Overview of Income Tax Scrutiny Advisory

The Income Tax Department reviews thousands of income tax returns filed by Indians every year and monitors and reviews the patterns of an individual’s income tax return filing. Income tax returns are selected either on a random basis for review or done deliberately if they fall within the set criteria or pre-set watch lists prepared by the Income Tax Department itself. Many of you receive such scrutiny notices; however, you should not be rattled by such notices.

Such scrutiny notices are sent by the Income Tax Department every year to businessmen and salaried individuals who file their income tax returns. It is a misconception that receiving a scrutiny notice makes you guilty of some crime. Instead, these notices are a routine action taken by the Income Tax Department as part of their check-up. The purpose of issuing such notices is to assess the pattern of Income Tax Return filing and to ensure that filing is done in accordance with the standard protocols and norms laid down by the Income Tax Department. 

What is Income tax scrutiny? 

When the income tax department sends a notice to a taxpayer under section 143(2) of the Income Tax Act summoning him/her to make enquiries regarding the returns filed in the assessment year, the process of income tax scrutiny is initiated if the income tax department has reasons and evidence to believe that the income and expenses declared in the returns have been incorrectly stated. The process of income tax scrutiny is aimed at providing the taxpayers with an opportunity to support the accuracy of their returns filed through necessary paperary evidence.

Applicable Legislative Provisions and statutory authority

According to Section 143(3) of the Income Tax Act, 1961, a detailed assessment is carried out of the income tax returns which is also referred to as scrutiny assessment.

The process of such income-tax scrutiny assessment is initiated to check whether:

1. The assessee has not understated the income or not;
2. The deductions, expenses, exemptions, losses etc. computed are legally and factually correct or not.

In order to satisfy itself regarding the claims made in the returns, the Assessing Officer carries out a detailed scrutiny. If the assessing officer finds any discrepancy, omission, inaccuracy etc., while examining the returns, then the officer can initiate his own assessment of the assessee’s returns, taking into consideration the relevant facts, under section 143(3) of the Income Tax act he has the power to launch suo moto inspection of the report These income tax scrutiny assessments are made under section 143(3) of the Income Tax Act. The assessing officer can levy penalties and charge additional interests, and may initiate prosecution proceedings against theassessee.  

Reasons for issuing Income Tax Scrutiny notice

Following are some of the reasons that may trigger the income tax scrutiny notice:

When you do not file an income tax return: 

This is one of the most common reasons for the initiation of scrutiny assessment when the income tax returns are not filed for the current financial year or multiple years. It can also happen that you fail to disclose a particular income in a particular financial year, and the difference in the calculation of the income tax may not match with the calculation done by the Income Tax department.

Rapid rise or fall in income:

In cases where a sudden or rapid rise or fall in the income is observed within a short span of time, the income tax department is alerted and may check the details of your income tax filed. For example, if the income tax return has risen from Rupees 5 lakhs to 50 lakhs in a financial year, then it may alert the Income Tax department.

Executing high-value transactions during a financial year:

In cases where high-value transactions are executed in a financial year, there is a high possibility of receiving a scrutiny notice from the income tax department. For instance, if you purchase a high-value asset or receive a huge sum in your account, which is not part of your normal income, then there is a possibility that the income tax department may send you a scrutiny notice.

Mismatch in TDS credit:

If a mismatch in the TDS credit has been observed by the Income Tax department, a scrutiny notice can be served to the concerned person.

Understating income or over-computing losses:

If the Income Tax department believes that you have understated the amount of income earned or that more loss has been computed in comparison to the previous financial year, a scrutiny notice can be issued against you. In businesses where the income and losses are highly volatile, the department usually sends notices to such businesses.

Failure to declare exempted income:

There are instances where you fail to disclose exempted income in the income tax return filings, such as the income generated from LTCG, interest income earned from a Bank Account, or any gifts received fall within the exempted category. In such cases too, a scrutiny assessment notice can be issued.

Apart from the above-mentioned instances, there are certain cases where compulsory scrutiny notices are issued by the Income Tax Department. The only thing you can do is to take measures to avoid happening of such cases. These cases are as follows:

1. Cases where an addition in an earlier assessment year of more than Rupees 10 lakhs on a substantial and recurring question of law or fact is confirmed in appeal or is pending before an appellate authority fall under compulsory scrutiny.
2. Cases where an addition in an earlier assessment year on the issue of transfer pricing of more than Rupees 10 crore on a substantial and recurring question of law or fact is confirmed in appeal or is pending before an appellate authority also fall under compulsory scrutiny.
3. All assessments relating to Survey under s. 133A of the Income Tax Act, not including the cases where no books of accounts/ necessary papers have been impounded and returned income not including any disclosure made during the survey is not less than the returned income of the preceding assessment year.Those cases where concealment of income is involved are selected for scrutiny notices.
4. The cases where some specific inputs or verifiable information pointing out tax evasion has been given by the government to the Income Tax Department.
5. Where the Income Tax Department has not granted registration under section 12AA of the Income Tax Act, yet the assessee has not stopped claiming exemption under section 11 of the Act.
6. Cases, where the approval has been denied under section 10(23C) of the Income Tax Act; yet the assessee has been found claiming exemption under the aforesaid section.
7. Computer-aided Scrutiny systems: cases are selected for scrutiny on the broad-based selection filters, which have been carefully designed by the DGIT. There is no element of subjectivity involved in the selection of such cases.

How should you respond to Income tax scrutiny notices?

Stop panicking:

You must not panic on receiving an income tax scrutiny notice. It can be a result of a random selection by the department, and there is nothing to worry about the same. It may be a regular check on the income and return statements. If you have nothing to hide from the income tax department, then you should not worry or panic about the notice. All that is expected from you is to draft a proper response for any unusual pattern in the income, expenses or deductions claimed in a financial year.

Thoroughly understand the particulars of the notice:

When you receive the scrutiny notice, the first thing to do is thoroughly understand the particulars of the notice and check all the relevant details of the notice, such as details of your PAN card, your name and the financial year in which the notice has been sent.

Check the details of the office and assessing officer:

There is also a need to verify the details of the notice and find the relevant provisions under which the notice has been issued. At this stage, you may require the assistance of professionals to understand the legal provisions under which the notice has been issued and start preparing your reply in accordance with the terms mentioned in the notice.

Start arranging the necessary papers:

Even if you believe that you have not understated your income or over-calculated your deductions and losses, or underpaid taxes, still you should arrange all the relevant necessary papers to support your claim as they come in handy at the time of the investigation. Some of the necessary papers that can be demanded are the salary slips etc.

Do not ignore such notices:

You must never make the mistake of ignoring such notices or take them lightly. Ignoring the notice may complicate matters for you and weaken your stand against the IT department. They may believe that their claims are indeed true and may impose severe penalties on you for your behaviour.

Do not hide any information from the IT department:

The income tax department has all the records of transactions done by you in the previous financial years. So do not make the mistake of hiding any information from the income tax department. Instead, show the details of the transactions in the first place. By hiding any information, you may expose yourself to further proceedings and may be liable for heavy penalties or fines.

Respond before the due date:

You must always deal with the matter with utmost sincerity and must pay due attention to requirements. Any information sought or necessary papers to be submitted to the Income Tax Department must be done before the due date. Do not delay in responding to the notice and always comply with the given deadlines.

Take professional assistance:

There is a possibility that you may not understand the legal terminologies used in the notice, and ignoring such terms and not responding to those terms properly is not the right way of dealing with the issue. In case you are not hundred per cent sure of the particulars of the notice, it is advised to take the professional assistance of a lawyer, chartered accountant, company secretary etc.

Maintain the record of the notices sent:

It is always better to maintain the record of the serial number or the notice number for reference purposes and for future communication with the Income Tax Department. 

Consequences of not responding to Income Tax scrutiny notices

Following are the consequences that may accrue if you fail to respond to the Income Tax Scrutiny notices within the time allotted:

Best Judgment Assessment:

The assessing officer will complete the scrutiny on the basis of ‘best judgment assessment’ under section 144 of the Income Tax Act, where the assessment is concluded and finalised on the judgment of the officer as he/she may deem fit; or

Imposition of penalty:

Recurring penalties of Rupees 10,000 can be imposed on you for every failure under section 271(1)(b); or

Warrant for search and seizure:

There is a possibility that a warrant can be issued against you for conducting search and seizure.

Prosecution:

Prosecution proceedings may also be initiated against you and you can be punished with imprisonment for a term with or without a fine under section 276 of the Income Tax Act.