Bombay High Court Upholds Penalty Under Section 271(1)(c): Transfer of Revalued Stock-in-Trade to Partnership Firm, Followed by Immediate Withdrawals, Held as a Tax Evasion Device—”A Mere Disclosure in Books Does Not Amount to Full and True Disclosure”

Court’s Decision

The Bombay High Court upheld the penalty of ₹33,34,096 imposed under Section 271(1)(c) of the Income Tax Act, 1961, ruling that the appellant had engaged in a “device” to evade tax. The court found that the appellant had deliberately structured transactions to avoid paying taxes by revaluing a property, transferring it to a partnership firm, and withdrawing funds from its capital account without disclosing the true nature of the transaction. The court held that such actions warranted a penalty and dismissed the appeal.

Facts

• The appellant, a real estate and construction company, purchased a plot of land at Agripada in 1982 for ₹25,00,000 and spent ₹26,61,283 on its development.
• In 1983, it entered into a partnership with six others under the name M/s. Nirmal Enterprises.
• The appellant revalued the plot at ₹1,04,53,500 and introduced it as its capital contribution to the firm.
• Within two years, the appellant withdrew a major portion of this revalued capital from the firm, reducing its capital balance to ₹2,00,000 by August 1986.
• In 1989, before the firm’s project was completed, the appellant retired from the partnership.
• For the Assessment Year 1984-85, the appellant filed a tax return declaring “Nil” income, claiming set-off of losses from earlier years.
• The Assessing Officer reassessed the income based on the Supreme Court ruling in Sunil Siddharthbhai and added ₹52,92,218 as profit on the stock-in-trade transfer.
• The Commissioner of Income Tax (Appeals) deleted this addition, but the ITAT reinstated it.
• The ITAT also imposed a penalty under Section 271(1)(c), which led to this appeal before the High Court.

Issues

1. Was the ITAT correct in upholding the penalty under Section 271(1)(c) of the Income Tax Act?
2. Did the appellant’s transaction—revaluing stock-in-trade, contributing it to a partnership, and subsequently withdrawing capital—constitute a tax evasion device?
3. Did the appellant’s disclosure of capital accounts in its returns amount to full and true disclosure as required by tax laws?

Petitioner’s Arguments

• The appellant argued that it had not concealed any facts or furnished inaccurate particulars.
• It contended that all transactions, including withdrawals from the capital account, were reflected in the books of accounts and tax returns.
• The appellant claimed that the ITAT wrongly applied Explanation 1 to Section 147, which states that mere production of books does not amount to disclosure.
• It relied on Supreme Court rulings (Calcutta Discount Co. Ltd., CIT v. Taj Borewells, CIT v. Smt. P.K. Kochammu Amma) to argue that there was no statutory requirement to disclose withdrawals separately.
• It claimed that the mere rejection of an assessee’s claim does not justify a penalty, citing Reliance Petroproducts Pvt. Ltd.
• The appellant also cited Jamnalal Sons Ltd., where similar transactions were not deemed tax evasion schemes and argued that two views were possible, in which case no penalty should apply (Durga Kamal Rice Mills).

Respondent’s Arguments

• The Revenue contended that the ITAT’s findings were justified as the transaction was structured to evade tax.
• The Revenue relied on the ITAT’s prior ruling confirming the addition of ₹52,92,218 to income, which had attained finality.
• The Revenue argued that the firm was merely a conduit for the appellant to withdraw capital gains without paying tax.
• It emphasized that withdrawals were made immediately after revaluation, proving tax avoidance intent.
• The Revenue relied on CIT v. Sunil Siddharthbhai, which allows tax authorities to scrutinize whether partnerships and asset transfers are genuine or a ruse to avoid tax.

Analysis of the Law

• Section 271(1)(c) of the Income Tax Act provides for penalties when an assessee conceals income or furnishes inaccurate particulars.
• Explanation 1 to Section 271 states that a penalty is justified if an assessee’s explanation is false or cannot be substantiated.
• The Supreme Court in Sunil Siddharthbhai ruled that if a transaction is a ruse for avoiding tax, tax authorities are justified in lifting the corporate veil and examining its true nature.
• The case law relied on by the appellant (Jamnalal Sons Ltd., Durga Kamal Rice Mills, Reliance Petroproducts Pvt. Ltd.) was distinguished as not applicable.

Precedent Analysis

• The High Court distinguished this case from Jamnalal Sons Ltd., where the ITAT had ruled that the transactions were genuine.
• It found that unlike in Jamnalal Sons Ltd., in this case, both the Assessing Officer and ITAT had concluded that the transactions were tax evasion devices.
• The court held that Reliance Petroproducts Pvt. Ltd. was not applicable, as this case involved deliberate structuring for tax avoidance, not just an incorrect claim.
• The court reaffirmed Sunil Siddharthbhai, ruling that tax authorities could scrutinize transactions to uncover tax evasion devices.

Court’s Reasoning

• The court found that the appellant structured transactions specifically to avoid paying tax:
  • The property was revalued significantly within a short period of purchase.
  • It was introduced as capital into a firm in which the appellant was a partner.
  • The appellant withdrew large sums soon after, leaving little capital in the firm.
  • The appellant retired from the firm before the project was completed.
• The court held that these transactions amounted to a device or subterfuge.
• It ruled that mere disclosure of capital accounts did not constitute full and true disclosure.
• The penalty was justified because:
  • The transaction was a deliberate tax evasion scheme.
  • The appellant failed to offer a credible explanation.
  • The findings of tax evasion had attained finality.

Conclusion

• The High Court upheld the penalty under Section 271(1)(c).
• It ruled that the findings of the Assessing Officer and ITAT—that the entire transaction was a device to evade tax—were valid and based on proper reasoning.
• The court answered the substantial question of law against the appellant and in favor of the Revenue.
• The appeal was dismissed with no costs.

Implications

• This ruling strengthens the power of tax authorities to scrutinize transactions involving revaluation and capital contributions to partnerships.
• It sets a precedent that mere disclosure in books does not absolve an assessee if the transaction is structured for tax avoidance.
• The decision reinforces Sunil Siddharthbhai, affirming that if a partnership is created as a conduit for tax evasion, tax authorities can intervene.
• Real estate and corporate entities must exercise caution in structuring revaluation-based capital contributions, as these will be closely examined for tax evasion motives.

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