In a significant decision, the Supreme Court has ruled that merely surrendering undisclosed income during a search does not automatically attract a penalty under Section 271AAA(1) of the Income Tax Act, 1961. This landmark judgment in the case of K. Krishnamurthy vs. The Deputy Commissioner of Income Tax (Civil Appeal No. 2411 of 2025) has clarified that a penalty under this section can only be levied when specific legal conditions are satisfied. The ruling emphasizes that tax authorities cannot indiscriminately impose penalties solely based on the voluntary disclosure of undisclosed income during a search operation.

The bench, comprising Justice J.B. Pardiwala and Justice Manmohan, emphasized a strict interpretation of the penalty provisions under Section 271AAA. The Court clarified that the imposition of penalties is not automatic and must meet the requirements outlined in Section 271AAA(2), which includes proper disclosure, a clear explanation of the income's source, and timely payment of taxes.

"The imposition of penalty under Section 271AAA requires the tax authorities to demonstrate that undisclosed income was found as a result of the search, not just voluntarily disclosed by the assessee."

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Background of the Case

The case stemmed from a search and seizure operation carried out on November 25, 2010, at the premises of K. Krishnamurthy, an individual involved in land procurement transactions in Karnataka. The search was related to a Memorandum of Understanding (MoU) dated January 19, 2009, between Krishnamurthy and others for the sale of land to Space Employees’ Co-operative Society Ltd.

Following the search, Krishnamurthy voluntarily admitted to an undisclosed income of ₹2,27,65,580. Despite this, the Income Tax Department later assessed his total income at ₹4,78,02,616 and imposed a penalty of 10% (₹47,80,261) under Section 271AAA, treating the entire income as undisclosed.

The appellant challenged this penalty through various appellate authorities, including the Commissioner of Income Tax (Appeals), the Income Tax Appellate Tribunal (ITAT), and the High Court of Karnataka, all of which upheld the penalty. Ultimately, the matter reached the Supreme Court.

Key Legal Issues Before the Supreme Court

The Supreme Court had to address the following crucial issues:

1. Can the Income Tax Department impose a penalty under Section 271AAA merely based on the voluntary disclosure of undisclosed income during a search?
2. Is compliance with all three conditions under Section 271AAA(2) mandatory for immunity from penalty?
3. Can the penalty be imposed on the entire assessed income, or should it be limited to the portion identified as ‘undisclosed income’ under the statutory definitions?

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1. Undisclosed Income Must Be ‘Found’ During Search, Not Just Disclosed

The Court rejected the automatic imposition of a penalty on the entire income assessed by the tax authorities. The Court ruled that only ₹2,49,90,000—derived from unreported land transactions—qualified as ‘undisclosed income’ under Section 271AAA. Consequently, the penalty should be imposed only on the undisclosed income portion and not the entire assessed amount of ₹4,78,02,616.

"Penalty cannot be imposed arbitrarily on the entire assessed income unless it qualifies as ‘undisclosed income’ under the Act."

2. Compliance with Section 271AAA(2) is Mandatory

To avoid penalties, the Supreme Court reiterated that the assessee must fulfill all three conditions under Section 271AAA(2), which are:

• Voluntary admission of the undisclosed income during the search (Section 132(4)).
• Explanation of the income's source.
• Timely payment of tax and interest on the disclosed income.

Failure to meet any of these conditions would justify the levy of penalties.

3. Penalty Should Be Limited to the Actual ‘Undisclosed Income’

The Court rejected the automatic imposition of a penalty on the entire income assessed by the tax authorities. The Court ruled that only ₹2,49,90,000—derived from unreported land transactions—qualified as ‘undisclosed income’ under Section 271AAA. Consequently, the penalty should be imposed only on the undisclosed income portion and not the entire assessed amount of ₹4,78,02,616.

"Penalty should be levied only on the amount that is defined as ‘undisclosed income’ under the law."