A) ABSTRACT / HEADNOTE

The appeal concerns the scope and operation of Section 271AAA of the Income Tax Act, 1961 the penal provision that empowers the Assessing Officer to impose a penalty equal to 10% of the “undisclosed income” of the “specified previous year” where a search under Section 132 has been initiated. The core issues were:

(i) whether the year in which the search was conducted (AY 2011–12 in this matter) was the specified previous year;

(ii) whether the Assessing Officer had discharged the onus to show that particular receipts constituted undisclosed income “found in the course of search”; and

(iii) whether the exemption in sub-section (2) of Section 271AAA applies where an assessee has admitted and later substantiated income and paid tax with interest albeit belatedly.

The appellant had disclosed Rs. 2,27,65,580 during the search and later, during assessment proceedings, offered an additional sum of Rs. 2,49,90,000 (land-related receipts) as income from other sources. The Revenue levied penalty on the entire returned income; the High Court and Tribunal upheld the broader levy.

The Supreme Court held that:

(a) by virtue of Explanation

(b)(ii) to s.271AAA, AY 2011–12 (the year of search) was the specified previous year;

(c) where an assessee admits an amount during the search, substantiates its derivation and pays tax with interest (even belatedly), the exemption in s.271AAA(2) operates and no penalty can attach to that admitted sum; and

(d) however, receipts of Rs. 2,49,90,000 constituted undisclosed income found in the course of search (sale deeds were obtained from the Society as a consequence of the search), and penalty at 10% is leviable on that amount only. The Court reiterated that s.271AAA is a penalty provision to be strictly construed and that the Assessing Officer bears the onus to demonstrate that particular receipts were found in the course of search.

Keywords: Section 271AAA; undisclosed income; specified previous year; found in the course of search; strict construction; search under Section 132; tax + interest payment; penalty exemption.

B) CASE DETAILS

C) INTRODUCTION AND BACKGROUND OF JUDGEMENT

The litigation arose after a search and seizure under Section 132 at the appellant’s premises on 25 November 2010, which led to an admission before the DDIT(Inv.) of income amounting to Rs. 2,27,65,580 and subsequent filing of returns for PY 2010–11 (AY 2011–12) reflecting total income of Rs. 4,77,11,330. The Assessing Officer completed assessment at Rs.4,78,02,616 on 15 March 2013 and consequent to the assessment passed penalty orders dated 30 September 2013 under Section 271AAA one for AY 2010–11 and another for AY 2011–12. The penalty assessing authorities treated the entire returned income as undisclosed income and imposed penalty at 10%. In appeals, the CIT(A) quashed penalty for AY 2010–11 but rejected relief for AY 2011–12; the ITAT and High Court affirmed the imposition for AY 2011–12.

The appellant challenged whether the Assessing Officer had the legal basis to treat all returned income as “undisclosed income found in the course of search”, whether the specified previous year was correctly identified, and whether the statutory exception in s.271AAA(2) applies when an assessee admits income during search, substantiates derivation and pays tax with interest belatedly.

The Supreme Court granted leave limited to the second question and proceeded to address the statutory text, the Explanation to s.271AAA, the onus of proof on the Revenue, and the distinction between admissions made during search and amounts later disclosed during assessment proceedings. The judgment therefore engages statutory interpretation, burden of proof for penalty imposition and the causal scope of “found in the course of search”.

D) FACTS OF THE CASE

An MOU dated 19 January 2009 recorded facilitation arrangements between Mr. Hashim Moosa and the appellant (and a co-procurer) for land acquisitions. The Society entered into land purchase transactions with Mr. Moosa on 26 September 2009. On 25 November 2010 the DDIT(Inv.) conducted search and, during the search, the appellant admitted Rs.2,27,65,580 as net income from other sources for AY 2011–12; the appellant also later, during assessment, offered Rs.2,49,90,000 as income from assignment of rights connected to land transactions of two third-parties (Mr. Sharab Reddy & N.H.R. Prasad Reddy). The sale deeds evidencing those third-party transactions were obtained by the Assessing Officer from the Society after the search.

The AO completed assessment for PY 2010–11 on 15 March 2013 and imposed penalties under s.271AAA on 30 September 2013 treating the entire returned income as undisclosed. The CIT(A) allowed relief as to AY 2010–11 but denied it for AY 2011–12; the ITAT and Karnataka High Court affirmed denial for AY 2011–12. On appeal the Supreme Court examined whether the specified previous year was AY 2011–12, whether amounts admitted during search satisfied s.271AAA(2), and whether the additional sum of Rs.2,49,90,000 (offered only during assessment and supported by sale deeds collected after search) amounted to undisclosed income found in the course of search so as to attract penalty.

The factual matrix thus divides receipts into (A) admitted during search (Rs.2,27,65,580) and (B) disclosed later during assessment following collection of sale deeds (Rs.2,49,90,000).

E) LEGAL ISSUES RAISED

i. Whether the year in which the search was conducted (AY 2011–12) is the specified previous year within the meaning of Explanation (b)(ii) to s.271AAA?
ii. Whether s.271AAA(1) mandates automatic levy of penalty once a search is conducted, or whether the Assessing Officer must first establish that particular receipts constitute undisclosed income found in the course of search?
iii. When an assessee admits income in a statement under s.132(4), substantiates the manner of derivation, and (albeit belatedly) pays tax and interest, does s.271AAA(2) bar imposition of penalty on that admitted sum?
iv. Whether amounts disclosed only during assessment but discovered by reference to documents obtained from third parties after the search qualify as “found in the course of search”?

F) PETITIONER / APPELLANT’S ARGUMENTS

The appellant contended that the penalty is not automatic; the Assessing Officer must first demonstrate that the assessed receipts fall within the statutory definition of “undisclosed income” in Explanation (a) to s.271AAA. Reliance was placed on authority that penal provisions are to be strictly construed and that the word “may” in the provision denotes discretionary (not mandatory) imposition. The appellant argued that the MOU showed only limited payments (Rs.10,00,000) and could not support the vast amounts characterized as undisclosed income.

It was urged that the appellant had voluntarily declared Rs. 2,27,65,580 during the search, had substantiated its derivation and eventually paid tax and interest; therefore s.271AAA(2) applied and the admitted sum could not attract penalty. Finally, the appellant asserted that the additional Rs.2,49,90,000 arose only during assessment, was not part of materials seized from his premises, and thus could not be treated as found in the course of search absent express proof of causation.

G) RESPONDENT’S ARGUMENTS

The Revenue maintained that there was concurrent factual findings that the search led to disclosure of income and that the assessee failed to meet the three conditions in s.271AAA(2) (admission in course of search, substantiation, and tax+interest payment within the prescribed frame). The respondent emphasized that the sale deeds were collected as a consequence of the search and that the appellant did not disclose the Rs.2,49,90,000 during the search; it was only offered during assessment after the AO sought documents. Reliance was placed on decisions (e.g., PCIT v. Amul Gabrani) construing s.271AAA(2) strictly and holding that exemption is available only where conditions are fulfilled; hence penalty on the entire returned income was justified.

H) JUDGEMENT

The Supreme Court dissected s.271AAA as a self-contained code and began from textual analysis. It held that the imposition of penalty under s.271AAA(1) is discretionary (“may”) and not automatic; nevertheless discretion is to be exercised according to law and not arbitrarily. The Court observed that the Explanation (b) makes a specified previous year include the year in which the search was conducted (Explanation (b)(ii)); since the search occurred on 25 November 2010 and the due date for filing returns for the preceding year had already expired on 31 July 2010, AY 2011–12 (the year in which the search was carried out) was the specified previous year.

The Court then turned to the meaning of “undisclosed income” in Explanation (a) and reiterated that, being a penalty provision, s.271AAA must be strictly construed and the Assessing Officer bears the onus to demonstrate that a receipt was represented by money, bullion, jewellery, document entries or transactions found in the course of search and not recorded prior to the date of search. On the facts, the Court accepted that the appellant had admitted Rs.2,27,65,580 before the DDIT(Inv.), had substantiated its derivation and had eventually paid tax with interest; therefore the conditions of s.271AAA(2) were met for that amount and no penalty could attach to it.

However, the Court found that Rs.2,49,90,000 was offered only in the assessment proceedings, and the sale deeds evidencing those transactions had been obtained from the Society as a consequence of the search. The Court gave a broad reading to “found in the course of search” encompassing documents discovered at third parties or obtained by subsequent enquiries instigated by and causally linked to the search and concluded that the Rs.2,49,90,000 constituted undisclosed income found in the course of search.

Because that amount was not admitted during the search nor substantiated at that time, s.271AAA(2) did not avail the appellant in respect of it. The Court accordingly directed penalty at 10% on Rs.2,49,90,000 only (and not on the entire returned income), disposing the appeal accordingly. The judgment stressed strict construction of penal provisions, the obligation on Revenue to prove the condition precedent of “found in the course of search”, and the causal scope of searches leading to third-party disclosures.

a. RATIO DECIDENDI

The operative legal conclusions are:

(1) s.271AAA(1) confers discretion not compulsion to impose penalty;

(2) the Assessing Officer must prove that the amount sought to be treated as undisclosed income was found in the course of search as defined in Explanation (a);

(3) Explanation (b)(ii) makes the year of search a specified previous year where appropriate;

(4) compliance with s.271AAA(2) (admission during search, substantiation and payment of tax + interest) negates imposition of penalty on amounts so admitted and substantiated even if payment is belated; and

(5) materials obtained from third parties or developed as a direct consequence of the search fall within “found in the course of search” and may support levy of penalty on amounts revealed thereby. These propositions form the binding ratio the adjudicatory authorities must apply in future cases involving s.271AAA.

b. OBITER DICTA 

The Court reiterated broader administrative law principles: discretion under penalty statutes must be exercised “guided by law” and cannot be arbitrary. It observed that the doctrine of strict construction applies to penal fiscal provisions, and therefore the Revenue’s burden of proof is proportionately greater when attributing particular receipts to undisclosed income. The judgment also commented by reference to earlier tribunal and High Court views that procedural steps post-search (e.g., collection of documents from third parties) often form a causal chain traceable to the search and so may be treated as part of the “course” of search; this obiter guidance will inform fact-sensitive exercises of the AO’s onus in future cases.

c. GUIDELINES

1. Penalty under s.271AAA(1) is discretionary — Assessing Officers must record reasoned findings before directing penalty.

2. Where an assessee admits an amount during s.132 search, substantiates its derivation in the s.132(4) statement and pays tax with interest (even belatedly), s.271AAA(2) operates to exclude that admitted amount from penalty.

3. The AO must demonstrate, by tangible and verifiable material, that the unpaid/undeclared amount was represented by money, bullion, jewellery, entries, documents or transactions found in the course of search as defined in Explanation (a). Bare inference or post-hoc assessment is insufficient.

4. Documents obtained from third parties or produced as a direct consequence of the search (causal nexus) may qualify as found in the course of search; the AO should record the causal link when relying on such materials for penalty.

5. Where part of the returned income qualifies for exemption under s.271AAA(2) and part does not, penalty should be confined to the non-exempt portion — the AO must compute penalty proportionately.

I) CONCLUSION & COMMENTS

The judgment strikes a careful balance between the Revenue’s need to penalize clandestine receipts and the taxpayer’s right to a reasoned, evidence-based decision. By emphasizing the Assessing Officer’s onus to demonstrate that specific receipts were found in the course of search, the Court curtailed any mechanical or blanket levying of penalties on entire assessments. Simultaneously, by construing “found in the course of search” broadly to include documents obtained from third parties as a causal consequence of the search, the Court preserved the legitimate reach of enquiries that flow from a search operation.

Practically, the decision requires tax authorities to

(i) record clear findings linking seized or discovered materials to the amounts sought to be taxed as undisclosed income;

(ii) distinguish admissions made during search (which, if substantiated and taxed, attract the s.271AAA(2) exception) from amounts revealed only later; and

(iii) apply penalty proportionately.

For practitioners, the case is important authority to oppose blanket penalty orders and to push for compartmentalized assessment of amounts based on whether they were admitted in the s.132(4) statement or discovered subsequently. Administratively, the ruling underscores good decision-making practice: reasoned findings, causal narration of investigative steps, and proportional computation of penalty.

J) REFERENCES

a. Important Cases Referred

1. K. Krishnamurthy v. The Deputy Commissioner of Income Tax, Civil Appeal No. 2411 of 2025, judgment 13 Feb. 2025.

2. Dilip N. Shroff v. CIT, (2007) 6 SCC 329.

3. Som Raj & Ors. v. State of Haryana & Ors., (1990) 2 SCC 653.

4. DCIT v. Aryan Mining & Trading Corporation Ltd., 2019 SCC OnLine ITAT 4649.

5. Ajay Kumar Sood Engineers & Contractors K N Kandla & Co. v. DCIT, ITAT Chandigarh Bench, MANU/IG/0095/2024.

6. PCIT v. Amul Gabrani, ITA No.1251 of 2018 (Delhi HC decision referenced, July 24, 2024).

b. Important Statutes Referred

1. Income Tax Act, 1961, ss. 132, 139(1), 143(3), 271AAA (including Explanation (a) and (b)).