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Sidheswar Jena
PhD Scholar in Law

Abstract

The Indian tax system, characterized by its federal structure and evolving reforms, incorporates stringent penalty provisions to deter non-compliance and evasion. This paper examines the system’s key components, analyzes the penalty mechanisms under the Income Tax Act, 1961, and the Goods and Services Tax (GST) regime, and critiques their contradictions with effective tax collection strategies. It further evaluates the constitutional validity of these provisions, highlighting judicial challenges and their alignment with fundamental rights. Drawing on recent data and case law as of 2025, the study argues that while penalties enhance revenue mobilization, their disproportionate application undermines equity, fosters litigation, and raises questions of constitutional propriety. Recommendations for reform emphasize proportionality, intent-based assessments, and enhanced enforcement mechanisms to balance deterrence with taxpayer rights.

Introduction

India’s tax framework operates within a federal paradigm, mandating that taxes be levied only by authority of law. Direct taxes, primarily income tax, are governed by the Income Tax Act, 1961, under the Central Board of Direct Taxes (CBDT), while indirect taxes have been streamlined through the GST regime since 2017, administered by the Central Board of Indirect Taxes and Customs (CBIC). The system’s objectives include revenue generation, economic equity, and compliance promotion, with digital initiatives like faceless assessments marking recent advancements.

Penalty provisions serve as critical tools for enforcement, imposing civil and criminal sanctions to curb evasion. However, their implementation reveals contradictions: while aimed at boosting collections, they often result in burdensome litigation and disproportionate impacts on small taxpayers. This paper critically examines these aspects, juxtaposing them against tax collection efficacy and constitutional benchmarks, using updated data as of 2025.

Overview of the Indian Tax System

The Indian tax system bifurcates into direct and indirect levies, with the central government empowered over income tax and GST. Direct taxes, including personal and corporate income tax, contributed significantly to fiscal revenues, with gross direct tax collections reaching ₹27.02 lakh crore in FY 2024-25 (provisional figures). The GST, a destination-based tax unifying erstwhile levies like VAT and excise, recorded gross collections of ₹22.08 lakh crore in the same period, reflecting a 9.4% year-on-year growth.

Reforms such as the Vivad se Vishwas scheme and amnesty provisions under GST aim to reduce disputes and encourage voluntary compliance. Nonetheless, challenges persist, including complex compliance for micro, small, and medium enterprises (MSMEs) and regional disparities in enforcement.

Penalty Provisions in the Indian Tax System

Penalties in the Indian tax regime are multifaceted, encompassing monetary fines, interest, and prosecution, designed to deter violations while facilitating revenue recovery.

Under the Income Tax Act, 1961

• Under-reporting and Misreporting (Section 270A): Imposes 50% of evaded tax for under-reporting and 200% for misreporting, replacing older concealment penalties since 2017.
• Concealment of Income (Section 271(1)(c)): Ranges from 100% to 300% of tax evaded for inaccurate particulars.
• Late Filing (Section 234F): Fixed at ₹5,000 (or ₹1,000 for low-income earners).
• TDS/TCS Failures (Sections 271C, 271CA): Equivalent to 100% of undeducted tax.
• Prosecution (Section 276C): Up to 7 years imprisonment for evasion exceeding ₹25 lakh.

Appeals lie with the Commissioner (Appeals) or Income Tax Appellate Tribunal (ITAT).

Under the GST Regime

• Late Filing (Section 47): ₹50 per day (capped at ₹5,000–₹10,000 based on turnover).
• Non-Fraudulent Evasion (Section 122): 10% of tax due or ₹10,000, whichever is higher.
• Fraudulent Evasion (Section 74): 100% penalty plus 18% interest.
• General Penalty (Section 125): Up to ₹25,000.
• Criminal Offenses (Section 132): 6 months to 5 years imprisonment for evasion over ₹5 crore.

Amendments in 2024, effective from November 2024, introduced amnesty for waiving interest and penalties in non-fraud cases for FY 2017-18 to 2019-20 if taxes are paid by specified dates.

These provisions underscore a shift toward intent-differentiated penalties, yet their stringency remains a point of contention.

Contradictions and Arguments Regarding Tax Collection

Penalty provisions enhance tax collection by deterring evasion, contributing to robust revenue growth. However, contradictions abound:

• Disproportionate Harshness vs. Compliance: High penalties for minor errors, such as 300% under Section 271, treat bona fide mistakes as willful evasion, leading to high litigation rates (e.g., 40% GST appeals). This erodes trust and contradicts simplification goals, as evidenced by amnesty schemes waiving penalties to recover dues.
• Enforcement Gaps: Low audit coverage (1-2% of returns) undermines deterrence, with evasion persisting due to low detection probabilities. Studies highlight how complex structures exacerbate this for MSMEs.
• Revenue Focus Over Equity: Penalties often exceed dues, functioning as additional revenue streams, disproportionately affecting small entities while corporates leverage rulings.
• TDS Mechanism Flaws: Collecting 40% of direct taxes, TDS causes cash-flow issues and refund backlogs, contradicting efficient collection.

These paradoxes suggest penalties inflate short-term revenues but hinder long-term compliance, advocating for AI-driven audits and graduated sanctions.

Constitutional Validity and Challenges

Penalty provisions derive legitimacy from constitutional entries enabling revenue protection, but challenges invoke Articles 14 (equality), 19(1)(g) (trade freedom), 21 (life and liberty), and 300A (property rights).

Judicial Validations

• In Sivagaminatha Moopanar v. ITO (1955), penalties were upheld as non-arbitrary under Article 14.
• Mak Data Pvt. Ltd. v. CIT (2013) affirmed proportionality under Section 271.

Key Challenges

• Retrospective Taxation: The Vodafone case, involving retrospective amendments, violated predictability and Article 14, leading to arbitration losses and the 2021 repeal. Penalties amplified these issues, contradicting ex post facto prohibitions under Article 20(1).
• TDS Provisions: A 2024 PIL by Ashwini Upadhyay challenged TDS as violative of Articles 14, 19, and 21, but was dismissed by the Supreme Court in January 2025 as “very badly drafted.”
• GST Penalties: State of Kerala v. Builder’s Association (2024) mandated mens rea for fraud penalties, invalidating automatic impositions.
• Broader Issues: Reverse burden in Black Money Act challenges Article 21, with low conviction rates questioning proportionality.

Judicial scrutiny underscores the need for intent-proof and equitable application, recognizing tax planning as a potential right under Articles 21 and 300A.

Conclusion

Penalty provisions in India’s tax system are indispensable for revenue integrity but exhibit contradictions that impede efficient collection and constitutional adherence. Reforms should prioritize proportionality, technology integration, and stakeholder equity to foster a compliant ecosystem. Future research could explore empirical impacts of 2024 amendments on evasion rates.