Analysis, Income Tax

Being Forewarned is Being Forearmed: Income Tax

Are you an individual who does tax planning meticulously and pays taxes judiciously but still wonders if you are shooting in the dark? We bring to you a series of articles to help you understand what you have to watch out for and help you structure a comprehensive legal strategy backed by sufficient data-driven evidence to reduce potential tax concerns.

Why do you need it?

The Income tax law book is a 2000-page book, containing about 800 sections. These statutes have innumerable amendments and have led to lakhs of case laws (judgements), and it can be safely concluded that it is one of the most complicated legislations in the legal system.

As per Income tax department statistics for financial year 2015-16, about 4 crore IT returns are filed by individuals alone, thus it is one of the most relevant pieces of legislation even though most people are aware of it only as much as Maria Sharapova is about cricket. The standard compliance with income tax laws is poor in India and the complexity of the law could potentially be one of the prime reasons behind this problem.

If you knew potential pitfalls that other individual taxpayers have faced, wouldn’t it lead to better appreciation of the requirements and improved compliances?

Further, identification of risks associated with certain types transactions will reduce unpleasant surprises that may frequently spring up during the lifecycle of a tax dispute.

The data piece

A good place to start the analysis of the issues faced by individual taxpayers is the decisions of tax courts in respect of cases involving individual assesses.

We chose to look at the disposed of appeals involving individual taxpayers for financial years 2015-16 & 2016-17 from the Income Tax Appellate Tribunal (ITAT), Mumbai to analyse what the data tells. It is a good illustration of the potential problems a litigant may face but the actual problems may differ forum to forum on account of regional factors.

We found that out of total 12,000 judgements delivered by ITAT Mumbai in the last two financial years, individual assesses are primarily concerned with about 3500 judgements. Our goal is to harness insights from these judgements.

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Top 5 most litigated issues against individuals

Of the approximate 800 sections, the sections that are most litigated with respect to individuals are given below:

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  1. Unexplained cash credit (Sec. 68) – This section empowers the Assessing Officer to bring within tax net any sum found credited in the books of a taxpayer, for which the taxpayer fails to offer satisfactory explanation regarding its nature and source.
  2. Unexplained expenditure (Sec. 69C) – When assessee has incurred expenditure but offers no or unsatisfactory explanation about the source of expenditure then the amount may be deemed to be the income of the taxpayer for that year.
  3. Special provision for full value of consideration in certain cases (Sec. 50C) – This section deals with the transaction of sale of immovable property and determination of value to be adopted for calculating capital gains in the hands of the seller.
  4. Exemption of Capital Gains on Transfer of Long-Term Capital Assets (Sec. 54F) – This provision exempts capital gains earned from transfer of long-term capital asset (other than the residential house) if the capital gains earned are invested in another residential house within a certain period of time.
  5. Unexplained Investments (Sec. 69) – Where in a year the taxpayer has made investments which are not recorded in the books of account, if any, and he offers no or unsatisfactory explanation about the nature and source of the investments then the value of the investments may be deemed to be the income of the taxpayer of that year.

Also Read: Speed Check of ITAT Forums

What next?

The above data talks about the top 5 sections, which collectively account for 23% of the total cases against individuals at the ITAT level in the last two financial years. The number of first level notices which would have been issued by the tax department involving these sections will potentially be a higher number than the number of cases at the ITAT level.

Insights from the cases involving these top 5 sections can help many individual taxpayers to be forewarned about challenges that could be mounted by the tax department and also to understand the path that has proven to work best in similar cases.

Given the importance of the top 5 sections on large number of individual taxpayers, in the next few articles of this series, we will delve into a detailed data driven analysis of each of the above mentioned legal provisions.

Now some litigation statistics from a tax policy angle

Here are some statistics from the data on the overall number of returns filed, direct tax contribution by Companies and composition by party type of ITAT Mumbai cases disposed in F.Y 2015-16 and 2016-17:

  • 93% of income tax returns filed by individuals
  • 31% of cases in the ITAT apply to individuals
  • 61% of total direct tax collected from by companies
  • 47% of cases in the ITAT apply to companies

The data is indicative of the fact that the tax department with its limited resources may be trying to focus all their efforts in catching the so called big fishes.

While a large number of cases involve companies, the question that our data raises is that is whether a still significant number of cases against individuals justified?

Article individual data

As you see in the above graph, a large number of tax cases for individual were in favour of the individuals.

A message in a bottle

Pursuing a case until the ITAT level (which is the second appellate authority) can be both time and money consuming, especially for the revenue department where the success rate is about 5%. An informed decision to appeal should be taken to avoid cost as well as burden of litigation in a losing cause.

We believe chance litigation should be avoided in all spheres, more so in the tax cases given the settled law that any gap in the income tax legislation must be interpreted in a liberal manner to provide due benefit to the assessee.

(Note: The statistics are based on publicly available information relating to judgements. Complete information was not available in all the documents and therefore there might be some inconsistency in the data.

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