Income Tax Prosecution and Compounding of Offences

Which law applies to your income tax prosecution: 1961 or 2025?

The date of the default decides. The Income-tax Act 2025 came into force on 1 April 2026 and uses the idea of a tax year instead of the old previous year and assessment year. Offences relating to periods before that date continue to be dealt with under the 1961 Act, because the repeal and savings provision of the new Act keeps pending and future proceedings for old years alive under the old law. So a person who failed to file a return for assessment year 2022-23 will still be prosecuted under section 276CC of the 1961 Act, not section 479 of the new one.

The good news is that the Finance Act 2026 amended both Acts in parallel. The prosecution provisions of the 1961 Act were substituted with effect from 1 March 2026, and the new Act's provisions with effect from 1 April 2026. Under both, rigorous imprisonment has gone, the maximum sentence for a first offence is two years of simple imprisonment, and many smaller defaults now attract only a fine.

For prosecutions already pending in court on those dates, there is an argument that the accused should get the benefit of the lighter punishment, based on the long-settled principle that a reduced penalty can apply to pending cases unless the law says otherwise. Courts will decide this case by case. It is worth raising in any pending matter, especially at the stage of sentencing or in a plea for compounding.

Income tax offences after the 2026 changes

The main offences, their old and new section numbers, and the punishment as it stands on 24 October 2026. 'Tiered' means: tax above ₹50 lakh, simple imprisonment up to 2 years, or fine, or both; above ₹10 lakh up to ₹50 lakh, simple imprisonment up to 6 months, or fine, or both; ₹10 lakh or less, fine only.

The procedural provisions moved too. Offences by companies are in section 487 (old 278B), the presumption of a culpable mental state in section 490 (old 278E), the rule that offences are non-cognizable in section 492 (old 279A), special courts in section 495 (old 280A) and trial as a summons case in section 497. Undisclosed foreign income and assets are dealt with separately under the Black Money Act 2015, which has its own, heavier offences and is not covered here.

How does an income tax prosecution start?

It starts inside the department. A prosecution proposal is usually triggered by a search, a large addition in assessment, a confirmed penalty for under-reporting or misreporting, persistent non-filing, or a TDS default picked up from the deductor's statements. The assessing officer or the investigation wing prepares a proposal, and the department generally issues a show cause notice asking the person why a complaint should not be filed. That notice is not required by the Act, but CBDT practice is to give the person a chance to respond before sanction.

Sanction is the legal gate. Under section 491(1) of the new Act (section 279(1) of the old), no court can take cognizance unless a Principal Commissioner, Commissioner, Commissioner (Appeals) or Joint Commissioner (Appeals) has sanctioned the prosecution. The sanctioning authority must apply its mind to the material; a sanction that simply repeats the proposal can be challenged. Once sanction is granted, an officer files a complaint before the designated special court, which in Delhi NCR is a magistrate's court notified for these cases.

Because the offences are non-cognizable, there is no FIR, no police investigation and, in practice, no arrest. The court examines the complaint, issues summons, and the accused appears, usually with a lawyer, and furnishes a bail bond. After the 2026 amendments, with maximum punishment of two years for a first offence, the trial follows the simpler summons case procedure.

How to reply to a prosecution show cause notice

Treat the show cause notice as your best chance to stop the case. Once a complaint is filed, getting out of it takes years or a compounding fee. A reply that goes to the facts, with documents, persuades the sanctioning authority far more often than people expect, particularly where the tax has been paid and the default had a real explanation.

When Advocate B.K. Singh reads a prosecution show cause notice, the first thing he checks is the status of the penalty and appeal on the same issue. If the penalty for under-reporting has been deleted on merits, or granted immunity, the prosecution for the same year usually cannot stand, and the reply should say so with the order attached. If the appeal is pending, the reply should explain why the addition is disputed and ask the department to wait for the appellate outcome.

The reply should also deal with wilfulness. Evasion and false verification are offences only if the act was wilful. A return filed late because the books were with an auditor who fell ill, a TDS payment delayed because the bank account was frozen, a figure taken from a wrong Form 26AS entry: each of these, with proof, goes to reasonable cause, which section 486 of the new Act (old section 278AA) treats as a defence for several offences. Finally, if compounding is a realistic option, the reply can say that you intend to apply, which sometimes leads the department to hold back while the application is processed.

How a prosecution runs once the complaint is filed

1. Hearing before cognizance, then summons

   For complaints filed after 1 July 2024, section 223 BNSS requires the magistrate to give the accused a chance to be heard before taking cognizance. Use it: point out defects in sanction, a deleted penalty, or a director with no role. If the court takes cognizance, it issues summons.

2. Appearance and bail

   The offences are bailable and non-cognizable, so you appear and furnish a bail bond. You can apply for exemption from personal appearance on later dates, which courts usually grant to a working person if a lawyer is present.

3. Notice of accusation

   In a summons case the court tells the accused the particulars of the offence and asks whether he pleads guilty. A plea of not guilty takes the case to evidence. This is also the stage to raise objections to sanction or limitation.

4. Prosecution evidence

   The department examines the assessing officer, the sanctioning authority if needed, and produces the returns, assessment orders and penalty orders. Cross-examination usually focuses on wilfulness and on what the officer actually knew.

5. Defence evidence and arguments

   The accused can lead evidence of reasonable cause, payments made, appellate orders and the conduct of the auditor or accountant. Arguments follow, then judgment.

6. Appeal or revision

   A conviction can be appealed to the Sessions Court; orders taken before trial can be challenged in revision or under section 528 BNSS in the High Court. Our post on criminal appeal or revision explains which route fits which order.

Defences that matter in income tax prosecution

The presumption is the first thing to understand. Section 490 of the new Act (old section 278E) presumes a culpable mental state for offences that need one, and the accused can rebut it only by proving, beyond reasonable doubt, that he had no such state of mind. That is a heavy burden, so the defence must be built on documents, not on general statements of good faith.

The penalty link is the strongest defence where it applies. The Supreme Court held in K.C. Builders v Assistant Commissioner of Income Tax (2004) that where the finding of concealment is set aside by the appellate authority on merits, the prosecution based on the same concealment cannot continue. The new Act goes further for evasion and false verification: section 491(3) bars prosecution under sections 478 and 482 for a tax year where the penalty for under-reporting has been reduced or waived under the immunity provision in section 469 (the old section 270AA).

For non-filing, two arguments fail more often than not. Filing a belated return does not, by itself, wipe out the offence of not filing on time, and the pendency of assessment or appeal does not by itself stop the trial, as the Supreme Court held in Sasi Enterprises v Assistant Commissioner of Income Tax (2014). What does help is showing that the tax payable was small after TDS and advance tax, that there was reasonable cause for the delay, and that the return was filed before any notice.

For TDS defaults, the key fact is the payment date. After the 2024 amendment, carried into section 476(2), there is no offence if the TDS was paid to the government on or before the due date for filing the TDS statement for that period. For later payments, delay with interest paid, financial distress backed by records, and a short default period all help both in court and in compounding.

Are directors and partners personally liable?

They can be. Section 487 of the new Act (old section 278B) makes every person who was in charge of and responsible to the company for the conduct of its business at the time of the offence liable along with the company, unless he proves that the offence was committed without his knowledge or that he took all due diligence to prevent it. Directors, managers and secretaries can also be liable if the offence was committed with their consent, connivance or neglect. The same applies to partners of firms.

In practice the complaint must contain specific averments about each person's role. A bare statement that all directors were in charge of the business is often challenged, especially for non-executive and independent directors who had no role in finance. A director who had resigned before the default, with the resignation filed with the ROC, should raise that at the first opportunity, through a discharge application or a petition to the High Court. Our post on discharge applications explains how that works in a criminal case generally.

The principal officer of a company, typically the person treated as such by the assessing officer, is often the one named in TDS prosecutions. If you were named without notice that you were being treated as principal officer, that is a point worth raising.

What is compounding of an income tax offence?

Compounding is a settlement of the criminal case with the department. You pay the tax, interest and penalty due, plus compounding charges, and the competent authority passes an order compounding the offence. The prosecution, if already filed, is then brought to an end in court, and if not filed, it is never started. Compounding is not an admission of the offence and is not a conviction.

The power sits in section 491(4) of the new Act and section 279(2) of the old: the Principal Chief Commissioner, Chief Commissioner, Principal Director General or Director General may compound any offence under the chapter, either before or after the institution of proceedings. The CBDT can issue directions on how this is done, and it has: the current guidelines are dated 17 October 2024, with clarifying FAQs issued on 17 March 2025. They were framed under the 1961 Act; check whether a revised version has been issued for the new Act before you file.

Compounding is not a matter of right. The authority can refuse in cases of habitual offending, or where the person has not paid the tax and other dues, and the guidelines spell out the conditions. But the 2024 guidelines made it far more accessible than before, and for most first-time defaulters who have paid the tax it is the realistic way out.

What changed in the 2024 compounding guidelines

The October 2024 guidelines replaced the 2022 version. The changes that matter most to an applicant:

• No time limit. The earlier rule that an application had to be filed within a fixed period of the complaint was removed. You can apply at any time, even after the prosecution has reached trial.
• All offences compoundable. The old split into categories, and the list of offences that could never be compounded, was dropped. Offences relating to search orders, previously excluded, can now be compounded.
• One fee per application. A fee of ₹25,000 for a single application, or ₹50,000 for a consolidated one covering several offences or years, adjustable against the compounding charges.
• Simpler TDS charges. For TDS defaults, compounding charges are a single rate of 1.5% per month or part of a month on the tax in default, for the period of default. Charges for other offences are set out in an annexure to the guidelines.
• Co-accused and companies. A company and its directors can apply separately or together, without paying separate fees. Companies in insolvency can apply, subject to conditions tied to the resolution stage.
• Repeat applications cost more. A second or later application for an offence already covered earlier attracts higher multiples of the charges. Rejection on merits bars a fresh application for the same offence and year.

How to apply for compounding

1. Pay the dues first

   Pay the tax, interest and penalty for the offence and years concerned, or have the payment ready. An application with unpaid dues is treated as defective and returned.

2. Identify the competent authority

   Applications go to the Principal Chief Commissioner or Chief Commissioner having jurisdiction over your case. For TDS defaults across several TANs, the guidelines name the office where the default is largest.

3. File the application with the fee

   File the application in the prescribed format, with details of the offence, the years, the prosecution if pending, and the fee. A consolidated application can cover several offences and years.

4. Respond to the department's working

   The department works out the compounding charges under the guidelines and may ask for clarifications. Check the working: the period of default and the amount on which charges are calculated are common sources of error.

5. Pay the charges and obtain the order

   Once the charges are communicated, pay them within the time allowed. The compounding order is then passed and, where a case is pending, filed in court so the prosecution can be closed.

Documents for a prosecution reply or a compounding application

Should you fight the case or compound it?

It depends on the strength of the defence and the cost of compounding. If the penalty has been deleted on merits, if the director named had no role, or if the sanction is plainly defective, fighting the case, or getting it quashed early, is often the better course. Compounding in those cases means paying for an offence that may not exist.

If the default is real, the tax has been paid, and the only question is mental state, compounding is usually the sensible choice. The charges are known, the process takes months rather than years, and there is no risk of conviction. After the 2026 changes the risk of jail is lower than before, but a conviction for a tax offence still matters for licences, directorships, visas and the next prosecution, which is punished more severely as a second offence.

There is also a middle path. You can contest the prosecution while a compounding application is pending, and many courts will adjourn the trial for a reasonable time to let the department decide. If compounding is refused, the defence continues.

Common mistakes in income tax prosecution cases

The first is ignoring the show cause notice because the tax has been paid. Payment helps, but it does not answer the notice; a reply is still needed. The second is skipping court dates. Non-cognizable and bailable as these offences are, a person who does not appear after summons can face warrants, and the bail bond can be forfeited.

The third is letting the penalty appeal lapse. Because the outcome of the penalty often decides the prosecution, an unappealed penalty order on the same facts weakens the defence badly. The fourth, for companies, is leaving every director to fend for himself. A coordinated response, with clear evidence of who handled tax and accounts, protects those who had no role.

The last is applying for compounding late and badly. An application with unpaid dues, the wrong years or a missing co-accused is returned, and a later fresh application can attract higher charges. It is worth getting it right the first time. For advice on structuring tax compliance in a business, our corporate law consultancy page explains how we work with companies and their accountants.

What to do this week if you have a prosecution notice or court summons

• Note the reply date on the show cause notice, or the first hearing date on the summons.
• Find out which Act and which section applies, by the year of the default.
• Collect the assessment and penalty orders and check the status of every appeal.
• Pay any undisputed tax, interest and penalty, and keep the challans.
• Gather evidence of reasonable cause for the delay or mistake.
• For a company, list who was actually in charge of tax and accounts in that period.
• Decide, with advice, whether to reply on merits, apply for compounding, or both.
• Do not miss the first court date; arrange a bail bond and a lawyer to appear.

Getting the notice read before you reply

Income tax prosecution is now less frightening than it was, but it still ends in a criminal record if handled badly, and the cheapest point to stop it is before sanction. If you want an advocate to read the prosecution notice or the complaint with your assessment papers, the team of Advocate B.K. Singh at B.K. Singh & Associates can look at them with your accountant and tell you whether to contest, compound or both. Send the papers through our online enquiry page, or read about our work in criminal courts in Delhi. Where a search has already taken place, our post on rights during a search covers the agency side.