Penalty Proceedings Must Be Initiated and Concluded Within The Prescribed Timeline Under Section 275(1)(C): Karnataka High Court Upholds ITAT Order"

On January 17, 2025, the Karnataka High Court in Principal Commissioner of Income Tax v. Shri K. Umesh Shetty (Income Tax Appeal No. 165 of 2020) dismissed the Revenue’s appeal and upheld the Income Tax Appellate Tribunal (ITAT)’s decision setting aside the penalty levied under Section 271-D of the Income Tax Act, 1961. The Division Bench comprising Hon’ble Justice Krishna S. Dixit and Hon’ble Justice G. Basavaraja ruled that the penalty proceedings were barred by limitation under Section 275(1)(c) of the Act.

The Court held: "Penalty proceedings must be initiated and concluded within the prescribed timeline under Section 275(1)(c). Failure to adhere to statutory time limits undermines the legislative intent of timely enforcement of tax laws."

"Initiation of Penalty Proceedings Triggered by ITO’s Reference, Not by Issuance of Show Cause Notice"

The Court emphasized that the penalty proceedings under Section 271-D commenced from the date the Income Tax Officer (ITO) referred the case to the Additional Commissioner for the imposition of a penalty, not from the date of issuance of the show cause notice. Observing a delay of nearly one year between the reference date (16.11.2016) and the issuance of the show cause notice (10.11.2017), the Court ruled that the proceedings were initiated beyond a reasonable timeframe.
"The period of limitation under Section 275(1)(c) is not merely about the conclusion of proceedings but also requires timely initiation. A delay in initiating proceedings defeats the legislative mandate and principles of judicial discipline," the Court noted.

Revenue’s Appeal Overturned in Favor of Assessee

The Revenue appealed against the ITAT’s order dated 20.09.2019, which had set aside the penalty of Rs. 10 lakhs levied on Shri K. Umesh Shetty under Section 271-D for alleged violations of Section 269-SS (prohibiting acceptance of cash loans above Rs. 20,000). The penalty was imposed by the Additional Commissioner of Income Tax via an order dated 22.02.2018.
The ITAT had held that the penalty order was barred by limitation under Section 275(1)(c). The Revenue, arguing that no limitation period was prescribed for the initiation of penalty proceedings, contended that the proceedings were valid as they were concluded within six months from the issuance of the show cause notice. The High Court dismissed the Revenue’s arguments and upheld the ITAT’s decision, ruling in favor of the assessee.

"Law of Limitation Is Based on Justice and Diligence," Observes High Court

The High Court reiterated the importance of adhering to statutory timelines in penalty proceedings, citing the overarching principle of limitation laws. It stated:
"The purpose of limitation laws is to ensure that legal actions are taken with reasonable diligence. Allowing unfettered discretion to initiate proceedings at any time is inconsistent with the principles of fairness and judicial economy."
The Court relied on the following three key observations:
1.    Trigger Point for Penalty Proceedings: The Court clarified that the reference by the ITO to the Additional Commissioner on 16.11.2016 was the first step in initiating the penalty proceedings. The delay in issuing the show cause notice on 10.11.2017 violated the principle of reasonable diligence.
2.    No Unlimited Discretion for Revenue Authorities: The Court rejected the Revenue’s argument that there was no limitation for initiating penalty proceedings, stating:
"In a system founded on the rule of law, there is no room for absolute discretion. Limitation provisions must be interpreted purposively to uphold legislative intent."
3.    Completion vs. Initiation: The Court distinguished between the initiation and conclusion of proceedings under Section 275(1)(c). While the section explicitly prescribes a timeline for completing penalty proceedings, the initiation must also adhere to principles of reasonable diligence.

Doctrine of Delay and Laches Applies in Absence of Statutory Provision

The High Court highlighted that where no specific limitation is prescribed for initiating penalty proceedings, the doctrine of delay and laches applies. It quoted the Delhi High Court’s observations in Clix Capital Services:
"If the Revenue’s stand is accepted, authorities could initiate penalty proceedings at their whim, leading to unreasonable delays and arbitrary enforcement. Such an interpretation is against the principles of fair play and due process."
The Court emphasized that statutory provisions must be interpreted in a way that prevents unfettered discretion and ensures timely enforcement.

"Revenue Failed to Provide Justification for Delay," Rules Court

The Court found that the Revenue did not offer any explanation for the nearly one-year delay between the ITO’s reference (16.11.2016) and the issuance of the show cause notice (10.11.2017). Citing the lack of diligence, the Court observed: "Even in the absence of a specific statutory limitation for initiation, the authorities must act within a reasonable time. Unexplained delay violates principles of judicial propriety and legislative intent."

"Circulars Cannot Override High Court Decisions"
The Revenue relied on CBDT Circular No. 9/DV/2016, which aligned with the Grihalakshmi Vision decision. However, the Court held that departmental circulars cannot override binding High Court judgments, especially when conflicting interpretations exist. It observed:
"The CBDT Circular reflects the departmental view but cannot prevail over judicial precedents that emphasize reasonable timelines for initiating proceedings."

In conclusion, the High Court ruled in favor of the assessee, holding that the penalty proceedings were time-barred as they were not initiated within a reasonable timeframe. The appeal by the Revenue was dismissed, with the following findings:
•    Penalty proceedings under Section 271-D are triggered by the ITO’s reference, not the show cause notice.
•    The delay in issuing the show cause notice violated the doctrine of delay and laches.
•    The penalty order was invalid as it exceeded the limitation period prescribed under Section 275(1)(c).

The High Court dismissed the appeal, stating: "Legislative intent and judicial propriety demand strict adherence to limitation provisions. Allowing arbitrary initiation of penalty proceedings undermines the principles of fairness and justice."

Date of Decision: January 17, 2025