The Overlooked Compliance Faultline
Interest and penalty under GST may appear to be routine statutory outflows, but their treatment under the Income-tax Act determines whether they are legitimate deductions or permanent disallowances.
Every year, auditors find differences between books, GST portal payments, and tax audit reporting, triggering notices and queries.
The reason is simple — what seems like a single GST payment actually contains three distinct legal species: tax, interest, and penalty.
Each carries its own consequence under Section 37(1) of the Income-tax Act and distinct reporting under Form 3CD.
This article consolidates the law, interpretation, and professional handling of GST interest and penalty for AY 2025-26.
The Legal Character under GST Law
| Nature | Section | Trigger | Legal Essence |
|---|---|---|---|
| Interest on delayed tax payment | 50(1) | Failure to pay GST within due date | Compensatory — compensates Government for time value of money |
| Interest on undue ITC utilisation | 50(3) | Wrong availment or utilisation of ITC | Compensatory, but arises only after determination of wrong credit |
| Penalty (non-fraud) | 73 | Non-fraudulent short payment or omission | Penal |
| Penalty (fraud/suppression) | 74 | Fraud, wilful misstatement, suppression | Penal / deterrent |
| Late fee for delayed return | 47 | Delay in GSTR-3B/GSTR-1 filing | Procedural penalty |
The jurisprudence draws a clear distinction:
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Interest compensates for delayed payment — not a punishment.
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Penalty and late fee are punitive, arising from default or contravention.
This characterization is central to tax deductibility.
Income-tax Treatment — Section 37(1) Interpretation
(A) Interest on GST — Allowable Expenditure
Interest under Section 50(1) or 50(3) of the CGST Act is a compensatory payment for use of government funds, allowable as a business expenditure u/s 37(1).
Judicial authorities consistently uphold this view:
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Pratibha Processors v. UOI (1996) 88 ELT 12 (SC) — Interest is compensatory, not penal.
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CIT v. Ahmedabad Cotton Mfg. Co. Ltd. (1994) 205 ITR 163 (SC) — Statutory interest deductible under Section 37(1).
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DCIT v. Sesa Goa Ltd. (2013) 140 ITD 458 (Panaji) — Interest on delayed duty payment allowed as business expenditure.
Caution:
Interest on wrongly availed ITC is deductible only after determination under Section 73 or 74; self-assessed but unconfirmed liabilities should be carefully substantiated.
Result: Deductible in computing business income when genuinely compensatory and supported by records.
(B) Penalty and Late Fee — Not Deductible
Penalties and late fees under Sections 73, 74, and 47 are hit by Explanation 1 to Section 37(1), which bars deduction of any expenditure incurred for purposes that are an offence or prohibited by law.
Judicial precedents are categorical:
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Haji Aziz & Abdul Shakoor Bros. v. CIT (1961) 41 ITR 350 (SC) — No deduction for penalty for law breach.
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Maddi Venkataratnam & Co. (P) Ltd. v. CIT (1998) 229 ITR 534 (SC) — Even if incidental to business, penalty is not allowable.
Result: Fully disallowed while computing taxable income, though recorded in accounts for completeness.
Accounting Recognition & Disclosure Logic
| Nature | P&L Head | Books Treatment | Documentation Essentials |
|---|---|---|---|
| Interest on GST | Finance Cost / Statutory Interest | Charge to P&L | Payment challan, computation, portal ledger |
| Penalty / Late Fee | Other Expenses / Exceptional Item | Charge to P&L but add back in computation | DRC order, portal evidence |
| Direct Portal Payment (not in books) | Not in P&L | Report separately in Form 3CD (Clause 26) | GST Cash Ledger extract |
Professional Advisory:
Keep separate ledgers for “Interest on GST” and “Penalty/Late Fee”. Merging both under “Statutory Dues” compromises deductibility analysis and invites audit queries.
Tax Audit (Form 3CD) Implications
| Clause | Disclosure Requirement | Practical Handling |
|---|---|---|
| Clause 21(d) | Report all penalties or late fees inadmissible u/s 37(1). | Mention description and amount debited. Interest not required here. |
| Clause 26 | Report payments made but not routed through P&L (e.g. directly through GST portal). | Capture any interest/penalty auto-adjusted in GSTR-3B but not booked. |
| Clause 44 | GST-wise expenditure bifurcation. | Classify such items under Column (7) — “Expenditure not liable to GST.” |
Illustrative Mapping (Clause 44):
| Particular | Amount (₹) | GST Applicability | Clause 44 Column |
|---|---|---|---|
| Interest on delayed payment | 18,000 | Not liable | Col. (7) |
| Penalty under Section 74 | 5,000 | Not liable | Col. (7) |
| Late fee for GSTR-3B delay | 2,000 | Not liable | Col. (7) |
Integrated Legal-Audit Matrix
| Nature | CGST Section | Legal Character | Income-tax Treatment | Tax Audit Disclosure | Key Advisory |
|---|---|---|---|---|---|
| Interest on delayed tax | 50(1) | Compensatory | Allowable u/s 37(1) | Clause 44 (Col. 7) | Ensure booked in accounts, supported by challan. |
| Interest on wrong ITC | 50(3) | Compensatory (after determination) | Allowable | Clause 44 (Col. 7) | Verify adjudication; self-computed interest needs basis. |
| Penalty (non-fraud) | 73 | Penal | Disallowed u/s 37(1) | Clause 21(d), 44 (7) | Maintain computation and add-back evidence. |
| Penalty (fraud/suppression) | 74 | Penal / Deterrent | Disallowed | Clause 21(d), 44 (7) | Mandatory disallowance. |
| Late fee for return | 47 | Penal | Disallowed | Clause 21(d), 44 (7) | Treat conservatively. |
Audit Red Flags & Compliance Safeguards
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Interest auto-debited on portal but not booked — ensure Clause 26 disclosure and reconciliation with GSTR-3B.
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Combined “GST dues” account — split before audit; otherwise deductibility classification fails.
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Unsupported self-computed interest — retain basis of computation; officers question ad-hoc provisions.
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Penalty wrongly deducted — review add-back in computation statement; disallow under Explanation 1 to Section 37(1).
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Clause 44 precision — report only non-GST-liable outflows under Column (7); avoid duplication.
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Documentation — preserve DRC orders, payment challans, and reconciliation sheets for future assessments.
Professional Closing Insight
The thin line between compensatory interest and penal levy carries heavy tax implications.
While both arise from the same statute, their treatment under the Income-tax Act depends solely on purpose and intent.
A sound professional approach therefore demands that we:
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Classify by character, not by caption,
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Disclose with documentary precision, and
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Defend deductibility through evidence, not explanation.
In the present era of GST–Income-tax data integration, accuracy in these disclosures defines both tax sustainability and audit credibility.
“Errors of classification invite questions of intent.”
Hence, every compliance professional must treat GST interest and penalty not as routine payments, but as markers of accounting integrity.
