Penalty under Section 271(1)(c) cannot rest solely on doubtful inferences from disallowed depreciation claims.

The assessee, a dealer in industrial oxygen and argon gases, claimed depreciation on gas cylinders allegedly purchased during Assessment Years 2001–02 and 2003–04. The Assessing Officer disallowed the depreciation under Section 43(1) read with Explanation 3 of the Income Tax Act, 1961, expressing doubts regarding the genuineness, cost, delivery, and possession of the cylinders, and levied penalties under Section 271(1)(c) for concealment of income and furnishing inaccurate particulars.

The Commissioner of Income Tax (Appeals) and the Income Tax Appellate Tribunal affirmed the penalties, relying substantially on the Tribunal’s findings in the quantum proceedings that the transactions were dubious and intended to avoid tax.

The assessee appealed to the Gujarat High Court, challenging penalties of Rs.2,12,500 for A.Y. 2001–02 and Rs.75,795 for A.Y. 2003–04.

The assessee contended that 250 cylinders had already been taken on hire in March 2000 from M/s. Ashok Air Products Pvt. Ltd. and were subsequently purchased, making the authorities’ doubts regarding delivery unfounded.

1. Whether, on the facts and circumstances of the case, the Tribunal was justified in law in sustaining the penalty of Rs.2,12,500 under Section 271(1)(c) of the Income Tax Act for A.Y. 2001–02.

2. Whether, on the facts and circumstances of the case, the Tribunal was justified in law in sustaining the penalty of Rs.75,795 under Section 271(1)(c) of the Income Tax Act for A.Y. 2003–04.

The Court applied Section 271(1)(c) of the Income Tax Act, 1961, under which penalty may be imposed for concealment of income or furnishing inaccurate particulars, and Section 43(1) read with Explanation 3, concerning the determination of the actual cost of an asset for depreciation purposes.

The Court distinguished the determination of taxable income in quantum proceedings from the separate question of whether the assessee had concealed income or furnished inaccurate particulars so as to warrant penalty under Section 271(1)(c).

It also considered the Tribunal’s reliance on McDowell & Co. v. CTO, [1985] 154 ITR 148 (SC), concerning impermissible tax avoidance through sham or dubious transactions.

The governing principle applied was that penalty cannot be sustained merely on the basis of doubt or an inference regarding the genuineness of a transaction, particularly where the relevant factual circumstances support a bona fide explanation.

The High Court held that the Tribunal had relied excessively on the confirmation of the quantum disallowance without independently examining whether the statutory requirements for imposing penalty under Section 271(1)(c) were established.

The CIT(A)’s findings showed that the assessee had already taken possession of 250 cylinders on hire in March 2000; therefore, the absence of fresh delivery in August 2000 did not necessarily establish that the subsequent purchase was fictitious or non-genuine.

The Court found that the authorities had ignored this material circumstance and had inferred an intention to evade tax primarily because the seller had claimed short-term capital gains against brought-forward losses and unabsorbed depreciation.

Since the issue concerning delivery was doubtful and the assessee’s possession of the cylinders was not disputed, the Court concluded that the evidence did not establish concealment or furnishing of inaccurate particulars. The confirmation of the depreciation disallowance in quantum proceedings, by itself, could not justify the penalty.

It held that the penalties under Section 271(1)(c)—Rs.2,12,500 for A.Y. 2001–02 and Rs.75,795 for A.Y. 2003–04—could not be sustained merely on the basis of doubts and inferences concerning the delivery and genuineness of the cylinders.

The orders confirming the penalties were set aside, and both tax appeals were allowed.