Tax department rejected ₹37.82 lakh deduction, but ITAT cancelled the 200% penalty: What the ruling means

A tax deduction claim that is later rejected by the Income Tax Department does not automatically amount to misreporting of income, the Income Tax Appellate Tribunal (ITAT), Bangalore, has ruled. The tribunal deleted a ₹23.31 lakh penalty imposed on a cooperative housing society after it claimed a ₹37.82 lakh deduction on interest income.

The ruling in Pashupalana Elake Noukarara Gruha Nirmana Sahakara Sanga Nigama v. Income Tax Officer, ITA No. 2366/Bang/2025, concerned assessment year 2018-19. The tribunal held that the deduction claim was a debatable legal issue, particularly because there were conflicting judicial decisions on whether such interest income qualified for deduction under section 80P(2)(d) of the Income-tax Act.

Why was the ₹37.82 lakh deduction rejected?

The Mysore-based cooperative housing society had filed its return on 29 September 2018, declaring nil income. It disclosed interest income from various banks and claimed ₹37.82 lakh as deduction under section 80P(2)(d). It also claimed another ₹50,000 under section 80P(2)(c)(ii).

During scrutiny, the assessing officer disallowed the section 80P deduction. The officer relied on a Karnataka High Court ruling that had held that interest earned by a cooperative society on deposits with cooperative banks was not eligible for deduction under section 80P(2)(d) in the circumstances of that case.

The department subsequently initiated penalty proceedings under section 270A. It treated the deduction claim as misreporting of income and determined the under-reported income at ₹37.82 lakh. Tax on the amount was calculated at about ₹11.65 lakh, resulting in a penalty of ₹23.31 lakh, equivalent to 200% of the tax.

The society challenged the penalty, arguing that the claim had been made in good faith and that all relevant details had been disclosed in its return and financial statements.

ITAT finds the tax issue was debatable

The Bangalore ITAT agreed with the taxpayer.

The tribunal noted that while one Karnataka High Court ruling had gone against the taxpayer, an earlier Karnataka High Court decision had taken a different view. The tribunal also noted that the adverse decision was pending before the Supreme Court.

It further pointed out that several other judicial decisions had allowed similar deduction claims. Against this background, the tribunal said the question of whether interest earned from cooperative banks qualified for deduction under section 80P(2)(d) was a highly debatable issue.

The tribunal also found a procedural problem in the penalty proceedings. The initial notice issued to the taxpayer referred to under-reporting of income, while the penalty order ultimately imposed the penalty for under-reporting arising from misreporting.

Full disclosure helped the taxpayer

Section 270A provides for a penalty of 50% of the tax on under-reported income, while misreporting can attract a penalty of 200%.

However, the ITAT said the taxpayer had disclosed the relevant facts and that its claim did not fall within any of the specified categories of misreporting under section 270A(9).

The tribunal also held that even if the income could technically be regarded as under-reported, the taxpayer’s bona fide claim was covered by the exclusion under section 270A(6)(a).

It therefore directed the assessing officer to delete the entire ₹23.31 lakh penalty. The society’s appeal was allowed.

What taxpayers should consider

The ruling does not mean that every incorrect deduction claim will escape penalty. The facts were important here. The taxpayer had disclosed the income and deduction claim, and the underlying tax position was subject to conflicting judicial interpretations.

For taxpayers, the distinction between a wrong or unsuccessful legal claim and misreporting of facts can therefore be significant when the tax department considers a penalty under section 270A. A claim that is transparently disclosed but later rejected on a debatable interpretation of tax law does not, by itself, establish misreporting, the ITAT held.