Income from unlawful sources

Section 2(24) of the Income Tax Act, 1961 gives an inclusive definition of the word ?income?. The expression ?income? is very wide and the object of the Income Tax Act being one to tax income, it has to be given an extended meaning.

Section 2(24) of the Income Tax Act, 1961 gives an inclusive definition of the word ?income?. The expression ?income? is very wide and the object of the Income Tax Act being one to tax income, it has to be given an extended meaning. Any kind of income earned by the assessee attracts income tax at the point of its accrual or receipt. Of course, statutory exemptions and deductions as permitted under relevant provisions of the Act, which could be availed of by a taxpayer. However, the fact remains that the Act makes an obligation to pay tax on all income received. The taxability of income earned by the assessee by resorting to unlawful means came up for consideration in Mohamad Abdul Kareem and Co v CIT (16 ITR 412). In this case, several persons formed a partnership agreeing that all the arrack shops leased in the names of those persons should be run by the partnership. The application submitted for registration of the partnership was rejected on the ground that the formation of a partnership with regard to arrack and toddy shops were prohibited by the abkari law, without the prior permission of the district collector.

However, the assessing officer assessed each firm in the status of an ?association of persons?. This was objected to by the assessee on the grounds that since there was no lawful partnership, the assessment could be made only upon each individual lessee and not upon the entire body of lessees as an association. The contention of the assessee that the association formed for unlawful purpose has no legal existence and cannot be recognised as an assessable unit under the taxing statute, was negated by the Madras High Court. In CIT v SC Kothari (69 ITR 1), the issue before the Gujarat High Court was regarding taxability of income derived from an illegal trade. Taking into account the English case law on the point, the division bench held that the taint of illegality or wrong-doing associated with income, profits and gains is immaterial for the purpose of taxation. Even if a trade is illegal, it is still a trade within the meaning of the Act, and its income, profits and gains arte chargeable with income tax.

In CIT v Piara Singh (124 ITR 40 (SC)), the substantial question of law before the Supreme Court was whether the loss, which arose from the confiscation of currency notes was an allowable deduction under the Act. While upholding the judgment of the high court and dismissing the appeal filed by the revenue, the Supreme Court observed that the income tax authorities found that the assessee was carrying on the business of smuggling. The court held that he was liable to tax on income from that business. In Dr TA Quereshi v CIT (287 ITR 547), the issue before the Supreme Court was whether the loss sustained by the assessee in unlawful business conducted by him could be treated as a business loss. The Court held that cases are to be decided by courts on legal principles and not on moral views. Law is different from morality. The primary function of the Act is to bring the income of various kinds into the tax net. The income tax authorities are not concerned about the manner or means of acquiring income. The income might have been earned illegally or by resorting to unlawful means. Any illegality tainted with the earning has no bearing on its taxability.

The assessee having acquired income in an unethical manner or by resorting to acts forbidden by law cannot be heard to say that the state cannot be a party to such sharing of ill-gotten wealth. Allowing such income to escape the tax net would be nothing but a premium or reward to a person for doing an illegal trade.

It is not possible for the income tax authorities to act like police to prevent the commission of unlawful acts but it is possible for the tax machinery to tax such income. During such process, strict rules of evidence are not applicable to the income tax authorities. Those pieces of evidence, which are not sufficient in ordinary legal proceedings to prove a particular fact would be sufficient for the tax officials to assess the income of an individual. The Act considers the income earned legally as well as tainted income alike. There is nothing like an illegal income so far as the tax collector is concerned. Even if the assessee is prosecuted by law enforcing authorities for commission of offence, the income earned by the offender would be income liable for assessment. It is not a defense in such cases that the State is also becoming a party to the illegal act by sharing the booty.

This point was considered in Madras High Court in CIT v K Thangamani (309 ITR 15). The facts in this case were that the assessee was engaged in tax consultancy and audit work. During the search conducted at the residential premises and office of the assessee, certain incriminating documents were seized. From the documents seized it was revealed that the assessee had been claiming and receiving income tax refunds by filing bogus certificates with returns of income prepared by him even in the names of non-existing persons.

The assessee filed a return of income for the assessment year 1987-88 declaring an income of Rs 29,700. The assessment was reopened under section 147 of the Act, on the basis of information available after the search, and a sum of Rs 7,29,424, being the TDS certificates encashed by the assessee during the previous year, was treated as ?professional income?.

For the assessment year 1988-89, the assessee filed a return of income admitting an income of Rs 32,870. The assessment was completed by the assessing officer by treating the deposits made by the assessee during the previous year relevant to the assessment year by determining a sum of Rs 60,09,366 as his income from ?undisclosed sources? as well as by taking into consideration the bogus claim made by him. ?The high court held that when the tribunal found that the assessee had indulged in fabricating TDS certificates and got refunds from the department, it should not have come to the conclusion that such income was not taxable. There was a clear factual finding recorded by the assessing officer as well as the commissioner (appeals) to the effect that the assessee had indulged in filing bogus TDS certificates and got refund of the amounts from the department. It was also the admitted position of the assessee before the department as well as the Central Bureau of Investigation during the course of investigation into the offence that he had indulged in the act of fabricating TDS certificates and collecting refunds from the department. Hence, the order of the tribunal was set aside and the order passed by the commissioner (appeals) was restored. The Court rightly concluded that the amount was liable to tax because the Act casts an obligation to pay tax on all income earned or received. The Act brings to tax income, which is earned legally, as well as tainted or illegal income.

The author is advocate, Supreme Court

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First published on: 03-05-2009 at 23:05 IST