1. The assessee doing business in explosive materials and detonators filed a return for the assessment year 1971-72 on 7-12-1974 showing an income of Rs. 6,674. An assessment was made on 30-11-1976 on a total income of Rs. 24,772. The ITO had made an estimate of business income at Rs. 15,000, disallowed a sum of Rs. 3,240 being interest paid to the creditors treated as non-genuine and added Rs. 10,000 as income from undisclosed sources on account of cash credits not accepted as genuine.
The matter went on appeal and by his order dated 17-9-1977, the AAC reduced the income by Rs. 7,790. The matter was further taken up to the Tribunal on appeal. For the assessment year 1972-73 there were additions made to the total income on account of certain cash credits not accepted as genuine. The appeal for this year also went up before the AAC and subsequently before the Tribunal. The AAC deleted the additions made for this assessment year to the extent of Rs. 3,240 being the interest disallowed for the assessment year 1971-72 and treated it as a payment to self. The Tribunal by its order dated 30-1-1979, dealing with the assessment year 1972-73, gave credit to the assessee for a sum of Rs. 6,000 on account of additions made earlier for the assessment year 1971-72. The relevant portion of the Tribunal's order is as under: In the assessment year 1971-72, the income returned was Rs. 6,674 and the income estimated from business was Rs. 15,000. We think, we can give a benefit of Rs. 6,000 out of the additions made in this year which would be available to the assessee for introducing by way of credits relating to the assessment year 1972-73.
2. Thus, the assessee got credit to the extent of Rs. 6,000 for the assessment year 1972-73 on account of additions made for the assessment year 1971-72.
3. On 10-3-1978 the ITO started the penalty proceedings under Section 271(1)(c) of the Income-tax Act, 1961 ('the Act') on the following: In view of the AAC's decision for the year under consideration and the provisions of the newly introduced Explanation 2 to Section 271(1)(iii) of the Act, penalty proceedings are initiated in terms of Explanation read with Section 27(1A) for concealment of income.
Issue notice under Section 271(1)(c).
On 28-3-1980 resorting to Explanation 2 to Section 271(1)(c) read with Section 271(1A), the ITO levied a penalty of Rs. 6,000. This was upheld by the AAC against whose order the present appeal is filed before us.
4. The learned counsel for the assessee has challenged the levy of penalty on several grounds. There were no penalty proceedings started and no penalty levied at the time of the original assessment. Penal provisions including Explanation 2 to Section 271 are substantive provisions of law. Explanation 2 and Section 271(1A) were introduced with effect from 1-4-1976. According to the learned counsel, in the light of the Supreme Court decision in Brij Mohan v. CIT  120 ITR 1, the assessee having filed a return on 7-12-1974, the law applicable on that day would govern his case. Not only would, therefore, the penalty provisions relating to the Explanation 2 be applicable in the first instance, quantum of penalty would also be governed by the law relevant to the date of filing the return. Penalty, according to the learned counsel, thus, was not leviable at all in the first instance.
Alternatively it could be levied only in terms of the tax and not the income alleged to be concealed.
5. It is also pointed out that in the present case the ITO 'in any proceedings before him' did not find out any concealment. The deemed concealment, if any, on the basis of the Explanation 2 was before the AAC. The fact of concealment even under the deeming provisions cannot be changing from authority to authority. At any rate, the authority before whom concealment is established for the first time alone has the right to initiate the proceedings. According to the learned counsel, the ITO could not have initiated proceedings for levying penalty in this case. If at all a penalty can be levied, relying on the decision of the Allahabad High Court in CIT v. Shadiram Balmukand  84 ITR 183, it is claimed that the AAC may perhaps be competent to start the proceedings. If the ITO were to levy the penalty, he should be specifically empowered in this regard. It is not correct to say that Explanation 2 is a rule of evidence and does not affect any substantive right.
6. For the department stress is laid on the orders of the authorities below. Even though the penalty is levied in the present case on the basis of the Explanation 2 to Section 271, there is nothing called 'deemed concealment'. This is also a concealment and the Explanation is only a rule of evidence to come to a conclusion as to whether there was concealment or not. Referring to Section 271(1A), it is pointed out that this section specifically removes the bar, if any for initiation of penalty. Relying on the decision in J.S. Parkar v. V.B. Palekar  94 ITR 616 (Bom.), the learned counsel has pointed out that we are dealing here with matters of procedure. In J.S. Parkar's case (supra) Section 69A of the Act was held to be a rule of evidence and held to apply even for earlier years. Being matters of procedure the provisions in the present case also would apply to years in respect of which action could be taken. This cannot be called strictly restrospective operation of the provisions. Concealment has already taken place on account of the operation of the specific provisions.
Reference is made also to the decision of the Gujarat High Court in the case of CIT v. Drapco Electric Corporation  122 ITR 341.
7. According to the learned counsel, the ITO is not precluded from starting penalty proceedings. It is nowhere stated that the authority before whom a claim for a set off is made only can start the penalty proceedings. As to before whom the claim is made is not relevant at all in this connection. Proceedings were pending before the ITO insofar as the appeal was finally decided only on 30-1-1979. Appeal is a continuation of the proceedings earlier started. Reliance is placed on the decision in Gojor Bros. (P.) Ltd. v. Ratan Lal Singh AIR 1974 SC 1380. According to the learned counsel, initiation or levy of penalty in this case is not barred by limitation. Section 275 of the Act does not bar it. In the alternative it is claimed that there being no specific provision, Section 275 may not apply at all. Clause (b) of Section 275 would put the time limit up to 31-3-1981, the end of the proceedings being reckoned from the Tribunal's order on 30-1-1979, the penalty was actually levied on 28-3-1980. The case of penalty having arisen after the due date, the quantum of penalty also does not call for any interference.
8. Levy of penalty in this case involves interpretation of substantial provisions of law, Explanation 2 to Section 271(1)(c) which runs as under: Where the source of any receipt, deposit, outgoing or investment in any assessment year is claimed by any person to be an amount which had been added in computing the income or deducted in computing the loss in the assessment of such person for any earlier assessment year or years but in respect of which no penalty under Clause (iii) of this sub-section had been levied, that part of the amount so added or deducted in such earlier assessment year immediately preceding the year in which the receipt, deposit, outgoing or investment appears (such earlier assessment year hereafter in this Explanation referred to as the first preceding year) which is sufficient to cover the amount represented by such receipt, deposit or outgoing or value of such investment (such amount or value hereafter in this Explanation referred to as the utilised amount) shall be treated as the income of the assessee, particulars of which had been concealed or inaccurate particulars of which had been furnished for the first preceding year; and where the amount so added or deducted in the first preceding year is not sufficient to cover the utilised amount, that part of the amount so added or deducted in the year immediately preceding the first preceding year which is sufficient to cover such part of the utilised amount as is not so covered shall be treated to be the income of the assessee, particulars of which had been concealed or inaccurate particulars of which had been furnished for the year immediately preceding the first preceding year and so on, until the entire utilised amount is covered by the amounts so added or deducted in such earlier assessment years.
was inserted by the Taxation Laws (Amendment) Act, 1975 with effect from 1-4-1976. The return was filed in this case on 7-12-1974. The AAC's order based on which a deemed concealment was inferred was passed on 17-9-1977 and the subsequent Tribunal's order which provided for an increased set off was passed on 30-1-1979. In our opinion, for several reasons the penalty levied in this case cannot be upheld and should be cancelled.
9. It is well settled that penalty under Section 271 can be levied if the ITO, the AAC or the Commissioner (Appeals) 'in the course of any proceedings under this Act' is satisfied about the different defaults specified therein. The specific use of the word 'or' in Section 271(1) while referring to the authorities competent to levy penalty clearly indicates that satisfaction should be of the person who is empowered to levy the penalty. It certainly cannot be inferred from the provision of Section 271(1) that if the ITO is satisfied, the AAC or the Commissioner (Appeals) could levy a penalty or if any of the latter persons are satisfied about the default, the ITO could levy penalty.
Apart from the absence of any position to support a case as above, prima facie, it would be incongruous to find power in one authority not specifically so empowered for finding a default where it is discovered only by some other authority. We have no hesitation in holding that for the purposes of levying penalty under Section 271(1) under any of the clauses or Explanation thereto, it is absolutely necessary that the authority levying penalty should be satisfied about the default.
10. Penalty is leviable if the satisfaction takes place 'in the course of any proceedings under this Act'. It is a natural corollary of what is stated in the preceding paragraph that the proceedings should also be those before the authority who is competent to levy penalty and who has to be satisfied. Even as on the satisfaction by any AAC or the Commissioner (Appeals) the ITO cannot levy a penalty, it would be equally without jurisdiction for him to start penalty proceedings or levy penalty if the finding of default is in the course of proceedings not before him but before any other authority.
11. Explanation 2 does lead to the levy of penalty in certain circumstances, but the Explanation itself lays down the circumstances justifying the penalty. It is not like Explanation 1--a criterion deductible from the stated fact such as the returned income is less than 80 per cent of the assessed income--which has been held to be a rule of evidence. In the case of Explanation 2 certain specific criteria are laid down which being satisfied a natural inference by way of a fiction is made of concealment. The Explanation in fact states that that part of the amount added, etc., 'shall be treated as the income of the assessee'.
This is clearly an introduction of a fiction whereby what is not the income of the assessee is treated as income of the assessee particulars of which have been concealed, etc. By definition and practice, the present would fit in as a positive example of what a legal fiction is.
A legal fiction can never be regarded as a rule of evidence. Fiction gives rise to substantive provisions of law which affects the subject with regard to his rights and obligations. The analogy sought for from the decision in J.S. Parkar's case (supra) would not, therefore, apply.
Explanation 2 directly effects substantial rights of the assessee and cannot be regarded as a mere rule of evidence or a matter of procedure which could be adopted retrospectively.
12. Explanation 2 specifies that certain amounts could be treated as income concealed in certain circumstances. Levy of penalty under Section 271 can be done only according to and under the provisions therein specified. If in a normal case a fiction or deeming penalty cannot be levied by an authority not empowered to be so under Section 271(1), we do not see how the mere fact of a fiction with specific empowerment in this behalf can authorise any one, the ITO, the AAC or the Commissioner (Appeals) to levy penalty where they are not so empowered. We cannot agree with the learned counsel for the department that insofar as some provision for levying penalty obtains and the ITO is not precluded from initiating or levying penalty, he could do either or both. Levy of penalty follows an actual empowerment in this behalf.
If the ITO has not been mentioned or specified as competent to levy penalty in a particular case, the levy of such penalty cannot be upheld. No authority in this regard has been cited by the learned counsel for the department to support him.
13. Applying the above principles which clearly follow from the words of and the decisions on Section 271(1), we find that the penalty has been levied by the ITO for the assessment year 1971-72. There were absolutely no proceedings pending before him for this year. To argue that appellate proceedings before the appellate authorities would be a continuation of the assessment proceedings and that would give jurisdiction to the ITO to levy penalty cannot also be accepted because Section 271(1) specifically and separately mentions the ITO, the AAC and the Commissioner (Appeals), the second and the third of whom are really appellate authorities. Whatever be the position of the general decision in Gojer Bros. (P.) Ltd.'s case (supra), in view of the specific and separate mention of the original assessing and the appellate authorities in Section 271(1), it is impossible to support the learned departmental counsel's stand in this regard. In the first place, therefore, proceedings before the AAC or the Tribunal, even if they are pending, cannot be regarded as specifying the condition of 'in the course of any proceedings' in Section 271(1) as far as the ITO is concerned. More than that, in the present case, the Tribunal having passed its final order on 30-1-1979, on the day of passing of the penalty order by the ITO on 28-3-1980 even the appellate proceedings were not pending anywhere On this ground alone the penalty levied should be cancelled.
14. The finding as to concealment under Explanation 2 to Section 271(1) can be said to be made when the set off was allowed by the AAC and subsequently by the Tribunal. The person, thus, who could be said to have been satisfied about the concealment, if at all, was either the AAC or the Tribunal. If at all penalty can be levied, only either of or both these persons could levy penalty. Apart from the fact that these people did not levy penalty in the present case, there is a more important fact that for the assessment year 1971-72 there were no proceedings pending before the AAC or the Tribunal. Even if the AAC or the Tribunal wanted to levy penalty in the present case in the absence of any proceedings pending for the assessment year 1971-72 before them, they can never acquire jurisdiction for the assessment year.
Fundamentally each assessment year being a separate period, the appellate authority never gets jurisdiction unless the particular assessment year is in appeal before him. The ITO, therefore, has absolutely no jurisdiction to levy penalty in the present case when he cannot be said to be satisfied about the default having been committed.
Penalty deserves to be cancelled for this reason too. The above view will not render the provisions nugatory since situation can be found where the ITO and the other authorities can act under the section.
15. Explanation 2 was brought on the statute book with effect from 1-4-1976. The return was filed on 7-12-1974. On the authority of Brij Mohan's case (supra) the default, if any, even it be a deemed default, can be said to have occurred only when the return was filed, i.e., in 1974. The penalty in the present case being a matter of substantial right and not one of procedure cannot have retrospective effect, that being not provided for and cannot, therefore, be levied at all for the assessment year 1971-72. The question, therefore, of quantum of penalty which also would follow Brij Mohan's case (supra) does not arise.
16. There is a still more important reason why penalty cannot be sustained in the present case. If the fact of retrospective operation on the ground of the matter being one of procedure, as urged by the learned departmental counsel, is accepted, the incongruous position would be that whenever the ITO looks into the file of any assessee and finds that a set off has been granted for an earlier year's addition for any of the years, even it be the assessment years 1960-61, 1950-51 or 1940-41, it would appear Explanation 2 would empower him to treat the assessee as having concealed income and be liable to the levy of penalty. Certainly amendment of Section 271 in 1976 introducing Explanation 2 would not have such a ridiculous result as its objective.
Apart from the above, even though the AAC has given the set off against interest paid to non-genuine loans, the Tribunal has given the set off in respect of the additions made to the goods account. For the assessment year 1971-72, the ITO estimated as against returned income of about Rs. 6,000, the assessee's business income at Rs. 15,000.
Certainly the addition made to the business income would be an amount added in computing the income. The estimate of income is made by the ITO for certain reasons such as the unsatisfactory nature of the accounts. Such additions do not stand in the same way as the additions on account of a cash credit, disallowed expenditure, etc. Whenever the ITO on account of the incompleteness of the assessee's set of accounts makes an addition to the goods account, it would automatically follow that Explanation 2 would be invoked in a subsequent year. It is one thing for an assessee's set of accounts for a business to be rejected, it would be another thing to make an estimate of the income. The number of occasions when books of account maintained by an assessee fall short of the state of perfection required by the ITO would be legion and in many cases, it may not be prudent business or economy for an assessee to strive for maintaining perfect accounts. In both these cases an estimate has to be made by the ITO for the assessment purposes. To grant that in all these cases an automatic application of Explanation 2 follows would be an astounding proposition. It deserves to be noted that Explanation 2 will automatically be applicable because when once the ITO makes an addition to the goods account, that much of money is added to the income of the assessee. If the assessee does not bring back that amount by way of investment, etc., in a subsequent year the natural corollary is that he has either invested or spent that amount in the very same year. To take an example in the present case for the assessment year 1977-78 as against the business income of Rs. 6,000, an estimate of income of Rs. 15,000 was made. The assessee has, thus, put into his hands an extra sum of Rs. 9,000. The assessee must either spend that money or invest it either in the year 1971-72 or in any subsequent year. Whether he claims a set off for this investment or expenditure or not, automatically the set off has to be thought of because the excess money is there. If there is no investment, the ITO can clearly come to the finding that the extra Rs. 9,000 has been spent by the assessee and ask for the assessee's for the source of such explanation expenditure ; naturally the assessee cannot have any explanation because the money has come into existence only on account of the addition made by the ITO. The inevitable inference is that the investment or expenditure is traceable only to the addition made. In other words, the addition to the goods account has automatically brought into existence an expenditure or investment to which though not for a subsequent assessment year but for the same assessment year 1977-78, the provisions of Explanation 2 will be applicable. Even without any retrospective operation of the provisions or treatment but as a matter of procedure in the years subsequent to 1-4-1976, the above absurd position would face the taxpayer and the department if Explanation 2 is invoked in respect of an estimated addition. We have no hesitation in holding that where set off is claimed as in the present case against an addition to the goods account, Explanation 2 cannot particularly apply.
17. We, therefore, hold that the provisions of Explanation 2 are not applicable in the case and the ITO is not competent to levy the penalty. The penalty levied is cancelled. The penalty amount, if paid, is directed to be refunded. The appeal is allowed.