Tax penalty demand recovery adjusted from refunds during appeal-recovery above 20% held unlawful; excess must be refunded.

Where an assessee sought stay of recovery pending first appeal, the HC held that, absent any PCIT direction permitting recovery above 20% of the disputed demand, the AO was bound by CBDT instructions limiting recovery as a pre-condition for stay. Since the revenue had already recovered, by adjustment of refund, an amount exceeding 20% of the disputed penalty demand for AY 2021-22, the recovery was unlawful. The HC directed the revenue to retain only 20% of the disputed penalty and refund the balance to the assessee within four weeks of upload of the order.

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1. ISSUES PRESENTED AND CONSIDERED

(i) Whether, pending disposal of an appeal before the First Appellate Authority, the tax department can adjust accrued refunds against a disputed penalty demand so as to recover/retain an amount exceeding 20% of the disputed demand, in the absence of any direction from the competent authority permitting recovery above 20%.

(ii) Whether, upon the Assessing Officer's admission that recovery by refund adjustment has exceeded 20% of the disputed demand, the assessee is entitled to a direction for refund of the excess amount and retention limited to 20%.

2. ISSUE-WISE DETAILED ANALYSIS

Issue (i): Legality of recovery/adjustment beyond 20% of disputed demand pending first appeal

Legal framework (as discussed by the Court): The Court considered the CBDT Instruction dated 21 March 1996 as modified by the Office Memoranda dated 29 February 2016 and 31 July 2017. The Court noted that the Office Memorandum dated 31 July 2017 standardizes the stay process and permits the Assessing Officer to insist on recovery of 20% of the disputed demand as a pre-condition for stay of the balance demand. The Court further noted that deviation from 20% (more or less) is contemplated only in specified circumstances, requiring reference to and decision by the administrative Pr. CIT/CIT on the quantum/proportion to be paid for granting stay.

Interpretation and reasoning: The Court found it undisputed that (a) the penalty demand was under challenge before the First Appellate Authority, (b) refunds for subsequent years were adjusted against the disputed penalty demand, resulting in recovery exceeding 20% of the disputed demand, and (c) the Assessing Officer had not received any direction from the PCIT to recover more than 20% as a condition for stay. The Court treated the CBDT instructions as binding on the department in the context of recovery/stay pending appeal and held that adjustment leading to recovery beyond 20% without competent authorization was contrary to these instructions.

Conclusion: Recovery by adjustment of refunds beyond 20% of the disputed demand, without any direction from the PCIT permitting such excess recovery, was held contrary to the applicable CBDT instructions and therefore impermissible in the facts found.

Issue (ii): Entitlement to refund of the excess amount and limitation of retention to 20%

Legal framework (as discussed by the Court): The same CBDT framework was applied to determine the permissible extent of retention/recovery pending appeal, i.e., 20% of the disputed demand absent approval for a higher amount.

Interpretation and reasoning: The Court noted that the Assessing Officer's order acknowledged that more than 20% had been collected by way of refund adjustment while the appeal was pending, yet the excess was not refunded. Given the admitted excess recovery and the absence of authorization to exceed 20%, the Court directed that only 20% of the disputed penalty be retained and the balance be refunded. The Court accepted the department's submission that four weeks from uploading of the order would be a reasonable time to effect the refund.

Conclusion: The Court directed the respondents to retain only 20% of the disputed penalty demand for the relevant assessment year and to refund the balance excess adjustment within four weeks from uploading of the order.

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