A penalty order is invalid if it ignores an Advance Pricing Agreement (APA) and denies a virtual hearing.

A penalty order is invalid if it ignores an Advance Pricing Agreement (APA) and denies a virtual hearing.

Issue

Is a penalty order passed under Section 270A of the Income-tax Act, 1961, legally valid if it is issued without considering significant subsequent events like the assessee entering into an APA and filing a modified return, and also without following the mandatory procedure of granting a virtual hearing?

Facts

• In a scrutiny assessment for the Assessment Year 2017-18, a large transfer pricing (TP) adjustment of ₹31.15 crores was made to the assessee’s income.
• Subsequently, the assessee entered into an Advance Pricing Agreement (APA) with the Central Board of Direct Taxes (CBDT), a formal mechanism to resolve transfer pricing disputes. This APA covered the year in question.
• As required by law after signing an APA, the assessee filed a modified return under Section 92CD(1). In this return, they voluntarily offered an income of ₹14.16 crores as the TP adjustment (as agreed in the APA) and paid the due tax on it.
• The Assessing Officer (AO), however, failed to pass the final assessment order based on this modified return.
• Instead, the AO went ahead and passed a penalty order under Section 270A. This penalty order completely ignored the crucial and undisputed facts of the APA and the modified return.
• Additionally, the AO passed this penalty order without granting the assessee a virtual hearing, which was a mandatory procedural requirement under the Faceless Penalty Scheme, 2022.

Decision

The court ruled in favour of the assessee.

• It held that the penalty order was legally unsustainable because the AO had failed to take into consideration undisputed and highly material facts—namely, the existence of the APA, the filing of the modified return, and the voluntary payment of tax by the assessee.
• Furthermore, the order was passed in clear violation of the mandatory requirement under the Faceless Penalty Scheme to provide a virtual hearing.
• The impugned penalty order was set aside, and the matter was remanded back to the AO with a specific direction to first provide a virtual hearing to the assessee and then pass a fresh, reasoned order after considering all the facts of the case.

Key Takeways

• Subsequent Events Must Be Considered: An AO cannot pass a penalty order based on an old assessment order while completely ignoring significant subsequent events like the signing of an APA and the filing of a modified return. These events fundamentally alter the basis of the original disputed addition.
• Penalty Proceedings Follow Final Assessment: Penalty proceedings are consequential to the finally determined income. The AO acted prematurely and improperly by passing a penalty order before the final assessment order based on the modified return was even passed.
• A Virtual Hearing is a Mandatory Right: Under the faceless assessment and penalty schemes, the provision for a virtual hearing is a key component of the principles of natural justice. Denying this right is a fatal procedural flaw that can, by itself, render the final order invalid.
• The Purpose of an APA is to Settle Disputes: The APA mechanism is designed to provide tax certainty and avoid prolonged litigation. An assessee who enters into an APA and complies with its terms by filing a modified return and paying the tax has a very strong case for having the penalty dropped, a fact the AO must consider in the fresh proceedings.