Article

No Penalty for Underreporting of Income Can Be Levied When Addition of Deemed Income is Made in the Assessment

Article

No Penalty for Underreporting of Income Can Be Levied When Addition of Deemed Income is Made in the Assessment

I. Introduction

The Income-tax Act, 1961 (hereinafter “the Act”) embodies a comprehensive framework for assessment of income, levy of tax, and imposition of penalties for non-compliance. A critical component of this regime is penalty for underreporting or misreporting of income under section 270A, introduced by the Finance Act, 2016 to replace the erstwhile provisions of section 271(1)(c). The intent behind section 270A was to bring clarity and objectivity to penalty proceedings by categorising defaults into two distinct heads—underreporting and misreporting.

However, the levy of penalty becomes problematic where the addition arises solely by virtue of deeming provisions, such as those under sections 43CA, 50C, or 56(2)(x). These provisions artificially substitute actual transaction values with notional figures like stamp duty value or valuation officer’s determination, irrespective of the assessee’s actual conduct. This creates a legal conundrum: whether such additions constitute “underreporting of income” attributable to the assessee so as to justify a penalty under section 270A.

Judicial opinion has consistently held that penalty cannot be levied in such cases, as the element of concealment, misstatement, or conscious underreporting is absent. This article analyses the statutory scheme, judicial precedents, and interpretative principles supporting the proposition that no penalty for underreporting can be levied where income is determined under deeming provisions.

II. Legislative Framework of Penalty under Section 270A

Section 270A empowers the Assessing Officer (AO), Commissioner (Appeals), or Principal Commissioner to direct that any person who has underreported income shall be liable to pay a penalty in addition to tax. Sub-section (2) enumerates situations where underreporting is deemed to occur, such as assessed income being greater than returned income, or reassessed income exceeding earlier assessed income. Sub-section (8) enhances the penalty to 200% of tax where underreporting is due to misreporting. Sub-section (9) provides instances of misreporting, such as misrepresentation of facts, failure to record investments, false entries, or failure to report receipts.

The law carves out important exceptions to what constitutes “underreported income.” The underreported income shall not include:

- Income where assessee offers a bona fide explanation and discloses material facts [s. 270A(6)(a)].
- Income determined on the basis of estimates [s. 270A(6)(b) & (c)].
- Additions in conformity with Transfer Pricing Officer’s determination [s. 270A(6)(d)].

These carve-outs embody the principle that penalty is not automatic and cannot be levied where additions rest on estimation, deeming fictions, or issues of valuation beyond the assessee’s control.

III. Nature of Deeming Provisions

Sections 43CA, 50C, and 56(2)(x) aim to plug the perceived mischief of undervaluation in real estate transactions by substituting actual consideration with stamp duty value (SDV) or value determined by the District Valuation Officer (DVO). Section 50C applies to transfers of capital assets (land/building). Section 43CA applies to stock-in-trade transactions of immovable property. Section 56(2)(x) taxes the buyer for acquiring property at less than SDV, treating the difference as income from other sources.

Additions under these provisions are not based on factual concealment but on statutory deeming fictions. The assessee may have disclosed full particulars of the transaction, including actual price, yet be subjected to addition merely because SDV exceeds such consideration.

Thus, such additions lack the essential ingredient of “mens rea” or culpable conduct and cannot form the foundation of penalty.

IV. Judicial Precedents

1. ITAT Ahmedabad in Narayanbhai Shivabhai Patel v. ITO [2025] 178 taxmann.com 576: Held that additions under s. 56(2)(x) are not absolute; valuations are estimates; penalty u/s 270A not leviable.

In this case , the assessee purchased two properties at prices lower than the stamp duty value. The Assessing Officer invoked section 56(2)(x) and treated the difference as income, further imposing penalty under section 270A for underreporting. The Tribunal held that such addition is not absolute since the assessee could contest the stamp duty value under section 50C and the Assessing Officer would then be required to refer the matter to the Valuation Officer. Moreover, DVO’s valuation is only an estimate, and if within 20% of the consideration, no addition arises. Thus, additions under section 56(2)(x), based on deemed values or estimates, cannot be categorised as “underreporting” of income to attract section 270A. The assessee had disclosed all material facts, and there was no misreporting. Consequently, the Tribunal quashed the penalty, holding that no penalty is leviable on deemed income additions.

2. ITAT Raipur in Smt. Saroj Shrivastava v. ITO [2024] 164 taxmann.com 1409: Penalty deleted as AO failed to specify whether it was underreporting or misreporting.

In this case, the assessee’s assessment was reopened, and additions were made towards deemed disallowance of improvement cost, denial of HRA claim, and capital gains. The Assessing Officer levied penalty under section 270A, citing both “underreporting” and “misreporting” without specifying the precise limb. The Tribunal held that penalty proceedings must be based on a clear satisfaction recorded in the assessment order, specifying the exact nature of default. A vague reference to both limbs reflects non-application of mind and renders the penalty unsustainable. It was further observed that additions on estimation or deemed disallowances cannot automatically qualify as underreporting. Following precedents, including Golden Peace Hotels and Alrameez Construction, the Tribunal concluded that the penalties imposed were erroneous, arbitrary, and without merits. Accordingly, the penalty order was quashed, reaffirming that no penalty under section 270A is leviable on additions arising from deeming or estimated provisions.

3. ITAT Mumbai in Alrameez Construction (P.) Ltd. v. CIT/NFAC [2023] 152 taxmann.com 382: Deeming provision additions cannot be treated as concealment; penalty arbitrary.

In this case the Assessing Officer made additions under sections 43CA read with 56(2)(x)—both deeming provisions—and initiated penalty under section 270A for “misreporting.” The Tribunal held that where income is computed solely by legislative deeming (e.g., substituting consideration with stamp/DVO values), the case does not fall within “under-reporting” under section 270A. In such situations, neither concealment nor active understatement by the assessee is established; the adjustment is a statutory substitution beyond the assessee’s volition. Further, the penalty notice failed to specify the precise limb—“under-reporting” or “misreporting”—and did not demonstrate how section 270A(9) was attracted. Mere use of the word “misreporting” without particulars was termed arbitrary. The Tribunal also noted the quantum acceptance was largely to buy peace, negating mens rea. Consequently, the penalty under section 270A was deleted, affirming that deemed-income additions cannot, by themselves, trigger under-reporting penalties.

4. In Jaibalaji Business Corporation (P.) Ltd. v. ACIT [2023] 147 taxmann.com 333 (ITAT Pune), the assessee sold land below stamp duty value and the Assessing Officer invoked section 43CA, ultimately substituting the sale consideration with the District Valuation Officer’s (DVO) figure. The original addition of ~₹2.80 crore was rectified to ₹7.05 lakh after the DVO’s report. Penalty under section 270A was then imposed on the premise of under-reported income. The Tribunal deleted the penalty, holding that the DVO’s valuation was itself an estimate derived by averaging rates of other nearby properties, and the difference with the assessee’s declared value was minimal. By virtue of section 270A(6)(b), income determined on the basis of an estimate (where accounts are otherwise correct and complete) is expressly excluded from “under-reported income.” As the sole foundation for the addition was an estimated value under a deeming provision (section 43CA), it could not sustain penalty under section 270A. Accordingly, the penalty was quashed.

5. Deemed Income vs. Actual Concealment: Historically, courts have distinguished between income deemed by legal fiction and actual concealment. The Supreme Court in S. Teja Singh v. Commissioner of Income-tax /[1959] 35 ITR 408 (SC), while dealing with a different section, established the principle that “in construing the scope of a legal fiction it would be proper and even necessary to assume all those facts on which alone the fiction can operate.” This means that while deemed income is treated as income for taxation, the legal fiction should not be extended beyond its intended purpose, especially to penal provisions that require a higher degree of culpability. The Gujarat High Court in Baroda Tin Works v. Commissioner of Income-tax /[1996] 221 ITR 661 (Gujarat), in the context of Section 271(1)(c) and Sections 68-69C, held that “the fiction created under sections 68, 69, 69A, 69B and 69C by itself cannot be extended to penalty proceedings to raise the presumption about concealment of such income.” This landmark ruling clearly states that the deeming provisions for income do not automatically lead to a presumption of concealment for penalty purposes. The burden remains on the department to prove actual concealment if a penalty under general provisions is sought.

6. In Sai Bhargavanath Infra v. ACIT [2022] 144 taxmann.com 168 (ITAT Pune), the assessee, a builder, sold flats at values slightly below stamp duty valuation. The Assessing Officer invoked section 43CA and made additions as deemed income. The assessee argued that the difference was within 10%, which should not trigger additions. The Tribunal examined the first proviso to section 43CA, inserted by Finance Act 2020 (effective 1-4-2021), allowing a 10% tolerance between actual sale consideration and stamp value. Referring to CIT v. Vatika Township (P.) Ltd. (SC), it held that beneficial provisions are to be construed retrospectively, as they mitigate hardship and confer relief without imposing new burdens. Since the difference was within 10% tolerance, no addition could be sustained even for AY 2015-16. The Tribunal thus deleted the addition, clarifying that deemed income adjustments under section 43CA cannot form the foundation for penalty under section 270A when based on such marginal or estimated differences.

V. Principles Underlying the Judicial Approach

i. Penalty provisions must be strictly construed:

ii. Absence of mens rea where disclosure is full and bona fide.

iii. Role of estimation: valuations inherently uncertain, falling within s. 270A(6).

iv. Doctrine of Lex Non Cogit ad Impossibilia: law does not compel impossible compliance.

VI. Comparative Analysis: Old Section 271(1)(c) v. New Section 270A

Earlier, under section 271(1)(c), courts consistently held that deemed additions under section 50C do not attract penalty. The transition to section 270A formalises underreporting/misreporting categories but does not alter the principle that deemed additions lack culpability. ITAT rulings reaffirm continuity of this reasoning.

VII. Policy Rationale

The object of sections 43CA/50C/56(2)(x) is to curb undervaluation in real estate and circulation of black money. However, the provisions apply even where no evasion intent exists. To balance harshness, Parliament introduced tolerance limits and appellate remedies. Thus, while substantive additions may be justified, penalty would defeat fairness where assessee has acted transparently.

VIII. Counter-Arguments and Rebuttal

Argument: Deemed income is taxable, so non-reporting equals underreporting.
Rebuttal: Deemed income arises by legislative substitution, not by assessee’s act.

Argument: Section 270A is strict liability.

Rebuttal: Even so, s. 270A(6) excludes estimated/deemed income; purposive interpretation avoids injustice.

Argument: Immunity under s. 270AA exists.

Rebuttal: Its existence does not justify penalty where substantive law disallows it.

IX. Broader Implications

1.Relief for taxpayers from arbitrary penalties on valuation differences.
2.Focus for Revenue on genuine cases of concealment.
3. Reinforcement of principle that penal consequences cannot follow from legal fictions unless expressly provided.

X. Conclusion

Jurisprudence is settled that no penalty for underreporting can be levied where additions are made under deeming provisions. These additions are statutory fictions, valuations are estimates, and notices often lack clarity. Thus, while tax may be payable on deemed income, penalty cannot be levied in absence of culpable conduct. This ensures taxation is harsh but penalisation is just, fair, and proportionate.