upholding the levy of penalty

the Mumbai Income-tax Appellate Tribunal (‘ITAT’) has recently issued an important ruling in the case of Asia Pacific Performance SICAV (‘APP’) upholding the levy of penalty for concealment of income and furnishing of inaccurate particulars because the tax payer wrongly set-off its exempt long-term capital losses (‘LTCL’) against taxable long-term capital gains (‘LTCG’).

Background

1. APP, a tax resident of Luxembourg, was registered with the securities and Exchange Board of India (‘SEBI’) as a sub-account and was investing in Indian securities in accordance with the SEBI (Foreign Institutional Investors) Regulations, 1995. In its Indian tax return for Assessment Year (‘AY’) 2007-08, APP, inter-alia, claimed a set off of LTCL of approximately Rs 10.6 million arising from sale of shares on which securities transaction tax (‘STT’) was paid, against LTCG earned on non-STT paid shares. LTCGs arising on sale of shares on which STT has been paid is exempt from tax under section 10(38) of the Income-tax Act, 1961 (‘Act’). However, LTCGs arising on sale of shares on which STT is not paid (eg off market transactions) are taxable in the hands of FIIs / sub-accounts at 10 percent.

2. APP’s case was selected for scrutiny assessment and the set-off of LTCL on STT paid shares against LTCG from non-STT paid shares was denied. APP did not appeal the disallowance before the appellate authorities. Thereafter, the assessing officer also levied penalty on APP under section 271(1)(c) of the Act on the basis that APP had been unable to furnish a plausible explanation qua the legal claim made by it, as well as on the ground that it had failed to make a true and full disclosure of facts material to the computation of income.

3. APP appealed against the penalty order and was granted relief by the first level appellate authority ie the Commissioner of Income-tax (Appeals) [‘CIT(A)’]. The CIT(A) granted relief to APP on the basis that penalty could not be levied (i) where two views were reasonably possible, and (ii) material facts had been truly and fully disclosed, as was the case with APP. Aggrieved by the order of the CIT(A), the Indian Revenue authorities (‘IRA’) preferred an appeal to the second level appellate authority, ie the ITAT against the order of the CIT(A).

APP’s contention before the ITAT

4. APP put forth the following arguments before the ITAT to substantiate its claim:

· The only condition imposed in law under section 70(3) of the Act is that LTCL may be set-off only against LTCG and not short term capital gains.

· Since the introduction of section 10(38), exempting LTCG arising from sale of shares on which STT has been paid, no consequent amendment was made in either section 70 of the Act (relating to set-off of losses) or under any other section of the Act. Accordingly, LTCL could be set off against LTCG irrespective of whether STT in its respect has been paid or not and the taxpayer can choose the course which is more beneficial to it.

· The exemption under section 10(38) of the Act relates to a class of transactions and not the sourceof income (being the shares sold by APP) or head of income.

· Any ambiguity in law is to be interpreted in favour of the taxpayer as has been laid down by the Indian Supreme Court^[1].

· APP also placed reliance on the erstwhile ruling of the Mumbai ITAT in the case of Nalin P Shah^[2]wherein penalty under section 271(1)(c) of the Act was deleted in respect of set-off of losses arising from an exempt source against taxable income.

Decision of the ITAT

Whether ‘income’includes ‘losses’

5. After considering APP’s contentions, the ITAT held that APP’s case was wholly unmaintainable.

6. The ITAT relied on several Supreme Court rulings[3]to arrive at the above conclusion. The Supreme Court rulings broadly lay down the principle that the words ‘income’or ‘profits and gains’ used in the Act should be understood to include ‘losses’,ie loss is negative profit. The Act seeks to levy tax on the ‘total income’ of a tax payer. A particular stream of income will form part of ‘total income’ if (i) it comes within the purview of the charging provisions of the Act, and (ii) it is computed in the manner laid down in the Act. If either of these conditions fail, the income will notbe part of the total income that can be charged to tax.

7. The ITAT further noted that the Supreme Court had in its judgment in the case of Harprasad & Co (P) Ltd held that neither is a taxpayer obliged to disclose loss from a source of income in its return where such income is tax exempt, nor is the IRA obliged to compute or assess such exempt loss.

8. The ITAT noted that the fallacy in the case of APP was in the reading of the term ‘income’occurring in section 10(38) of the Act, to mean only positive income and for which there is no warrant in law or under the provisions of the Act. Where the income from sale of shares on which STT has been paid falls under section 10(38) of the Act, then loss in respect of the same source of income cannot be distinguished merely because of a different arithmetical result and cannot be treated differently.

Were two views possible in APP’s case?

9. The ITAT noted that the Supreme Court in its past rulings had made it abundantly clear that the term ‘income’includes ‘losses’. Hence, the contrary position taken by APP was nothing but a patent and blatant misreading or misapplication of law, and could not be considered as giving rise to two views; consequently APP’s arguments were held to be false.

Whether APP was liable to penalty?

10. Section 271(1)(c) of the Act empowers the IRA to levy penalty on a taxpayer where, the taxpayer has either (i) concealed particulars of his income, or (ii) furnished inaccurate particulars of his income. Further, Explanation 1 to section 271(1) of the Act provides that where a taxpayer (a) fails to offer an explanation or offers an explanation which is found to be false, or (b) offers an explanation which he is unable to substantiate and fails to prove that the explanation is bonafide and that all material facts to the computation of income has been disclosed, then the taxpayer will be deemed to have concealed particulars of his income.

11. The ITAT held that true and full disclosure itself is not sufficient to escape penalty under section 271(1)(c) as Explanation to section 271(1) of the Act further requires the assessee to substantiate its claim and prove it to be bona fide. The ITAT observed that APP had failed to substantiate its position given the clear position of law. Merely raising a legal plea, without any proper basis in law or in facts would not by itself constitute a debatable issue and thus Explanation 1 to section 271(1) of the Act was clearly attracted to APP’s case.

12. Further APP’s claim of true and full disclosure of all facts material to the computation of income was also not accepted by the ITAT. The ITAT observed that the circular[4], issued by the Central Board for Direct Taxes (‘CBDT’) laying down the procedure for filing tax returns electronically, provided that considering that the electronic tax returns (‘e-tax return’) were meant to be ‘annexure-less’,a taxpayer could file documents, furnish reasons and make disclosures in support of various claims made by it in the return, in pursuance to the first noticeissued by the IRA initiating scrutiny assessment proceeding.

13. The first notice initiating scrutiny assessment proceedings in APP’s case for AY 2007-08 was issued on September 22, 2008, scheduling the first hearing for September 29, 2008. The ITAT ruling states that since this was merely a formal notice, the matter was adjourned sine die. Further, APP filed a letter with the IRA on October 1, 2008 bringing the status to the fore and also communicating that clarifications may be sought by the IRA in the future. Further, on the revival of the assessment proceedings in July 2009, a notice under section 142(1) of the Act was issued to APP, in response to which the APP again failed to bring out its position in respect of the set-off of loss claimed. It was only on August 28, 2009 ie on the very last day of hearing in the scrutiny assessment proceedings, that APP, in response to specific queries raised by the IRA, disclosed the position adopted by it in respect of the set off of exempt LTCL against taxable LTCG.

14. Given the above, the ITAT rejected the observation of the CIT(A) that APP had made true and full disclosures of all facts material to the computation of income.

15. Lastly, the ITAT disregarded APP’s reliance on the ruling in the case of Nalin P Shah (supra), on the basis that the ruling did not discuss the maintainability in law of the taxpayer’s claim on merits or in relation to the levy of penalty. The ITAT noted that section 271(1) of the Act casts the onus to furnish an explanation on the taxpayer and in its absence or substantiation of the explanation, the taxpayer is deemed to have concealed the particulars of his income.

16. In the instant case, the ITAT held that APP could not be said to have furnished any explanation as its explanations were contrary to law and in any case, APP can only be considered as having failed to substantiate its explanation. Given all of the above, the ITAT upheld the levy of penalty under section 271(1)(c) of the Act by the IRA on APP