There has been an increase in income tax notices. Here’s why and how to respond.

This article delves into the reasons behind the increase in income tax notifications and offers practical advice on how to respond to them effectively.

Reasons for the increase

The increase in these notices is largely due to the Income Tax Department’s increased focus on compliance and its efforts to identify discrepancies in financial reporting. These include:

• Incorrect filing of income tax return: One of the most common reasons for receiving an income tax notice is the selection of the wrong tax return form. For individuals, there are four forms: ITR 1, ITR 2, ITR 3 and ITR 4. Many taxpayers who earn income for the first time from capital gains or futures and options (F&O) trading mistakenly use ITR 1 or ITR 4, instead of ITR 2 or ITR 3. This can result in such income not being disclosed, leading to incorrect return notices.
• Inconsistency with Form 26AS: Taxpayers who filed their returns in June 2024 using Form 26AS data are now receiving notices due to discrepancies in income details. Some taxpayers did not verify their actual income with Form 26AS details, which at that time might not have reflected their income for the last quarter (January to March) of the 2024 tax year. This has led to under-reporting and subsequent demand notices.

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• Non-taxable donations: Gifts received from specified family members are exempt from income tax and there is currently no provision on income tax return forms to declare these gifts as non-taxable. Still, some people have received notices of demand for failure to pay tax on such gifts, highlighting a loophole in the reporting process.
• Unprocessed reviewed returns: Some taxpayers who filed a revised return after identifying errors on their original return have received notices based on their original returns. These notices are typically generated because the revised return has not yet been processed or because an automated inquiry requires additional verification by the taxpayer.

How to Respond to Income Tax Notices

• Check the notice: Always confirm the authenticity of a notice by checking it on the Income Tax Department’s e-filing portal under the “Pending Actions” tab. This is especially important due to widespread phishing scams, especially those related to tax refunds.
• Understand the type of notice: Notices are issued under different sections of the Income Tax Act, and each requires a specific response. For example, Section 139(9) deals with defective returns, while Section 143(1) deals with processing errors. Identifying the type of notice helps determine the actions required.
• Submit a timely response: Each notice includes a specific response time. For example, defective refund notices typically allow 15 days for rectification, while demand notices typically allow 30 days to respond. Meeting these deadlines is critical to avoiding penalties, interest charges, or legal action. Responding within the stipulated time demonstrates compliance and a willingness to cooperate with the tax authorities.

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• Correct errors by filing a revised return: If a notice highlights errors or omissions, correct them by filing a revised return or providing the necessary information. For example, notices issued under Section 139(9) for defective returns can be cured by correcting the errors and re-filing the return within the stipulated 15-day period.
• Pay additional taxes if necessary: In cases where a notice demands additional tax due to unreported income or discrepancies, immediately calculate and pay the correct amount, including applicable interest. It is important to note that in such cases, it is not necessary to file a revised return. Instead, you can respond to the pending demand directly through the e-filing portal dashboard under the Pending Actions tab.

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The increase in income tax notifications is also partly due to the expanded scope of compliance measures such as the reporting of financial transactions (SFT). Banks, financial institutions and other entities are now required to report high-value transactions, leading to increased scrutiny of taxpayers’ activities. Even minor discrepancies or unusual transactions can lead to a notification.

By responding quickly and accurately and seeking professional advice when necessary, taxpayers can ensure compliance, avoid delays in processing tax refunds, and minimize the risk of penalties.

Neeraj Agarwala is a partner at Nangia & Co LLP.