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By Aditya Bhattacharya, Partner & Akriti Sharma, Trainee Associate
This article critically examines the recent press release by the Ministry of Finance regarding the crackdown on bogus claims of deduction and exemption by the Income Tax Department. While the department aims to prevent tax evasion and strengthen compliance, the Press Release raises several legal and procedural concerns. This article seeks to address several key gaps in the Press Release, as it lacks clarity in its language and intent. Lastly, the article aims to highlight that a more balanced and transparent approach is required to ensure compliance without compromising the rights of the taxpayers.
Tax evasion and tax avoidance present significant challenges to India’s economic growth. When taxpayers misuse the legal provisions in order to evade taxes, it not only undermines the integrity of the tax system but also results in a substantial loss of revenue for the state. Although it is essential for the Tax Authorities to address such misuse, any regulatory action must be backed by due process of law.
On 14th July 2024, the Ministry of Finance issued a press release stating that the Income Tax Department had launched a large-scale verification operation across multiple locations in the country, targeting individuals and entities involved in facilitating fraudulent claims of deductions and exemptions in their Income Tax Returns (ITRs). On a plain reading, and with the rising concern over tax evasion and the misuse of legal provisions, such action appears to be a firm step towards ensuring compliance and safeguarding the integrity of the taxation system. However, a closer look at the press release reveals the lack of clarity in its language and structure, as well as how the circular could be potentially misused by the authorities, harming honest taxpayers.
Is Fear the New Face of Tax Compliance?
The press release states that deduction provisions such as sections 10(13A), 80GGC, 80E, 80D, 80EE, 80EEB, 80G, 80GGA, and 80DDB are being misused, and taxpayers are fraudulently claiming deductions and exemptions without a valid justification. It is pertinent to mention here that the concept of deductions is interpretative in nature. This means that what the department considers a wrongful claim may not always be intentional fraud. The complexities involved in the deduction provisions often lead to situations wherein taxpayers and the authorities may interpret the same deduction claim differently. Most importantly, it also overlooks the fact that the majority of the taxpayers rely on professionals for filing their ITRs. In such a scenario, honest errors are inevitable, especially when the provisions are complex and interpretative in nature.
Thus, the action taken by the Department is not aimed at educating or assisting the taxpayers, but at cautioning them, by creating a sense of fear and uncertainty. The words used are very selective, most particularly the word ‘stern action’. It says that the “Income Tax Department is poised to take stern action against continued fraudulent claims, including penalties and prosecution wherever applicable”. This raises several questions, such as what is meant by ‘stern action’? What exactly does it mean in practice? Will minor or unintentional errors also lead to such action? The lack of a clear definition and ambiguity in the intent behind such actions make them vague and open to interpretation.
By using strong language and repeatedly highlighting the search and seizure operations, the Department is also not trying to reduce litigation or enhance compliance, but is trying to warn the taxpayers that anyone making a deduction claim might be subject to ‘stern action’.
‘Trust Taxpayers First’, But Due Process Later?
One of the major concerns arising from the press release is the lack of a clear distinction between taxpayers who are intentionally committing fraud and those who are unaware of the deductions and exemption provisions and are often misled by the professionals who file their Income Tax Returns. If the Income Tax Department proceeds with recovery actions and levies penalties, or initiates prosecution without conducting a proper inquiry and establish whether the taxpayer had the actual knowledge or intent, it will result in a gross miscarriage of justice, thereby creating a situation where more litigation will be generated before High Courts on accounts of coercive recoveries by the authorities. The innocent taxpayers will be left with no option but to seek relief before the High Courts and challenge such actions on the grounds of denial of due process, arbitrary treatment, and violation of natural justice.
The taxation laws are built on the principles of natural justice, which means that the taxpayers should be given a reasonable time and opportunity to hear and present their case before any penalty and prosecution are imposed. However, the Department fails to address the due procedure for initiating such stern actions. Although the department claims that it expects voluntary compliance from the taxpayers by following the principle of ‘Trust Taxpayers First’, in reality, it is creating a sense of fear and uncertainty amongst the taxpayers. As a result, the taxpayers may gradually lose their trust in the administrative system and avoid claiming deductions that they are legally entitled to, in order to avoid potential scrutiny and unnecessary litigation.
On the other hand, the Department also states that many fraudulent returns are being filed using fake or temporary email addresses. The question that arises before us is how the notices will be served to the taxpayers, and how will they respond to such notices if they are not even aware that their returns are under scrutiny. In such circumstances, how does the Department aim to follow the principles of natural justice? Additionally, when a taxpayer makes a wrongful claim, the priority of the Department is “recovery” of the amount from the taxpayer. In the absence of such a term in the Press release, the Department has tried to sideline the broader objective of tax administration and shift its primary focus to imposing penalties and prosecution against the taxpayers.
Furthermore, the press release also indicates that the Department is increasingly relying on advanced technologies, such as artificial intelligence (AI), and ground-level intelligence and third-party sources to identify suspicious patterns in the Income Tax Returns. Although AI tools have proven to be effective in many aspects, the biased nature of the algorithms used in AI and the automated flagging of minor discrepancies will have a significant impact on the taxpayers. Thus, the taxpayers who will be subjected to such scrutiny or penal action are likely to challenge such actions before the judiciary, leading to a surge in litigation in the months ahead.
Conclusion
As a good tax system is not achieved by creating fear, but by earning the trust of the taxpayers through due process, the approach taken by the Department to curb the misuse of deduction and exemption provisions should be more balanced and fair. There are instances where honest taxpayers have been harassed over minor discrepancies, and by empowering the tax authorities to take ‘stern action’ without any clear mechanism will further increase the risk of misuse of powers by the authorities. Although, the Department claims to uphold the principle of “Trust Taxpayers First,” in reality, rather than building trust, it has created a sense of fear and uncertainty amongst the taxpayers. Therefore, a system that deters the misuse of provisions and ensures compliance without compromising the rights of the taxpayers is essential. At the same time, there should be a balance between the powers given to the authorities and safeguarding the rights of the honest taxpayers.