Effective Tax Rate on undisclosed income under IDS, 2016 is still 45% – here is why

Introduction
1. Under the Income Declaration Scheme, 2016 (‘IDS, 2016’ or ‘the scheme’) a person is required to declare his undisclosed income by paying tax, surcharge and penalty totalling to 45% of such undisclosed income declared. Recently, there has been some discussion in the media that effective rate of tax on undisclosed income has come down to 31% from 45%. This conclusion seems to have been arrived at by drawing an inference from the response to the 5th question of the 3rd set of FAQs issued on 30th June, 2016 wherein it has been assured that no departmental enquiry shall be made in respect of sources of payment of tax, surcharge and penalty. The relevant question reads as under:
“Question No.5 : Where a valid declaration is made after making valuation as per the provisions of the Scheme, read with IDS Rules and tax, surcharge & penalty as specified in the Scheme have been paid, whether the department will make any enquiry in respect of sources of income, payment of tax, surcharge and penalty?
Answer: No”
The basis of arriving at 31% tax rate is as follows: Suppose, Mr. X has an undisclosed income of Rs. 145 and out of Rs. 145 , he declares Rs. 100 and accordingly, he pays tax of Rs. 45 (Rs.100×45%). Now, drawing support from response to question No.5 Mr. X is of the view that after declaration he will have a total legitimate income of Rs. 145 [Rs.100 which was declared under the scheme plus Rs.45 for which no question shall be asked regarding its source] and accordingly the effective tax rate is 31% (45/145×100).
2. Why, here is why the aforesaid view does not reflect the correct position.
♦ The basic requirement for making a declaration under the IDS is that there should be undisclosed income which has so far remained untaxed. The scheme does not define as to what constitutes “undisclosed income”, but section 183 of the scheme categories it in three parts-First part covers a case where the person has failed to furnish a return of income under section 139 of the Act. Second part covers a case where the person has failed to disclose any income chargeable to tax in the return of income before the commencement of IDS i.e., 1 June 2016. Third part covers a case where income of a person has escaped assessment by reason of the omission or failure on the part of such person to furnish the return of income or to disclose fully and truly all material facts necessary for the assessment or otherwise.
♦ As can be observed, section 183 nowhere provides that if one is successful in explaining the source of income to the satisfaction of the Assessing Officer (‘AO’), such income shall be treated as legitimate income, even though no tax has been paid in respect of such income.
♦ Further, on perusal of the scheme and the forms, it is clear that the scheme does not require disclosure of the manner in which undisclosed income has been derived by the declarant as it merely requires disclosure of income assessment year-wise and head-wise (salary, income from house property, capital gain etc.). In that sense, the issue dealt with by Question No.5, is merely clarificatory in nature.
♦ Moreover, the scheme doesn’t mandate a declarant to disclose his entire undisclosed income. It is entirely upto him whether to disclose his entire undisclosed income or part income. The only condition is that he must pay the full amount of tax (including surcharge and penalty) within the specified timeline in respect of undisclosed income declared by him under this scheme. However, he will get the immunity only in respect of such undisclosed income which he declares under the scheme, the balance shall be subject to tax under the Income-tax Act whenever the AO detects such income.
♦ This aspect has been clarified by the CBDT in its FAQ [Circular No. 17 of 2016, dated 20.6.2016]
“Question No.10 : If a person declares only a part of his undisclosed income under the Scheme, then will he get immunity under the Scheme in respect of the part income declared?
Answer: It is expected that one should declare all his undisclosed income. However, in such a case the person will get immunity as per the provisions of the Scheme in respect of the undisclosed income declared under the Scheme and no immunity will be available in respect of the undisclosed income which is not declared.”
♦ Further, this position emerges from the combined reading of section 188 and section 197(c) of the scheme. For ready reference the relevant extracts of section 188 and section 197(c) have been re-produced as under:
“Undisclosed income declared not to be included in total income.
188. The amount of undisclosed income declared in accordance with section 183 shall not be included in the total income of the declarant for any assessment year under the Income-tax Act, if the declarant makes the payment of tax and surcharge referred to in section 184 and the penalty referred to in section 185, by the date specified under sub-section (1) of section 187.”
“Section 197. For the removal of doubts, it is hereby declared that–
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(c) where any income has accrued, arisen or received or any asset has been acquired out of such income prior to commencement of this Scheme, and no declaration in respect of such income is made under this Scheme,–
(i) such income shall be deemed to have accrued, arisen or received, as the case may be; or
(ii) the value of the asset acquired out of such income shall be deemed to have been acquired or made,
in the year in which a notice under section 142, sub-section (2) of section 143 or section 148 or section 153A or section 153C of the Income-tax Act is issued by the Assessing Officer, and the provisions of the Income-tax Act shall apply accordingly.”
♦ Section 188 of the scheme provides that “the amount of undisclosed income declared in accordance with section 183” shall be excluded from the total income of the declarant for any assessment year under the Income-tax Act if he pays tax at 45% within the specified date. The declarant will be given a certificate of declaration under section 183 in respect of “amount of undisclosed income declared and accepted” by the Department. Accordingly, the immunity under section 188 shall be restricted to the amount of undisclosed income declared and accepted under the scheme.
♦ Section 197(c) of the scheme introduces a deeming fiction regarding accrual of undeclared income/acquisition of asset [acquired out of such income] which has already accrued/been acquired prior to the commencement of scheme. According to this section, any undisclosed income not declared under this scheme can be taxed in the year in which a notice under section 142/143(2)/148/153A/153C is issued by the AO, irrespective of the year it belongs to.
♦ Now, in the above example, if Mr. X has declared Rs. 100 under this scheme and, therefore, in future years, he may be relying on section 188 claim before the AO that he had made disclosures of Rs. 100 under IDS, 2016, to that extent he should not be subjected to double taxation. However, the remaining Rs. 45 may be taxed by the AO by invoking section 197 (c), if it comes to his knowledge that Rs. 45 is, in fact, an income which was never offered to tax earlier. At that point of time, the AO may also levy penal interest, and initiate penalty & prosecution proceeding.

Effective Tax Rate on undisclosed income under IDS, 2016 is still 45% – here is why is written by CA Chandan Kumar. Mere assurance that the source of payment of tax shall not be enquired into is insufficient to convert an undisclosed income into a legitimate income for tax purpose.

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