In a recent judgement, the Mumbai bench of the Income Tax Appellate Tribunal ( ITAT ) upheld the order of the Commissioner of Income Tax (Appeals), asserting that simply making a claim that is not legally sustainable does not constitute furnishing inaccurate particulars of income by the assessee.
The respondent/ assessee, Fidelity Management & Research Co. registered as trusts and tax residents in foreign countries, had initially filed their income tax returns in India under the category of “Capital Gains” based on the income earned from the sale of securities. These assessees, sub-accounts of Funds registered with the Securities Exchange Board of India ( SEBI ) as Foreign Institutional Investors (FIIs), also reported dividend income, which they claimed was exempt from tax. However, after referencing rulings in similar cases, such as the AAR ruling in the XYZ/ABC Equity Fund case ( 2001 ) and Fidelity Advisors Series VIII (2004), the assessees revised their returns, declaring no taxable income and requesting a refund, arguing that their income should be categorized as “business income,” not subject to tax in India under Article 7, read with Article 5 of the DTAA, due to the absence of a Permanent Establishment ( PE ) in India.
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The Assessing Officer ( AO ) reviewed this stance within the context of the Indian government’s scheme allowing FIIs to operate in Indian securities and the specific provisions under Indian Income-Tax law regarding FII taxability. The AO concluded that FIIs are permitted to invest as investors in the capital market, with gains from securities being taxed as “capital gains” under Section 115AD of the Income-Tax Act, 1961, as outlined in the SEBI Regulations. The AO further asserted that allowing FIIs to claim business income status would contradict SEBI Regulations and disrupt the regulatory framework.
In examining the assessees’ prospectuses, the AO noted that the funds’ primary objective was capital growth, with income derived from dividends and capital gains, which were either distributed or accumulated. The AO rejected the assessees’ contention that their income should be classified as “business income” and thus not taxable in India.
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Consequently, the AO completed the assessment under Section 143(3), taxing the income under “capital gains” and initiated penalty proceedings under Section 271(1)(c) for making false claims in the revised returns. The AO found the explanations provided by the assessees unsatisfactory and imposed penalties accordingly.
The assessees challenged these penalties before the Commissioner of Income Tax (Appeals) [CIT(A)], arguing that the original returns had accurately reported capital gains income. They cited the AAR rulings in similar cases to justify their revised returns and the claim for treaty benefits. They also pointed out that the AO had not clearly stated whether the penalties were for concealing income or furnishing inaccurate particulars. The assessees argued that penalties should not apply in cases where subsequent legal rulings establish a different interpretation of the law.
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The CIT (A) reviewed the case and noted that the assessees had fully disclosed the reasons for revising their returns and that there was no evidence of inaccurate particulars. The tribunal, after hearing arguments from both sides, observed that the revised returns were based on a bona fide belief, supported by the AAR ruling that the income might qualify as business profits, which would be exempt from tax in India due to the absence of a PE. The tribunal found that the AO had not demonstrated any falsehood in the particulars provided by the assessees.
The tribunal referred to the Supreme Court’s judgment in the case of CIT vs. Reliance Petro Products (P) Ltd., which held that Section 271(1)(c) of the Income Tax Act applies when there is concealment of income or furnishing of inaccurate particulars. The Supreme Court ruled that merely making an incorrect legal claim does not equate to furnishing inaccurate particulars. Applying this precedent, the tribunal held that the penalties imposed by the AO in the assessees’ cases were not sustainable.
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In conclusion, the two member bench of the tribunal comprising R.V Easwar ( President ) and P.M Jagtap ( Accountant member ) upheld the CIT(A)’s orders canceling the penalties imposed by the AO and dismissed the appeals filed by the Revenue. The tribunal’s decision reaffirmed the principle that penalties under Section 271(1)(c) should not be imposed in cases of genuine legal interpretation differences where no inaccurate particulars are furnished.
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