Excess Adjustment of Income Tax Refund Against Disputed Penalty Held Invalid by Bombay High Court

Background of the Dispute

Fork Media Group Private Limited approached the Bombay High Court by way of a writ petition challenging an order dated 19 December 2024 passed by the Centralized Processing Centre (CPC). By this order, CPC adjusted substantial refund amounts due for later assessment years against a penalty demand that was already under challenge in appeal.

The core grievance was that while a penalty of Rs.1,16,85,263/- had been imposed under section 270A for Assessment Year (AY) 2021–22, and that penalty was pending in appeal before the First Appellate Authority, the income tax department had nonetheless set off almost the entire penalty by unilaterally adjusting refunds of:

• Rs.37,00,594/- for AY 2022–23, and
• Rs.43,17,534/- for AY 2023–24

This resulted in total adjustment of Rs.80,18,128/- against the disputed penalty. The assessee contended that in terms of CBDT Instruction No. 1914 dated 21 March 1996, as subsequently modified by Office Memoranda dated 29 February 2016 and 31 July 2017, the department is ordinarily restricted to recover only 20% of the disputed demand when an appeal is pending.

According to the assessee, only 20% of the disputed penalty (Rs.23,37,053/-) could have been lawfully retained, and the balance portion of the adjusted amount (Rs.56,81,075/-) ought to have been refunded.

Chronology of Events

Assessment and Penalty Proceedings

1. Assessment for AY 2021–22

   • An assessment order dated 23 December 2022 was passed under section 143(3) r.w.s 144B of the Income Tax Act 1961.
   • The effect of the assessment was reduction of the returned loss from Rs.7,37,54,036/- to Rs.37,48,863/-.
   • Importantly, the assessment order itself did not generate any tax demand.

2. Penalty under section 270A

   • Thereafter, a penalty order dated 21 June 2023 was issued under section 270A, imposing a penalty of Rs.1,16,85,263/- for AY 2021–22.
   • The assessee filed an appeal against this penalty order before the First Appellate Authority on 7 November 2023.
   • Thus, as on the date when the refunds for subsequent years were adjusted, the penalty demand was disputed and was the subject matter of a pending first appeal.

Refunds for Subsequent Years and Their Adjustment

For AY 2022–23 and AY 2023–24, CPC processed the returns and determined refunds as under:

• AY 2022–23: Refund determined at Rs.37,00,594/-
• AY 2023–24: Refund determined at Rs.43,17,534/-

CPC proceeded to adjust these refunds aggregating Rs.80,18,128/- against the outstanding penalty of Rs.1,16,85,263/- relating to AY 2021–22.

This adjustment resulted in recovery of an amount far exceeding 20% of the disputed penalty, despite the fact that:

• The penalty was already in appeal before the First Appellate Authority; and
• There was no order from the Principal Commissioner of Income Tax (PCIT) or Commissioner of Income Tax (CIT) authorising any departure from the standard 20% recovery norm.

Representations by the Assessee

After noticing the adjustments, the assessee addressed multiple representations to the jurisdictional Assessing Officer seeking refund of the excess amount recovered. Specifically, letters were sent on:

• 11 November 2024
• 16 December 2024
• 17 February 2025

In these letters, the assessee clearly pointed out that:

• The penalty under section 270A was under appeal.
• CBDT Instruction No. 1914 dated 21 March 1996 and the subsequent Office Memoranda issued on 29 February 2016 and 31 July 2017 restrict recovery to 20% of the disputed demand during pendency of first appeal.
• Therefore, the department was required to confine recovery to 20% and refund the excess amount collected through refund adjustment.