Penalties Paid to Stock Exchanges and Penalty on Health

Penalties Paid to Stock Exchanges and Penalty on Health and Education Cess Claimed Pre-Retrospective Amendment Deleted

Issue

Whether payments made to stock exchanges for operational lapses (e.g., bad delivery, short delivery, client code modification) are allowable business expenditures under Section 37(1) or hit by Explanation 1 as penalties for violation of law.
Whether penalty under Section 270A for under-reporting/misreporting can be levied when the assessee claimed deduction of health and education cess based on favorable jurisdictional High Court precedent prior to a retrospective amendment disallowing the claim.

Facts

Issue 1 (Stock Exchange Charges – AY 2021-22):
- The assessee-company claimed deduction for payments made to stock exchanges under heads such as bad/short delivery, late reporting, security deposit/fund shortages, and client code modification.
- The Assessing Officer (AO) disallowed the entire claim under Section 37(1) read with Explanation 1, treating these payments as non-deductible penalties for violating law/rules of stock exchanges.
- The Tribunal had previously allowed identical claims in the assessee’s own case for earlier years, relying on jurisdictional High Court rulings (ITO v. Angel Capital and Debit Market Ltd. and CIT v. The Stock and Bond Trading Company).
Issue 2 (Penalty under Section 270A – AY 2020-21):
- The assessee claimed deduction of health and education cess in its return of income in good faith, relying on the jurisdictional High Court decision in Sesa Goa Ltd. v. Jt. CIT, which held cess to be an allowable deduction.
- Finance Act subsequently inserted Explanation 3 to Section 40(a)(ii) with retrospective effect from April 1, 2005, making cess non-deductible.
- The AO disallowed the claim based on the retrospective amendment and levied penalty under Section 270A for under-reporting/misreporting of income, which was affirmed by the CIT(A).

Decision

Issue 1: The Tribunal held that merely labeling payments as “penalties” does not change their underlying nature. Following jurisdictional High Court precedents, these payments represent non-statutory compensatory charges for operational and procedural lapses under stock exchange bye-laws, falling outside the purview of Explanation 1 to Section 37(1). The disallowance made by the AO was deleted in favor of the assessee.
Issue 2: The Tribunal ruled that the assessee’s claim was bona fide at the time of filing, as it was based on prevailing jurisdictional High Court law (Sesa Goa Ltd.). Penalty under Section 270A cannot be fastened retroactively due to a subsequent retrospective amendment. The penalty levied by the AO and sustained by the CIT(A) was deleted in favor of the assessee.

Key Takeaways

Nature of Stock Exchange Penalties: Charges levied by stock exchanges for operational and procedural irregularities (shortages, late reporting, client code modifications) are compensatory in nature rather than punitive for statutory violations, making them fully allowable under Section 37(1).
Immunity from Penalty on Retrospective Amendments: Penalty for under-reporting or misreporting under Section 270A cannot be imposed when a deduction is claimed in good faith under existing judicial precedents, even if the law is subsequently amended with retrospective disallowance.

IN THE ITAT MUMBAI BENCH ‘C’

ICICI Securities Ltd.

Deputy Commissioner of Income-tax

NARENDER KUMAR CHOUDHRY, Judicial Member
and ARUN KHODPIA, Accountant Member

IT Appeal Nos. 1927 and 1928 (MUM) of 2026
[Assessment years 2020-21 and 2021-22]

AUGUST 31, 2026

Nitin Jain, Ld. A.R. for the Appellant. Ajay Soneji, Ld. Sr. DR for the Respondent.

ORDER

Narender Kumar Choudhry, Judicial Member.- These two appeals have been preferred by the Assessee against the separate orders dated 04.12.2025 and 10.12.2025, impugned herein, passed by the National Faceless Appeal Centre/Ld. Commissioner of Income Tax (Appeals), Mumbai (in short “Ld. Commissioner”), u/s 250 of the Income Tax Act, 1961 (in short “the Act”), for the A.Ys. 2020-21 and 2021-22.

2. Coming to ITA No. 1928/Mum/2026, which pertains to the addition/disallowance of Rs. 2,80,87,838/- paid to the stock exchanges, made by the AO and affirmed by the Ld. Commissioner, we deem it appropriate to adjudicate this appeal first.

3. Coming to the factual aspects of the case, it is observed that, during the assessment proceedings, the AO, on perusal of the tax audit report, noticed that the tax auditor had reported penalties amounting to Rs.2,80,87,838/- as expenditure by way of penalty or fine for violation of any law for the time being in force. The penalties were under the following heads:

–

Bad Delivery / short Delivery

–

Late reporting

–

Security Deposit Charges

–

Fund Shortages

–

Client Code Modification

4. The AO, therefore, issued a show-cause notice to the Assessee, who contended that Explanation 1 to Sec. 37(1) of the Act covers only expenditure incurred for a purpose, which is an offence or prohibited by law. The penalties were paid in the normal course of business and not for any infraction of law or offence and, therefore, were allowable as business expenditure. In support thereof, the Assessee also relied upon the judgment of the Hon’ble Tribunal in its own case for the A.Y. 2007-08.

5. The AO, however, not being convinced, found that the expenditure of Rs. 2,80,87,838/- towards penalties paid to the stock exchanges for violation of any law for the time being in force was covered by Sec. 37(1) r.w. Explanation 1 and, accordingly, liable to be disallowed and added to the total income. The AO further observed that penalty proceedings u/s 270A of the Act were liable to be initiated for under-reporting of income. The AO, thus, issued a show-cause notice dated 13.12.2023, to which the Assessee replied on 18.12.2023, inter alia, as under:

“2. As regards Penalties paid to stock exchanges amounting to Rs. 2,80,87,838/

2.1. At the outset, the Assessee submits that Your Goodself has erred in alleging that the tax auditor has categorically noted that the expenditure are by way of penalty or fine for violation of any law for the time being in force and therefore covered under the provisions of section 37(1) read with Explanation 1 of the Act.

In this regard, the Assessee submits that the reporting made by the tax auditor in Form 3CA-3CD is the disclosure requirement and the same cannot be considered as underlying basis to form a view for the purpose of making disallowance under section 37(1) of the Act. The Assessee also submits that the Assessing Officer cannot make disallowance based on observations made in tax audit report.

2.2 Without prejudice, the Assessee submits that stock exchange has charged penalties amounting to Rs.2,80,87,838 during the financial year ended on March 31, 2021. The penalty is on account of bad delivery/ short delivery, late reporting, security deposit charges, fund shortages, client code modification.

The assessee is a stock-broker and in the normal course of its equity broking business, if any errors/exceptions occur (as mentioned above), the assessee is liable to penalties.

2.3. Section 37 of the Income-tax Act, states that any expenditure laid out or expended wholly or exclusively for the purposes of business or profession shall be allowed in computing income chargeable to tax under the head profits and gains of business or profession. Explanation 1 to section 37(1) further states that expenditure incurred by an assessee for any purpose which is an offence, or which is prohibited by law shall not be deemed to have been incurred for purpose of business or profession and shall not be allowed as deduction.

However, the above penalties paid by the assessee have been paid by the assessee in its normal course of business and not for the purpose of infraction of any law or in the nature of offence and therefore, the same shall be allowed as business expenses. The Assesssee craves leave to submit additional evidence in order to substantiate its claim that the expenses are incurred in the normal course of business.

2.4. Further, the Assessee invites Your Goodself’s attention to the Assessee’s own case for AY 2007-08 wherein the facts of the case is similar to the facts of AY 2007-08. The Assessce reproduces the relevant extract as under: (attached as Annexure 4)

“8. The penalties were levied by the Stock Exchange on account of bad delivery/short delivery, wrong claim of corporate benefits, late reporting, security deposit shortages, fund shortage and client code modification.

8.4. The Hon’ble High Court in the above case agreed with the order of the Tribunal that the amount paid were not on account of any infraction of law and hence allowable as business expenditure. Facts being similar, we follow the above decision and uphold the order of the Ld. CIT(A).’ (Underlined for emphasis)

2.5. The Assessee also relies on the decision of the Hon’ble Jurisdictional High Court in case of CIT v. M/s The Stock and Bond Trading Company (ITA No. 4117 of 2010) wherein it was held as under:

“3. As regards the second question is concerned, the finding of fact recorded by the CIT (A) and upheld by the ITAT is that the payments made by the Assessee to the Stock Exchange for violation of their regulation are not an account of an offence or which is prohibited by law. Hence, the invocation of explanation to section 37 of the Income Tax Act, 1961 is not justified. ”

2.6. Thus, applying similar ratio to the Assessee’s case in the captioned AY, the penalties were imposed on account of similar nature and hence payment made cannot be treated as on account of violation of law and shall be allowed u/s 37(1) of the Act.”

6. The AO, though considered the aforesaid reply of the Assessee, however, did not find the same satisfactory and ultimately made the disallowance of Rs. 2,80,87,838/- u/s 37(1) r.w. Explanation 1 of the Act by observing and holding as under:

“5.1.5 The assessee also requested for personal hearing through VC. Accordingly, a Video Conference was held on 20.12.2023. The authorised representative (AR) of the assessee appeared in the VC and made oral submissions. The AR of the assessee made substantially the same submission as has been made in the written response to the SCN. The submission of the assessee has been considered. However, assessee’s contention in this regard is found to be untenable. It is to be underlined that in the current assessment year the tax auditor has categorically reported this amount of Rs. 2,80,87,838/- as expenditure by way of penalty or fine for violation of any law for the time being in force paid to stock exchanges. The assessee has submitted that these penalties are in consequence of the following:

–

Bad Delivery / Short Delivery

–

Late reporting

–

Security Deposit Charges

–

Fund Shortages

–

Client Code Modification

–

Non Allocation / Non Confirmation

5.1.6 Thus, it is seen that the penalties have been incurred due to various lapses on the part of the assessee and as a consequence the laws and rules laid down by the stock exchanges have been violated. Assessee’s contention that these expenses incurred by way of penalties are in the normal course of business is thus found to be untenable. The penalties have been imposed by the stock exchanges for violation of their laid down rules and regulations and hence such penalties are due to lapses on the part of the assessee. Therefore, these penalties cannot be considered to be regular expenses or normal business expenses as claimed by the assessee. Hence, these expenses by way of penalties which have been incurred due to lapses on the part of the assessee, would be liable to be disallowed as per the provisions of section 37(1) r.w. explanation 1. Further, assessee has referred to the decision of the Hon’ble ITAT Mumbai in its case for assessment year 2007-08. However, it is to be mentioned that it has not been established that the facts of the case involved in the AY 2007-08 is same as the current assessment year. It is a fact that this year the tax auditor has categorically reported the issue in the tax audit report and also the penalties have been imposed for lapses and violation of stock exchanges rules & laws such as Bad Delivery, Short Delivery etc. as mentioned above. So, it can not be said that the facts in the instant case is similar to the facts involved in respect of which the decision of the Hon’ble ITAT Mumbai has been referred to or the fact as to whether the issue has attained finality. Also, the facts of the case cannot be said to be similar to the facts involved in the judicial decisions referred to by the assessee. In view of this, the assessee’s contention on this issue is found to be untenable. Therefore, the amount of Rs. 2,80,87,838/- paid as penalty to stock exchanges is disallowed as per the provisions of section 37(1) r.w. explanation 1 of the Income Tax Act and accordingly added to the total income of the assessee. Penalty proceedings u/s 270A is initiated for under reporting of income”

7. The Assessee, thus being aggrieved, preferred the first appeal before the Ld. Commissioner, challenging the aforesaid disallowance. The Ld. Commissioner affirmed the same by distinguishing the Assessee’s case for the A.Y. 2007-08, wherein the Hon’ble Tribunal had held the penalty to be allowable as business expenditure u/s 37(1) of the Act. In the instant case, however, the tax auditor had categorically reported the amount of Rs. 2,80,87,838/- as expenditure by way of penalty or fine for violation of any law for the time being in force, paid to the stock exchanges.

8. Thus, the Assessee, being aggrieved, has preferred the instant appeal. Before us, it has been claimed that the penalties were levied by the stock exchanges on account of bad delivery/short delivery, late reporting, security deposit charges, fund shortages, client code modification and shortfall of margin money. The penalties were imposed to ensure strict adherence to compliance requirements and procedural discipline. The nature of such lapses was explained in detail by the Assessee in its letter dated 18.12.2023 filed during the assessment proceedings. Though the AO referred to these submissions in the assessment order, however, he rejected the same and did not follow the Tribunal’s order dated 15.09.2017 in the Assessee’s own case for the A.Y. 2007-08 in Dy. CIT v. ICICI Securities Ltd. [IT Appeal No. 2702 (Mum.) of 2011], in which the Bench cancelled the penalties levied for identical non-compliances. In that decision, the Hon’ble Tribunal relied upon the judgment of the Hon’ble Jurisdictional High Court in ITO v. Angel Capital and Debit Market Ltd. [ITA (L) No. 475 of 2011, dated 28-7-2011].

9. The Assessee further claimed that, in the appeal against the order passed u/s 263 of the Act for the A.Y. 2020-21 in ICICI Securities Ltd. v. Pr. CIT 217 ITD 81 (Mumbai – Trib.)/ITA No. 3766/Mum/2025, decided on 06.01.2026, the Hon’ble Tribunal decided the issue in its favour, holding that the penalties in question were not statutory penalties imposed for violation of law, but compensatory charges levied for operational and procedural lapses under the bye-laws and regulations of the stock exchange. The Ld. Counsel further submitted that, though the Ld. Commissioner observed in the impugned order that the exact nature of the penalties was not clear from the narration in the assessment order, the AO, in para 5.1.6 thereof, referred to the facts involved in the decision of the Hon’ble ITAT, Mumbai. The Ld. Counsel also relied upon the judgment of the Hon’ble Jurisdictional High Court in CIT v. The Stock and Bond Trading Company [IT Appeal No. 4117 of 2020, dated 14.10.2011].

10. On the contrary, the Ld. DR refuted the claim of the Assessee by relying upon the orders passed by the authorities below.

11. We have heard the parties, perused the material available on record and given thoughtful consideration to the rival claims of the parties. The facts involved in the instant case are pari materia with those in the Assessee’s own case for the A.Y. 2007-08, decided vide order dated 15.09.2017 in ITA No. 2702/Mum/2011. The distinguishing feature considered by the Ld. Commissioner while sustaining the disallowance was that the auditor had specifically categorised the payments as penalties or fines for violation of law in force. On that basis, the authorities below made and affirmed the disallowance of the penalties levied by the stock exchanges.

12. We observe that, the penalties levied in the year under consideration and in the A.Y. 2007-08 were on account of bad delivery/short delivery, wrong claim of corporate benefits, late reporting, security deposit shortages, fund shortages and client code modification. Thus, the heads of penalties are substantially similar.

13. The Hon’ble Tribunal, in the Assessee’s own case for the A.Y. 200708 in ITA No. 2702/Mum/2011, decided on 15.09.2017, considered identical penalties and, following the judgment of the Hon’ble Jurisdictional High Court in Angel Capital and Debit Market Ltd. (supra), affirmed the order of the then Ld. CIT(A), allowing the penalties paid as business expenditure, by observing and holding as under:

“8. The 2nd ground of Revenue’s appeal is against the deletion by the Ld. CIT(A) of the addition made by the AO on account of penalty of Rs.16,02,024/- for violation of the bye laws of the Stock Exchange. The penalties were levied by the Stock Exchange on account of bad delivery/short delivery, wrong claim of corporate benefits, late reporting, security deposit shortages, fund shortage and client code modification. The AO has disallowed penalty paid to Stock Exchange amounting to Rs.16,02,024/- on the ground that it is ground that it is penal is nature.

8.1 In appeal, the Ld. CIT(A) has held that Explanation to section 37(1) is not applicable to such type of expenditure. Therefore, he deleted the disallowance of Rs.16,02,024/- made by the AO.

8.2 Before us, the Ld. counsel of the assessee relied on the decision by the Hon’ble Bombay High Court in the case of Income Tax Commissioner v. Angel Capital and Debit Market Ltd. [ITA (L) No. 475 of 2011].

8.3 On the other hand, the Ld. DR supports the order passed by the AO.

8.4 We have heard the rival submissions and perused the relevant materials on record. In the case of Angel Capital and Debit Market Ltd.(supra), the following question of law raised by the Revenue was before the Hon’ble High Court

“(C) Whether on the facts and in the circumstances of the case and in law the Hon’ble Tribunal was justified in deleting the disallowance made by the Assessing Officer of claim of the Assessing Company for a deduction of payment of Rs.6,51,240/- towards penalty paid to Stock Exchange even though such penalty payment was clearly disallowance under Explanation to Section 37(1) of the Income Tax Act?”

The Hon’ble High Court in the above case agreed with the order of the Tribunal that the amount paid were not on account of any infraction of law and hence allowable as business expenditure. Facts being similar, we follow the above decision and uphold the order of the Ld. CIT(A). The 2nd ground of appeal is thus dismissed.”

14. We further observe that, in the Assessee’s case for the A.Y. 2020-21 concerning the challenge to the order u/s 263 of the Act, the Hon’ble Tribunal also considered identical penalties levied by the stock exchanges and held that they were not statutory penalties imposed for violation of law, but compensatory charges levied for operational and procedural lapses under the bye-laws and regulations of the stock exchange. Such payments do not fall within the mischief of Explanation 1 to Sec. 37(1) of the Act. The Hon’ble Tribunal, accordingly, sustained the decision of the then AO allowing the penalties as expenditure u/s 37(1) of the Act by observing as under:

“Penalties paid to Stock Exchange amounting to Rs. 64,64,367/

32. The next issue pertains to the allowability of expenditure incurred by the assessee towards penalties paid to the stock exchange amounting to Rs. 64,64,367/-. The learned Principal Commissioner observed that the Assessing Officer had allowed the said expenditure without examining whether it was hit by Explanation 1 to section 37(1) of the Act, which disallows expenditure incurred for any purpose which is an offence or which is prohibited by law.

33. It was noted by the learned Principal Commissioner that the tax auditor had reported the said amount under the head “expenditure by way of any other penalty or fine” in Form 3CD, and that the Assessing Officer had failed to enquire into the true nature of the payments so made.

34. Before the learned Principal Commissioner as well as before us, the assessee submitted that mere reporting of an amount as “penalty” in the tax audit report is only a disclosure requirement and cannot, by itself, lead to the conclusion that the expenditure is hit by Explanation 1 to section 37(1). It was submitted that the nature of the levy and the context in which it is imposed must be examined to determine its allowability.

35. It was explained that out of the total amount of RS. 64,64,367/-, a sum of Rs. 35,95,617/- pertained to charges levied by the stock exchange during the financial year on account of bad delivery/short delivery, late reporting, security deposit shortages, fund shortages, client code modification, and shortfall of margin money, as per various circulars issued by the National Stock Exchange. The balance amount of Rs. 28,68,750/-was paid pursuant to a settlement order passed by the Securities and Exchange Board of India under section 15JB of the SEBI Act, 1992.

36. The assessee further placed reliance on the relevant SEBI and stock exchange circulars, clarifying that such charges are regulatory and compensatory in nature, intended to streamline compliance and discipline in the functioning of the market, and are not punitive in the sense of being imposed for an offence or an act prohibited by law.

37. The relevant extract of the stock exchange circular, explaining the nature of such penalties and disciplinary actions, has been reproduced in the original draft and demonstrates that the charges levied depend upon the frequency and gravity of the violation and are designed to ensure adherence to compliance requirements.

38. Upon a careful consideration of the material on record, it is evident that the penalties in question are not statutory penalties imposed for violation of law, but are in the nature of compensatory charges levied for operational and procedural lapses under the byelaws and regulations of the stock exchange. Such payments do not fall within the mischief of Explanation 1 to section 37(1).

39. The distinction between expenditure incurred for an offence or for a purpose prohibited by law, and expenditure incurred in the ordinary course of business for regulatory non-compliances of a technical or procedural nature, is well recognised in law. The latter category of expenditure has consistently been held to be allowable.

40. In this context, reliance placed by the assessee on judicial precedents, including the decision of the Hon’ble Karnataka High Court in J.K. Panthaki & Co. v. ITO (2012) 344 ITR 329, clearly brings out the scope and ambit of Explanation 1 to section 37(1) and supports the assessee’s case.

41. It is also an undisputed fact that in the assessee’s own case for an earlier assessment year, the Tribunal has held that penalties levied by the stock exchange on account of similar operational lapses are allowable as business expenditure. The Assessing Officer, by allowing the claim, had thus followed a consistent view.

42. In view of the above factual and legal position, it cannot be said that the Assessing Officer committed any error in allowing the expenditure, much less an error prejudicial to the interests of the Revenue. The learned Principal Commissioner was, therefore, not justified in invoking revisionary jurisdiction on this issue.”

15. We further observe that the Hon’ble Jurisdictional High Court in Angel Capital and Debit Market Ltd. (supra) considered the claim for deduction of payment made towards, penalty paid to the stock exchange and affirmed the decision of the Hon’ble Tribunal, based on the finding of fact that the amount was paid on account of irregularities committed by the Assessee’s clients. Such payments were not on account of any infraction of law and were, therefore, allowable as business expenditure.

16. We further observe that the Hon’ble High Court in The Stock and Bond Trading Company (supra) also dealt with payments made to the stock exchange for violation of its regulations and by, considering Angel Capital and Debit Market Ltd. (supra), held that such payments were not made for an offence or a purpose prohibited by law, by observing and holding as under:

1 Two questions of law raised by the Revenue in this Appeal read thus:

A Whether on the facts and in the circumstances of the case and in law the Tribunal was justified in deleting the additions made by the Assessing Officer under section 40(a) (ia) of the Income Tax Act, 1961 claimed by the assessee firm being VSAT charges amounting to Rs.3,12,597/- and NSE lease line charges amounting to Rs.1,66,301/- and Transaction charges of Rs.4,45,024/- paid by the Assessee Firm to the National Stock Exchange, even though the Assessee had failed to deduct tax at source while making such payments as required under section 194J of the Income Tax Act, 1961?

B Whether on the facts and in the circumstances of the case and in law the Tribunal was justified in deleting the additions made by the Assessing Officer under proviso to section 37(1) of the Income Tax Act, 1961 being penalty imposed by the National Stock Exchange on the Assessee?

2 As regards the first question is concerned, counsel for the Revenue states that the said question is answered against the Revenue in case of The Income Tax Commissioner Mumbai City-4 v. Angel Capital & Debit Market Ltd. in Income Tax Appeal (L) No.475 of 2011 dated 28th July, 2011. Hence, the first question cannot be entertained.

3 As regards the second question is concerned, the finding of fact recorded by the CIT (A) and upheld by the ITAT is that the payments made by the Assessee to the Stock Exchange for violation of their regulation are not an account of an offence or which is prohibited by law. Hence, the invocation of explanation to section 37 of the Income Tax Act, 1961 is not justified. In our opinion, in the facts and circumstances of the present case, no fault can be found with the decision of the ITAT. Accordingly, the second question cannot be entertained.

4 Appeal is accordingly disposed of with no order as to costs.

17. In view of the aforesaid analysis, the disallowance of Rs. 2,80,87,838/- made by the AO in respect of penalties paid to the stock exchanges is unsustainable. Though the auditor categorized the payments in the tax audit report as penalties or fines for violation of law in force, however, it is undisputed that the penalties considered by the Hon’ble Tribunal in the Assessee’s own cases for the A.Ys. 2007-08 and 2020-21 are pari-materia with those involved in the instant case. Mere classification of the payments under the head “penalties” cannot alter their true character or justify disregarding the decisions of the Hon’ble Jurisdictional High Court and the Tribunal, which treated such payments as non-statutory compensatory charges levied for operational and procedural lapses under the bye-laws and regulations of the stock exchange and, therefore, outside the mischief of Explanation 1 to Sec. 37(1) of the Act.

18. Thus, the addition/disallowance made by the AO and affirmed by the Ld. Commissioner cannot be sustained and the same is, accordingly, deleted.

19. The Assessee has also raised ground Nos. iii and iv, relating to the short grant of TDS of Rs. 10,020/- and levy of excess interest of Rs. 410/-u/s 234C of the Act. However, these grounds were not pressed during the course of hearing and are, accordingly, dismissed as not pressed.

20. Coming to ITA No. 1927/Mum/2026 (A.Y 2020-21), we observe that in this case, the then AO made the addition of Rs. 8,82,65,295/- by disallowing the deduction claimed qua “health and education cess”, in view of Explanation 3 to Sec. 40(a)(ii) of the Act, as introduced with retrospective effect from 01.04.2005, as inserted by the Finance Act, 2022 made effective from 1st April 2022,

21. The AO, vide assessment order dated 24.09.2022, also initiated penalty proceedings u/s 270A of the Act for under-reporting of income.

22. The AO also issued a show-cause notice dated 24.09.2022 u/s 274 r.w.s. 270A of the Act, requiring the Assessee to explain why penalty u/s 270A should not be imposed for under-reporting of income.

23. In response, the Assessee filed its reply dated 17.10.2022, inter alia, claiming that the education cess had been claimed on the basis of the judgment of the Hon’ble Jurisdictional High Court in Sesa Goa Ltd. v. Jt. CIT 423 ITR 426 (Bombay), wherein cess was held to be an allowable deduction, while computing income chargeable to tax. It was further claimed that Explanation 3 to Sec. 40(a)(ii) of the Act was inserted by the Finance Act, 2022, with retrospective effect from 01.04.2005 and, therefore, no penalty could be levied, as the claim was based upon the aforesaid judgment and the Explanation was introduced subsequently.

24. The AO considered the Assessee’s reply dated 16.05.2024 and its claim concerning the retrospective insertion of Explanation 3 to Sec. 40(a)(ii) of the Act. However, vide penalty order dated 27.02.2025 passed u/s 270A of the Act, the AO ultimately held the Assessee to be in default for under-reporting income of Rs. 9,82,65,295/- on account of education cess disallowed in the assessment and levied a penalty of Rs. 1,23,65,704/-, being 50% of the tax payable on the income of Rs. 9,82,65,295/- computed in the hands of the Assessee.

25. The Assessee, being aggrieved, challenged the said penalty before the Ld. Commissioner, who, though sustained the penalty levied, however, changed its basis by holding that it is not a case of levying tax on under reported income for the difference between maximum amount not chargeable to tax and assessed income where there is a return filed in response to notice u/s 148 and not u/s 139 but penalty could be levied for “misrepresentation of facts” u/s 270A(9)(a) of the Act. Consequently, the Ld. Commissioner directed the AO to recalculate the penalty for underreporting, as a consequence of misreporting u/s 270A(9)(a) of the Act, by holding as under:

SUMMARY of the discussion is that the section under which penalty is levied is not correct. The assessee has filed the return of income u/s 139. It is not a case of not filing a return of income u/s 139 and later filing a return of income in response to notice u/s 148. It is not a case of levying tax on under reported income for the difference between maximum amount not chargeable to tax and assessed income where there is a return filed in response to notice u/s 148 and not u/s 139. In this connection penalty can be levied under ‘misrepresentation of facts’ u/s 270A(9)(a). The assessing officer shall recalculate penalty under underreporting as a consequence of misreporting u/s 270A(9)(a).

26. Thus, the Assessee, being aggrieved, has preferred the instant appeal.

27. The Ld. Counsel for the Assessee claimed that penalty cannot be imposed, where the Assessee has offered a bona fide explanation and its claim was allowable in view of the judgments of various Courts.

28. The Ld. Counsel also relied upon the decision of the Hon’ble Tribunal in Wellknown Polysters Ltd. v. Dy. CIT (IT) [2026] 187 (Mumbai – Trib.)/ITA No. 9492/Mum/2025, decided on 29.05.2026 and further claimed that penalty cannot be imposed in respect of a disallowance arising pursuant to a retrospective amendment, particularly in view of the judgment of the Hon’ble Tribunal in Koshambh Multired (P.) Ltd. v. Dy. CIT [IT Appeal No. 1031 (Ahd.) of 2025, dated 21-8-2025].

29. On the contrary, the Ld. DR relied upon the order of the Ld. Commissioner, sustaining the penalty and changing its basis.

30. We have heard the parties, perused the material available on record and given thoughtful consideration to the rival claims of the parties. We observe that the Hon’ble Coordinate Bench of this Tribunal in Wellknown Polysters Ltd. (supra) dealt with an identical issue, wherein penalty u/s 270A of the Act was levied on account of disallowance of education cess, pursuant to the retrospective amendment made by the Finance Act, 2022. After considering the judgment of the Hon’ble Jurisdictional High Court in Sesa Goa Ltd. (supra), the Tribunal deleted the identical penalty levied, by observing as under:

“2. Brief facts of the case are as under:

2.1. The assessee is a company and filed its return of income for the year under consideration on 15.02.2021 declaring total income at Rs. 2,37,16,74,630/-. The case was selected for scrutiny and notice under section 143(2) of the Act was issued. In response to the statutory notices, the assessee furnished various details and explanations. Thereafter, assessment under section 143(3) of the Act came to be completed on 24.10.2022 determining the total income at Rs. 2,40,35,49,937/- after disallowing the claim of deduction towards education cess amounting to Rs. 3,18,75,307/-.

2.2. Subsequently, penalty proceedings under section 270A of the Act were initiated separately for under-reporting of income. In response to the notice issued, the assessee filed a reply dated 11.11.2022 contending that the disallowance of education cess arose only on account of the retrospective amendment brought in by the Finance Act, 2022. It was submitted that the deduction towards education cess had been claimed much prior to the said amendment and was otherwise supported by judicial precedents prevailing at the relevant point of time.

2.3. The assessee placed reliance upon the decision of the Sesa Goa Ltd. v. JCIT reported in 379 ITR 321, wherein the Hon’ble Bombay High Court held that “by no stretch of imagination can such a claim be said to constitute furnishing of inaccurate particulars of income or concealment of income. “

2.4. The assessee further submitted that the legislature itself, while introducing the amendment, recognized the bona fide nature of such claims made in earlier years and, accordingly, inserted a special saving provision under section 155(18) of the Act, which excluded levy of penalty subject to fulfilment of prescribed conditions. It was contended that the assessee had every intention to comply with the proviso to section 155(18) by filing the prescribed application before the Ld. AO for recomputation of income, thereby ensuring that the claim of deduction towards cess would not be treated as under-reported income.

2.5. However, it submitted that the prescribed form contemplated under the proviso to section 155(18) had not been notified by the CBDT at the relevant time and, therefore, the assessee was rendered incapable of making such an application. The assessee thus contended that, in the absence of the prescribed mechanism due to a technical impossibility beyond the control of the assessee, no adverse inference could be drawn against it.

2.6. The assessee also relied on following decisions of the Hon’ble Bombay High Court and Hon’ble Ahmedabad Tribunal in support of the submissions.

CIT v. Yahoo India Pvt. Ltd [ITA 2014 of 2012 (Bombay High Court)]

ITO v. IN. K. Industries Ltd [ITA No. 1910/Ahd/2011, order dated 02.05.2016 (Ahmedabad ITAT)]

Sun Petrochemicals Pvt. Ltd v. ITO [ITA No. 1010/Ahd/2009 (Ahmedabad ITAT)]-

2.7. The Ld. AO ignored the submissions of the assessee and levied penalty of Rs. 68,12,391/- being 50% of the amount of the tax payable or disallowance made on under reporting of the income u/s. 270A of the Act.

Aggrieved by the Order of the Assessing Officer, the assessee preferred an appeal before the Ld.CIT(A).

3 .The Ld. CIT(A) while confirming the penalty observed as under:

“I have considered the submission of the assessee as filed above, case records and gone through the AO’s observation & decision in penalty vis- a-vis assessment order. It is observed from the penalty order that the AO has imposed penalty of Rs. Rs. 68,12,391/- after being satisfied on completion of scrutiny assessment as per the acceptance of the appellant regarding proposed disallowance of deduction of education cess of Rs. 3,18,75,307/-. I find from the case records vis-a-vis assessment order that despite getting multiple opportunity of hearing the appellant miserably failed to file satisfactory compliance/explanation with supporting documents before the assessing officer (AO) in favour of its claim being the penalty levied under section 270A of the Income-tax Act deserves to be deleted. It is observed that the appellant had claimed deduction of education cess in its return of income filed for the relevant assessment year on the bona fide belief, supported by judicial precedents. At the same time it is also observed that the appellant has realised that the disallowance in question is a direct result of a retrospective amendment of Act. Therefore it is mandatory in nature for which the appellant itself has already paid tax in respect of amount of disallowance made on account of cess. Thus the contention of the appellant that the penalty order passed being illegal, beyond jurisdiction and unjustified is incorrect and unacceptable.

Further during appeal proceeding also neither the appellant nor its authorised representative has justifiably established what prevented them to explore the option of making an application by virtue of section 155(18) of the Act. Therefore the appellant miserably failed to substantiate the grounds taken by them with the supporting documents This indicates the appellant is unable to establish its claim in grounds of appeal that penalty being unjustified and unwarranted. Hence for this reason the appeal is liable to be dismissed Considering the entire conspectus of the case theimposition of penaltyof Rs. 68,12,391/- made in the penalty order by the AO under section 270Aof the I.T Act standconfirmed And the grounds taken by the appellant are dismissed.

4 . Aggrieved by the Order of the Ld. CIT(A) the assessee is an appeal before this Tribunal.

5 .The Ld. AR reiterated the submissions advanced before the authorities below. It was submitted that the disallowance of education cess arose solely on account of the retrospective amendment introduced in the Income-tax Act by the Finance Act, 2022. The Ld. AR contended that, at the time of filing the return of income for the relevant assessment year, the assessee had claimed deduction of education cess under a bona fide belief, duly supported by prevailing judicial precedents, that such expenditure was allowable under the Act.

5.1. In support of the aforesaid contention, reliance was placed on the decision of the Sesa Goa Ltd. v. JCIT, wherein the Hon’ble Bombay High Court had accepted the allowability of deduction towards education cess.

5.2 On the contrary the Ld. DR relied on the Orders passed by the authorities below.

We have perused the submissions advanced by both sides in light of records placed before u/s.

6. Admittedly, the amendment introduced by the Legislature was retrospective in nature. However, while introducing the said amendment, the Legislature itself recognized the bona fide nature of such claims made in the preceding assessment years and consciously incorporated a saving provision in section 155(18), providing that no penalty shall be leviable subject to fulfilment of certain conditions. For the sake of convenience, the relevant provision and proviso are reproduced hereinbelow:

“Section 155

[(18) Where any deduction in respect of any surcharge or cess, which is not allowable as deduction under section 40, has been claimed and allowed in the case of an assessee in any previous year, such claim shall be deemed to be underreported income of the assessee for such previous year for the purposes of sub-section (3) of section 270A, notwithstanding anything contained in sub-section (6) of section 270A, and the Assessing Officer shall recompute the total income of the assessee for such previous year and make necessary amendment; and the provisions of section 154 shall, so far as may be, apply thereto, the period of four years specified in sub-section (7) of section 154 being reckoned from the end of the previous year commencing on the 1st day of April, 2021:

Provided that in a case where the assessee makes an application to the Assessing Officer in the prescribed form and within the prescribed time, requesting for recomputation of the total income of the previous year without allowing the claim for deduction of surcharge or cess and pays the amount due thereon within the specified time, such claim shall not be deemed to be under reported income for the purposes of sub-section (3) of section 2704.]

6.1. On a perusal of the aforesaid provision, it becomes evident that the proviso is in the nature of a beneficial and saving provision inserted by the Finance Act, 2022. The proviso grants an opportunity to the assessee to withdraw such claim and avoid consequential penal proceedings, thereby acknowledging the debatable and contentious nature of the issue prevailing in the earlier assessment years.

6.2. We further note that, for the assessment year under consideration, i.e., A.Y. 2020-21, the claim made by the assessee was duly supported by judicial precedents prevailing at the relevant point of time and, therefore, the same cannot be regarded as furnishing of inaccurate particulars of income or as a case of misreporting/underreporting of income. In our considered view, a claim made on the basis of a plausible interpretation of law prevailing during the relevant period cannot attract penalty merely because such claim subsequently became inadmissible pursuant to a retrospective legislative amendment.

6.3. It is also pertinent to note that the assessee was prevented by reasonable cause from availing the benefit contemplated under the proviso to section 155(18), inasmuch as the prescribed form and procedure for making the application were admittedly not notified by the CBDT at the relevant point of time. Thus, the failure to file the prescribed application cannot be attributed to any deliberate default or contumacious conduct on the part of the assessee. The existence of such reasonable cause, coupled with full disclosure of all material facts in the return of income, clearly rules out any intention to under-report income so as to warrant levy of penalty.

6.4. There is nothing on record to demonstrate that the claim made by the assessee was either mala fide or lacking in disclosure of material facts. Considering the entirety of the facts and circumstances of the case, we are of the considered view that the penalty levied under section 270A of the Act is unsustainable in the eyes of law and deserves to be deleted.”

31. We further observe that the Hon’ble Jurisdictional High Court in Sesa Goa Ltd. (supra) held that health and education cess is an allowable deduction, while computing income chargeable to tax. The Assessee, therefore, claimed the deduction in good faith. Explanation 3 to Sec. 40(a)(ii) of the Act, made retrospectively applicable from 01.04.2005 by the Finance Act, 2022, which came into effect from 01.04.2022, was a subsequent development, whereas the Assessee had already claimed the deduction by filing its return of income on 13.02.2021 and revising the same on 29.05.2021. Thus, liability by way of penalty cannot be fastened upon the Assessee on account of the subsequent retrospective amendment.

32. Thus, in view of the aforesaid findings, the penalty levied by the AO and affirmed by the Ld. Commissioner by changing its basis, is liable to be deleted and the same is, accordingly, deleted.

33. Resultantly, the Assessee’s appeal is allowed.

34. In the result, both the appeals filed by the Assessee are accordingly allowed.