Section 271G Penalty Deleted as Substantial TP Compliance & Reasonable Cause Established: ITAT Mumbai

DCIT Vs D. Navinchandra Gems Private Limited (ITAT Mumbai)

The ITAT Mumbai disposed of Revenue’s appeals for Assessment Years 2013-14 and 2015-16 challenging the orders of the Commissioner of Income-tax (Appeals), which had deleted penalties levied under Section 271G of the Income-tax Act, 1961. The penalties arose from transfer pricing proceedings under Section 92CA(3), where the Transfer Pricing Officer (TPO) alleged non-furnishing of prescribed documentation under Section 92D read with Rule 10D of the Income-tax Rules, 1962.

The assessee, engaged in the business of importing rough diamonds, cutting and polishing diamonds, and exporting finished diamonds, had entered into international transactions with its Associated Enterprises (AEs). The assessee benchmarked these transactions using the Transactional Net Margin Method (TNMM). During the transfer pricing proceedings, the TPO sought documentation prescribed under Section 92D and Rule 10D. According to the TPO, the assessee failed to furnish certain documents, particularly those contemplated under Rule 10D(1)(g), (h) and (i), and furnished only entity-level margins instead of transaction-specific or segmental profitability relating to AE transactions. Although no transfer pricing adjustment was ultimately made, the TPO levied penalties under Section 271G at 2% of the value of the international transactions.

The assessee contended that it had furnished all relevant documentation to the extent available, that TNMM had been consistently accepted in earlier years, that segmental information had been provided wherever possible, and that certain documents required under Rule 10D were either irrelevant for TNMM or had not been specifically called for under Section 92D(3). It also relied on Section 273B, asserting that any alleged deficiency was supported by reasonable cause. Before the Commissioner (Appeals), the assessee further submitted that identical penalties in earlier years had already been deleted by appellate authorities, including the Tribunal. The Commissioner (Appeals) accepted these submissions and deleted the penalties.

Before the Tribunal, the Revenue argued that although no transfer pricing adjustment had been made, the TPO had recorded detailed findings showing that the assessee possessed complete books and records from which segment-wise profitability could have been computed. According to the Revenue, by failing to correlate AE and non-AE transactions and furnish transaction-specific profitability, the assessee prevented proper determination of the Arm’s Length Price (ALP), thereby attracting penalty under Section 271G irrespective of the absence of any transfer pricing adjustment.

The assessee, on the other hand, pointed out that the TPO himself had recorded that its overall margins were within the range of comparable companies and therefore no adjustment to the ALP was warranted. It argued that the penalty had been initiated separately despite acceptance of the benchmarking exercise. The assessee also relied on earlier Tribunal decisions in its own case, where on identical facts it had been held that the assessee had substantially complied with the TPO’s directions to the extent practically possible, considering the peculiar nature of the diamond trade, and that any shortfall constituted reasonable cause under Section 273B.

The Tribunal observed that it was undisputed that the TPO had accepted the assessee’s international transactions to be at arm’s length and had not made any adjustment under Section 92CA(3). Although the TPO alleged deficiencies in documentation, the Tribunal found that the assessee had furnished transfer pricing reports, segmental information to the extent available, and other supporting documents. The grievance of the TPO essentially related to the absence of transaction-specific profitability and inability to verify certain details. The Tribunal held that once the TPO accepted the benchmarking results without disturbing the ALP, it could not simultaneously contend that the assessee had failed to furnish such fundamental information as to frustrate determination of the ALP.

The Tribunal further accepted that the nature of the assessee’s business in diamond trading and manufacturing involved practical difficulties in maintaining precise transaction-wise cost allocation between AE and non-AE transactions. It noted that this aspect had already been recognised by coordinate benches in the assessee’s own earlier cases, which had held that the assessee had substantially complied with the TPO’s requirements and that any deficiency was backed by reasonable cause within the meaning of Section 273B. Since the Revenue had not demonstrated any distinguishing feature for the assessment years under appeal, the Tribunal followed the earlier decisions.

The Tribunal also rejected the Revenue’s reliance on the Bombay High Court decision in Shatrunjay Diamonds, holding that the judgment concerned disallowance under Section 40A(2)(b) relating to excessive or unreasonable expenditure and not penalty proceedings under Section 271G. It held that the statutory framework governing Section 271G is distinct and that the relevant consideration in penalty proceedings is whether reasonable cause exists under Section 273B. Referring to the Tribunal’s decisions in Kapu Gems LLP and Interjewel Pvt. Ltd., the Tribunal observed that those decisions had similarly recognised the practical difficulties inherent in the diamond trade and upheld deletion of penalties under Section 271G.

Finding no infirmity in the orders of the Commissioner (Appeals), the Tribunal upheld the deletion of penalties under Section 271G for both assessment years and dismissed the Revenue’s appeals.

FULL TEXT OF THE ORDER OF ITAT MUMBAI

These two appeals filed by the Revenue are directed against the separate orders passed by the learned Commissioner of Income Tax (Appeals)-55, Mumbai [hereinafter referred to as “CIT(A)”]under section 250 of the Income Tax Act, 1961 [hereinafter referred to as “the Act”], both dated 29.05.2025, for Assessment Years 2013-14 and 2015-16, whereby the learned CIT(A) has deleted the penalty levied by the Transfer Pricing Officer under section 271G of the Act. The penalty orders in both the years were passed by the Deputy Commissioner of Income Tax, Transfer Pricing Officer-1(2)(2), Mumbai [hereinafter referred to as “the Transfer Pricing Officer or TPO”]under section 271G of the Act, being dated 26.04.2017 for A.Y. 2013-14 and 25.04.2019 for A.Y. 2015-16. The penalty proceedings emanate from the transfer pricing proceedings undertaken under section 92CA(3) of the Act in the case of the assessee.

Facts of the Case

2. The assessee is a private limited company engaged in the business of import/purchase of rough diamonds, cutting and polishing of diamonds, and export/sale of finished diamonds. The assessee had entered into international transactions with its Associated Enterprises and had benchmarked the same by adopting Transactional Net Margin Method (TNMM) as the most appropriate method. During the course of transfer pricing proceedings, the TPO required the assessee to furnish documentation as prescribed under section 92D read with Rule 10D. According to the TPO, the assessee failed to furnish certain information and documents, particularly those required under clauses (g), (h) and (i) of Rule 10D(1). Consequently, penalty proceedings under section 271G were initiated and penalty at the rate of 2% of the value of international transactions was levied.

3. The common facts, as emanating from the penalty orders and appellate orders, are that the assessee had undertaken substantial international transactions with its Associated Enterprises, including purchase and sale of rough and polished diamonds. The assessee had adopted TNMM and computed entity level margins, comparing the same with comparable companies. The TPO, however, held that for proper benchmarking under TNMM, transaction-specific or segmental profitability relating to AE transactions was required. The TPO observed that the assessee furnished only entity level margins which included both AE and non-AE transactions, and therefore failed to furnish the requisite documentation necessary for determination of Arm’s Length Price under section 92C.It was further observed by the TPO that due to failure on the part of the assessee to furnish requisite documentation, the TPO was prevented from determining the ALP under any of the prescribed methods, though no adjustment was ultimately made to the ALP. On this basis, penalty under section 271G was levied.

4. The assessee contended before the TPO that:

• It had furnished all relevant documentation and details to the extent available.
• The TNMM method adopted by the assessee was accepted in earlier years as well as in the present year.
• Segmental results of AE and non-AE transactions along with financials were furnished.
• Certain documents as required under Rule 10D(1)(g), (h), etc., were either not relevant under TNMM or were not specifically called for under section 92D(3).
• There existed reasonable cause for any alleged non­compliance, and therefore penalty was not leviable in view of section 273B.

However, the TPO did not accept these submissions and proceeded to levy penalty.

5. Before the learned CIT(A), the assessee reiterated that it had substantially complied with the requirements of section 92D and the documentation furnished was sufficient for determination of ALP under TNMM. It was also submitted that the TPO had accepted the ALP without making any adjustment and the requirement of furnishing certain documents under Rule 10D was not relevant under TNMM. It was further argued that there existed reasonable cause for any alleged deficiency, attracting protection under section 273B and identical penalty levied in earlier years had been deleted by appellate authorities including ITAT. The assessee also relied on judicial precedents and orders passed in its own case for earlier years.

6. The learned CIT(A), after considering the submissions, deleted the penalty.

Year specific details are:

7. Aggrieved by the orders of CIT(A), the Revenue is in appeal before us and has raised following grounds of appeal which are same for both the years:

1. Whether the CIT (A) was correct in deleting the penalty levied u/ s.271G of the Act by holding that the assessee had made substantial compliance, failing to note that under TNMM adopted by the assessee, the profit of the international transaction has to be furnished, whereas the assessee has only furnished the entity level margins which consists of overall profits on AE and significant non-AE transactions?

2. Whether the decision of the CIT (A) is not vitiated for the reason that the CIT(A) has not given any finding on how the assessee has complied with clause (d), (g), (h) and (m) of Rule 10D(1), that have been specifically invoked by the TPO?

3. Whether the ld. CIT (A) erred in holding that there was reasonable cause for non-compliance of sec. 92D read with Rule 10D(1) without specifying the cause of such non-compliance or demonstrating how the same was reasonable?

4. Whether the ld. CIT (A) was correct in ignoring the ratio laid down in the decision of Hon’ble Bombay High Court in the case of M/ s. Shatrunjay Diamonds (261 ITR 258) holding that the initial burden was cast upon the assessee?

5. The ld. CIT (A) erred in deleting the penalty for the reason that no adjustment was made to the ALP, failing to note that by not producing the material documents necessary to determine the ALP under any of the prescribed methods u/ s.92C(1) of the Act, the assessee effectively prevented the TPO to make any determination as recorded by the TPO in the order u/ s.92CA(3) of the Act.

8. During the course of hearing before us, the learned Departmental Representative (DR) submitted that though no adjustment to the Arm’s Length Price has been made in the transfer pricing proceedings, the TPO has nevertheless recorded detailed adverse observations in the order passed under section 92CA(3) of the Act, which form the very foundation for initiation and levy of penalty under section 271G of the Act. The learned DR specifically drew our attention to the relevant findings recorded by the Transfer Pricing Officer in the para 7.13-7.15 of the order. Referring to the extracted paragraphs placed on record, the learned DR submitted that the TPO has categorically recorded that the assessee was maintaining complete books of account, including purchase and sales registers, which contained details of transactions with Associated Enterprises as well as non-AEs. It was further noted by the TPO that from the invoices and records maintained, the assessee was in a position to identify the quality and quantity of diamond pieces and, therefore, it was possible for the assessee to work out profitability separately for AE and non-AE segments. However, despite availability of such records, the assessee failed to carry out proper correlation and did not compute segment-wise profitability, merely stating that it was not possible to trace the cost of each piece of diamond. The learned DR further emphasised that the TPO has observed that the assessee itself had chosen TNMM as the most appropriate method and, having done so, it was under an obligation to maintain and furnish proper documentation to enable correct application of the method. According to the TPO, the stand of the assessee that it was not possible to compute separate profitability was contradictory to its claim of having maintained proper documentation and audited accounts. It was further submitted that the TPO has clearly concluded that the assessee, by not furnishing the required documentation and segmental details, has prevented the Revenue authorities from making any determination of the Arm’s Length Price.

9. Accordingly, it was contended that the learned CIT(A) erred in overlooking these categorical findings of the TPO and in deleting the penalty merely on the ground that no adjustment was made to the ALP, without appreciating that the failure to furnish documentation itself constitutes an independent default under the provisions of section 271G.

10. On the other hand, the learned Authorised Representative, supporting the order of the learned CIT(A), submitted that the very foundation of the penalty under section 271G does not survive in the facts of the present case. He invited our specific attention to paragraph 9 of the order passed by the TPO, as placed on record, to demonstrate that after considering the facts and circumstances of the case, the TPO himself has categorically recorded that the assessee’s overall margins were within the range of comparables and, therefore, the value of international transactions with Associated Enterprises was not disturbed and no adjustment was made. The learned AR emphasised that the TPO has expressly recorded as under:

“…the assessee’s overall margin is in the range of the comparables, therefore, the value of international transactions with AE are not being disturbed & no adjustment is made in the assessee’s case…”

11. The learned AR further submitted that the TPO has proceeded to initiate penalty “separately for failure to furnish the required documentation”, even though the benchmarking exercise stood accepted. According to him, this itself shows that the penalty has been levied in a purely technical manner without demonstrating any prejudice to the determination of ALP.

12. The learned AR, in support of the order of the learned CIT(A), further placed reliance on various judicial precedents, including the decision of the Coordinate Bench in assessee’s own case for A.Y. 2012-13, wherein on identical facts, the penalty levied under section 271G was deleted. Drawing our attention to the said decision, the learned AR submitted that the Co-ordinate Bench, while adjudicating the identical issue, has upheld the deletion of penalty by recording a categorical finding that the assessee had substantially complied with the directions of the TPO and had furnished requisite information to the extent practicably possible, having regard to the peculiar nature of the diamond trade.

13. The learned AR specifically referred to the findings where the Co-ordinate Bench followed the decision in assessee’s own case for A.Y. 2011-12 (ITA No. 6304/Mum/2016), where in it has been observed that:

“…the assessee to the extent possible in the backdrop of the nature of its trade had furnished several details on several occasions from time to time with the TPO… we are of the considered view that the assessee had substantially complied with the directions of the TPO and placed on his record the requisite information, to the extent the same was practically possible in light of the very nature of its trade…”

14. It was further highlighted that the Co-ordinate Bench has also held that even if there was any shortfall in compliance, the same was attributable to practical difficulties inherent in the business and thus constituted a “reasonable cause” within the meaning of section 273B of the Act, thereby rendering the levy of penalty unsustainable.

15. The learned AR submitted that the Co-ordinate Bench, in the aforesaid decision, has categorically upheld the order of the CIT(A) deleting the penalty under section 271G, and the said decision has attained finality. It was thus contended that the issue being squarely covered in favour of the assessee in its own case on identical facts, the order of the learned CIT(A) for the years under consideration deserves to be upheld.

16. We have heard the rival submissions and perused the material available on record, including the penalty orders passed under section 271G, the orders of the learned CIT(A), and the judicial precedents relied upon by the parties.

17. At the outset, it is an undisputed position emerging from the record that the Transfer Pricing Officer, while completing the proceedings under section 92CA(3), has not made any adjustment to the value of international transactions entered into by the assessee with its Associated Enterprises. On the contrary, the TPO himself has recorded a categorical finding that the overall margins of the assessee were within the range of comparables and, therefore, the value of international transactions was not disturbed.

18. At the same time, the TPO has proceeded to initiate and levy penalty under section 271G on the premise that the assessee failed to furnish certain documentation as required under section 92D read with Rule 10D. Thus, the issue for consideration before us is whether, in the facts of the present case, such alleged deficiency in documentation justifies levy of penalty under section 271G.

19. From the perusal of the penalty order as well as the material placed before us, it is evident that the assessee had furnished various details, including transfer pricing study report, segmental information to the extent available, and other supporting documents. The grievance of the TPO is essentially that the assessee furnished entity-level margins instead of transaction-specific profitability and that certain details were either not furnished in the manner required or were not capable of verification. However, it is equally evident that despite such alleged deficiencies, the TPO has accepted the benchmarking results and has not disturbed the Arm’s Length Price of the international transactions. In our considered view, this aspect assumes considerable significance. Once the TPO, on the basis of material available on record, accepts the transactions to be at Arm’s Length Price, it cannot simultaneously be contended that the assessee failed to furnish such fundamental information so as to frustrate determination of ALP.

20. Further, we find merit in the contention of the assessee that the nature of its business, being that of diamond trading and manufacturing, involves practical difficulties in maintaining precise segment-wise cost allocation for each transaction with AE and non-AE. This aspect has been duly recognised by the Coordinate Bench in assessee’s own case for earlier years. In this regard, we find that the Coordinate Bench of the Tribunal in assessee’s own case for A.Y. 2012-13, while dealing with an identical issue, has held as under:

“…we are of the considered view that the assessee had substantially complied with the directions of the TPO and placed on his record the requisite information, to the extent the same was practically possible in light of the very nature of its trade… the failure to the said extent on the part of the assessee… can safely be held to be backed by a reasonable cause, which thus would bring the case of the assessee within the sweep of Sec. 273B of the Act…” (para 20 of ITA No. 6304/Mum/ 2016)

21. The bench, on identical facts, has upheld the deletion of penalty under section 271G. The Revenue has not brought on record any distinguishing feature in the facts of the present years vis-a-vis the earlier years decided by the Co-ordinate Bench.

22. We further note that the learned CIT(A), while deleting the penalty, has recorded a finding that the assessee had made substantial compliance with the requirements of section 92D and that any shortfall, if at all, was supported by reasonable cause within the meaning of section 273B. The learned CIT(A) has also taken note of the fact that no adjustment to ALP has been made by the TPO.

23. In our considered view, the findings recorded by the learned CIT(A) are well reasoned and are in consonance with the judicial precedents on the issue. The provisions of section 271G, though mandatory in nature, cannot be invoked in a mechanical manner. Where the assessee has substantially complied with the requirements and where the benchmarking of international transactions has been accepted without any adjustment, the levy of penalty merely on technical or venial breaches is not justified. Further, the existence of reasonable cause, as contemplated under section 273B, stands established in the present case, particularly in view of the peculiar nature of the business and the practical constraints involved in maintaining transaction-wise documentation in the manner expected by the TPO.

24. Before we conclude, it would be appropriate to deal with Ground No. 4 raised by the Revenue regarding applicability of the decision of the Hon’ble Bombay High Court in the case of Shatrunjay Diamonds (261 ITR 258).The contention of the Revenue is that the learned CIT(A) has ignored the binding ratio laid down by the Hon’ble jurisdictional High Court, wherein it has been held that the initial burden lies upon the assessee to establish that the price paid in related party transactions is not excessive or unreasonable.

25. We have carefully examined the said contention. A perusal of the judgment of the Hon’ble Bombay High Court shows that the issue therein arose in the context of section 40A(2) (b) of the Act relating to disallowance of excessive or unreasonable expenditure. The Hon’ble Court has held that where transactions are entered into with related parties covered under section 40A(2)(b), the burden lies upon the assessee to demonstrate that the price paid is not excessive or unreasonable. Thus, the ratio of the said judgment is clearly confined to a situation where the Assessing Officer has invoked section 40A(2) (b) and made a disallowance on the ground that the expenditure incurred is excessive or unreasonable. In the present case, however, the issue before us pertains to levy of penalty under section 271G for alleged failure to furnish documentation prescribed under section 92D read with Rule 10D. The statutory framework governing these provisions is entirely distinct. While section 40A(2)(b) deals with substantive disallowance based on reasonableness of expenditure, section 271G deals with penal consequences for non-furnishing of information, subject to the saving clause provided under section 273B.

26. We further find that the Coordinate Bench in the case of Kapu Gems LLP (ITA No.5438/Mum/2024) has examined this very argument of the Revenue and has categorically held that the decision in Shatrunjay Diamonds is rendered in the context of section 40A(2)(b) and cannot be applied to penalty proceedings under section 271G. The Bench has emphasised that in penalty proceedings, the relevant consideration is whether the assessee had a reasonable cause for the alleged failure. Similarly, in the case of Interjewel Pvt. Ltd. and connected matters(ITA No. 5628/Mum/2016), the Co-ordinate Bench has upheld the deletion of penalty under section 271G by taking into account the peculiar nature of the diamond trade and the practical difficulty in maintaining segment-wise details, thereby accepting the existence of reasonable cause within the meaning of section 273B.

27. In the present case, we have already recorded a finding that the assessee had furnished substantial documentation and that the alleged deficiency relates to inability to furnish precise segmental details between AE and non-AE transactions due to inherent practical constraints in the diamond business. This explanation has been accepted by the learned CIT(A) as constituting reasonable cause, and the Revenue has not brought on record any material to controvert the same. Further, it is a matter of record that the TPO has not made any adjustment to the Arm’s Length Price of the international transactions. Therefore, it cannot be said that the assessee has failed to discharge any burden so as to frustrate the determination of ALP. In view of the foregoing discussion, we are of the considered opinion that the reliance placed by the Revenue on the judgment of the Hon’ble Bombay High Court in Shatrunjay Diamonds is misplaced and distinguishable on facts as well as in law. Accordingly, this ground raised by the Revenue is devoid of merit and is hereby dismissed.

28. In light of the foregoing discussion, and respectfully following the decision of the Coordinate Bench in assessee’s own case on identical facts, we find no infirmity in the orders passed by the learned CIT(A) deleting the penalty under section 271G for both the assessment years under consideration.

29. Accordingly, the appeals filed by the Revenue for A.Ys. 2013-14 and 2015-16 are dismissed.

Order pronounced in the open court on 13.05.2026.