Notice Likely Triggered by Large Sums in Schedule El, Which May Be Well Within the Law, Say Experts
Several senior professionals, equity partners of at least two Big 4 firms, members of well-known partnership ventures, as well as some retired senior personnel, have received scrutiny notices from the Income Tax (I-T) department questioning the amounts on which no tax has been paid by them. Most of these individuals served with the notices for the financial year 2023-24 are understood to have shown these earnings as ‘exempt income’ in their I-T returns, as is allowed under regulations.
Tax-exempt income (Schedule El) can come from various sources, such as profits shared by a firm with its partners, agricultural income, disbursements of retirement benefits like provident fund and gratuity, and government-backed investment schemes like the Public Provident Fund (PPF). When filing the Income Tax Return (ITR) form, these earnings are recorded under Schedule El to exclude them from the computation of total income under Section 10 of the I-T Act, 1961.
Over the past year, the tax office has taken action against individuals who have fraudulently claimed large amounts as farm income, benefits from bogus donations to little-known political parties, and fake rent receipts. However, what has surprised many is the current examination of receipts like partnership profits and full and final settlement amounts of retirees. Since a firm pays the tax, the profits distributed subsequently are exempt for the partners. Some tax practitioners speculate that this might be a system error the IT department needs to address.
Besides the compulsory selection criteria for the scrutiny of ITRs, returns are also picked based on certain risk parameters established by the department. This year, claims of large amounts of exemption seem to have been one of the criteria for selection. Many partners of large professional partnership firms inevitably receive a share of profit from the firm, which is exempt, as the remuneration paid by a firm to its partners cannot exceed 60% of its profits. Similarly, retiring employees receive gratuity and provident funds, which are exempt from tax up to certain limits. Many cases have been subject to scrutiny based on this new parameter.
A little bit of vetting or thought process may have helped avoid needless scrutiny of genuine cases claiming exemption, said Gautam Nayak, a senior tax professional and partner at CNK & Associates. The scrutiny notices seek a plethora of information, including sources of income and documents to support the exempt income claims. These notices are issued a little over a year after the end of the financial year under review. The current batch of notices, asking for detailed information, was issued since mid-August.
According to Ashish Karundia, founder of the CA firm Ashish Karundia & Co, the intent behind Schedule El is to promote transparency and facilitate comprehensive disclosure of such exempt income, not to initiate proceedings. “Given that much of this information is already available with the tax department, initiating scrutiny based solely on disclosures made under Schedule El, particularly under the category of ‘other exempt income,’ may not align with the legislative framework,” Karundia explained. This approach risks placing an avoidable compliance burden on taxpayers who have reported their exempt income accurately and in accordance with the law.
Taxpayers who escape scrutiny notices (issued under Section 143) may discover later that ‘reassessment proceedings’ (under Section 148) have been initiated against them. The department has a longer timeframe to issue reassessment notices, particularly if the escaped income exceeds ₹50 lakh. “It’s essential that no adverse inferences are drawn merely from the reporting of exempt income in this schedule, where its exempt status is clearly supported. Equally important is that any questionnaires issued to taxpayers as part of scrutiny proceedings be relevant, specific, and appropriately tailored to the case facts,” said Karundia. This would be consistent with the guidance issued by the Central Board of Direct Taxes (CBDT) earlier this year, aiming to ensure that inquiries remain focused and proportionate.
While most grappling with the scrutiny notices would probably be able to defend their claims, they will nonetheless have to navigate the complexities of dealing with the department.
