Saturday, April 11, 2009

A Much Needed Reading Down of Dharmendra Textiles

An earlier post highlighted the implications of the decision of the Supreme Court in Dharmendra Textiles (306 ITR) on penalty proceedings under the revenue laws, including the Income Tax Act. The Court there overruled its earlier decision in Dilip Shroff, and concluded that there is no requirement of mens rea in the case of penalty proceedings. Thus, it does not need to be shown that the assessee deliberately concealed income to avoid tax, as long as it is shown that some income escaped assessment.

This decision was widely perceived as being unduly harsh on assessees, by making penalty proceedings possible even in cases of innocent mistakes on the part of assessees. Not only did the decision mean that income inadvertently not declared by the assessee would result in penalty proceedings, but also resulted in the possibility that if deductions claimed by the assessee were subsequently disallowed, the amount of the disallowance would be subject to penalty. Given the complicated issues of law involved in the case of some deductions, this had the potential of resulting in grossly inequitable results.

It was this very issue that was considered recently by the Mumbai ITAT in ACIT v. VIP Industries. The case involved cross appeals from an order of the Commissioner of Income Tax (Appeals), the relevant one dealing with a deleted penalty. The assessee had claimed a 100% deduction for scientific research expenditure under section 35 of the Income Tax Act, and had included the cost of a car in the computing the amount of the deduction. The Assessing Officer had concluded that the car had not been used for scientific or research purposes, and thus disallowed the deduction to that extent. On this addition, a penalty had been imposed by him, which was deleted by the CIT(A).

In appeal before the ITAT, the Revenue placed reliance on the decision in Dharmendra Textiles, contending that penalty can be imposed even when income remains undisclosed without the conscious act of the assessee. However, the Tribunal rejected this contention, drawing a distinction between income which is not disclosed, and income which is declared to be tax-free. There are two ways in which the income declared by an assessee to be taxable can be lesser than that actually sought to be taxed by the AO. One is if the amount disclosed is lesser than the amount actually earned, and second is if the amount taxable is reduced by a deduction, which is subsequently disallowed. In the second case, the taxable income is increased not due to the discovery of undisclosed income, but because of a disallowed deduction. The Tribunal held that in such a case, since there is no ‘undisclosed’ income, the decision in Dharmendra Textiles could not be interpreted to require the imposition of a penalty.

While this part of the decision does seem to narrow the scope of Dharmendra Textiles, a closer reading also lends support to the possibility that this discussion of the Supreme Court decision is, in fact, obiter, and cannot really be said to be of much legal relevance. This is because in the portion of the judgment immediately preceding the discussion of Dharmendra Textiles, the tribunal examined in detail section 271 (dealing with penalty proceedings), and concluded that the explanation given by the assessee was sufficient for the purposes of section 271. Thus, even if the broad interpretation of Dharmendra Textiles was followed, it would have sufficed for the facts before the Tribunal. However, inspite of this red herring in the decision, the decision does provide a much needed rallying point for assessees seeking a way around the Apex Court dictum.


Anonymous said...

Dharmendra Textiles is being reconsidered by the Supreme Court. The exact scope of the reconsideration is however not yet clear.

Rishabh Sancheti said...

Quite interesting post.

Two more judgments of the Supreme Court regarding penalty under fiscal statutes provide insights into the Court's firm belief in obliterating the requirement of "mens-rea".

The Court is of the view that in cases where the statute prescribes penalty for an action or omission, the background of such act or omission need not be gone into. The judgment in Guljag Industries [2007 (7) SCC 369, which was later affirmed in Bajaj Electricals case, 2009(1) SCC 308] considered the requirement of mens rea under the Rajasthan Sales Tax Act. In the said judgment, the Supreme Court held that mere technical defaults would suffice for inviting penalty. Interestingly, in Guljag Industries case while the Supreme Court has considered its earlier judgment in D.P. Metals (2002 (1) SCC 279), it is not clear as to what will happen if on issuance of show cause notice, the assessee corrects the mistake/fault/omission pointed out, i.e. whether penalty would still be leviable?

Most interesting is the observation in Guljag Industries case that such penalty clauses are "to provide a remedy for loss of revenue" meaning thereby that the requirement of "offence" stricto sensu do not apply at all.

Anonymous said...

SC case has been heard, subject to verification of this fact, by a bench consisting of Hon'ble Justice Kapadia and Hon'ble Justice Alam. The judgment is likely to be pronounced after the vacations.

Anonymous said...

A Division Bench (as in the above comment) reconsidering the larger bench - could that be correct ?

Rishabh Sancheti said...

See: Central Board of Dawoodi Bohra Community ( 5 judges bench, per R.C. Lahoti, C.J., ratio in para 12, (2005) 2 SCC 673).

Ergo, a Division Bench, per the force of this constitution bench judgment, is not competent to reconsider or even doubt the correctness of a 3 judges bench decision. Even to be able to raise a doubt, it at least has to be a bench of similar strength.

Anonymous said...

The judgment has been delivered. It is reported in as Union of India Vs Rajasthan Spinning. As Rishabh rightly pointed out, Dharmendra Textiles judgment has not been reconsidered in strict sense of that term. It has, however, been read down, or rather read correctly, in almost similar kind of effort as Kanbay Software decision from Income-tax Appellate Tribunal did. Is it not the high time that a larger bench should lay down law on this issue ?

Shantanu Naravane said...

The decision in Rajasthan does consider Dharmendra, but seems a tad disappointing when it comes to laying down the law on the point.
With respect to the Excise Act, and s. 11AC thereof, the decision only says that the ingredients of the provision have to be satisfied, and if they are, then the AO has no discretion in determining the quantum of penalty. It is silent on the burden of proof and presumption of guilt, which is what has the practical effect of doing away with the mens rea requirement. Also, it specifically states that the decision shall have no relevance for other statutory provisions considered in Dharmendra, which would include s. 271 of the Income Tax Act.
Having said that, there are some broad observations in the case which may be useful for those seeking to argue against Dharmendra.
However, on an overall assessment, the decision only seems to create further controversy and scope for debate.

Siddhartha Singh said...

Can anyone tell me wt is the status of dharmendra textiles case after the latest Reliance Petroproducts v. CIT, Ahemdabad judgment