Supreme Court On Undisclosed Income and Penalty Under Section 271AAA Income Tax Act

The Supreme Court in a Civil Appeal delivered a judgment by partly allowing the appeal in I.T.A. No. 125 of 2017 upholding the order of the High Court of Karnataka at Bengaluru. The appeal had challenged the dismissal of the appeal of the appellant under Section 260A of the Income Tax Act, 1961 (hereinafter 'the Act 1961'), for levy of penalty under Section 271AAA of the Act 1961.

The matter pertains to a search and seizure operation done at the premises of the appellant on November 25, 2010, under Section 132 of Act 1961., wherein the appellant revealed an income of Rs.2,27,65,580/- in respect of Assessment Year (AY) 2011-2012. Subsequently, an Assessment Order dated March 15, 2013, was passed by the Assessing Officer (AO), determining the total income at Rs.4,78,02,616/- for the Previous Year (PY) 2010-2011 pertaining to AY 2011-2012.

This assessed income included the amount disclosed during the search and an additional amount of Rs.2,49,90,000/- offered during the assessment proceedings regarding land transactions. Subsequently, penalty orders under Section 271AAA of the Act 1961 were passed for both AY 2010-2011 and AY 2011-2012. The penalty for AY 2010-2011 was later set aside by the Commissioner of Income Tax (Appeals). The penalty for AY 2011-2012 was upheld by the ITAT and subsequently by the High Court.

The Supreme Court undertook a detailed interpretation of Section 271AAA of the Act 1961. The Court noted that although Section 271AAA(1) provides the Assessing Officer with the discretion to impose a penalty of ten percent on the unreported income of the said previous year, the discretion is not absolute and needs to be exercised cautiously. The Court stressed that penalty under this section can only be imposed in case of unreported income in the said previous year.

The Court proceeded to interpret Section 271AAA(2), which lays down exceptions to charging penalty under sub-section (1) with three conditions being required to be satisfied by the assessee: (i) making a confession of the undisclosed income and describing its derivation in a statement under Section 132(4) at the time of search; (ii) establishing the mode of derivation; and (iii) depositing the tax along with interest on the undisclosed income. The Court held that compliance with all three conditions in Section 271AAA(2) is mandatory for the assessee to avoid penalty under Section 271AAA(1).

Regarding the expression ‘undisclosed income’, the Court reiterated that as Section 271AAA is a penalty provision, it must be strictly construed. The onus lies on the Assessing Officer to demonstrate and prove that the undisclosed income of the specified previous year was found during the course of or as a result of the search.

*The Apex Court, However on the recoveries observed that "At times, search of an assessee leads to a search of another individual and/or further investigation/interrogation of third parties. All these steps and recoveries therein would fall within the expression ‘found in the course of search’.

The Court also clarified the meaning of ‘specified previous year’ as defined in the Explanation to Section 271AAA. In the present case, the Court determined that AY 2011-12, being the year in which the search was conducted, was the specified previous year.

Applying these principles to the facts, the Supreme Court held that no penalty under Section 271AAA(1) was attracted on the sum of Rs.2,27,65,580/- admitted by the appellant during the search before the DDIT (Inv.) for AY 2011-12, as the appellant had also substantiated the manner of its derivation and paid the tax and interest thereon, albeit belatedly, thus satisfying all the conditions of Section 271AAA(2).

However, concerning the additional income of Rs.2,49,90,000/- relating to land transactions, which was offered by the appellant only during the assessment proceedings and not during the search, the Court held that the exception under Section 271AAA(2) was not applicable. The Court reasoned that this income constituted undisclosed income found during the search, as the sale deeds related to these transactions were collected from the Society as a result and in continuation of the search at the appellant’s premises. Consequently, penalty under Section 271AAA(1) was leviable on this amount as the conditions of Section 271AAA(2) were not met.

The Supreme Court, thus partly allowed the appeal, directing the appellant to pay penalty at the rate of 10% only on the undisclosed income of Rs.2,49,90,000/- and not on the entire assessed income of Rs.4,78,02,616/-. search of an assessee leads to a search of another individual

Coram: Justice J.B. Pardiwala and Justice Manmohan
Between: Vinod Kumar vs State (Govt. of NCT of Delhi) 2025 INSC 209
Date of Judgment: 13-02-2025