Fake Deductions & Refunds: Approach Before & After Income Tax Assessment

Fake Deductions/Refunds – Approach Before and After Assessment, Reassessment and Penalty Proceedings

The article discusses the Income Tax Department’s verification drive against fraudulent or incorrect deduction and refund claims and outlines approaches available to taxpayers at different stages. It covers revised returns under Section 139(5), condonation under Section 119(2)(b), updated returns under Section 139(8A), reassessment responses under Section 148, and penalty provisions under Section 270A, including immunity under Sections 270A(11A) and 270AA. It states that updated returns may be filed within the prescribed period with additional tax under Section 140B and explains the consequences of choosing a normal return or updated return during reassessment. The article discusses possible defences during penalty proceedings, including bona fide conduct, fraudulent or unauthorised actions by intermediaries, vague penalty notices, and technical defaults in filing Form 68. It cites judicial decisions concerning penalties, immunity and intermediary misconduct. It also discusses prosecution provisions amended by the Finance Act, 2026, including rationalisation of offences, reduced imprisonment and graded offences. The article concludes by emphasising timely action, complete disclosure and deliberate selection among available statutory routes.

The Verification Drive / The high risk of getting caught

1. A press release issued by the Central Board of Direct Taxes (CBDT) dated 14.07.2025, recorded that the Income Tax Department had initiated a large-scale verification operation across multiple locations in the country, targeting individuals and entities who had facilitated fraudulent claims of deductions and exemptions in Income Tax Returns(‘ITRs’). The action followed a detailed analysis of the misuse of tax benefits under the Income-tax Act, 1961 (the Act), frequently in collusion with professional intermediaries.

2. The Department’s analysis disclosed that multiple individuals and agencies — including employees of MNCs, PSUs, government bodies and academic institutions, as well as entrepreneurs — had misused deductions and exemptions under Sections 10(13A), 80GGC, 80E, 80D, 80EE, 80EEB, 80G, 80GGA and 80DDB of the Act, and were consequently implicated in the nation-wide operation. The findings were substantiated by search and seizure operations conducted in Maharashtra, Tamil Nadu, Delhi, Gujarat, Punjab and Madhya Pradesh. Three features of the exercise merit emphasis at the outset, because they shape the defenses that are realistically available to an assessee.

3. The evidentiary base is data-led, not testimonial. The Department combined financial data received from third-party sources with ground-level intelligence and artificial-intelligence tools to identify suspicious patterns. A defense built purely on assertion is therefore unlikely to succeed; the assessee must produce primary documents.

4. The intermediary, not merely the assessee, is the target. The Department has proceeded against organized rackets operated by certain ITR preparers and intermediaries who filed returns claiming fictitious deductions and exemptions, and in some instances filed false TDS returns to claim excessive refunds. Where the assessee is in truth a victim of such a racket, the Department’s own findings are a resource available to the assessee, not merely a threat.

5. The exercise has since moved from enforcement to nudge. In December 2025 the CBDT launched a targeted ‘NUDGE’ campaign, issuing SMS and email advisories to taxpayers flagged as high-risk under Sections 80GGC and 80G, and inviting them to revise their returns for AY 2025-26 or file updated returns for earlier years and withdraw incorrect claims. Enforcement action revealed that bogus donations had been routed through Registered Unrecognized Political Parties (‘RUPPs’) — many of them non-filers, non-operational at their registered addresses and not engaged in any political activity — which were used as conduits for routing funds and issuing bogus donation receipts.

6. Taxpayers had been made to believe that by claiming deductions under Section 80GGC of the Act they could decrease their tax liability. The Department has, however, initiated assessments against such false deductions and has penalized bogus claims.

7. In view of the erroneous claims and the enforcement drive of the Income Tax Department, it is recommended to avail the provisions of the Act dealing with filing an updated return, in addition to the option to file a revised return, if time permits.

Approach before the initiation of assessment/reassessment [or at Investigation stage]

8. An assessee who has filed a false return with fake claims can before the initiation of assessment or reassessment proceedings or during investigation proceedings, avail the options of filing three kinds of returns as explained below:

a) Revised Return- u/S. 139(5) of the Act: The assessee can file a revised return if there are any omissions or wrong statements in the original or belated return filed. As per this provision, as amended by the Finance Act, 2026, the timeline granted to file such a return is before the end of the relevant assessment year or before the completion of assessment. [The assessee can file a revised return before March 31^st of 2027 if an incorrect return was filed for the AY 2026-27]. When the Assessee has voluntarily claimed an erroneous refund, there could be debate about whether there is an ‘omission or a wrong statement’ so as to be in a position to file revised return. This option is also not popular because the time limit to file revised return for older years has already expired.

b) Condonation Return- u/S. 119(2)(b): The assessee can file a condonation return only if the department approves the request for condonation of delay u/S. 119(2)(b). [This is not a preferable option since the time in which this application will be cleared is highly uncertain and its acceptance or rejection is dependent on the Officer’s discretionary powers.]

c) Updated Return- u/S. 139(8A): The assessee can file an updated return. The timeline granted under this provision for filing the updated return is forty-eight months from the end of the relevant assessment year (i.e 4 years). [The assessee can file an updated return for the AY 2026-27 till March 31^st of 2031]. In some cases, the statute permits filing of Updated return during reassessment proceedings. This option is highly recommended over others as penalty will not be imposable as per section 270A(11A) since additional tax is payable under this option.

9. If an assessee files an updated return, then they will be liable to pay additional income tax u/S. 140B in accordance with the table given below:

10. Given the above, it is advised to file any of the correct return before assessment or reassessment proceedings are initiated as such an ITR will be considered the base Return of Income for the Penalty Proceedings u/S. 270A. If no return is filed or if a correct return is filed in response to S. 148 notice, then u/S. 270A (2) underreported income will be calculated by deducting the income assessed from the maximum amount not chargeable to tax.

Approach if assessment is initiated

11. Once the assessment proceedings have been initiated, the assessee is precluded from filing updated return of income under section 139(8A), considering the bar placed under the 3^rd proviso thereunder.

12. Further, there is no question of filing a revised return of income or any return of income. The option of getting the delay in filing the revised return condoned under 119(2)(b) of the Act, is also not practical in view of the opinion expressed above.

13. However, an assessee can still file correct particulars by making true and correct disclosures, without putting up artificial defense against the erroneous claims and seek mercy during penalty and prosecution proceedings if any are initiated.

Approach if reassessment is initiated

14. Once the reassessment proceedings have been initiated, the assesse can exercise two options within the time allowed under the notice issued under section 148 of the Act:

a) File a normal return in response to the notice u/S. 148

b) File an updated return in response to the notice u/S. 148

15. An assessee can choose between the above two options depending upon the outcome of the penalty proceedings as discussed in the subsequent paragraphs.

16. There exists a notion that during assessment proceedings, if true and honest disclosure is made and the return filed u/S. 148, then this disclosure is accepted by the department, and therefore the question of penalty ceases to exist. In precedents such as Amit Kumar Goyal vs ITO bearing case number ITA No. 5362/Del/2025 (A.Y.: 2019-20), Ansh Organisers Private Limited vs DCIT bearing case number ITA No. 257/AHD/2026 (A.Y.: 2020-21) and ACIT vs. Nawazuddin Nawabuddin Siddiqui reported in [2026] 186 taxmann.com 876 (Mumbai – Trib.) [18-05-2026] passed by the Hon’ble benches of the ITAT do support the above-stated practice.

17. The above view is not supported by the bare reading of the provisions u/S. 270A. The provisions u/S. 270A (2)/(3) are extracted as follows:

Penalty for under-reporting and misreporting of income Section 270A

….

(2) A person shall be considered to have under-reported his income, if

….

(a)the income assessed is greater than the income determined in the return processed under clause (a) of sub-section (1) of section 143;

(b) the income assessed is greater than the maximum amount not chargeable to tax, where no return of income has been furnished (or where return has been furnished for the first time under section 148);

 (3) The amount of under-reported income shall be,—

(i) in a case where income has been assessed for the first time,—

(a) if return has been furnished, the difference between the amount of income assessed and the amount of income determined under clause (a) of sub-section (1) of section 143;

(b) in a case where no return of income has been furnished or where return has been furnished for the first time under section 148,—

(A) the amount of income assessed, in the case of a company, firm or local authority; and

(B) the difference between the amount of income assessed and the maximum amount not chargeable to tax, in a case not covered in item (A);

18. It is relevant to note from the above, that the additional income, if any offered vide return under section 148 of the Act will not be the starting point to impose penalty.

19. In several cases, the judicial bodies have held that when there is a difference between the original returned income and the subsequent return u/S. 148, the penalty stands to be applied even when the Assessing Officer merely accepts the same without any further additions. The same also holds good when the return is filed for the first time as a reply to the notice issued under section 148 of the Act.

20. Recently, in the case of Mahaveer Singh v. PCIT bearing case number ITA No. 840/Ahd/2025 (A.Y.: 2018-19) passed by Hon’ble bench upheld that when the assessee has not filed the original return and has filed a response to S. 148 belatedly, his actions clearly attract the provisions of Section 270A(2)(b) of the Act.

21. In the case of Gunmala Jain vs. ITO reported in [2026] 182 taxmann.com 451 (Jaipur – Trib.)[22-12-2025], wherein similar to the facts of the notification as discussed above, the Hon’ble tribunal has refused to waive off the penalty.

22. Similar precedents can be seen in the case of Sanjeev Kumar Manchand Rajput vs. ITO reported in [2023] 157 taxmann.com 747 (Pune – Trib.) [13-07-2023].

23. Out of the above two options an updated return is advantageous [since it provides certainity] to the assessee since u/S. 270A (2) the normal return filed as a reply to the notice u.S.148 will not be considered while calculating the underreported income. But if an updated return is filed then the assessee can claim immunity u/S. 270A(11A)

Approach on conclusion of assessment or reassessment

24. If the above suggested approach has been followed by the assessee, ideally it results in a clean order. Further, if any penalty proceedings have been initiated the procedure to be followed is discussed in the subsequent segment.

25. If the assessee has not acted in accordance with the above given approach, it is advised not to file an appeal in cases of genuine disallowances/additions/denial of deductions, since in such cases of false deductions the assessee may not get any relief.

26. In cases of tax credit mismatches or income computation errors the assessee is advised to file for a rectification u/S. 154 and if aggrieved from such an order, the assessee can exercise the option to appeal against the higher authorities.

Approach during and upon conclusion of the penalty proceeding [immunity option]

27. Once penalty proceedings have been initiated the assessee can consider the below stated approach. The penalty can be initiated for two broad categories under section 270A:

• Underreporting
• Underreporting as a consequence of misreporting [hereinafter referred to as misreporting]

28. In case the department finds that the case is one of Underreported Income:

a) Upon completion of the Assessment or reassessment, notice of demand u/S. 156 is issued along with the order and computation sheet directing an Assessee to pay the demand within 30 days. The assessee willing to opt for an immunity can pay the demand as may be determined in the aforesaid notice, instead of filing an appeal. On satisfaction of the above conditions in a timely manner, the assessee can file an immunity application under Section 270AA by filing Form 68.

b) On successful resolution, the assessee will be able to enjoy the immunity from imposition of penalty under section 270A and immunity from initiation of proceedings under section 276C or section 276CC.

c) In case of incorrect computation of tax then the assessee can file an application u/S. 154 for rectification of mistake along with immunity application accompanied by a request to the Assessing Officer to grant the same.  The challenge here would be to meet the requirement to pay taxes within 30 days [one of the conditions to apply for immunity] and also file Form 68 (for immunity) within the period directed under Section 270AA [within one month from the end of the month in which the assessment/reassessment order has been passed].

29. In case the department finds that the case is one of Misreported Income:

a) The penalty levied for misreporting of income is 200% of tax payable on underreported income, but the Union Budget 2026 expanded the scope of S. 270AA by granting immunity in cases of underreporting of income as a result of misreporting where additional income-tax amounting to one hundred per cent of the amount of tax payable on under-reported income has been paid within the period specified in the notice of demand, in lieu of such penalty.

b) An application for immunity u/S. 270 AA can be filed in cases of misreporting even during the penalty proceedings as the provision reads as follows:

(b) where penalty has been levied or, as the case may be, leviable under the circumstances referred to in sub-section (9) of section 270A, additional income-tax amounting to one hundred per cent of the amount of tax payable on under-reported income has been paid within the period specified in the notice of demand, in lieu of such penalty;

But this approach is not advisable since the settlement amount payable whether today or after the passage of time, i.e when the penalty order is passed, would remain the same. Therefore, it is suggested that the assessee fights the case on the basis of merits and considers immunity against misreported income only if it is ultimately held against the assessee vide an order of penalty under Section 270A.

Approach on conclusion of penalty proceeding

Once the penalty proceedings have been concluded and if the same operates against the assessee, then the assessee has the following option depending upon the basis of levy of penalty

– There is an option to pay the penalty whether it is levied for underreporting or misreporting.

– There is an option to file immunity even if a penalty is levied for underreporting, if all the conditions referred to in Section 270AA have been satisfied, even if there is a technical delay in filing Form 68 [form prescribed for opting immunity under Section 270AA, which is to be filed within one month from the end of the month in which the assessment/reassessment order is passed].

– Filing of immunity application against Penalty levied for Misreporting; [this option has been deliberated in the preceding paragraphs]

– Filing of Appeal against penalty, whether it is for misreporting or underreporting.

30. One of the possible conditions that an Assessee can raise during the penalty proceedings or before the appellate authorities, if the penalty has been levied for misreporting is as under.

a) The assessee should make an effort to reclassify the penalty as levied under Section 270A(9) for misreporting to a penalty which is leviable under section 270A(7) for underreporting, and demonstrate that the subject addition does not fall under any of the said clauses of section 270A(9) of the Act.

b) Once it is reclassified as underreported income, the assessee can then make a case under Section 270A(6)(a), stating that there was true and honest disclosure based on bona fide conduct of the assessee. If the assessing officer is satisfied, or if the appellate authorities are satisfied, they can drop the penalty under that clause.

c) Alternatively, once it is reclassified as underreported income, the assessee can demonstrate that all the ingredients of Section 270AA have been satisfied and therefore eligible for immunity, though there is a technical default in not filing Form 68 [this impediment can be overcome by immediately filing Form 68, irrespective of whether the penalty has been initiated for underreporting or misreporting of income, immediately on receipt of the assessment order within the time lines allowed under Section 270AA of the Act. Rejection of such immunity applications on a vague basis will also give additional ammunition to the assessee before the appellate authorities in defending misreporting income on the basis of the vagueness of the notice/rejection order of immunity].

d) Where inaccurate particulars have been furnished or an incorrect claim made owing to the unauthorized or fraudulent acts of an intermediary such as a tax practitioner or ITR preparer — this does not amount to conscious concealment by the assessee.

Multiple appellate courts have accepted such a defense. Reliance is placed upon Shri Ravikiran Netla v. ITO bearing case number ITA No. 2123/Bang/2018, where it was held that an assessee cannot be penalized for the fraudulent or unauthorized actions of a tax consultant, particularly where the assessee has acted bona fide, has not derived any undue benefit, and has taken corrective measures upon discovering the irregularity.

For the above defense to be valid the assessee must fulfill three conditions:

(i) Bona fide conduct- The assessee must show that he did not   know, and could not reasonably have known, that the claim was false.

(ii) Absence of undue benefit. The refund must not have been retained. Where the refund was shared with the intermediary as commission, the assessee should be prepared to demonstrate the quantum retained and, ideally, its repayment.

(iii) Corrective measures. The assessee must have moved promptly upon discovering the irregularity.

e) The assessee can also contend that penalty proceedings are invalid where they have been initiated under vague pretexts, that is, where the Assessing Officer fails to specify whether the penalty is for under-reporting or misreporting of income under Section 270A. In the absence of a clear charge, and of satisfaction recorded as to the ingredients of Section 270A (9), the denial of immunity under Section 270AA is arbitrary and unsustainable. This argument is valid even when the assessing officer refers to misreporting as a limb without specifying the applicability of the sub-clauses thereunder, or even when Section 270A(9)(a) has been referred to without specifying the exact item under the said sub-clause.

Reliance may be placed on Schneider Electric South East Asia (HQ) PTE Ltd. v. Asst. CIT bearing case number W.P.(C) No. 5111 of 2022 (Delhi High Court), decided on 28.03.2022, wherein the Hon’ble Court held that the denial of immunity on the ground that penalty had been initiated for misreporting of income was not merely erroneous but arbitrary and bereft of reason, because the penalty notice had failed to specify the limb — underreporting or misreporting — under which the proceedings had been initiated, and there was not even a whisper as to which limb of Section 270A was attracted or how the ingredients of sub-section (9) were satisfied. The Court set aside the order passed under Section 270AA (4) and directed the Assessing Officer to grant immunity.

This principle has been upheld in multiple decisions. In Prem Brothers Infrastructure LLP v. NFAC [2022] 142 taxmann.com 38/288 Taxman 768 (Delhi) (HC) wherein the Hon’ble Delhi High Court followed Schneider Electric and granted immunity where the addition arose from a difference of opinion on disallowance under Section 14A.

In such cases penalty notices are not legally tenable, and this has been upheld in multiple rulings.

• CIT v. Manjunatha Cotton & Ginning Factory [2013] 359 ITR 565 (Karnataka);
• Muninaga Reddy v. ACIT [2017] 396 ITR 398 (Karnataka);
• Safina Hotels (P.) Ltd. v. CIT [2016] 237 Taxman 702 (Karnataka);
• S. Chandrashekar v. ACIT [2017] 396 ITR 538 (Karnataka) / [2017] 293 CTR 409 (Karnataka);
• Prince Consultancy (P.) Ltd. v. DCIT [2017] 54 ITR(T) 334 (Mumbai – Trib.);
• Meherjee Cassinath Holdings (P.) Ltd. v. ACIT [2017] 187 TTJ 722 (Mumbai – Trib.);
• Mohd. Sharif Khan v. DCIT [2017] 58 ITR(T) 260 (Jaipur – Trib.);
• Ms. Sandhya Gadkari Sharma v. DCIT [2016] 181 TTJ 462 (Mumbai – Trib.);
• Kanhaiyalal D. Jain v. ACIT [2017] 185 TTJ 553 (Pune – Trib.).

31.  With respect to instances where all the conditions for granting immunity are satisfied and if there is a technical default in filing Form 68, the following precedents have held that such technical defaults can be overcome in the view of substantial justice to the Assessee:

• Natarajan Anandh Kumar  vs. DCIT [2024] 159 taxmann.com 637 (Madras)[23-01-2024]
• Natal Mary Pedru Rodrigues vs. DCIT [2026] 188 taxmann.com 785 (Mumbai – Trib.)[06-07-2026]
• Punam Kanwar Bhati vs. ITO [2024] 113 ITR(T) 750 (Jodhpur – Trib.)[21-03-2024]
• Rohit Kapur vs. PCIT [2023] 454 ITR 198 (Delhi)[14-03-2023]

32. Therefore, on the receipt of the penalty order, there is no fixed approach. The approach of the assessee should depend on the ingredients of the penalty order, among other things, before concluding whether an appeal has to be filed or whether immunity or outright payment of the penalty is appropriate.

Prosecution proceedings

33. The assessee should also be aware of the prosecution proceedings that may be initiated. Vide the Finance Act, 2026, the said provisions have been substantially decriminalized as follows

• Substantial decriminalisation of prosecution provisions through rationalisation of offences.
• Rigorous imprisonment has been replaced with simple imprisonment for most prosecution provisions.
• Maximum term of imprisonment has been significantly reduced, with several offences previously punishable with imprisonment up to 7 years now carrying a maximum punishment of 2 years.
• Introduction of graded offences, whereby the severity of punishment is aligned with the nature, gravity, and monetary threshold of the default.
• Prosecution framework shifted towards proportionality, reserving harsher consequences for serious and wilful violations while reducing criminal exposure for procedural and technical defaults.

Conclusion

34. The verification drive commenced on 14.07.2025 has exposed a large body of assessees, many of them salaried and many of them unwitting, to the most severe civil penalty in the Act. The preconception that a candid disclosure in response to a notice under Section 148 extinguishes penalty is, as demonstrated, unsustainable: Section 270A(2)(b), as amended with retrospective effect from 01.04.2017, was enacted for precisely that case.

35. Yet the position is far from hopeless, and it has improved. The insertion of Section 270A(11A) with effect from 01.03.2026 has, for the first time, made available a route by which an assessee may purchase a statutory immunity from penalty through complete disclosure and payment of an enhanced additional income-tax. Section 270AA continues to offer immunity in cases of under-reporting, and a substituted charge of one hundred per cent in place of two hundred per cent in cases of misreporting. Judicial decisions such as Schneider Electric have helped the taxpayer’s hold the Revenue to the discipline of identifying the limb it invokes. And the Ravikiran Netla line recognizes that an assessee who has acted bona fide, retained no undue benefit and moved promptly to correct the record should not bear the consequences of another’s fraud.

36. The determinative variable, across every one of these routes, is time. The way forward, for the assessee and the adviser alike, is therefore to act early, to disclose completely, and to elect deliberately between routes that the statute now makes mutually exclusive.

[It is suggested the assessee takes legal help from qualified lawyers/Chartered accountants before deciding on the future course of action for the above issues.]