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Why amendment in taxation laws was brought in the middle of demonetisation

Demonetisation was a blow which struck at the heart of decades of planning by the corrupt. All those sacks of cash worthless within a few hours. The only way to redeem them was to deposit them in the banks and thus declare them as your income. The hardest part of this was gauging the taxation cost of this exercise. Each deposit would obviously catch the eye of the Income Tax Department and hence some tax would be payable on this.

And this is when the rumours began. Many social media messages portrayed that one would have to pay anywhere between 200% to 90% of the deposits as tax. This news created panic among the crooks, and they began looking at alternate “jugaad” to convert their cash into legal tender or other assets. This was partly debunked by us here.

The legal position though was worth studying and understanding. The penalty laws as per Income Tax Act, were amended in the latest budget, and some draconian provisions which gave undue power in the hands of the taxmen were withdrawn.

Simply put, the new laws stated as below:

  1. A penalty of 50% of tax amount for “under-reporting”
  2. A penalty of 200% of tax amount for “mis-reporting” as a consequence of “under-reporting”

Before we proceed, we need to understand these two new concepts which were brought in.

“Under reporting” meant that the income disclosed by the person, was lower than his actual income. In the context of demonetisation, “under-reporting” would be triggered if: A person deposits Rs 10 lacs as cash, but shows his income as only Rs 6 lacs, and cannot prove that the balance Rs 4 lacs was not his income.

“Mis-reporting” on the other hand referred to malafide “misrepresentation or suppression of facts” and similar actions. The new laws put the onus on the tax officer to prove that “mis-reporting” had taken place, thus it was not as straight forward a provision as the “under-reporting” clause.

What further complicate things was that the way the law was worded, it meant that the stringent 200% penalty of “mis-reporting” could be invoked ONLY if there was “under-reporting”.

To understand the consequence of this, let us take an example:

Mr A has Rs 50 lacs of black money. He deposits all of it in the bank and declares the entire amount as income. He pays 30% thereof as tax, under the regular provisions. Thus, Mr A, by declaring the total deposits and not hiding anything, has avoided the “under-reporting” clause. Thus he avoids the 50% penalty.

Now, as per the law, he could even avoid the 200% penalty for “mis-reporting” since, this could be triggered ONLY in the case of “under-reporting”. Further, the way the law was worded, there was a chance that the 200% penalty would be applied only on the income which was under-reported, and not on the total deposits. So there was a view in professional circles that one could get away with paying just 30% as tax!

This rate (excluding other consequences such as indirect tax laws etc.) was lower than the 45% offered to the Income Declaration Scheme applicants, and hence was not desirable. Mr A could appeal against any decision at multiple levels. He could appeal to the Commissioner (Appeals), the Income Tax Tribunal and even the Courts. Some of the legal means of avoiding penalty are given here.

Thus as per the old law, a crook caught in demonetisation had very good chances of paying just 30% Income tax.

To avoid this anomaly, where an IDS applicant faced a tax rate of 45% and a crook caught in the demonetisation scheme pays just 30% tax, a new scheme of Pradhan Mantri Garib Kalyan Yojana was brought in. It was done through the introduction of Taxation Laws (Second Amendment) Bill, 2016 in Lok Sabha yesterday.

This scheme primarily serves two purposes:

  1. It doesn’t allow people to use the possible loophole of getting away with just 30% tax as explained above.
  2. It clears the air on all kinds of tax and penalty numbers doing the rounds on the social media.

Taxation amendment during demonetisation
Details of the amendment brought in by the government. Source.

It should be noted that while 30% appeared the likely amount of tax to be paid, which could have “inspired” people to deposit their unaccounted cash, WhatsApp messages and many other considerations had also created the fear and confusion by circulating numbers like 200%. This turned off people from demonetisation, who then began looking for illegitimate means. This could have defeated the purpose of the drive.

Secondly, a gross tax rate of 50% with immunity from certain laws, but not from FEMA, PMLA, Narcotics, and Black Money Act, meant that the people caught after IDS, were not at any advantage over the people who had come clean during the IDS.

Thirdly, although the tax rate is 50%, the effective loss to the depositor is around 57%-60%, considering that he would lose interest on 25% of the money deposited in the Pradhan Mantri Garib Kalyan Yojana for 4 years.

Fourth, the scheme has not just given a 50% rate, but has also warned that if anyone did not go for this, and tried to hoodwink the department by paying just 30% tax, and if caught, he would have to pay tax in excess of 85%.

So in effect, this scheme is a carrot and stick approach. The stick landed hard on November 8th, and now a small carrot has been dangled so that the intention of the demonetisation scheme is achieved.

Now the question arises if this is another Voluntary Income Disclosure Scheme? Not exactly because after the scrapping of old notes, it is not exactly “voluntary”, and the old IDS granted much greater immunity from further prosecution, as compared to this new scheme.

The Pradhan Mantri Garib Kalyan Yojana will most likely ensure better legal compliance from those who have stacks of black money or unaccounted cash, and discourage them from using illegal means to trick the department.

They can buy peace of mind (to an extent) buy parting away with 50%-60% of their money, and the Government also gets a substantial tax revenue, as compared to the old provisions where they could have been sitting with just 30% tax.

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