Taxation is founded on principles of certainty, fairness, and predictability. Taxpayers rely on existing laws and judicial precedents to structure their financial affairs, confident that the rules will not be changed retroactively to their disadvantage. However, recent amendments to the Income Tax Act, 1961, have upset this trust, penalizing deductions that were legally permissible when claimed. The introduction of retrospective clarifications coupled with harsh penalties raises serious legal and ethical concerns.
Before the Finance Act, 2022, the deductibility of “cess” on income tax under Section 40(a)(ii) of the Income Tax Act was a debated issue. Courts consistently held that “cess” was distinct from “tax” and therefore not disallowed under this provision.
For instance, in Sesa Goa Ltd. v. JCIT (Bombay High Court), the court held that cess was not covered by Section 40(a)(ii).
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Similarly, in Chambal Fertilisers v. JCIT (Rajasthan High Court), it was ruled that cess and surcharge did not constitute “tax” for disallowance purposes.
Based on these judgments, many taxpayers legitimately claimed deductions for cess in their tax returns. Numerous assessments were completed without objections under Section 143(1), reinforcing the understanding that these claims were valid.
The Finance Act, 2022, introduced Explanation 3 to Section 40(a)(ii), clarifying with retrospective effect from April 1, 2005, that “tax” includes “cess” and “surcharge.” This meant deductions claimed in earlier years, based on the law at the time, were retrospectively invalidated.
To enforce this change, Section 155(18) was added, allowing reopening of past assessments to disallow such deductions. More concerningly, it introduced a deeming fiction that any such deduction automatically amounts to “under-reporting of income” under Section 270A(3). This provision overrides the protection granted by Section 270A(6), which normally shields taxpayers who act in good faith.
A narrow escape was offered through a provision to Section 155(18), allowing taxpayers to voluntarily withdraw such claims and pay the due tax, thereby avoiding the label of under-reporting. Rule 132 prescribed the procedure and timeline for this, but the window was brief. Many taxpayers missed it or chose not to act, believing their original claims were legally sound.
Once rectification proceedings under Section 154 begin, cess deductions are disallowed, triggering penalty proceedings under Section 270A. Taxpayers who pay the demanded tax then seek immunity under Section 270AA, hoping to avoid penalties.
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However, tax authorities typically reject these immunity applications, reasoning that failure to withdraw claims under Rule 132 converts under-reporting into misreporting, which attracts a 200% penalty and disqualifies the taxpayer from immunity.
Appellate tribunals have upheld many such penalty orders, strictly applying the deeming fiction under Section 155(18). Their reasoning is that the retrospective law treats past deductions as under-reporting or misreporting, leaving taxpayers little defense regardless of their genuine reliance on prior court rulings.
Although no formal legal challenges have yet been filed against these retrospective amendments or the associated penalties, several important legal and constitutional concerns arise:
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These concerns highlight a tension between the legislative intent to curb tax avoidance and the fundamental principles of justice and predictability in tax administration.
India’s courts have previously emphasized the importance of legal certainty and fairness in tax matters:
The 2022 amendment, however, conflicts with these judicial principles by branding lawful past actions as defaults and imposing penalties retrospectively.
While the government’s goal may be to protect the revenue base and deter tax avoidance, retrospective penalization of past deductions that were legitimate at the time undermines trust in the tax system.
If taxpayers cannot rely on the law as it stands when they file returns, the principles of certainty, fairness, and predictability cornerstones of taxation are eroded. This creates an unpredictable environment where legitimate claims made today could become penalties tomorrow.
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Though no court challenges have been initiated so far, these amendments raise critical questions about balancing legislative authority with taxpayer rights. How the judiciary might eventually respond to these issues remains to be seen, but the implications for India’s tax jurisprudence are significant.
Ultimately, maintaining trust in the tax system requires that taxpayers are not penalized for acting in good faith based on the law as it existed at the time.
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