Balancing Act: Human Probability vs Concrete Evidence in Taxation Disputes

Balancing Act: Human Probability vs Concrete Evidence in Taxation Disputes

Article by CA Sunil Maloo

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1.     Introduction:

1.1  Taxation disputes often arise due to differences in the interpretation of tax laws, the assessment of income and deductions, and the determination of tax liability. In such disputes, the Assessee relies on concrete evidences such as books of accounts, invoices, bank statements, and other documents to support his contentions, while the Assessing officer may challenge the same by highlighting the human probability aspect of the case. This paper explores the balancing act between human probability and concrete evidence in taxation disputes.

2.     Concept of Principle of Human Probabilities

2.1  The Human Probabilities principle is a standard of proof used in income tax law. It is a concept that recognizes that in some situations, it is not possible to provide conclusive evidence to prove a case, but rather a judgment must be made based on probabilities and common sense.

2.2  Under the Human Probabilities principle, the decision-maker must take into account all the evidence, including circumstantial evidence, and make a determination based on what a reasonable person would conclude from that evidence. This approach recognizes that not all evidence can be presented in a straightforward manner, and that sometimes inferences must be drawn from the evidence in order to make a determination.

2.3  In tax law, the Human Probabilities principle is often invoked in cases where there is incomplete documentation or where the taxpayer's books and records are inadequate or unreliable. In such cases, the tax authorities may use indirect methods of computing the taxpayer's income, based on assumptions and estimates of what the taxpayer's income might be. The tax authorities will use their judgment, experience, and common sense to determine what is reasonable in the circumstances, and apply the Human Probabilities principle to arrive at a determination of the taxpayer's tax liability.

2.4  In summary, the principle of Human Probabilities allows the AO to use their judgment and experience to determine a taxpayer's tax liability when direct evidence is lacking, but the AO must still provide a reasonable basis for their determination and give the taxpayer an opportunity to respond.

3.     How the concept developed?

3.1  In Indian tax laws, the concept of Human probability was first recognized by the Hon’ble Supreme Court in the case of CIT vs. Durga Prasad More (1971) 82 ITR 540 (SC), which is being explained hereunder –

3.2  Facts of the said case and issues involved –

Assessment years: AY 1958-59 and 1959-60

Issue: Whether income from a property should be taxed in the hands of the assessee or in the hands of the Trust

Property was registered in their name as trustee of the oral trust through a conveyance deed dated 30/09/1940, before the trust settlement deed was executed on 10/09/1941. Assessing Officer asked for source of purchase of property; Assessee claimed it was purchased using Streedhan of their wife. The AO, Appellate Assistant Commissioner, and Tribunal rejected Assessee's contention for the following reasons:

·       Assessee's wife didn't have a source of income to accumulate a large sum for the purchase of the property

·       Assessee was unable to explain the source of income of their wife

·       Sale deed was executed before the trust deed

·       Even after the Tribunal rejected Assessee's contention, they allowed the income to be taxed in their hands for several years without objection

3.3  Held by the Supreme Court -

3.3.1       The Supreme Court in the Durga Prasad More case held that an apparent must be considered real until it is shown that there are reasons to believe that the apparent is not the real party. The party who relies on a recital in a deed has to establish the truth of those recitals, otherwise, it will be easy to make self-serving statements in documents either executed or taken by a party and rely on those recitals. The taxing authorities are entitled to look into the surrounding circumstances to find out the reality of the recitals made in those documents.

3.3.2       Regarding the question of onus, the law does not prescribe any quantitative test to find out whether the onus in a particular case has been discharged or not. It all depends on the facts and circumstances of each case. In some cases, the onus may be heavy, whereas in others, it may be nominal. In this case, the assessee was receiving some income, which he claimed was his wife's income. However, he was unable to provide a credible source for how his wife had accumulated the sum of two lakhs before the year 1940, a big sum at the time. The Tribunal found his story to be fantastic and disbelieved it.

3.3.3       The Supreme Court also noted that there is no proof that the consideration for the conveyance passed from the assessee, and therefore, it was necessary to judge the evidence before them by applying the test of human probabilities. Science has not yet (by that time) invented any instrument to test the reliability of the evidence placed before a court or tribunal. Therefore, the courts and tribunals have to judge the evidence before them by applying the test of human probabilities.

4.     Understanding the Impact of Sumati Dayal vs. CIT on Taxation (1995) 214 ITR 801 (SC)

4.1  The finding of the Supreme Court of India in the case of Sumati Dayal is a clear example of the application of the principle that the apparent must be considered real until it is shown that there are reasons to believe that it is not the real, and that the taxing authorities are entitled to look into the surrounding circumstances to find out the reality. The case dealt with the issue of whether the amount credited in the capital account of the appellant was her winnings from races or not.

4.2  The Court also observed that the transaction about the purchase of the winning ticket took place in secret, and direct evidence about such purchase would be rarely available. An inference about such a purchase had to be drawn on the basis of the circumstances available on the record. The conduct of the appellant as disclosed in her sworn statement as well as other material on the record, supported the inference that the winning tickets were purchased by the appellant after the event.

4.3  The Settlement Commission found the Assessee's claim about her winning in races to be contrived and not genuine for the following reasons:

·       The Assessee’s knowledge of racing is very meagre.

·       The claim of the appellant to have won a number of Jackpots in three or four seasons at three different centres, namely, Madras, Bangalore and Hyderabad appears to be wild and contrary to statistical theories and experience of the frequencies and probabilities.

·       The Assessee’s books do not show any drawings on race days or on the immediately preceding days for the purchase of Jackpot combination tickets, which entailed sizable amounts varying generally between Rs. 2,000 and Rs. 3,000.

·       While the Assessee’s capital account was credited with the gross amounts of race winnings, there were no debits either for expenses and purchases of tickets or for losses.

·       The appellant further stated that she had no record of her expenditure at the racecourse as against her claim of winnings.

·       In view of the exceptional luck claimed to have been enjoyed by the appellant, her loss of interest in races from 1972 assumes significance.

4.4  The Settlement Commission concluded that if the claim of winnings in races was false and what were passed off as such winnings really represented the appellant's taxable income from some undisclosed sources, it would be different. The winnings in racing became liable to income tax from 1-4-1972, but one would not give up an activity yielding or likely to yield a large income merely because the income would suffer tax.

4.5  Based on the above observations, the Court held that the appellant's claim about the amount being her winnings from races was not genuine. The finding that the said amounts were income of the appellant from other sources was based on evidence and not rejected unreasonably.

4.6  In conclusion, the finding of the Supreme Court of India in the case of Sumati Dayal is a well-reasoned decision, which shows that the taxing authorities are entitled to look into the surrounding circumstances to find out the reality, and that the matter has to be considered by applying the test of human probabilities. The Court's decision is in line with the principle that the apparent must be considered real until it is shown that there are reasons to believe that it is not the real.

5.     Overreliance on Human Probability by Assessing Officers

5.1  It is inappropriate for the Assessing Officer to routinely apply the principle of human probability in each and every case to disregard the explanations and documentary evidences of the Assessee, merely citing the above decisions of Supreme Court in the cases of Durga Prasad More and Sumati Dayal.

5.2  In routine practice, it is observed that the AO by placing the reliance on Principle of Human probability and citing these two decisions from the Hon’ble Supreme Court, sets aside the explanation and documentary evidences of the Assessee and makes additions to the total incomes of the Assessee. Below examples are illustrations of few of such cases –

a)     Cases of cash deposits out of the “Over the counter” sales being made by the Assessee – despite the Assessee explains with documentary evidences the details of daily sales made, regular frequency of cash deposits, GST returns, Purchase Party Confirmation, Audited Books of Accounts etc;

b)     Cases of cash deposits during the Demonetization Period – despite the Assessee explains with documentary evidences to prove the fact that same is out of either of –

a.      Opening balance of the case as on the date of Demonetization;

b.     Earlier cash withdrawals from bank accounts

c.      Cash sales for the year

d.     Realization from the debtors

e.     Old savings

f.       From sale of any asset

g.      Agricultural income

h.     Gift received in cash

c)      Abnormal Gains from Share markets – despite assessee has produced all the documents and proved that the purchase as well as sale is through the stock exchange and well documented

d)     Abnormal Gains from Online Gaming / Virtual Digital Assets – despite assessee has produced all the documents and proved that the gains are earned in real time transactions and same are well documented

e)     Investment in Unquoted shares at Premium – despite assessee has produced all the documents and also explained the source of the said investments

f)       Holding of huge cash balance for long time – despite assessee has produced all the documents and also explained the source of the said cash balance

g)     Cash deposited in piecemeal manner during the Demonetization – despite assessee has produced all the documents and also explained the source of the said cash deposits

h)     Cash deposits out of Cash Sales of Jewellery – despite assessee has produced all the documents to prove that the cash deposit is out of the cash sales made, the details of Sales invoice, regularity of transactions, GST returns, purchase party confirmation etc.

5.3  While these decisions do provide guidance on the use of human probability in tax assessments, they do not provide blanket authorization for Assessing Officers to ignore documentary evidence and rely solely on human probability. Each case must be evaluated on its own merits, and the Assessing Officer must provide clear and cogent reasons for rejecting the evidence presented by the Assessee.

5.4  Furthermore, it is imperative that Assessing Officers exercise caution and apply the principle of human probability judiciously, as an overreliance on this principle may lead to incorrect tax assessments and may result in unwarranted harassment to the Assessee. Instead, the Assessing Officer should adopt a balanced approach, taking into account all the relevant evidence and arguments presented by the Assessee, before arriving at a decision.

6.     Principle of Apparent Reality

6.1  One important principle that is relevant in the context of the balancing act between human probability and concrete evidence is the principle of apparent reality. This principle states that apparent must be considered real until it is shown that there are reasons to believe that it is not the real. In the context of taxation disputes, this principle means that the assessing officer should rely on the apparent state of affairs unless the taxpayer fails to provide a satisfactory explanation for any discrepancies or anomalies.

6.2  The principle of apparent reality is well-established in Indian income tax law. For example Section 69A of the Income Tax Act, 1961, provides that if any investment, expenditure or any other sum of money is found to be unexplained, then it may be deemed to be the income of the taxpayer. However, the section also provides that if the taxpayer can provide a satisfactory explanation for the same, then it will not be deemed to be his income.

6.3  In the case of CIT vs. Daulat Ram Rawatmull [1973] 87 ITR 349 (SC), the Supreme Court of India held that the principle of apparent reality is an important principle in the context of taxation disputes. The Supreme Court held that the onus to prove that the apparent is not the real is on the party who claims it to be so.

6.4  The principle of apparent reality reinforces the importance of concrete evidence in taxation disputes. The assessing officer is entitled to rely on the concrete evidence unless the taxpayer is able to provide a satisfactory explanation for any discrepancies or anomalies. However, the principle also recognizes the importance of human probability in such disputes. If the taxpayer is able to provide a satisfactory explanation for the apparent state of affairs, then the assessing officer must take such explanation into account before making an assessment.

6.5  In conclusion, the principle of apparent reality is an important principle in the context of taxation disputes. It reinforces the importance of concrete evidence in such disputes, but also recognizes the importance of human probability. The assessing officer must balance the concrete evidence with the human probability aspect of the case before making an assessment, and the taxpayer must provide a satisfactory explanation for any discrepancies or anomalies in order to avoid being assessed adversely.

7.     Fair Evidence or Blind Probability: Court’s Decisions on Assessing Officer's Overreliance on Human Probability

7.1  The court has repeatedly challenged the routine application of the principle of human probability by Assessing Officers to disregard the explanations and documentary evidence of the Assessee, citing specific cases such as Durga Prasad More and Samati Dayal. The principle of human probability may be a relevant consideration in assessing the credibility of evidence, but it cannot be applied mechanically and without considering the specific facts and circumstances of each case.

7.2  Several courts have held that the Assessing Officer cannot reject the evidence produced by the Assessee merely on the ground of human probability, especially when such evidence is corroborated by other facts and circumstances.

7.3  For instance, in the case of CIT v. P. Mohanakala, the Supreme Court held that the Assessing Officer cannot brush aside the evidence produced by the Assessee without conducting a proper enquiry or investigation.

7.4  The Gujarat High Court case of Chetnaben J Shah vs ITO [2017] 79 taxmann.com 328 (Gujarat) basically said that the Commissioner of Income Tax (Appeals) made the right decision based on the law and the statements made by the taxpayer. The court also stated that mere speculation is not enough to add income to someone's tax return. There must be some actual evidence or documentation to support the addition of income. Therefore, based on the previous decision in the Kailashben Manharlal Chokshi case and the specific circumstances of this case, the court ruled in favor of the taxpayer and against the Department.

7.5  Bombay High Court, in CIT vs Mukhtar Minerals (P.) Ltd [2020] 120 taxmann.com 186 (Bombay), stated that both the CIT (Appeals) and the ITAT have analyzed the explanation provided by the Assessee and the circumstances surrounding it. After examining the evidence, the two authorities have jointly concluded that the Assessee's explanation is highly probable. These findings are mutually agreed upon by both the authorities, and therefore, cannot be challenged. Furthermore, as per the judgment in Sumati Dayal (supra), the explanations given under Section 68 of the Income-tax Act must be assessed based on human probabilities, and they cannot be dismissed arbitrarily. Hence, in this case, the Assessee's argument appears to be more persuasive than that of the Revenue.

7.6  The Chennai Tribunal in the case of DCIT vs M.C. Hospital [2022] 142 taxmann.com 122 held that the Assessing Officer added the cash balance of the assessee firm as undisclosed income under section 69A read with section 115BEE. The Assessing Officer argued that the cash deposits made by the assessee in the bank between 1-4-2016 and 8-11-2016 were undisclosed income. He further noted that one doctor increased the firm's turnover by 202%, the cash receipts were incomplete, the increase in pharmacy sales was beyond human probabilities, and the books were unreliable. The ITAT, however, found that there was no dispute about the availability of cash balance and its source with the assessee. Thus, once the availability of cash in hand is proved, the assessee cannot be asked to furnish proof of acquisition of such amount in currency notes of a particular denomination.

7.7  In the case of Jatinder Kumar Jain vs ITO, ITAT Chandigarh bench has stated that the Hon'ble Punjab and Haryana High Court in the case of Pr. CIT (Central) v. Hitesh Gandhi and another judgment of the Hon'ble Apex Court in the case of CIT v. Daulat Ram Rawatmull have held that if there is documentary evidence available, the test of human probability cannot be used to question the bonafides of the assessee based on mere suspicion and surmises. The judgments of Sumati Dayal v. CIT and CIT v. Durga Prasad More, which relate to the issue of circumstantial evidence, cannot be applied here as the assessee has provided sufficient evidence in support of their claim and the Department has not been able to disprove it.

7.8  The Kolkata ITAT in the case of Navneet Agarwal vs ITO [2018] 97 taxmann.com 76, has held that when investigating an alleged scam, the legal evidence produced by the assessee should guide the decision in the matter rather than general observations based on probabilities and human behavior. It is important to establish the involvement of the assessee in the scam with evidence, and any allegations of cash payments should be proved by the revenue with evidence. The claim of the assessee cannot be rejected based on conjectures and probabilities unless specific evidence is brought forward to disprove the validity of the documentary evidence produced. The burden of proving a transaction to be bogus rests on the party who claims it to be so, and suspicion cannot take the place of evidence. Judicial notice of notorious facts cannot be taken based on generalizations, and courts of law are bound to go by evidence. The onus is on the party alleging a scam to establish the chain of events and the live link of the assessee's action giving her involvement in the scam. If the AO relies on any statements or third party as evidence to make an addition, opportunity of cross-examination has to be provided to the assessee.

7.9  The High Court of Andhra Pradesh and Telangana ruled in the case of Pendurthi Chandrasekhar vs DCIT [2018] 91 taxmann.com 229 that the Commissioner of Income Tax's findings were invalid as they were based on personal perception and not legal evidence. The Commissioner had claimed that the gifts received by the assessee from his maternal aunt were odd and lacked occasion. However, the Court held that the Act does not require a specific occasion for a relative to give a gift, and the donor in this case was the assessee's own maternal aunt, who falls under the definition of "relative" as per the explanation to Section 56(2)(v) of the Act. The Court also noted that the gift did not fall beyond the "human probability" test, and it was not permissible for the Assessing Officer to judge the conduct of the donor without legal evidence.

7.10                     The High Court of Delhi, in the case of PCIT v. Smt. Krishna Devi [2021] 126 taxmann.com 80 (Delhi), ruled that one cannot use the theory of human behavior and preponderance of probabilities as an excuse to ignore the evidence presented by the respondent. Additionally, the case of Sumati Dayal (supra) is specific to its own facts and cannot be used as a blanket defense.

7.11                     The ITAT Surat Bench has stated in the case of Sandipkumar Parsottambhai Patel vs ITO [2022] 137 taxmann.com 373 that the decision in Sumati Dayal v. CIT [1995] 80 Taxman 89/214 ITR 801 (SC) is not relevant to the assessee under consideration as the evidence produced by the assessee proves that the transaction of purchase and sale of shares was genuine. The Assessing Officer and CIT(A) relied on Sumati Dayal to make an addition to the income of the assessee, but the ITAT Surat Bench rejected this approach. The ITAT Surat Bench further observed that the addition cannot be made on the basis of generalization, human probabilities, suspicion, conjectures, and surmises, as the assessee has provided sufficient evidence to prove the transaction was genuine, such as ledger accounts, contract notes, bank statements, broker confirmations, share certificates, share transfer forms, debit notes, and cash receipts, among others.

7.12                     In tax law, the Hon'ble Supreme Court has set standards for proving the authenticity of transactions. In the case of Omar Salav Mohamed Sait v. CIT [1959] 37 ITR 151, the court held that surmises, suspicion, and conjectures cannot be the basis for adding to tax liability.

7.13                     In CIT (Central) v. Daulat Ram Rawatmull [1973] 87 ITR 349 (SC), the court ruled that the burden of proving a transaction to be bogus lies with the party making the claim. To discharge this burden, legal evidence that directly proves the fact of bogusness or establishes circumstances unerringly and reasonably raising an inference to that effect must be presented.

7.14                     Similarly, in Umacharan Shah & Bros. v. CIT [1959] 37 ITR 271, the court held that suspicion, however strong, cannot replace evidence in tax cases.

7.15                     Therefore, the Assessing Officer must exercise caution while relying on the principle of human probability and must give due consideration to the documentary evidence and explanations produced by the Assessee. The blind application of the principle of human probability can lead to unjust and arbitrary assessments, and can violate the fundamental principles of natural justice.

8.     Balancing Act:

8.1  The Indian income tax law recognizes the importance of human probability in taxation disputes. For example Section 68 of the Income Tax Act, 1961, provides that if any sum is found credited in the books of accounts of the taxpayer and the explanation given by the taxpayer is not satisfactory to the assessing officer, then the sum may be treated as the income of the taxpayer. However, the section also provides that if the taxpayer can explain the nature and source of the sum and proves that it is not his income, then the sum will not be treated as income.

8.2  This provision indicates that the assessing officer must balance the concrete evidence with the human probability aspect of the case before making an assessment. The Supreme Court of India has also emphasized the importance of balancing the evidence in taxation disputes. In the case of CIT vs. Durga Prasad More (1971), the Court held that the assessing officer cannot rely on suspicion, conjecture or surmise to make an assessment, but must have some material on record to support his assessment.

9.     Conclusion:

9.1  The balancing act between human probability and concrete evidence is essential in taxation disputes. The assessing officer must take into account the circumstances and probabilities of the case, along with the concrete evidence, before making an assessment. Similarly, the taxpayer must provide a satisfactory explanation for any discrepancies in his books of accounts or other documents to avoid being assessed adversely. The Indian income tax law provides a framework for balancing human probability with concrete evidence in taxation disputes, and it is the duty of both the assessing officer and the taxpayer to adhere to this framework for a fair and just assessment of tax liability.