Budget 2026: Govt moves to rationalise penalty and prosecution provisions to cut litigation

Presenting the Union Budget 2026–27, Finance Minister Nirmala Sitharaman announced a major revamp of penalty and prosecution provisions under the Income Tax Act to reduce litigation and ease compliance. She proposed a single, integrated order for assessment and penalties to prevent multiple proceedings. Sitharaman also said no interest would apply on penalty amounts during pending appeals, and reduced the mandatory pre-deposit for appeals from 20% to 10%, offering significant cash-flow relief to taxpayers.

Tax experts have welcomed the move as a step towards decriminalisation and trust-based tax administration. “The Centre has undertaken a comprehensive rationalisation of the penalty and prosecution provisions in Budget 2026. The objective is to decriminalise technical offences, convert penalties for procedural defaults into fees to reduce litigation, and ensure that punishment is proportionate to the gravity of the offence,” said CA Dr Suresh Surana.

Conversion of penalties into fees

One of the key proposals is the conversion of penalties into mandatory fees for certain procedural and technical defaults, such as failure to furnish prescribed reports or statements. These fees will be levied automatically, removing discretion and reducing disputes that typically arise from penalty proceedings.

Rationalisation of prosecution provisions

The Finance Bill 2026 also proposes a softer prosecution framework. For several offences, the government plans to shift from “rigorous imprisonment” to “simple imprisonment”, reduce the maximum term of incarceration, and introduce fine-only mechanisms for smaller defaults, signalling a move away from criminalisation of minor tax lapses.

Integration of assessment and penalty

Currently, assessment and penalty proceedings are conducted separately, often resulting in parallel litigation. Under the new approach, penalties for under-reporting of income will be imposed within the assessment order itself. Additionally, no interest will be charged on penalty amounts during the pendency of appeals before the first appellate authority, providing clarity and relief to taxpayers.

Changes for unexplained income

The Budget also proposes changes to the tax rate and penalty structure for unexplained income, such as cash credits and unexplained investments, with the aim of rationalising enforcement while maintaining deterrence against serious tax evasion.

Other significant changes

Several other penalty-related provisions have been revised. A new penalty framework for crypto-assets has been introduced for failure to furnish transaction statements, with penalties of ₹200 per day for delays and ₹50,000 for inaccurate information. Under the Black Money Act, prosecution will not be initiated where the aggregate value of foreign assets—excluding immovable property—does not exceed ₹20 lakh, with retrospective effect from October 1, 2024. The maximum penalty for non-compliance with information notices has also been increased to ₹25,000.

Overall, the reforms mark a clear shift towards simplification, proportionality and reduced litigation, reinforcing the government’s push for a more taxpayer-friendly compliance regime.