Illegal collection penalty under VAT cannot apply where no tax was collected and the underlying transaction was exempt.

Section 40(2) of the Tamil Nadu VAT Act could not be invoked where the dealer had not collected any tax and the deduction was made by the contractee under the TDS mechanism in Section 13. The statutory scheme provided for deduction and refund of TDS amounts, subject to adjustment of any arrears, and once the underlying works contract was accepted as exempt, the retained amount had to be refunded. Penalty for illegal collection was therefore inapplicable because Section 40(2) presupposes collection in contravention of Section 40(1) and a corresponding opportunity of hearing. The adjustment of TDS towards penalty was impermissible.

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Issues: Whether penalty under Section 40(2) of the Tamil Nadu Value Added Tax Act, 2006 could be levied and TDS amount adjusted against the petitioner when the tax was deducted by the contractee in respect of a works contract later held to be exempt.

Analysis: The petitioner itself had not collected any tax; the deduction at source was made by the contractee under Section 13 of the Tamil Nadu Value Added Tax Act, 2006. That provision contains a specific mechanism for deduction and refund, and where the dealer establishes that the transaction is not liable to tax, the amount deposited is to be refunded after adjustment of arrears, if any. Section 40(1) and Section 40(2) deal with illegal collection of tax by a person or registered dealer, and penalty can be imposed only when there is collection in contravention of Section 40(1) and after reasonable opportunity of hearing. Since the petitioner did not collect tax and the assessment itself accepted the claim of exemption, Section 40(2) was not attracted. The adjustment of the TDS amount towards penalty was therefore impermissible.

Conclusion: The penalty under Section 40(2) and the adjustment of the TDS amount were unsustainable, and the petitioner was entitled to refund of the amount retained.

Ratio Decidendi: Penalty for illegal collection of tax cannot be imposed under the collection provision where the assessee neither collected the tax nor falls within the statutory prohibition, and TDS deducted by a third party must be refunded when the underlying transaction is held exempt.

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