In a significant reform aimed at reducing tax litigation and improving ease of doing business, Union Finance Minister Nirmala Sitharaman, in her Union Budget 2026 speech, announced a comprehensive rationalisation of penalty and prosecution provisions under the Income Tax Act. The proposals, outlined in paragraphs 113 to 120 of the Budget speech, seek to simplify compliance, decriminalise minor offences, and strike a balance between taxpayer facilitation and deterrence for serious violations.
Integrated Assessment and Penalty Proceedings
Addressing the long-standing concern of multiplicity of proceedings, the Finance Minister proposed integrating assessment and penalty proceedings through a single common order. This move is expected to significantly reduce compliance burden and procedural delays for taxpayers.
In a major relief, she announced that no interest liability will accrue on the penalty amount for the period during which an appeal is pending before the first appellate authority, irrespective of the eventual outcome of the appeal. Additionally, the quantum of mandatory pre-deposit for filing appeals is being reduced from 20% to 10%, calculated only on the core tax demand, excluding penalty and interest components.
Updated Returns Even After Reassessment Begins
As a further step to reduce litigation, the Budget proposes to allow taxpayers to file updated returns even after reassessment proceedings have been initiated. Such updated returns will be subject to an additional tax of 10% over and above the applicable tax rate for the relevant assessment year.
Crucially, once an updated return is filed, the assessing officer will be bound to base proceedings solely on that updated return, providing taxpayers a meaningful opportunity to correct disclosures and settle disputes early.
Immunity Framework Extended to Misreporting
Currently, the Income Tax Act provides immunity from penalty and prosecution in cases of underreporting of income under specified conditions. FM Sitharaman announced that this immunity framework will now be extended to cases of misreporting as well.
However, this relief comes with a higher cost: taxpayers seeking immunity in misreporting cases will be required to pay 100% of the tax amount as additional income tax, over and above the applicable tax and interest. The government said this ensures fairness while discouraging deliberate misreporting.
Technical Defaults to Attract Fee, Not Penalty
In another taxpayer-friendly measure, penalties for certain technical and procedural defaults are proposed to be converted into fees. These include failures such as:
- Not getting accounts audited where required,
- Non-furnishing of transfer pricing audit reports, and
- Default in filing statements of financial transactions (SFTs).
This change is aimed at reducing harsh consequences for procedural lapses that do not involve tax evasion.
Rationalisation and Decriminalisation of Prosecution
The Finance Minister also proposed a broad rationalisation of the prosecution framework, while retaining deterrence for serious offences. Key highlights include:
- Decriminalisation of non-production of books of account and documents, and
- Decriminalisation of TDS-related offences where payment is made in kind.
For minor offences, prosecution will be replaced with fine-only penalties, eliminating the fear of imprisonment for low-risk non-compliance.
Graded Prosecution for Serious Offences
For remaining serious offences, the prosecution regime will be graded based on the quantum of offence. These cases will attract only simple imprisonment, with the maximum term capped at two years, significantly lower than earlier provisions. Courts will also be empowered to convert imprisonment into fines, providing judicial flexibility.
Relief for Small Foreign Asset Disclosures
In a notable relief for resident taxpayers, the Finance Minister highlighted that there is currently no penalty for non-disclosure of non-immovable foreign assets with an aggregate value below ₹20 lakh. The Budget now proposes to extend immunity from prosecution for such non-disclosures, with retrospective effect from October 1, 2024.
Big Push Towards Litigation Reduction
Taken together, these measures signal the government’s intent to move away from a punitive tax regime towards one focused on voluntary compliance, dispute resolution, and trust-based taxation. Tax experts believe the reforms could substantially reduce long-pending tax disputes and improve India’s investment climate.
Read More: Budget 2026: FM Sitharaman Proposes Extended ITR Revision Window and Staggered Filing Deadlines
