Under-reporting of income
7.1 Introduction
Finance Act, 2016, replaced section 271 by section 270A which provides penalty for under-reporting and misreporting of income. The new provision is applicable w.e.f. AY 2017-18 and also for original returns filed on or after 01-04-2021. The penalty under this section can be initiated by AO/JCIT(A)/ CIT(A)/CIT/PCIT who may be called initiating officers. The penalty can be initiated during the course of any proceedings before them under the Act. Under the new law there is no requirement of recording satisfaction by the Initiating Officer, but requirement of sub-section (2) that “a person shall be considered to have under-reported his income, if …..” requires a finding based on material referred in the assessment order, that there is an under-reporting of income within the meaning of sub-section (2) and he has to issue show cause notice indicating how the addition is considered as under-reporting of income and how the case falls under clauses (a) to (g) of section 270A(2). There are exceptions provided in sub-section (6) i.e. if a case falls under any of these exceptions, then addition to the total income will not be considered as under-reporting of income. Sub-section (1) to sub-section (7) covers various ingredients of under-reporting. In this chapter, these ingredients are briefly described.
7.2 What is under-reporting
Reporting means to prepare and submit statement of facts as required under Law to the prescribed authority. It means to disclose the relevant facts and figures known to the assessee. Thus, there is an obligation underlying in the expression “reporting” to disclose all the facts, accounts, statements, transactions, relevant to the computation of income for the relevant assessment year. The expression “under” linked with underreporting means some facts, figures, accounts, and statements which were required to be disclosed
have been either not disclosed or not correctly disclosed. Under-reporting of income will mean some income taxable under the provisions of the Act has either been not reported or reported at lesser figure than what was actual. Even though, motive may be inferred in the concept of under-reporting, but there is no presumption of any mental element in under-reporting. Under-reporting could be due to honest belief, facts being not in knowledge, advice of the experts, etc. Underreporting may be unintentional, or due to mistaken belief.
The section does not define what is under-reported income, but it provides circumstances as mentioned in sub-section (2) in which a person can be said to have under-reported his income. As per Merriam Webster dictionary, under-reporting is ‘transitive verb’, which means to report less than what is actually the case. It also implies under stating income. Thus, in general for initiating penalty proceedings u/s 270A, the difference between assessed income and returned income may be assumed as under-reporting of income.
7.3 Cases where a person is considered to have under-reported his income
Sub-section (2) provides circumstances/cases where a person is considered to have under-reported his income:
(i) Clause (a) - Where assessed income is greater than income determined by processing u/s 143(1)(a).
From this clause it appears that the first assessment (i.e. processing) has to be done u/s 143(1)(a). No case will be taken for scrutiny for being done u/s 143(3) in the first instance. Selection of the cases for scrutiny after they are processed u/s 143(1)(a) is carried out as per guidelines issued by the CBDT.
(ii) Clause (b) - Where no return of income is furnished, or where return is first time furnished u/s 148 and income assessed is greater than maximum amount not chargeable to tax.
It covers two situations. One is where no return is furnished, then assessed income under section 144 will be underreported income. Second situation is where return is first time furnished in response to notice u/s 148 and assessed income is greater than maximum amount not chargeable to tax. Thus, if assessed income in the return filed u/s 148 is below maximum amount not chargeable to tax, there will not be any underreported income.
(iii) Clause (c) - Where income is reassessed, then reassessed income is greater than income assessed, or income reassessed earlier.
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In the case of reassessment, if reassessed income is greater than earlier assessed or reassessed income, there will be under-reporting of income in the reassessment.
iv) Clause (d) - This clause applies where income is assessed or reassessed as per section 115JB or 115JC, (i.e. deemed income) and such assessed or reassessed deemed income is greater than such deemed income under these sections, processed u/s 143(1)(a).
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v) Clause (e) - This clause applies where no return of income is furnished or where return is first time furnished u/s 148, and income assessed as per the provisions of section 115JB or section 115JC is greater than maximum amount not chargeable to tax.
If no return of income is filed, it will be difficult to know whether book profit is more than regular profit and therefore whether provisions of section 115JB or 115JC will be applicable. Ex-parte assessment may be done under regular provision. This aspect seems to be superfluous in this clause. The case would otherwise be covered under clause (b). Where return is furnished for the first time in response to notice u/s 148 and assessee claims to be covered under deemed income, then there will be underreported income if assessed deemed income is greater than maximum amount not chargeable to tax.
(vi) Clause (f) - This clause applies where deemed income u/s 115JB or 115JC is reassessed and such reassessed income is greater than deemed income assessed or reassessed earlier under these sections.
In the case of reassessment, if reassessed deemed income is greater than earlier assessed or reassessed deemed income, there will be under-reporting of income in the reassessment.
(vii) Clause (g) - This clause applies where income assessed or reassessed has the effect of reducing loss or converting such loss into income.
If declared loss is reduced in assessment or reassessment or is converted into positive income, there will be under-reporting of income. Thus, under-reporting is a consequence of facts as stated in this sub-section. If these facts as per sub-section (2) exist, there will be under-reporting. It seems to be a mechanical conclusion and creates a situation of “Shall Presume” unless rebutted by assessee under sub-section (6).
7.4 Computation of under-reported income
Computation of under-reported income u/s 270A is provided in sub-section (3) as under:—
(i) Where return is furnished - Difference between income assessed and income determined u/s 143(1)(a).
For example - if returned income is ` 5 lakhs but after correcting arithmetical error accepted u/s 143(1)(a) at ` 7 lakhs but u/s 143(3) income is assessed at ` 10 lakhs, then under-reported income would be ` 3 lakhs.
(ii) Where return is not furnished, or return is furnished first time under section 148, then:—
Under-reported income will be the amount of income assessed in the case of company, firm, or local authority.
Under-reported income in case of other person, will be difference between amount of income assessed and maximum amount not chargeable to tax.
For example - income assessed first time in the case of a company/ firm/local authority is ` 7 lakhs, then underreported income would be ` 7 lakhs. But in any other cases, under reported income would be ` 4.5 lakhs after giving margin of basic exemption of ` 2.5 Lakhs.
(iii) In cases not covered in (i) and (ii) above, i.e. in cases of reassessment/recomputation, the difference between income reassessed/ recomputed and income assessed/computed in the preceding order.
For example - Income originally assessed is ` 7 lakhs and after reassessment it is assessed at ` 10 lakhs, then underreporting would be of ` 3 lakhs.
(iv) Where, return is filed and assessment/reassessment is done u/s 115JB/115JC and where the assessed/reassessed deemed total income u/s 115JB/115JC is greater than proceeded/returned deemed income u/s 115JB/115JC .
(v) For working out underreported income, in the case of assessment made u/s 115JB/115JC, the AO has to work out underreported income in computation of income as per general provisions of the Act. Where proceeded income/earlier assessed income (normal provisions) is ‘B’ and assessed/reassessed income (normal provisions) is ‘A’, then under-reporting in normal computation would be (A-B). If assessment/ reassessment is done u/s 115JB or u/s 115JC then under-reported income in assessment u/s 115JB/115JC would be C-D where “C” is assessed/reassessed deemed income and “D” is proceeded/earlier assessed income. Aggregate of under-reporting will be under-reported income in normal computation and under-reported income in section 115JB/115JC computation.
Proviso to sub-section 3 provides the formula for aggregation of underreported income in case of computation of income u/s 115JB/115JC. The formula is (A-B) + (C-D).
(vi) The calculation of amount of under-reported income is given in the proviso to sub-section (3). This proviso reads as under:
Provided that where under-reported income arises out of determination of deemed total income in accordance with the provisions of section 115JB or section 115JC, the amount of total under-reported income shall be determined in accordance with the following formula— (A — B) + (C — D) where,
A = the total income assessed as per the provisions other than the provisions contained in section 115JB or section 115JC (herein called general provisions).
B = the total income that would have been chargeable had the total income assessed as per the general provisions been reduced by the amount of under-reported income.
C = the total income assessed as per the provisions contained in section 115JB or section 115JC.
D = the total income that would have been chargeable had the total income assessed as per the provisions contained in section 115JB or section 115JC been reduced by the amount of under-reported income:
Provided further that where the amount of under-reported income on any issue is considered both under the provisions contained in section 115JB or section 115JC and under general provisions, such amount shall not be reduced from total income assessed while determining the amount under item D.
The above computation of total under-reported income shows that:—
(i) There are two under-reported income, one which arises when total income in computed under normal/general provisions of the Act, and other which arises when book profit u/s 115JB or total adjusted income u/s 115JC is computed. However, no such distinction is provided while using the expression “under-reported income” in item B or item D. This may create confusion and computational error resulting into litigation.
(ii) For the sake of clarity let under-reported income computed under normal provisions of the Act is marked as UR(N) & under reported income computed under deemed income u/s 115JB or u/s 115JC is marked as UR(D). Thus, A-B will be marked as
UR(N) & C-D is marked as UR(D). The total under-reported income will be UR(N) + UR(D).
(I) Some examples how this formula will work are given below—
(i) Suppose there are two issues on which addition is made by the AO. On one issue addition is made only in computation of income under normal provision of the Act and on second issue addition is made both in the computation of total income under normal provisions of the Act and in the computation of deemed income u/s 115JB & u/s 115JC.
Let this under-reported income on two issues is marked as UR(N)1 & UR(N)2 in computation under normal provisions and are marked as UR(D)1 & UR(D)2 in computation of deemed income.
i. Since addition is made on the first issue under normal provisions, it will give rise to UR(N)1. Since, no addition is made in the deemed income on first issue, UR(D)1 will be nil as C & D will be equal.
ii. On the second issue addition is made both under normal provisions as well as under deemed computation, there will be UR(N)2, but by virtue of proviso, such under-reported income will not be reduced from D and therefore, C & D will be equal & so UR(D)2 will be nil.
iii. Thus, total under-reported income will be—
UR(N)1 + UR(N)2
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ii) In the above example let addition is made on first issue only in the computation of deemed income and on the second issue addition is made both in the normal computation as well as in the deemed computation. The total under-reported income will be as under.
i. Since, addition on the first issue is made only in the deemed income, the under-reported income will be C-D= UR(D)1 and A-B will be nil.
ii. Since, addition on the second issue is made both in the normal computation as well as in the deemed computation, then by virtue of proviso to sub-section (3), UR(D)2 will be nil, and A-B will be equal to UR(N)2.
iii. Thus, the total under-reported income arising from these two issues will be-
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UR(D)1 + UR(N)2.
iii) Suppose in the above example addition on the first issue is made only in the normal computation and on the second issue only in the deemed computation. Then total under-reported income will be computed as under-
i. On the first issue under-reported income will be- A-B = UR(N)1 and C-D will be nil.
ii. On the second issue under-reported income will be C-D= UR(D)2 but A-B will be nil.
iii. The total under-reported income will beUR(N)1 + UR(D)2.
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iv) Suppose in the above example additions on the both issues are made in the deemed computation of income and not in the normal computation of income than-
i. On the first issue under-reported income will be A-B= nil and C-D= UR(D)1.
ii. On the second issue also, under-reported income will be A-B=nil and C-D= UR(D)2.
iii. Total under-reported income will be-
UR(D)1 + UR(D)2
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v) Suppose in the above example additions are made on both issues both under normal provisions of the Act as well as under deemed computation of income than total under-reported income will be –
i. On the first issue under-reported income will be A-B=UR(N)1 and C-D= nil by virtue of proviso.
ii. On the second issue under-reported income will be A-B= UR(N)2 and C-D= nil by virtue of proviso.
iii. Total under-reported income will be –UR(N)1+ UR(N)2
(vi) In a case where tax is levied on the basis of book profit u/s 115JB or on adjusted total income u/s 115JC in the return of income or in the original assessment but after making addition to the normal computation of income(and no addition is made in the book profit), tax levied on such assessed/reassessed total income is greater than tax earlier levied on book profit than assessment/reassessment may be made as per normal provisions of the Act. For the purposes of levy of penalty difference between the Tax as per return (or as per original assessment) and tax as per assessment on that return (or as per reassess-
ment) is likely to be considered as additional tax, 50% thereof [for the penalty u/s 270A(1)] or 200% thereof (for the purpose of penalty u/s 270A(8)) shall be the amount of penalty as the case may be.
(vii) Thus, where assessment is being made as per book profit or adjusted income u/s 115JB/115JC no penalty is leviable u/s 271(1)(c) if addition is made in the normal computation of income which does not affect deemed income u/s 115JB or u/s 115JC. But u/s 270A under reported income will be inferred whether addition is made either under normal computation, but no addition is made in the deemed computation or addition is made in the deemed computation, but no addition is made in the normal computation or addition is made in both kind of computation.
(II) Defence and implications of misreporting for assessees and AO: The defence to the assessee for under-reported income either under normal computation or under deemed computation of income will be available u/s 270A(6) and for the AO, either under normal computation or under deemed computation, under-reported income can be inferred as inconsequence of misreporting of income u/s 270A(9).
(III) Penalty provisions for under-reported income under different computation methods: The issue will arise if provisions of section 270A(6) are satisfied in case of under-reported income under normal provisions and not satisfied for under reported income under deemed computation. It is felt that AO can levy penalty for that under-reported income for which section 270A(6) is not satisfied.
(IV) Penalty calculation for under-reported income: Since, penalty for under-reported income is calculated as 50% of tax on under-reported income, then whatever may be the quantum of total under-reported income, calculated as per sub-section (3) of section 270A, penalty will be confined/limited to 50% of the additional tax worked out on the basis of normal addition and/or deemed income for which section 270A(6) is not satisfied.
(V) Implication on penalty of no addition in book profit: Also, if there is some positive figure of under reported income say UR(N)1 + UR(N)2 but there is no addition in the book profit, and assessment is done under deemed income, there is no additional tax liability, no penalty will be leviable. But where deemed income is enhanced, which results in higher tax liability, quantum of penalty will be computable. In the examples given in para [(v)] above there is an addition on both the issues in the deemed computation of income (as well as in normal computation of income) liability to additional tax will arise. The penalty for under-reporting income will be leviable.
7.5 In the loss case, assessed/reassessed loss is less than returned/assessed loss
For example, where returned loss is ` 8 lakhs and accepted u/s 143(1)(a) but u/s 143(3) loss is determined at ` 5 lakhs, then under-reported income would be ` 3 lakhs. If reassessment is done and loss determined is ` 3 lakhs, then under-reporting in reassessment would be of ` 2 lakhs.
Only the difference between assessed income/loss and returned income/loss will be treated as underreported income.
7.6 Exclusion from under-reporting
Sub-section (6) provides five circumstances, under which addition will not amount to underreporting. In brief they are-
7.6-1 Clause (a)
Where an explanation is furnished by the assessee in respect of any item of income added by the AO and the initiating authority is satisfied that explanation is bona fide and all the material facts to substantiate the explanation have been disclosed. There are four ingredients in this exclusion. One is that an explanation should be furnished by the assessee citing reasons for under-reporting of income. If no explanation is furnished no benefit of this exclusion will be available. Second and third ingredients are – if explanation is furnished then such explanation should be bona fide and all the material facts relating to the explanation are furnished. The fourth is that the initiating officer should be satisfied in respect of bona fide nature of the explanation and furnishing of material facts relating to the explanation.
All these four ingredients are explained below:—
(i) Explanation: From the addition made to the income determined in the processing u/s 143(1)(a), it can be prima facie inferred as under-reported income if it satisfies any of the conditions mentioned in Section 270A(2). The onus is on the AO to give a finding in the assessment order that the addition so made satisfies one of the seven clauses of sub-section (2). Once, this finding comes in the assessment order, then onus shifts on the assessee to explain that his case falls in any one clauses of sub-section (6). For this he has to submit reasons, why a particular claim for deduction, exemption, or expenditure, not accepted by AO, was claimed, why a particular receipt carrying income character was not declared as income, why there were deficiencies in the documents, evidence, explanation submitted with the return, or even during assessment proceedings. He has to recoup such deficiencies, fully and truly alongwith explanation. Mere reliance on submissions made during assessment/reassessment proceedings may not be sufficient during penalty proceedings.
(ii) The concept of bona fide
Clause (a) of sub-section (6) uses the expression “bona fide” i.e. where the explanation of the assessee is bona fide and other conditions are also fulfilled, then amount of addition may not be treated as underreported income. The expression “bona fide” has been explained by the Courts as under—
i. Bona fide is a Latin term meaning “good faith”. In legal terms, it is often used to refer to an act which is without fraud or deceit. Bona fide refers to a quality of genuineness.
ii. It is honest; genuine; actual; authentic or acting without deception or without the intention of defrauding.
iii. It means genuine, real, honest, and sincere1.
iv. The word “bona fide” means “in good faith”, “genuinely”, which are suggestive of honesty of purpose. They convey absence of intention to deceive and connote that the transaction in question is a true and genuine transaction and not a colourable and sham one and there are no strings of any kind attached to that transaction and that there is no secret or covert arrangement2.
v. For the purposes of section 270A(6)(a), an explanation will be bona fide where all the facts relating to the issue which are in the knowledge of the assessee and have bearing on computation of income have been disclosed, there is no evidence placed on record by the AO that explanation could not be bona fide; the probability of happening of the events or transactions or circumstances leading to non-inclusion of the item of income in the computation filed by the assessee are the same as the probability of their non-happening.
(iii) Concept of material facts
The expression “material facts” has been referred in section 6(a) of section 270A. It refers only to primary facts which the assessee is duty bound to disclose. There is no duty cast on the assessee to indicate or draw the attention of the Income-tax Officer to the inferences which can be drawn from the primary facts disclosed3. What facts are material, and necessary for assessment, will differ from case to case4. In brief, material facts would be those facts which have relevance to the computation of income. The explanation to be submitted for getting exclusion under clause (a) of sub-section (6) may have description of
1. Atma S. Berar v. Mukhtiar Singh, (2003) 2 SCC 3.
2. Gift-tax Officer v. Gautam Sarabhai Ltd. [1989] 29 ITD 212 (Ahd. - Trib.).
3. Calcutta Discount Co. Ltd. v. ITO [1961] 41 ITR 191 (SC); Associated Stone Industries (Kotah) Ltd. v. CIT [1997] 224 ITR 560 (SC).
4. Calcutta Discount Co. Ltd. v. ITO [1961] 41 ITR 191 (SC).
events, transactions or circumstances whose happening is as probable as the probability of their non-happening.
(iv) Satisfaction: The initiating officer has to record satisfaction that the explanation furnished by the assessee during penalty proceedings is bona fide and all the material facts relating to the explanation are furnished. Where no express satisfaction is recorded, it would deem that he was satisfied unless adverse satisfaction is recorded. In adverse view, the initiating officer is expected, rather required, while passing a speaking order, to state, why he considered the explanation as not bona fide and what material facts, which assessee could have produced, were not produced. The satisfaction of the initiating officer must be objective. Mere rejecting the explanation without pointing out how it is not bona fide and what relevant and material facts in possession and knowledge of the assessee were not produced, will not be sufficient to disallow the benefit of clause (a) of section 270A(6).
7.6-2 Clause (b)
Where AO (or the initiating authority) is satisfied that, even though the accounts are correct and complete, but method employed by the assessee is such that income cannot be deduced properly from them, estimate of assessable income can be made.
Exclusion from being unreported income will be available only when accounts are correct and complete, but method of accounting is defective. It will cover for exclusion those cases where bills and vouchers are correct, the balances are correctly drawn in the accounts, all the entries are correctly entered into the books but a method of accounting like hybrid system of accounting is followed. Where entries are not supported by vouchers and estimate of income is made by rejecting the books, exclusion under this clause may also be available.
Similar situation is described in section 145(3) as under:—
“145(3)—Where the Assessing Officer is not satisfied about the correctness or completeness of the accounts of the assessee, or where the method of accounting provided in sub-section (1) has not been regularly followed by the assessee, or income has not been computed in accordance with the standards notified under sub-section (2), the Assessing Officer may make an assessment in the manner provided in section 144”.
It may be noted that section 145(3) has three limbs. One is where AO is not satisfied with the correctness and completeness of the accounts; second is where the method of accounting provided in sub-section (1) has not been regularly followed by the assessee and third is where income has not been computed in accordance with the standards notified under sub-section (2). In clause (b) to section 270A(6), second and third limbs are covered. The first limb i.e. where AO is not satisfied in the correctness and completeness of the accounts is apparently covered in clause (c) to section 270A(6). How-
ever, issue is not free from doubt. One can safely argue that even first limb is covered in clause (b) as well. It is because if AO resorts to estimation of income and determines under-reported income and the case of the assessee does not fall under sub-section (9), no penalty for under-reporting of income can be levied.
In following cases, section 145(3) has been invoked on the ground that method of accounting has not been regularly followed by the assessee. If income is estimated and underreported income is worked out then in penalty proceedings, assessee will get the benefit of exclusion under clause (b) of section 270A(6):
(i) Where FIFO method or LIFO method for valuation of stock was inter-changeably was followed from year to year.5
(ii) Where mercantile accounting system or Accounting Standards are not followed. Accrued income is not recorded in the books of account.6
(iii) In a manufacturing unit consumption of different raw material is not recorded in systematic manner, sometimes being arbitrary and casual and in addition, no accounting method was followed on accounting wastage.7
(iv) Where POCM method and PCM method was followed differently in different years.8
(v) Where inflow and outflow of money was accounted for differently on cash and accrual method.
(vi) Where change in accounting method is not explained satisfactorily.
7.6-3 Clause (c)
The benefit of this clause is available where assessee has himself estimated his returned income or has disallowed an item of claim, or has added, by estimate, an item of income, but the AO/CIT/CIT(A)/PCIT has made higher estimate provided all the facts material to the addition or disallowance has been disclosed.
It will cover those situations where assessee himself made a disallowance by estimate such as one fifth of car expenditure, but AO disallowed one third of such expenditure. Also, where a disallowance is made by the assessee u/s 14A at certain amount which is increased by the AO as per calculation made under rule 8D. If higher estimated disallowance is made as against lower estimated disallowance offered by the assessee in the return of income, and as a result under-reported income is worked out, no penalty u/s 270A(1) read with section 270A(7) can be levied.
5. Principal CIT v. Shark Mines and Minerals (P.) Ltd. [2023] 151 taxmann.com 71 (Orissa)
6. Bangalore Beverages Ltd. v. ITO [2023] 152 taxmann.com 14 (Bangalore - Trib.).
7. Sidhant Leather Exports (P.) Ltd. v. CIT [2023] 150 taxmann.com 281 (Calcutta).
8. DCIT v. Sylvannus Builders & Developers Ltd. [2022] 145 taxmann.com 182 (AhmedabadTrib.).
