In cases where tax liability arose because of the retrospective amendment to the law or a court ruling, the interest payable on the demand will be waived, it said.
"However, no reduction or waiver of such interest shall be ordered unless the principal demand... Stands fully paid or satisfactory arrangements for payment of the principal demand have been made," CBDT guidelines to Chief Commissioner of Income Tax and Director General of Income Tax said.
The guidelines came seven weeks after the Direct Tax Dispute Resolution Scheme, announced by Finance Minister Arun Jaitley on February 28 last year, closed.
The scheme, which closed on January 31, provided for waiver of interest and penalty if the principal amount involved in retrospective tax cases is paid and all appeals against the government challenging the constitutional validity of the back-dated amendment to Income Tax laws are withdrawn.
UK's Cairn Energy plc has been slapped with over Rs 29,000 crore in tax demand including Rs 10,247 crore in principal due, for alleged capital gain it made in 2006 when it transferred its India business into a new subsidiary, Cairn India, and got it listed.
Simultaneously, the tax department also raised a tax demand of Rs 20,495 crore in Cairn India for failing to deduct withholding tax on alleged capital gains made by its erstwhile parent company Cairn Energy in 2006-07 when it reorganised India business.
Neither Cairn Energy nor Vodafone participated in the scheme that closed on January 31 and has dragged India to arbitration contesting the demands.
The tax department in the guidelines said the cases where the interest can be waived include ones where tax was not deducted because of an order passed by the High Court but the same has been reversed by "any retrospective amendment of law or a decision of the Supreme Court of India or a decision of a larger bench of the jurisdictional High Court."
Earlier this month, tax tribunal ITAT upheld levy of Rs 10,247 crore capital gains tax on UK's Cairn Energy Plc but has held that interest cannot be charged on it as the demand was raised using retrospective tax legislation.
The tribunal had also said that Cairn India should have withheld tax on capital gains made by its parent company.
The guidelines state that interest can be waived in cases where tax deduction at source could not happen because of seisure of books of accounts and other documents by the Income Tax department.
The same can also be done in cases where the default is related to "non-deduction or a lower deduction of tax in respect of a payment made to a non-resident (including a foreign company) being a resident of a country or specified territory outside India with whom India has entered into an agreement."
Commenting on the circular, Amit Maheshwari, Partner Ashok Maheshwary and Associates LLP said: "The interest waiver process will become much faster and efficient. Even existing unresolved waiver requests are covered and this will provide an efficient and quick resolution."