Prosecution without penalty?

The question: ‘Can prosecution proceedings continue if the corresponding penalty is deleted by the ITAT?’ has been a massive bone of contention between the Revenue and assessees in prosecution cases emanating from the Income Tax Act. Let us look at some cases on the interplay between penalty and prosecution:

KC Builders vs. ACIT (265 ITR 562)

SC holding

Prosecution proceedings would not survive if the corresponding penalty was deleted by the ITAT since the basis of prosecution would cease to exist.

Standard Chartered Bank vs. Directorate of Enforcement (4 SCC 278)

SC observation

The decision in KC Builders seemed to run contrary to an earlier decision of the SC in Assistant Collector of Customs vs. LR Melwani (AIR 1970 SC 962) and may have to be reconsidered.

This created judicial confusion on the status of prosecution proceedings as the observation in Standard Chartered was used to argue that KC Builders was not the correct case to be applied.

While in theory KC Builders stands on sound footing, the fatal flaw of SC’s reasoning emanates from the fact that often Tribunals dismiss cases on technical grounds without going into the merits of the case. In such a situation, it would be patently unfair to the revenue if the decision of the Tribunal was to be considered binding on the criminal court.

The confusion saw a measure of resolution in the case of Radheshyam Kejriwal, where a three-judge bench harmoniously construed the ratios of KC Builders, Standard Chartered and LR Melwani.

Radheshyam Kejriwal vs. State of West Bengal (333 ITR 58)

SC Holding

While prosecution and adjudication proceedings were independent of each other, dismissal of adjudication proceedings on technical grounds would not sound the death knell for prosecution proceedings. However, if the assessee was exonerated from the charges on merit in adjudication proceedings, such a finding would be binding on the criminal court due to the higher standard of proof required in criminal court.

It must, however, be noted, that Radheshyam Kejriwal read down the ratio in KC Builders only on the limited question of interplay between penalty and prosecution. It remains a popularly cited case to hold that if additions on the basis of which penalty was levied are deleted, the penalty itself cannot survive. Radheshyam Kejriwal, in turn, has been cited in 3 cases (affirmed in all judgments) before High Courts on matters dealing with prosecution on the basis of penalty which has been cancelled.

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