Income Tax Scrutiny Notice — Section 143(2) Reply

Income Tax Scrutiny — What It Means

An income tax scrutiny notice under Section 143(2) is a formal intimation that the Income Tax Department is examining your return in detail, beyond the routine processing. It does not mean fraud has been detected — most scrutiny cases are risk-based computer selections. However, it does require a systematic, document-backed response to every query raised by the Assessing Officer (AO) or the National Faceless Assessment Centre (NFAC).

Scrutiny Notice Types and Scope

Common Scrutiny Triggers

Financial Triggers

• Cash deposits in banks — especially large deposits in FY 2016-17 (demonetisation period); CBDT still processing those cases
• High-value property purchases — SFT-006 reports from registrars trigger scrutiny
• Foreign remittances — Form 15CA/CB filed for outward remittances are matched against declared income
• Large capital gains — especially from unlisted shares, property, or mutual funds
• Salary mismatch — declared salary in return vs TDS certificate (Form 16) mismatch
• High deductions — Chapter VI-A deductions disproportionate to income
• Turnover mismatch — GST turnover vs declared income in return

Transaction-Based Triggers

• Share transactions reported to SEBI vs capital gains declared
• Startup investors — Section 56(2)(viib) premium received
• Cash sales in business — large cash sales flagged by bank account analysis
• Professional services with high TDS (lawyers, doctors, architects) — TDS income vs return mismatch

The Scrutiny Process — Timeline

How to Respond to a Scrutiny Questionnaire

Documents Typically Required

• Bank statements for all accounts (savings, current, FD) for the relevant FY
• Audited financial statements (if applicable) with schedules
• Form 26AS / AIS / TIS reconciliation with return
• Property purchase/sale documents with valuation reports
• Investment proofs for Chapter VI-A deductions
• Books of accounts — cash book, ledger, journal
• Contract documents for large transactions
• Details of cash credits (Section 68) — identity, creditworthiness, genuineness of creditors

Response Strategy

1. Address every query — silence on any query point is an implicit admission
2. Provide documentary evidence — every explanation needs a supporting document
3. Cite applicable sections and case law — for contentious issues (e.g., Section 68 additions)
4. Establish identity, creditworthiness, and genuineness for cash credits (the three-prong test)
5. Challenge scope expansion — in limited scrutiny, the AO cannot examine issues beyond those specified in the 143(2) notice
6. File written submissions before personal hearing (in physical assessment cases)

Challenging Proposed Additions

Section 68 — Unexplained Cash Credits

If the AO proposes to add unexplained cash credits to income, you must establish: (1) Identity of the creditor (PAN, address), (2) Creditworthiness (creditor's income/financial position to lend), (3) Genuineness of the transaction (banking channel, contract, purpose). Failure on any prong results in addition. Counter: cite Supreme Court ruling in CIT v. Orissa Corporation — onus shifts to department if you provide prima facie evidence.

Section 69 — Unexplained Investments

For investments not fully explained from declared income sources. Provide: source of funds (inheritance, gifts, savings, prior year accumulated income), documentation, and return of the source's income.

Section 40A(3) — Cash Payment Disallowance

Payments above ₹10,000 cash to a person in a day are disallowed under Section 40A(3). Exceptions apply for Rule 6DD categories (payments to banks, agricultural payments, remote areas). Cite the exceptions applicable to your case.

Our Scrutiny Assessment Service

• Notice analysis — scope, time limits, grounds raised
• Document compilation and indexing
• Written response drafting with case law support
• Form 26AS/AIS reconciliation statement
• Representation before NFAC (faceless) or AO (physical)
• Objections to Draft Assessment Report
• Appeal filing if final order makes additions

Frequently Asked Questions

Faceless Scrutiny — Specific Best Practices

Under the National Faceless Assessment Centre (NFAC) scheme, the scrutiny response must be comprehensive and self-contained because there is no opportunity for informal clarification. Key NaFAC-specific best practices:

• Every document must be uploaded as a named, indexed PDF — not raw scanned images that are illegible. File naming convention: "Q1_Salary_Income_Form16_AY2024-25.pdf"
• Create a cover note that lists every query number and the corresponding document/page reference that addresses it
• For large document sets: upload a single PDF index document first, then numbered documents corresponding to the index
• The NFAC portal has file size limits — use PDF compression and split large documents into parts
• Always check the portal acknowledgement after uploading — the upload must show "Submitted" status, not just "Saved"

AIS vs 26AS — Which Controls for Scrutiny?

From AY 2021-22, the Annual Information Statement (AIS) on the IT portal replaces Form 26AS as the primary data source for the department. AIS contains much richer data than 26AS: it includes buying/selling of securities, real estate transactions, foreign remittances, dividends, interest, and more. Before responding to any scrutiny notice, download and review your AIS for the relevant year — the AO's queries are likely based on AIS data that doesn't match your return. Common AIS vs return discrepancies to check: securities transactions not declared as capital gains, rental income from AIS not declared, foreign remittances not explained.

Limited Scrutiny — Scope Cannot Be Expanded

A CASS-selected limited scrutiny is restricted to one or two specific issues identified in the Section 143(2) notice itself. The AO cannot convert it to a complete scrutiny or raise issues beyond those specified, without obtaining approval from the PCIT. If the AO is raising queries about items not specified in the 143(2) notice, clearly raise this objection in your response: "The present scrutiny is a limited scrutiny under CASS for [specified issue]. The query at serial number X relates to [different issue] which is not within the scope of this limited scrutiny. This expansion of scope is impermissible without PCIT approval under the CBDT guidelines on CASS selection."

Transfer Pricing in Scrutiny — Domestic and International

If the taxpayer is a company with related party transactions — whether domestic (Section 40A(2) transactions with specified persons) or international (Section 92 transactions with associated enterprises) — these are priority scrutiny areas. The Assessment Unit frequently makes additions under Section 40A(2) for payments to related parties at non-arm's-length prices (e.g., rent paid to promoter's family's property at above-market rates, or salaries paid to promoter family members disproportionate to role). Maintain transfer pricing documentation for all related party transactions above materiality thresholds, even domestic ones.

Section 50C Trap in Property Scrutiny

When an immovable property is sold at a price below the Stamp Duty Value (SDV / circle rate), Section 50C deems the SDV as the sale consideration for capital gains computation in the seller's hands. The AO will compute your capital gains using the SDV even if you actually received less. To challenge this: (a) if the SDV was fixed more than 6 months before the date of agreement, use the SDV at the date of agreement (not registration) — Finance Act 2016 provision; (b) if you believe the SDV itself is wrong, apply to the AO to refer to the District Valuation Officer (DVO) for an independent valuation — if DVO value is lower than SDV, DVO value is used for Section 50C computation.

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