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India’s ambitious overhaul of its direct tax system — billed as a cornerstone of Prime Minister Narendra Modi’s vision for a transparent, investor-friendly economy — has come under sharp scrutiny from within the government’s own policy establishment.

A new working paper from NITI Aayog, the government’s apex policy think tank, warns that the Income-tax Act, 2025, despite modernizing the six-decade-old 1961 law, “remains shackled to a punitive legacy” and risks undermining the country’s credibility as a predictable investment destination.

An Old Law in New Clothes

The report, “Towards India’s Tax Transformation: Decriminalization and Trust-Based Governance,” describes India’s tax regime as “over-criminalized and fear-driven” — one that still assumes taxpayers are guilty until proven innocent.

While the new Act simplifies compliance and streamlines processes, it retains 35 criminal provisions that can lead to imprisonment for actions as minor as delays in filing returns or not providing electronic access to records.

“It is a system that criminalizes error as much as evasion,” the report states bluntly.

Such criticism carries weight: NITI Aayog is not an external critic but the government’s strategic policy arm. Its recommendation for “deep decriminalization” signals an internal recognition that India’s tax administration — long plagued by litigation, coercion and discretion — is incompatible with the government’s “trust-based governance” mantra.

Fear vs. Trust: Competing Models of Compliance

The paper’s core argument is philosophical. India’s fiscal transformation, it argues, cannot rest on legislative redesign alone but must be anchored in a new social contract between the state and taxpayer — one built on proportionality and trust, not fear and compulsion.

Drawing on global precedents, NITI Aayog notes that mature tax systems — such as those of the United States, United Kingdom and Australia — reserve criminal prosecution for wilful, fraudulent acts that threaten fiscal integrity. Ordinary procedural lapses are handled administratively through civil penalties and audits.

By contrast, India’s law still mandates imprisonment for 25 of its 35 tax offences, often without requiring proof of malicious intent.

“Such a framework deters investment, encourages litigation and erodes voluntary compliance,” the paper observes, adding that punitive enforcement “creates more fear than revenue.”

The Digital Dilemma

Perhaps most striking for international observers is NITI Aayog’s warning about digital overreach.

Under Sections 247 and 474 of the new Act, tax officers can compel individuals and companies to disclose passwords, encryption keys or other digital credentials to access data stored on personal devices or in the cloud.

Failure to comply is punishable with up to two years in prison — a measure the think tank says could breach constitutional guarantees of privacy and protection against self-incrimination.

The report describes these clauses as “compelled digital transparency” and cautions that they blur the line between legitimate fiscal oversight and state surveillance.

“India’s tax enforcement is entering the virtual domain without adequate guardrails,” it says, noting that comparable powers in countries like Australia and the UK apply only to national security or serious organized crime, not to routine tax probes.

Constitutional and Global Concerns

The paper cites the Indian Supreme Court’s jurisprudence on privacy (Justice K.S. Puttaswamy v. Union of India, 2017) and the principle of testimonial compulsion under Article 20(3) of the Constitution. Requiring citizens to reveal passwords, it argues, effectively forces them to testify against themselves — a “mental act” already recognized as protected by Indian courts.

For global technology investors and multinational corporations operating in India, this warning resonates beyond the tax code. It touches the wider concern about how India wields its expanding digital powers — from data localization mandates to surveillance-authority overlaps.

“NITI Aayog’s critique reads as a cautionary note for emerging economies digitizing their governance without embedding due process,” says a Delhi-based tax policy expert who contributed to the paper.

What Changed — and What Didn’t

The 2025 Act does repeal 13 offences from the old 1961 law — including several procedural defaults by company liquidators and receivers — a shift towards civil enforcement that aligns with India’s Jan Vishwas Act (2023).

But these reforms are modest. The law still criminalizes failure to pay tax deducted at source (TDS), delays in filing returns, and technical lapses in compliance. The presumption of culpable mental state (Section 490) continues to place the burden of proof on the accused.

In short, while India’s new tax law is cleaner and more digital, its ethos remains punitive.

Reform or Regression?

For investors, the stakes are clear. An unpredictable or fear-based enforcement environment inflates compliance costs and chills entrepreneurship.

NITI Aayog estimates that over 70% of tax prosecutions in India involve non-fraudulent, technical breaches, many of which could be resolved administratively.

“Decriminalization is not leniency,” the report insists. “It is intelligent enforcement.”

Its recommendations include:

• Full decriminalization of 12 minor offences;
• Intent-based prosecution for 17 others;
• Judicial oversight for all digital searches and seizures;
• Replacement of imprisonment with civil fines or compounding in procedural defaults.

If implemented, these reforms could bring India closer to OECD standards and ease its long-standing “tax terrorism” reputation among global businesses.

Balancing State Power and Economic Freedom

The report’s underlying tension mirrors a broader global debate: how far should governments go in digitizing enforcement without eroding civil liberties?

From China’s social credit tax enforcement model to Europe’s data protection regime, the spectrum is wide. NITI Aayog’s call places India closer to liberal democracies that prioritize proportionality and judicial oversight.

“The future of fiscal governance lies not in how much power the state can exercise,” the report concludes, “but in how responsibly it uses it.”

The Global Lens

For a country positioning itself as the world’s fastest-growing major economy and a key manufacturing alternative to China, India’s tax administration is more than a domestic policy issue — it is a signal of how the state treats enterprise, data and dissent.

The NITI Aayog paper, while couched in bureaucratic language, reads like an internal reckoning. India may have modernized its tax architecture, but as the report warns, “a digital and deterrent state cannot coexist with a trust-based economy.”

Until that paradox is resolved, India’s journey toward becoming a predictable, rule-based fiscal power will remain incomplete.