Strict construction of penalty provisions bars penalty where advance tax cleared arrears and section 271(2) cannot create liability.

Penalty under section 271(1)(a) was construed strictly as a penal provision, requiring both default in filing the return and satisfaction of the liability conditions in section 271(1)(i). Where the assessee had paid advance tax and had no tax arrears at the relevant time, it did not fall within the class of persons liable to penalty. Section 271(2) was held to operate only after liability under section 271(1)(a) read with section 271(1)(i) is first established, and its legal fiction was confined to computation. On that footing, section 271(2) was not attracted and penalty was not leviable.

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Issues: Whether a registered firm which had paid advance tax and had no tax arrears at the relevant time was liable to penalty under section 271(1)(a) read with section 271(1)(i) of the Income-tax Act, 1961, and whether section 271(2) applied to enhance the penalty as if the firm were unregistered.

Analysis: The liability to penalty under section 271(1)(a) was held to arise only when the default in filing the return was read with the method of computation and the conditions stated in section 271(1)(i). The provisions were construed strictly as penal provisions in a taxing statute, and the Court held that where the assessee had already paid the assessed tax in advance and was not in arrears, it did not fall within the class of persons liable to penalty. Section 271(2) was treated as operating only after liability under section 271(1)(a) read with section 271(1)(i) is established, and its legal fiction was confined to the mode of computation once such liability exists.

Conclusion: Section 271(2) was not attracted, and the assessee was not liable to penalty for the assessment year in question.

Final Conclusion: The reference was answered against the Revenue and in favour of the assessee, affirming cancellation of the penalty.

Ratio Decidendi: Penalty under section 271(1)(a) can be imposed only on a person who is both in default and within the class made liable by section 271(1)(i); if advance tax has already discharged the assessed tax so that no arrears remain, section 271(2) cannot be invoked to create penalty liability.

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