Also, to justify the judgement, the learned Judges observed that the facts of the case were “rather peculiar and somewhat unique“. I don’t see what is “peculiar” or “unique” about an assessee forgetting to make a disallowance. It happens day-in and day-out. They also made something out of the fact that “even the AO made a mistake in overlooking the contents of the Tax Audit Report“. This, again, is an irrelevant consideration. How does the AO’s omission justify the assessee’s negligence? Also, the AO did notice it the second time when he issued the s. 148 notice. The assessee still overlooked it. So, what is to be made of it?
Anyway, so it is that the law has been laid down that it does not matter how careless or negligent or irresponsible you are whilst filing your return. If you can somehow manage to give the wrong claim the label of "human error/ silly mistake", you can go scot free.
Now, there are two things wrong with the judgement.
The first is that the department did not point out the deeming provision in Explanation 1 to s. 271(1)(c) which reads as follows:
"Where in respect of any facts material to the computation of the total income of any person under this Act ,—
(A) such person fails to offer an explanation or offers an explanation which is found by the Assessing Officer or the Commissioner (Appeals) or the Commissioner to be false, or
(B) such person offers an explanation which he is not able to substantiate and fails to prove that such explanation is bona fide and that all the facts relating to the same and material to the computation of his total income have been disclosed by him, then, the amount added or disallowed in computing the total income of such person as a result thereof shall, for the purposes of clause (c) of this sub-section, be deemed to represent the income in respect of which particulars have been concealed".
Courts have considered Explanation 1 to s. 271(1)(c) in a number of judgements and the consensus is that the "explanation" for the wrong claim should be a plausible one. Any and every explanation cannot be accepted as being "bona fide" (see CIT v. Mussadi Lal Ram Bharose 165 ITR 14 (SC)).
Now, what is contemplated by Explanation 1 to s. 271(1)(c) is an "explanation" on the "merits" of the claim for deduction. If that explanation has some merit, then, even if one does not agree with that explanation, you can say that it is a bona fide explanation and so penalty cannot be levied. But, if the explanation is ex-facie bogus, then, even if there is no concealment of income or furnishing of inaccurate particulars, penalty is still attracted.
This is exemplified in the judgement in CIT vs. Escort Finance Ltd 328 ITR 44 (Del). The assessee, a finance company claimed deduction u/s 35D even though that deduction is available only to an "industrial undertaking". The claim was disclosed in the Tax Audit Report. To prove that its claim was "bona fide", the assessee obtained the opinion of a Chartered Accountant. However, the Court rejected the argument of "bona fide" by pointing out that when it was clear to even a layman that there was no scope for getting a deduction, it was not understood how a Chartered Accountants who is supposed to be an expert in tax laws could give such an opinion. The assessee’s claim was held to be false and as liable for penalty despite due disclosure and a so-called opinion of a CA.
Now, in the present case, the assessee did not even have a fig leaf of an explanation to defend its claim. It straightaway admitted that it was wrong and blamed the whole thing on carelessness on his part.
So, how are the ingredients of Explanation 1 to s. 271(1)(c) satisfied? Is it now the law that a plea of carelessness/ negligence/ mistake will suffice to constitute a "bona fide" explanation?
Secondly, the Court’s attention was not drawn to the fact that penalty was intended to be a deterrent to prevent an assessee being casual about his responsibility to make a full and true disclosure of income.
This is particularly relevant in the present legislative scheme in which the assessees are trusted to do the right thing and a bulk of the returns are not picked up for scrutiny. If there is no deterrent, what is to prevent the assessee from "taking a chance"?
Now, lets see how the law laid down in Price Water House Coopers can be abused. Suppose you have incurred expenditure that you know is not deductible. Instead of straight away disallowing it and paying up the tax thereon, why not try your luck and take a chance without any incremental cost or risk. Here’s what you have to do:
(i) Make sure that the expenditure is prominently displayed in the P&L A/c and there is a reference to it in the audited accounts and the tax auditors’ report;
(ii) In the computation of income, "forget" to disallow the expenditure;
(iii) If your luck holds and the return gets processed u/s 143(1) and there is no scrutiny assessment, you are on velvet;
(iv) If your luck runs out and the AO hauls you up by the collar, just put up a sheepish face and say "Sorry Sir, I forgot. There was some confusion. I made a "silly mistake". Please forgive me".
That’s it. Even in the worst case scenario that you are caught red handed, you are only liable to pay the tax on the amount. No risk of penalty because you have "disclosed" in the accounts and audit report the fact that the expenditure is not allowable and only committed a "silly mistake".
So, why bother being honest & straightforward when there is such a premium on carelessness/ dishonesty?
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