Supreme Court clarifies penalty provisions under Section 271AAA of the Income Tax Act in search cases: K. Krishnamurthy vs. The Deputy Commissioner of Income Tax (2025)

Introduction

Date of the Judgment: February 13, 2025

Citation: 2025 INSC 208

Judges: J.B. Pardiwala and Manmohan J.

When can tax authorities impose penalties following a search operation? The Supreme Court of India addressed this question in a recent case concerning Section 271AAA of the Income Tax Act, 1961. The court clarified the scope and applicability of penalty provisions when undisclosed income is discovered during search and seizure operations.

The Supreme Court examined whether the imposition of a penalty under Section 271AAA(1) of the Income Tax Act is automatic following a search, and the conditions under which an assessee can avoid such penalty as per Section 271AAA(2). The bench comprised Justices J.B. Pardiwala and Manmohan J.

Case Background

The case originated from a search and seizure operation conducted at the appellant’s premises on November 25, 2010. The appellant, K. Krishnamurthy, had entered into a Memorandum of Understanding (MOU) on January 19, 2009, with Mr. Hashim Moosa and Mr. Surendra Reddy for procuring lands. According to the MOU, Krishnamurthy and Reddy were to receive Rs. 10,00,000 for facilitating the transfer of land from landowners to Mr. Moosa or his nominees.

A transaction occurred on September 26, 2009, between Mr. Hashim Moosa and the Space Employees’ Co-operative Society Ltd., for which the aforementioned MOU was relevant. During the search operation in 2010, the appellant disclosed an income of Rs. 2,27,65,580 as a consequence of the search.

Subsequently, a notice was issued to the appellant on August 21, 2012, under Section 142(1) of the Income Tax Act, 1961, requesting a return of income for the Assessment Year (AY) 2011-2012. The appellant filed the return on November 5, 2012, declaring a total income of Rs. 4,77,11,330 for the Previous Year (PY) 2010-2011.

The Assessing Officer (AO) issued an assessment order on March 15, 2013, assessing the total income at Rs. 4,78,02,616. The AO noted that during the search proceedings, the appellant admitted to income for the assessment years 2010-11 and 2011-12. The assessment also considered land transactions involving Mr. Sharab Reddy and Mr. NHR Prasad Reddy, where the appellant facilitated the transfer of their lands to the Society.

Timeline

Course of Proceedings

The Commissioner of Income Tax (Appeals) – 4, Bangalore, allowed the appeal (ITA No.119) against the penalty order dated September 30, 2013, for the Assessment Year 2010-2011. The CIT (Appeals) accepted the appellant’s submission that 2009-10 could not be the ‘specified previous year’ for the purpose of Section 271AAA of the Act 1961.

However, the appeal (ITA No.120) against the penalty order dated September 30, 2013, for the Assessment Year 2011-2012 was rejected. The rejection was based on non-compliance with Section 271AAA(2) of the Act 1961, stating that the assessee did not meet the liability prescribed under the section despite the time limits set by the Assessing Officer.

The Income Tax Appellate Tribunal (ITAT) also rejected the appellant’s appeal on October 17, 2016, citing non-compliance with Section 271AAA(2) of the Act 1961.

The appellant then appealed to the High Court under Section 260A of the Act 1961, which was dismissed on August 2, 2022. The High Court held that compliance with all three conditions in Sub-clause (2) of Section 271AAA of the Act is mandatory and that the appellant had not disclosed the income voluntarily, necessitating the search.

Legal Framework

The core legal provision in this case is Section 271AAA of the Income Tax Act, 1961, which deals with penalties when a search has been initiated. The section states:

“271AAA. Penalty where search has been initiated.—(1) The Assessing Officer may, notwithstanding anything contained in any other provisions of this Act, direct that, in a case where search has been initiated under section 132 on or after the 1st day of June, 2007, [but before the 1st day of July, 2012], the assessee shall pay by way of penalty, in addition to tax, if any, payable by him, a sum computed at the rate of ten per cent of the undisclosed income of the specified previous year.”

This section allows the Assessing Officer to impose a penalty of 10% on the undisclosed income of the specified previous year, in addition to any tax payable.

Sub-section (2) of Section 271AAA provides conditions under which the penalty under sub-section (1) shall not apply:

“(2) Nothing contained in sub-section (1) shall apply if the assessee, — (i) in the course of search, in a statement under sub-section (4) of section 132, admits the undisclosed income and specifies the manner in which such income has been derived; (ii) substantiates the manner in which the undisclosed income was derived; and (iii) pays the tax, together with interest, if any, in respect of the undisclosed income.”

Explanation (a) defines “undisclosed income” as:

“(a) “Undisclosed income” means — (i) any income of the specified previous year represented, either wholly or partly, by any money, bullion, jewellery or other valuable article or thing or any entry in the books of account or other documents or transactions found in the course of a search under section 132, which has — (A) not been recorded on or before the date of search in the books of account or other documents maintained in the normal course relating to such previous year; or……”

Explanation (b) defines “specified previous year” as:

“(b) “specified previous year” means the previous year — (i) which has ended before the date of search, but the date of filing the return of income under sub-section (1) of section 139 for such year has not expired before the date of search and the assessee has not furnished the return of income for the previous year before the said date; or (ii) in which search was conducted.”

Arguments

Arguments on Behalf of the Appellant

• Presumption of Automatic Levy: The appellant argued that the Revenue Authorities and the High Court erroneously presumed that the levy of penalty under Section 271AAA(1) is automatic, with the only exception being sub-clause (2) of the same section.
  • Example: Imagine a student who is automatically penalized for missing a deadline, without considering valid reasons for the delay. The appellant claimed a similar situation, where the penalty was levied without properly assessing the ‘undisclosed income’.
• Satisfaction of ‘Undisclosed Income’: The appellant contended that the Revenue Authorities levied the penalty without properly verifying the satisfaction of ‘undisclosed income’ as stipulated in Section 271AAA(1).
  • The appellant cited the ITAT Chandigarh Bench decision in Ajay Kumar Sood Engineers And Contractors K N Kandla & Co. vs. DCIT [MANU/IG/0095/2024], emphasizing that the Assessing Officer must record a specific finding that undisclosed income was found based on tangible, verifiable material during the search.
    Quote: “It is for the Assessing Officer to record a specific finding that undisclosed income as so defined has been found based on tangible verifiable material found during the course of search and the onus is thus on the Assessing officer (and not on the assessee) to satisfy the conditions before the charge for levy of penalty is fastened on the assessee…”
• Imposition of Penalty is Not Mandatory: The appellant argued that the authorities and the High Court ignored the principle established in Dilip N. Shroff vs. CIT [(2007) 6 SCC 329], which held that the imposition of penalty is not mandatory.
  • The appellant referred to the ITAT, Kolkata Bench decision in DCIT vs. Aryan Mining & Trading Corporation Ltd. [2019 SCC OnLine ITAT 4649], which applied this principle in the context of Section 271AAB (analogous to Section 271AAA), highlighting the importance of the word ‘may’ in the provision.
• Definition of ‘Undisclosed Income’ and ‘Specified Previous Year’: The appellant argued that unless there is undisclosed income in terms of the definition provided in the Explanation to Section 271AAA in the specified previous year, an order of levy of penalty cannot be issued by the Assessing Officer.
• MOU dated 19th January, 2009: The appellant submitted that the MOU only set out payments of Rs. 10,00,000 to the appellant and could not have formed the basis for the Penalty Order dated 30th September, 2013.
• Voluntary Declaration: The appellant contended that the declaration before the DDIT(Inv.) during search proceedings was made voluntarily and there was no demonstrable, direct co-relation between the declaration and the MOU dated 19th January, 2009.
  • The appellant also argued that paragraph 5 of the Assessment Order had no co-relation with the MOU, as the transactions referred to therein were found in “copies of sale deeds collected from the Society” and not from the appellant.
• Reliance on DCIT vs. Aryan Mining & Trading Corporation Ltd.: The appellant relied on the decision in DCIT vs. Aryan Mining & Trading Corporation Ltd., 2019 SCC Online ITAT 4649, to emphasize the meaning of ‘undisclosed income’.
  • Quote: “From bare perusal of the definition of the word “undisclosed income” we find that in order to bring a receipt or specie of income within the meaning of the said expression, it is obligatory for the AO to demonstrate and prove that the income is represented either wholly or partly by any money, bullion, jewellery or other valuable article or thing found in the course of search u/s 132 and which was not recorded on or before the date of search in the books of accounts or other documents maintained in the normal course relating to such previous year or otherwise not disclosed to the Commissioner before the date of search.”
• Penalty on Entire Returned Income: The appellant argued that the penalty could not have been imposed on the entire returned income for FY 2010-2011, and at the highest, it could have been imposed on the alleged undisclosed income of Rs. 2,27,65,580 referred to in the declaration at paragraph 4 of the Assessment Order.

Arguments on Behalf of the Respondent

• Concurrent Findings: The respondent argued that there were concurrent findings of all the authorities below against the appellant, upholding the penalty amount on the entire income returned, as the appellant had failed to meet the conditions of the section.
• Search and Assessment: The respondent emphasized that there was a search, and the assessment was completed at Rs. 4,78,02,616. The charging section is attracted as the assessee/appellant had failed to comply with the mandatory conditions of Section 271AAA (2) of the Act 1961.
• Failure to Adhere to Conditions: The respondent submitted that the assessee had failed to adhere to any of the conditions specified under Section 271AAA, as the assessee never admitted to any undisclosed income, and the income was detected only after a search. The assessee never disclosed or explained the manner in which that income was derived/earned, and did not pay the tax and the interest thereon until 2016.
• Reliance on PCIT vs. Amul Gabrani: The respondent relied on the Delhi High Court’s decision in PCIT vs. Amul Gabrani (ITA No.1251 of 2018 dated 24th July, 2024), which held that to claim the benefit of Section 271AAA(2), the assessee has to satisfy the requirements/conditions of the said sub-section.
  • The respondent pointed out that the judgment in Amul Gabrani was upheld by the Supreme Court in Special Leave Petition (Civil) Dy. No.43696 of 2024, where the Court observed: “We concur with the view taken by the Delhi High Court about the interpretation of sub-section 2 of Section 271AAA of the Income Tax Act, 1961”.

Submissions Table

Issues Framed by the Supreme Court

1. Whether the compliance with all the three conditions mentioned in Sub-section (2) of Section 271AAA mandatory or not?
2. Whether penalty prescribed @ 10% of undisclosed Income under Section 271AAA of the Act can be reduced if the tax together with interest on the undisclosed income as declared by the Assessee in the course of search in a statement under Section 132(4) is partly complied with, with a delay, in the absence of specific period for such compliance specified in the Sub-clause (iii) of Section 271AAA of the Act?

Treatment of the Issue by the Court: “The following table demonstrates as to how the Court decided the issues”

Authorities

Cases Relied Upon

• Dilip N. Shroff vs. CIT [(2007) 6 SCC 329] – Supreme Court of India
  • Legal Point: Imposition of penalty is not mandatory.
  • Reasoning: The Court referred to this case to emphasize that the imposition of a penalty is not automatic and depends on the specific circumstances and fulfillment of conditions.
• Som Raj and Others vs. State of Haryana and Others, (1990) 2 SCC 653 – Supreme Court of India
  • Legal Point: Discretionary power must be guided by law.
  • Reasoning: The Court cited this case to highlight that discretionary power is not unfettered and must be exercised judiciously, guided by legal principles.
• Ajay Kumar Sood Engineers And Contractors K N Kandla & Co. vs. DCIT [MANU/IG/0095/2024] – ITAT Chandigarh Bench
  • Legal Point: Assessing Officer must record a specific finding that undisclosed income was found based on tangible material.
  • Reasoning: The Court referred to this case to emphasize that the Assessing Officer has the onus to demonstrate and prove that undisclosed income was found during the search.
• DCIT vs. Aryan Mining & Trading Corporation Ltd. [2019 SCC OnLine ITAT 4649] – ITAT Kolkata Bench
  • Legal Point: Interpretation of ‘undisclosed income’.
  • Reasoning: The Court relied on this case to define ‘undisclosed income’ and to emphasize that the Assessing Officer must demonstrate and prove that the income is represented by money, bullion, etc., found during the search.
• PCIT vs. Amul Gabrani (ITA No.1251 of 2018 dated 24th July, 2024) – Delhi High Court
  • Legal Point: Conditions of Section 271AAA(2) must be satisfied to claim benefit.
  • Reasoning: The Court referred to this case to emphasize that to claim the benefit of Section 271AAA(2), the assessee must satisfy all the requirements/conditions of the said sub-section.

Legal Provisions Considered

• Section 132 of the Income Tax Act, 1961
  • Brief: Deals with search and seizure operations.
  • Reasoning: The Court considered this section as it relates to the initiation of search proceedings, which triggers the applicability of Section 271AAA.
• Section 139(1) of the Income Tax Act, 1961
  • Brief: Deals with the filing of returns of income.
  • Reasoning: The Court considered this section to determine the ‘specified previous year’ for the purpose of Section 271AAA.
• Section 142(1) of the Income Tax Act, 1961
  • Brief: Empowers the Assessing Officer to issue notices requiring the assessee to file a return of income.
  • Reasoning: The Court referred to this section as it was the basis for the notice issued to the appellant calling for the return of income.
• Section 143(3) of the Income Tax Act, 1961
  • Brief: Deals with assessment orders.
  • Reasoning: The Court referred to this section as the assessment order was the basis for determining the income and imposing the penalty.
• Section 260A of the Income Tax Act, 1961
  • Brief: Deals with appeals to the High Court.
  • Reasoning: The Court referred to this section as the appellant had preferred an appeal to the High Court under this section.
• Section 271AAA of the Income Tax Act, 1961
  • Brief: Deals with penalties where a search has been initiated.
  • Reasoning: The entire case revolves around the interpretation and application of this section.

Authorities Table

Judgment

How each submission made by the Parties was treated by the Court?

How each authority was viewed by the Court?

• Dilip N. Shroff vs. CIT [(2007) 6 SCC 329]: The Court followed this authority to emphasize that the imposition of penalty is not mandatory.
• Som Raj and Others vs. State of Haryana and Others, (1990) 2 SCC 653: The Court followed this authority to highlight that discretionary power must be guided by law.
• Ajay Kumar Sood Engineers And Contractors K N Kandla & Co. vs. DCIT [MANU/IG/0695/2024]: The Court relied upon this authority to emphasize that the Assessing Officer must record a specific finding that undisclosed income was found based on tangible material.
• DCIT vs. Aryan Mining & Trading Corporation Ltd. [2019 SCC OnLine ITAT 4649]: The Court relied upon this authority to define ‘undisclosed income’ and to emphasize that the Assessing Officer must demonstrate and prove that the income is represented by money, bullion, etc., found during the search.
• PCIT vs. Amul Gabrani (ITA No.1251 of 2018 dated 24th July, 2024): The Court affirmed this authority to emphasize that the conditions of Section 271AAA(2) must be satisfied to claim the benefit.

Final Order

The Supreme Court partly allowed the appeal, setting aside the judgment of the High Court and the order passed by the Income Tax Appellate Tribunal. The Court directed the appellant to pay a penalty of 10% on Rs. 2,49,90,000, which was the admitted undisclosed income during the search. The Court clarified that no penalty would be imposed on the remaining amount of Rs. 2,27,65,580, as the conditions of Section 271AAA(2) were met for that portion of the income.

The Court observed that the levy of penalty under Section 271AAA(1) is not automatic and the Assessing Officer must satisfy the condition precedent stipulated in the Explanation to Section 271AAA. The Court also emphasized that the imposition of penalty is not mandatory and depends on the specific circumstances and fulfillment of conditions.

Dissenting Opinion (if any)

There was no dissenting opinion in this judgment.

Ratio Decidendi

The ratio decidendi of this case is that while compliance with the conditions under Section 271AAA(2) is necessary to avoid penalties under Section 271AAA(1) of the Income Tax Act, the imposition of such penalties is not automatic. The Assessing Officer must demonstrate that undisclosed income was found based on tangible, verifiable material during the search, and the discretion to impose a penalty must be exercised judiciously, guided by legal principles. Furthermore, the penalty can be reduced if the conditions of Section 271AAA(2) are met for a portion of the undisclosed income.

Obiter Dicta (if any)

The Court’s discussion on the discretionary power of the Assessing Officer and the need for it to be guided by legal principles can be considered obiter dicta. While these statements are not directly essential to the decision, they provide valuable guidance on the interpretation and application of penalty provisions under the Income Tax Act.

Impact and Analysis

This judgment provides significant clarity on the interpretation and application of Section 271AAA of the Income Tax Act, particularly in cases involving search and seizure operations. It reinforces the principle that the imposition of penalties is not automatic and that the Assessing Officer must exercise due diligence in determining the existence of undisclosed income and the fulfillment of conditions for avoiding penalties.

For taxpayers, this judgment offers reassurance that they will not be subjected to arbitrary penalties and that their voluntary disclosures and compliance with the conditions of Section 271AAA(2) will be duly considered. It also emphasizes the importance of maintaining proper books of accounts and disclosing income in a timely manner.

For tax authorities, this judgment serves as a reminder of the need to conduct thorough investigations and to base penalty decisions on tangible, verifiable material. It also underscores the importance of exercising discretionary power judiciously and in accordance with legal principles.

Overall, this judgment promotes fairness and transparency in tax administration and contributes to a more predictable and equitable tax environment.

Flowchart Representation of the Decision-Making Process

Conclusion

In conclusion, the Supreme Court’s judgment in the case of K. Krishnamurthy vs. The Deputy Commissioner of Income Tax (2025) provides valuable guidance on the interpretation and application of Section 271AAA of the Income Tax Act. The Court clarified that while compliance with the conditions under Section 271AAA(2) is necessary to avoid penalties, the imposition of such penalties is not automatic. The Assessing Officer must demonstrate that undisclosed income was found based on tangible, verifiable material during the search, and the discretion to impose a penalty must be exercised judiciously, guided by legal principles. This judgment promotes fairness and transparency in tax administration and contributes to a more predictable and equitable tax environment.