Each year, many salaried individuals claim deductions while filing their income tax returns ranging from HRA to Section 80C investments. However, a significant number of these returns are later flagged by the Income Tax Department for scrutiny due to incorrect, inflated, or unsupported deduction claims.
If you are a salaried taxpayer and have received a notice under Section 143(2), this article explains why your return was selected, how the scrutiny process works, what the possible consequences are, and why professional guidance is strongly advised.
Common Deduction Claims That Trigger Scrutiny
Many salaried employees unknowingly (or sometimes deliberately) claim deductions without meeting the eligibility criteria or maintaining proper documentation. These include:
- House Rent Allowance (HRA) claimed without rent agreement or valid receipts
- Section 80C investments (LIC, PPF, ELSS, etc.) exceeding limits or claimed without proof
- Section 80D health insurance premiums without policy documents
- Interest on Education Loan (Section 80E) claimed without proof from a financial institution
- Leave Travel Allowance (LTA) claimed without undertaking actual travel or without tickets
- Donations under Section 80G to entities not registered or not verified
- Donations to political parties
- National Pension Scheme (NPS) under Section 80CCD claimed without deposit evidence
- Interest on Housing Loan (Section 24(b)) claimed in respect of a property not in use or under construction
Returns with such claims—especially if resulting in high refunds—are often picked for scrutiny.
Why You Receive a Scrutiny Notice (Section 143(2))
A notice under Section 143(2) indicates that your return has been selected for a detailed examination (scrutiny assessment). This is usually triggered by:
- Significant mismatch between the ITR and Form 26AS/AIS/Form 16
- High refunds claimed compared to tax paid
- Suspicious or unsupported deduction claims
- PAN-linked high-value transactions not disclosed in the return
- Patterns or anomalies identified using AI-based systems like Project Insight and CASS
It is important to understand that scrutiny is not an accusation—it is a verification exercise. But how you respond determines the eventual outcome.
Can You Recompute and Pay Tax After Receiving the Notice?
Yes. If you find an error or inflated deduction:
- You may voluntarily pay the differential tax with interest
- If time permits, file a revised return before the assessment concludes
Such voluntary action may soften penalties, but it does not provide immunity. It does, however, reflect cooperation and good faith.
Scrutiny Process – Step-by-Step Breakdown
1. Notice under Section 143(2): Initiation of Scrutiny
This notice serves as the starting point of the scrutiny process. It notifies you that your return is under review and invites you to furnish further details. You will be asked to respond within 15 to 20 days via the income tax portal.
If you receive a 143(2) notice, your case is now subject to regular assessment under Section 143(3).
Is it necessary to submit documents at this stage? No, at this stage you are not required to submit supporting documents. The 143(2) notice is only an intimation that your return has been selected for scrutiny. Detailed queries and document requisitions will follow separately through a notice under Section 142(1).
However, it is mandatory to respond to the 143(2) notice via the portal within the stipulated time to avoid adverse consequences such as best judgment assessment under Section 144. The mandatory response is essentially a formal acknowledgment and confirmation that you are complying with the notice
While immediate submission of documents is not required, it is advisable to start organizing relevant records and consult a Chartered Accountant to prepare for the upcoming 142(1) notice and scrutiny process.
2. Notice under Section 142(1) of income tax Act: Requisition of Information
Shortly after the 143(2) notice, you’ll receive a more detailed notice under Section 142(1) requesting explanations and documents.
What Makes 142(1) Critical?
The scope of this notice is wide and often goes well beyond the deductions claimed. Using powerful tools like Project Insight, AI-based monitoring, and 360-degree taxpayer profiling, the Income Tax Department collects data from:
- Banks, mutual funds, and stock exchanges
- Property registration offices
- Your PAN-linked bank accounts and other PAN/Aadhaar linked transactions
- Foreign remittance records
- TDS returns and GST filings (if applicable)
Common Queries in 142(1) Include:
- Proof of each deduction/exemption claimed
- Explanation and source of each credit entry in your bank account
- Clarification on large cash deposits or foreign remittances
- Verification of rent payments, travel, donations, etc.
Don’t Take a Notice Under Section 142(1) of Income Tax Act Lightly
Handling a notice under Section 142(1) casually is one of the most common and costly mistakes taxpayers make. This notice is often the first step before a full-blown scrutiny assessment and must be responded to with utmost care.
- Submitting incomplete or fake documents can backfire, every deduction must be supported by valid documentary proof.
- Every claim or deduction made in the return must be backed by valid documentary evidence, and supported by actual payment proof, such as bank entries or receipts.
- Merely stating that payment was made in cash without proper evidence will not be accepted.
- Even if deductions are reflected in Form 16 (as considered by your employer), you may be required to submit proof of those deductions during assessment proceedings.
- Ignoring the notice or giving vague explanations can lead to denial of claims, additional tax demands, penalties, or even prosecution in serious cases.
- The Income Tax Department now uses advanced data analytics and AI-based profiling — vague explanations or carelessness can trigger penalties and prosecution.
Tip: Handling a 142(1) notice casually is one of the biggest mistakes taxpayers make. This is where most scrutiny cases go wrong.
At this stage, hiring a qualified tax professional becomes critical. A vague or inconsistent reply—such as stating “personal savings” or “loan from friend” without documents—can easily result in additions to income and massive tax demands.
A Chartered Accountant can:
- Understand the logic behind each query
- Correlate your response with your ITR, Form 26AS, and AIS
- Ensure full compliance and avoid contradictory or risky statements
- Prepare structured responses and manage the case till closure
3. Review by Assessment Unit
After you submit your response to 142(1), the Faceless Assessment Unit will review it. Based on your documentation and explanations, they may:
- Accept your return as filed
- Seek further clarification
- Propose additions to your income and initiate reassessment
Note: Even if your deductions are justified, the officer is permitted to go beyond them and examine any undeclared income or unexplained transaction they discover during assessment.
4. Draft Assessment Order (Show Cause Notice Stage)
Once the assessing officer completes the review, they will issue a Draft Assessment Order, also known as a Show Cause Notice. This is one of the most critical stages in the scrutiny process.
It outlines:
- Proposed additions or disallowances to your income
- Recomputed tax, interest under Sections 234A/B/C, and potential penalty exposure
- Basis for each proposed addition or disallowance
Failure to respond or rebut the proposed additions will result in finalisation of the draft, leading to a potentially large tax demand and downstream proceedings.
You are usually given 3 to 7 days to respond. This short deadline makes it essential to act promptly and carefully.
Why This Stage Needs a Chartered Accountant
This stage is not a procedural formality. it is a legal and technical juncture that can substantially affect your financial outcome. Responding without professional guidance can lead to irreversible consequences.
A Chartered Accountant with experience in handling scrutiny assessments can:
- Assess the financial and legal impact of each proposed addition, including computation of revised tax, interest, and penalty
- Draft a well-structured, point-wise rebuttal with clarity and precision
- Quote relevant case laws, CBDT circulars, and judicial precedents to contest unjust additions
- Ensure that your response is aligned with legal provisions and that no further exposure is created
Strict adherence to the deadline is critical. If you approach a professional at the last minute, there may not be enough time to analyze the draft order, gather documentation, or prepare a strong defense
Well-drafted replies at this stage have led to many cases being closed without additions or with significantly reduced tax demands
5. Final Assessment Order under Section 143(3)
After considering your objections (if submitted), the department issues a Final Assessment Order. This is binding unless challenged through an appeal.
Consequences include:
- A formal tax demand under Section 156
- Accrual of interest on unpaid amounts
- Initiation of penalty proceedings
6. Penalty Proceedings
After completing the scrutiny assessment, the Income Tax Department may initiate penalty proceedings under Section 270A of the Income Tax Act if there is under-reporting or misreporting of income.
Penalty is not automatic, but once the department identifies incorrect reporting, a separate notice for penalty may be issued—often along with or shortly after the final assessment order under Section 143(3).
The officer may invoke penalties under Section 270A:
- 50% of tax on underreported income (genuine errors)
- 200% of tax in case of misreporting, false claims, or fabricated documents
- In severe cases, criminal prosecution under Sections 276C or 277 for wilful evasion
Voluntary payment or revision after receiving scrutiny notice may mitigate but not eliminate penalty exposure.
What Is Under-Reporting of Income?
Under-reporting refers to cases where:
- The assessed income exceeds the income returned by the taxpayer
- Deductions or exemptions were claimed without sufficient evidence
- Income was partially disclosed, such as omitting bank interest or capital gains
Example for salaried taxpayer:
- You claimed ₹2,00,000 under HRA without rent receipts or rental agreement.
- The assessing officer disallows the claim and adds it back to your income.
This results in under-reporting.
What Is Misreporting of Income?
Misreporting is considered a more serious offense and includes:
- Claiming fake deductions or exemptions with forged or fabricated documents
- Deliberately concealing income, such as rent from second property, interest income, or share trading profits
- Providing false entries, such as donations to non-existent NGOs
- Providing inaccurate facts in response to notices
Example:
- Submitting a fake rent receipt for an address you don’t reside at
- Claiming donation under Section 80G to a bogus or unregistered trust
- Declaring false interest on education loan from a non-bank source
In extreme cases, prosecution may be initiated under:
- Section 276C: Willful attempt to evade tax
- Section 277: False statement in verification
This could lead to imprisonment of 3 months to 7 years depending on severity.
7. Recovery Proceedings
Once the final assessment order is passed and a demand notice under Section 156 is issued, you are normally given 30 days to pay the tax, interest, and penalty (if any). If not paid within this period, the department may initiate recovery proceedings under Sections 220 to 226 of the Income Tax Act.
What Happens If You Don’t Pay?
If the tax demand is not paid and no action is taken by the taxpayer:
- Interest under Section 220(2) starts accruing on the unpaid amount.
- The Assessing Officer may issue:
- Notice of attachment of bank accounts or salary (Section 226(3))
- Order to freeze movable or immovable properties
- Recovery through employer or debtors
- Initiate garnishee proceedings against third parties holding your money
What If You Don’t Have Funds to Pay the Tax Demand?
If you are unable to pay due to financial hardship, you still have options. But doing nothing is not an option.
You should:
- File a Stay Application (Online) on the income tax portal, requesting deferment or installment-based payment of the demand.
- Clearly explain your financial position and attach supporting evidence (bank statements, liabilities, salary slips, etc.).
- In some cases, the department may:
- Grant a stay on recovery until the appeal is disposed
- Allow payment in instalments under Section 220(3)
- Reduce the recovery amount conditionally, especially if appeal is filed
Tip: You should either pay, appeal, or apply for stay within the 30-day window. If you ignore the demand, recovery will proceed automatically, often without further notice.
Important: Filing an appeal does not automatically stay recovery. You must separately request for stay of demand after filing appeal.
8. Appeal Remedies
If you disagree with the final assessment, you may file an appeal before the Commissioner of Income Tax (Appeals) within 30 days. You may also:
- Escalate to ITAT, High Court, or Supreme Court depending on the complexity
- Seek stay on demand during the pendency of appeal, subject to conditions
Appeals require strong documentation and legal representation
Key Takeaways
- Do not ignore notices under Sections 143(2) or 142(1)
- The department uses PAN-linked data and AI to identify discrepancies
- Deductions without proof or explanation are likely to be disallowed
- Scrutiny may extend beyond deductions, examining unexplained income or credits
- Engage a Chartered Accountant early to prepare strong, timely responses
- Avoid last-minute response to show cause notices—these often require quoting case laws
- Penalties and prosecution can follow if misreporting is established
Need Help with Scrutiny Proceedings?
At Balakrishna & Co., Chartered Accountants, we have over 35 years of experience in handling scrutiny assessments, tax disputes, penalty notices, and appeals. We assist clients across India in responding professionally and lawfully to every stage of the assessment process.
Phone: +91 86182 59712
Email: prakasha@balakrishnaandco.com
