Summary of this article
Budget eases tax penalties, links immunity to voluntary disclosure
Appeal costs cut as prosecution rules become more proportionate
One-time foreign asset disclosure offers prosecution relief
The Finance Minister has proposed several changes to the penalty and prosecution provisions under the Income Tax law in her Budget speech on February 1, 2026. The changes aimed at reducing disputes, easing the compliance burden on taxpayers and speeding up the processes.
“Multiplicity of proceedings is a hindrance to the ease of doing business. I propose to integrate assessment and penalty proceedings by way of a common order for both,” the Finance Minister said in her speech.
She further added that there will be no interest liability on the taxpayer on the penalty amount for the period an appeal is pending before the first appellate authority, irrespective of the eventual outcome of the appeal process.
The quantum of pre-payment for filing an appeal is also proposed to be reduced from 20 per cent to 10 per cent, and will continue to be calculated only on the core tax demand.
Voluntary Compliance Draws Incentives
As an additional measure to reduce litigation, the Finance Minister proposed allowing taxpayers to update their returns even after reassessment proceedings have been initiated, at an additional tax rate of 10 per cent over and above the rate applicable for the relevant year. “The assessing officer will then rely only on this updated return for the proceedings,” she said.
She also noted that while a framework for immunity from penalty and prosecution already exists in cases of underreporting, this will now be extended to misreporting as well.
The budget documents explains in detail, “There are broadly two kind of penalties – (i) underreporting of income due to mistakes or oversight where penalty is 50 per cent on tax amount and framework to underreporting of income in consequence of misreporting of income (ii) underreporting in consequence of misreporting of income on account of giving wrong or faulty information or misrepresenting the type of income where the penalty is 200% on tax amount.”
As per the framework for immunity from penalty and prosecution for underreporting of income, the document notes “proposes to extend the same on payment of 100 per cent of tax amount as additional income-tax.”
Misreporting of income in respect of unexplained cash credit, etc., however, as per the budget documents, is proposed to be settled with a payment of 120 per cent of the tax. “In such cases immunity shall not be granted where prosecution is initiated as per provisions of chapter-XXII of the Act,” it notes.
Relief for minor defaults and discouraging serious offences
Penalties for certain technical defaults—such as failure to get accounts audited, non-furnishing of transfer pricing audit reports, and default in furnishing statements of financial transactions—are proposed to be converted into fees.
The Finance Minister further proposed rationalising the prosecution framework under the Income Tax Act, while maintaining deterrence for serious offences. Non-production of books of account and documents, as well as TDS-related cases where payment is made in kind, are proposed to be decriminalised, with minor offences attracting only a fine, as proposed in the budget.
The remaining prosecutions will be graded in line with the quantum of offence and will entail only simple imprisonment, with the maximum term reduced to two years instead of 7 years. “In cases where presently the maximum punishment is two years, the punishment has been reduced to 6 months with or without fine and with no minimum imprisonment,” the budget document notes.
Courts will also be empowered to convert imprisonment into fines.
The Budget also proposed immunity from prosecution for non-disclosure of non-immovable foreign assets with an aggregate value of less than Rs 20 lakh, with retrospective effect from October 1, 2024.
One-Time Foreign Asset Disclosure Scheme for Small Taxpayers
To address practical issues faced by small taxpayers such as students, young professionals, tech employees and relocated NRIs, the Finance Minister proposed a one-time, six-month foreign asset disclosure scheme. The scheme will allow eligible taxpayers to disclose overseas income or assets below a specified threshold.
The scheme will apply to two categories of taxpayers:
(A) those who did not disclose their overseas income or assets, and
(B) those who disclosed their overseas income and/or paid the due tax but failed to declare the asset acquired.
For Category (A), the limit of undisclosed income or asset value is proposed to be up to Rs 1 crore. “Such taxpayers will be required to pay 30 per cent of the fair market value of the asset, or 30 per cent of the undisclosed income, as tax, along with an additional 30 per cent as income tax in lieu of penalty. Upon payment, they will receive immunity from prosecution,” the Finance Minister said in her speech.
For Category (B), the asset value is proposed to be up to Rs 5 crore. In such cases, immunity from both penalty and prosecution will be available on payment of a fee of Rs 1 lakh, FM added.
