Income Tax Penalty On Reduced Expenditure Claim Under APA Contrary To Act, Unsustainable: Bombay High Court

The Bombay High Court has held that imposing an income tax penalty on account of a reduction in an expenditure claim pursuant to a position settled under an Advance Pricing Agreement (APA) is contrary to the scheme of the Income-tax Act and cannot be sustained.

A division bench of Justice B.P. Colabawalla and Justice Farhan P. Dubash observed that the APA framework, introduced to reduce tax litigation, would be rendered ineffective if consequential penalties could be imposed after an expenditure claim was reduced pursuant to a position settled under an APA.

The court observed, “We also find force in the submission of Mr. Mistri that the entire scheme of APA which has been introduced in the Act with a view to reduce litigation will be rendered ineffective and irrelevant if consequential proceedings / levies such as penalty can be levied by an Officer on account of a reduction in the claim of expenditure pursuant to a position settled by agreement in the APA by treating it as a case of under-reporting of income.”

The case concerned GIA India Laboratory Pvt. Ltd., which faced a ₹47.88 crore penalty that was later reduced to ₹35.11 crore through a rectification order. The penalty arose from a transfer pricing adjustment relating to royalty, a deduction claimed for CSR expenditure, and a deduction claimed for education cess.

The royalty had been claimed at 65% of the operating profits of the India Graded Segment. The rate was subsequently settled at 53.5% under a renewed APA signed on March 27, 2025.

The court held that the difference between the two rates did not amount to misrepresentation or suppression of facts, since all necessary facts had been disclosed and were within the knowledge of the tax authorities.

“The mere fact that the royalty of a higher amount computed at 65% of the operating profits was claimed to be the Arm's Length Rate, but was eventually settled at 53.5%, would not mean that there was any misrepresentation or suppression of facts.”, the court noted

The court also relied on Section 92CD, which requires a taxpayer to file a modified return after an APA is entered into if a return for the relevant assessment year has already been filed. The assessing officer must then modify the assessment in accordance with the APA.

In this case, the modified return was filed after the APA was signed. The court held that once the assessment was modified in accordance with the APA, the royalty deduction in the return and the assessment would be the same. There could therefore be no penalty on that count.

The penalty also covered a ₹4.18 crore deduction claimed under Section 80G for CSR expenditure and a ₹2.03 crore deduction claimed for education cess. The tribunal had already deleted the CSR-related addition, and the court held that the penalty on that count could not survive.

On education cess, the claim had been made on the basis of the Bombay High Court's ruling in Sesa Goa Ltd., which was in force when the return was filed. The court held that merely giving up the claim later following a retrospective amendment would not attract penal consequences.

Section 270A provides for penalties for under-reporting income, with a higher penalty where the under-reporting is a consequence of misreporting. The court found that none of the statutory grounds for misreporting applied in the case.

The court accordingly quashed the March 28, 2025 penalty order. It held that the August 21, 2026 rectification order reducing the penalty from ₹47.88 crore to ₹35.11 crore would consequently not survive.

For GIA: Senior Advocate J.D. Mistri, along with Gunjan Kakad, instructed by Atul K. Jasani, 

For the Income Tax Department: Akhileshwar Sharma appeared