Finance Bill 2026: Rationalised Tax/Penalty for Unexplained Income (S. 102-106)

Clauses 46, 84 and 86 of the Finance Bill, 2026 bring significant changes to the taxation and penalty framework applicable to deemed incomes under sections 102 to 106 of the Income-tax Act, 2025. These sections cover income in the nature of:

• unexplained cash credits,
• unexplained investments,
• unexplained money or assets,
• unexplained expenditure, and
• certain amounts relating to hundi or negotiable instruments.

Until now, such income was subject to a high tax rate and a stand-alone penalty provision, creating a disproportionately severe regime. The proposed amendments seek to rationalise the tax rate and integrate penalties with the general misreporting framework.

All changes take effect from 1 April 2026, applicable from tax year 2026-27 onwards.

1. Existing Legal Position Prior to Finance Bill, 2026

Taxation under Section 195

Section 195 of the Income-tax Act, 2025 governs taxation of income referred to in sections 102 to 106. Under section 195(1), such income is currently taxed at a flat rate of 60%, irrespective of the assessee’s normal rate of tax.

Penalty under Section 443

Section 443 provides for a separate penalty where income determined by the Assessing Officer includes income referred to in sections 102 to 106. The penalty is quantified at 10% of the tax payable under section 195.

This structure operates independently of the general penalty provisions relating to under-reporting or misreporting of income.

2. Reduction in Tax Rate on Unexplained Income (Clause 46)

What Clause 46 Changes

Clause 46 proposes to amend section 195 to reduce the tax rate applicable to income referred to in sections 102 to 106:

• Existing rate: 60%
• Proposed rate: 30%

The reduction applies uniformly to all categories of income covered under sections 102 to 106.

Practical Effect

• The amendment removes the exceptionally high tax rate that was earlier applicable.
• The tax treatment of unexplained income becomes more proportionate, while retaining deterrence through penalty provisions.

3. Omission of Separate Penalty and Integration with Misreporting Provisions (Clauses 84 and 86)

Omission of Section 443 (Clause 86)

Clause 86 proposes to omit section 443 entirely. As a result, the stand-alone penalty specifically applicable to income under sections 102 to 106 will cease to apply.

Inclusion under Misreporting Framework Section 439 (Clause 84)

Clause 84 amends section 439, which governs penalties for under-reporting and misreporting of income. Key Amendments:

1. Section 439(11) (which enumerates cases of misreporting of income) is amended to expressly include income referred to in section 195(1)(b), i.e., income covered under sections 102 to 106.
2. A new section 439(13A) is inserted to provide that:
   • where additional income-tax is paid in accordance with section 267(5)(ii),
   • the income on which such additional tax is paid shall not be used as the basis for levy of penalty.

Consequence of the Change

• Income under sections 102 to 106 will now be treated as misreporting of income, rather than being governed by a separate penalty provision.
• Penalty exposure will flow only through section 439, subject to availability of immunity or settlement mechanisms.

4. Combined Effect of the Amendments

5. Legislative Intent and Policy Rationale

The amendments indicate a deliberate shift towards:

• rate rationalisation,
• removal of fragmented penalty provisions, and
• alignment with a unified misreporting-based penalty structure.

While the tax rate is reduced, the inclusion of such income within the misreporting framework ensures that deterrence is preserved, particularly in serious cases.

6. Implications for Taxpayers and Practitioners

• Lower headline tax rate does not imply automatic relief, as misreporting penalties may still apply.
• The availability of additional tax payment mechanisms and immunity provisions becomes strategically important.
• Litigation strategy for additions under sections 102 to 106 will need reassessment in light of the new framework.

Conclusion

Clauses 46, 84 and 86 of the Finance Bill, 2026 fundamentally restructure the treatment of unexplained income under the Income-tax Act, 2025. By reducing the tax rate to 30% and subsuming penalties within the misreporting regime under section 439, the amendments replace a rigid and isolated framework with a more coherent and integrated enforcement model, effective from tax year 2026-27 onwards.

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