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has introduced a significant change by rationalising the income tax penalty and prosecution rules. O.P Yadav, former commissioner of income tax, had pointed out in his article for ET Wealth Online why the government needs to simplify these tax penalty and prosecution rules.
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Budget 2026: Prosecution for not submitting an income tax return (ITR)
Section 479 of the Income Tax Act 2025 (which corresponds to Section 276CC of the Income Tax Act, 1961) provides for the prosecution of a person who fails to submit their income tax return, leading to potential imprisonment and fines. Right now, if the tax amount is over Rs 25 lakh, the punishment can be rigorous imprisonment ranging from of six months to seven years along with a fine; otherwise, it is imprisonment for three months to two years with a fine.
Taxmann research says that the Finance Bill 2026 has rationalised the threshold and proposed to provide:
- Simple imprisonment for a term up to two years, or fine, or both, where the tax that would have been evaded, had the failure not been detected, exceeds Rs 50 lakh;
- Simple imprisonment for a term up to six months, or fine, or both, where the tax that would have been evaded, had the failure not been detected, exceeds Rs 10 lakh but is not over Rs 50 lakh; and
- Fine only, in all other cases.
Budget 2026 converted certain penalties into fees: Does it help taxpayers?
Budget 2026 said that certain penalties are being converted into into fees for procedural defaults. For example: Penalty under section 447 for failure to furnish report under section 172 is converted to a fee under section 428(4). Graded fee of Rs 50,000 and 1,00,000 is provided depending upon the period of delay.
Another example: Penalty under section 454(1) for failure to furnish statement of financial transaction or reportable account is converted to a fee under section 427(3).
S. Sriram, Executive Partner at Lakshmikumaran and Sridharan attorneys, said to ET Wealth Online: “Conversion of penalty into a fee does not necessarily help the taxpayer – his financial burden is not reduced in most cases. In fact, the express discretion that the Tax Authorities had to waive the levy of penalty if reasonable cause is shown for the default, will now be taken away.”
Sriram says: “So, even in cases where there existed genuine reasons for the delay, the taxpayer would be fastened with a liability.”
When asked does the fee now become non-appealable to ITAT/courts unlike a penalty? Sriram said that unless an interpretation is advanced to contend that the ‘fee’ is nothing but a penalty levied for a quasi-criminal action, and that where there exists reasonable cause for not complying with the statutory requirement the fee/penalty cannot be levied, the scope of appeal against the levy will be limited to correctness of computation of the fee.
Highlights of the tax penalty and prosecution changes
1. Decriminalisation
- Procedural lapses such as non-production of books of account, documents etc. decriminalised.
- Only a fine is being provided for minor offences.
- Punishment for other offences will be graded in line with the degree of offence with only simple imprisonment and maximum imprisonment reduced to two years.
2. Rationalisation of penalty
- Conversion of penalties into fees for procedural defaults.
- Penalty for misreporting of income also eligible for immunity with payment of additional income-tax.
3. Removal of penal implications
- Voluntary payments to be treated as a non-punitive charge instead of a penalty under Customs. Customs Advance Ruling
- Customs Advance ruling validity increased to 5 years.
4. Foreign Asset of Small Taxpayers Disclosure Scheme
- A one-time 6-month foreign asset disclosure scheme for small taxpayers to disclose their overseas income or assets.
5. Penalty framework reforms
- IT assessment & penalty proceedings are proposed to be integrated by way of a common order for both.
- Conversion of penalties into fees for procedural defaults
- Penalty for misreporting of income also eligibility for immunity with payment of additional income-tax.
6. Block assessment
IT Assessment in case of third party in search cases will be restricted to only one year.
7. Immunity from Prosecution
Immunity from prosecution with retrospective effect from 1.10.2024 for non-disclosure of non-immovable assets with aggregate value less than Rs 20 lakh.
| Reduced imprisonment | Threshold for punishment for tax evaded | Offences decriminalised |
| ●Maximum punishment capped at 2 years for primary offences (earlier it was up to 7 years) ●3 years for repeat offences | ●Up to Rs 10 lakh: Fine and no imprisonment ●Rs 10 lakh to Rs 50 lakh: Simple imprisonment up to 6 months and or fine. ●Above Rs 50 lakh: Simple imprisonment up to 2 years and or fine. | ●Failure to pay TDS on winnings from lottery or crossword puzzle. ●Wilful failure to produce accounts or documents during tax notice period. ●Winnings from online games and virtual digital assets (VDA) paid wholly in kind. |
Rationalisation of prosecution proceedings
Taxmann research says that the Income Tax Act, 2025 contains several provisions under Chapter XXII that impose criminal liability on assessees and prescribe imprisonment, including rigorous imprisonment, ranging from three months to seven years for various offences.
These offences include falsification of books of account, failure to deposit TDS/TCS deducted, furnishing false statements, wilful attempt to evade tax, failure to file returns within the due date, abetment of a false return, removal, concealment or transfer of property to evade tax recovery, non-compliance with certain directions of the Assessing Officer, and related defaults.
Sections 473 to 485 lay down various offences attributable to the assessee and specify the nature and manner of punishment, along with the applicable conditions.
These provisions also cover time limits, exceptions, thresholds for the amount of tax evaded and the corresponding penalties, penalties for subsequent offences, and related matters.
The Finance Bill 2026 proposes the following changes to the provisions related to prosecutions.
Prosecution on contravention of the order during the search
Section 473 of the Income Tax Act, 2025 (which corresponds to Section 275A of the Income Tax Act, 1961) prescribes rigorous imprisonment for a term that may extend up to two years, along with a fine, where an assessee contravenes an order passed under Section 247 of the ITA 2025 [corresponding to Section 132 of the ITA, 1961] with the intent to obstruct search proceedings or interfere with evidence.
It is proposed to replace rigorous imprisonment with simple imprisonment up to two years, along with a fine.
Prosecution on failure to afford a facility for inspection during the search
Section 474 of the ITA 2025 [corresponding to Section 275B of the ITA 1961] prescribes rigorous imprisonment for up to two years, along with a fine, for failure to provide necessary facilities for the inspection of books or documents during search proceedings. It is proposed to substitute rigorous imprisonment with simple imprisonment for up to six months, a fine, or both.
Prosecution on removal or concealment of property to evade recovery
Section 475 of the ITA 2025 (which corresponds to Section 276 of the ITA 1961) provides for rigorous imprisonment up to two years along with a fine for the removal, concealment, transfer or delivery of property to prevent recovery of tax. It is proposed to replace rigorous imprisonment with simple imprisonment up to two years, along with a fine.
Prosecution for failure to deposit TDS
Section 476 of the ITA 2025 (which corresponds to Section 276B of the ITA 1961] prescribes rigorous imprisonment ranging from three months to seven years along with a fine if a person fails to pay the tax deducted at source (TDS) or fails to deposit TDS relating to winnings from lottery, crossword puzzle, winning from online games, benefit or perquisite arising from business or profession, or sum for transfer of a Virtual Digital Asset (VDA).
Offences relating to failure to pay or ensure payment of TDS on winnings from lottery or crossword puzzles and benefits or perquisites are proposed to be fully decriminalised. Further, cases involving winnings from online games and transfers of VDAs that are wholly in kind, are proposed to be excluded from criminal liability.
In other cases, a graded punishment structure has been proposed based on the amount of tax involved, which is as follows:
- Simple imprisonment up to 2 years, or fine, or both, where the tax amount exceeds Rs 50 lakh.
- Simple imprisonment up to 6 months, or fine, or both, where the tax amount exceeds Rs 10 lakh but does not exceed Rs 50 lakh.
- Fine only, in all other cases.
Prosecution for failure to deposit TCS
Section 477 of the ITA 2025 (which corresponds to Section 276BB of the ITA 1961) provides for rigorous imprisonment ranging from three months to seven years, along with a fine for failure to deposit tax collected at source.
A graded punishment structure is proposed under Section 477, based on the amount of tax involved, which is as follows:
- Simple imprisonment up to 2 years, or fine, or both, where the tax amount exceeds Rs 50 lakh.
- Simple imprisonment up to 6 months, or fine, or both, where the tax amount is between Rs 10 lakh and Rs. 50 lakh.
- Fine only, in all other cases.
Prosecution for willful attempt to evade tax
Section 478 of the ITA 2025 (corresponding to Section 276C of the ITA 1961) prescribes rigorous imprisonment and fine for wilful attempt to evade tax.
Sub-section (1) to Section 478 deals with a willful attempt to evade tax.
It provides that:
- If a person wilfully attempts to evade tax, penalty, or interest, or underreports income, and the amount involved exceeds Rs 25 lakh, the punishment is rigorous imprisonment of 6 months to 7 years, along with a fine.
- In all other cases, the punishment is rigorous imprisonment from 3 months to 2 years, along with a fine.
The Finance Bill 2026 has rationalised the above provisions and proposed to provide that the punishment for offences covered under Section 478(1) shall be:
- Simple imprisonment for a term up to two years, or fine, or both, where the amount sought to be evaded or the tax on under-reported income exceeds Rs 50 lakh;
- Simple imprisonment for a term up to six months, or fine, or both, where the amount sought to be evaded or the tax on under-reported income exceeds Rs 10 lakh but does not exceed Rs 50 lakh; and
- Fine only, in all other cases.
Further, a graded punishment structure is proposed in sub-Section (2) of Section 478, which deals with a wilful attempt to evade payment of tax. The punishment for offences under Section 478(2) is proposed to be modified as follows:
- Simple imprisonment for a term up to two years, or fine, or both, where the amount sought to be evaded exceeds Rs 50 lakh;
- Simple imprisonment for a term up to six months, or fine, or both, where the amount sought to be evaded is Rs 10 lakhs but does not exceed Rs 50 lakh and
- Fine only, in all other cases.
Prosecution for failure to produce books/comply with directions
Section 481 of the ITA 2025 (corresponding to Section 276D of the ITA, 1961) criminalises the failure to produce books of account or to comply with directions of the Assessing Officer, with rigorous imprisonment for up to 1 year and with a fine.
The Finance Bill, 2026, proposes to replace “rigorous imprisonment” with “simple imprisonment” and to reduce the term from one year to up to six months, or impose a fine, or both.
Prosecution for the abetment of false return
Section 484 of the ITA 2025 (corresponding to Section 278 of the ITA, 1961) penalises abetment of false returns or statements with imprisonment and fine. Currently, if the tax, interest, or penalty that would have been evaded exceeds Rs 25 lakh, the punishment includes rigorous imprisonment of six months to seven years with a fine; otherwise, imprisonment of three months to two years with a fine.
The Finance Bill, 2026, proposes to rationalise the provision by revising the threshold limits and the term of imprisonment, aligning them with the graded punishment structure of Rs 50 lakh, Rs 10–50 lakh, and other cases, as proposed under other prosecution-related provisions.
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