The Income Tax Appellate Tribunal ( ITAT ), Bangalore Bench, has clarified that penalties levied under the Value Added Tax ( VAT ) cannot be claimed as a deduction under Section 37 of the Income Tax Act, 1961.
In this case, the assessee, an individual running a business in Mysuru, had filed a return of income for the Assessment Year 2018-19. During the scrutiny assessment, the Assessing Officer (AO) disallowed a deduction of ₹2,74,202, which was classified as a VAT penalty. The AO reasoned that payments of a penal nature are not allowable as deductions under Section 37 of the Income Tax Act.
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The assessee appealed the AO’s decision, arguing before the Commissioner of Income Tax (Appeals) [CIT(A)] that the payment was not a penalty but arrears of VAT. The assessee further contended that the VAT authorities had waived penalties for earlier years, which indicated that the payment was not penal in nature. However, the CIT(A) upheld the AO’s decision, prompting the assessee to approach the ITAT.
The tribunal bench, comprising Shri George George K., Vice President, and Ms. Padmavathy S., Accountant Member, noted the key argument of the assessee: that the payment made during the relevant year was for VAT arrears and not a penalty.
The bench reviewed the Karnataka VAT authorities’ orders, which confirmed that penalties for certain years had been waived. However, the ITAT found that neither the AO nor the CIT(A) had adequately considered these waiver orders or distinguished between arrears and penalties.
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In light of the incomplete examination of facts, the ITAT restored the matter to the AO for fresh consideration. The AO was directed to review the VAT payment details, verify the nature of the payment, and determine whether it was penal or regular in nature.
The tribunal held that payments of a penal nature are not eligible for deduction under Section 37 of the Income Tax Act. However, if the payment was indeed for VAT arrears and not a penalty, it should be allowed as a deduction.
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