Income Tax Scrutiny: A Complete Guide from Notice to Appeal

The completion of audit season marks the beginning of another critical phase for taxpayers and professionals—scrutiny assessments. For those who receive a notice under Section 143(2) of the Income Tax Act, the journey requires careful planning, documentation, and decision-making. This comprehensive guide walks you through the entire scrutiny lifecycle, helping you prepare intelligently before selection, respond effectively during proceedings, and defend your position strategically after assessment.

Part 1: Before Scrutiny — Building a Strong Foundation

Understanding Why Returns Get Selected

Scrutiny assessments don’t happen randomly. The Income Tax Department uses the Computer-Assisted Scrutiny Selection System (CASS), which flags returns based on specific risk parameters. Understanding these triggers is the first step toward prevention.

Common CASS triggers include:

• Data mismatches: Discrepancies between Form 26AS, Annual Information Statement (AIS), and filed returns—especially concerning TDS credits, dividend income, or capital gains​
• High-value transactions: Large cash deposits, credit card spends, or property purchases disproportionate to reported income​
• Significant deviations: Unusual decline in gross profit, net profit margins, or sudden increase in expenses year-over-year​
• Refund claims: Exceptionally high refund claims relative to income reported
• Foreign transactions: Unreported foreign income, assets, or remittances​
• Non-matching stock values: Opening stock not matching previous year’s closing stock

Beyond CASS, manual scrutiny can be triggered by surveys, search and seizure operations, reassessment proceedings, or where additions made in earlier years on recurring issues have become final. ​

Proactive Measures to Reduce Scrutiny Risk

Document everything comprehensively: The biggest mistake taxpayers make is relying solely on Excel workings or ledger extracts. From an Assessing Officer’s (AO) perspective, these are merely summaries—not proof. Every number in your return should be traceable to source documents: bank statements, purchase invoices, sale bills, TDS certificates (Form 16/16A), investment proofs, loan agreements, property documents, and third-party confirmations. ​

Maintain year-on-year consistency: Review your current year’s return alongside the previous and subsequent years’ ITRs, tax audit reports under Section 44AB, and financial statements. Look for logical consistency in income patterns, expense ratios, capital account movements, and loan balances. Unexplained variations invite questions. If ratios have changed dramatically, prepare explanatory notes in advance.

Verify third-party data sources: Before filing, cross-check your return against Form 26AS and the Annual Information Statement (AIS) available on the e-filing portal. These capture TDS/TCS, high-value transactions, securities transactions, foreign remittances, and more. If there’s information you don’t recognize or cannot explain, address it before filing—either by including it or preparing a detailed explanation.

Register two responsible email addresses: The Income Tax portal allows you to register email addresses for receiving notices. Designate email IDs of two different responsible persons to ensure no communication is missed. Notices missed due to unmonitored mailboxes can lead to ex-parte assessments under Section 144, which are invariably adverse.

Avoid aggressive or judgmental positions: Claiming borderline deductions without solid backing, taking aggressive transfer pricing positions, or reporting transactions in legally ambiguous ways invites scrutiny. AOs operate under internal audit and review mechanisms—they need to justify their acceptance of claims to their superiors. If your explanations are vague or your documents inadequate, the AO will take the conservative route and make additions to protect themselves. ​

Time Limits You Must Know

• Notice under Section 143(2) must be issued within 3 months from the end of the financial year in which the return was filed. For example, if you filed your return for AY 2024-25 on 31st July 2024, the notice can be issued only until 30th June 2025.
• Scrutiny assessment completion: For assessment years 2019-20 onwards, assessment orders under Section 143(3) must be passed within 12 months from the end of the assessment year. For AY 2024-25, this means by 31st March 2026.

Part 2: During Scrutiny — Responding with Precision and Confidence

The Faceless Assessment Process (Section 144B)

Since 2019, most scrutiny assessments are conducted through the Faceless Assessment Scheme under Section 144B. This means:

• No physical interaction: All proceedings happen through the e-Proceedings tab on the income-tax portal
• Anonymous allocation: Your case is assigned to Assessment Units, Verification Units, Technical Units, and Review Units across India through an automated system
• Digital communication only: All notices, questionnaires, and orders are issued with a unique Document Identification Number (DIN) for traceability​
• Video hearing option: If you request, you’re entitled to a personal hearing via video conferencing​

Receiving the First Notice — Section 143(2)

The scrutiny process formally begins with a notice under Section 143(2) intimating the assessee that the case was selected for scrutiny. Subsequently after few weeks, assessee receives details questionnaire required to be submitted under Section 142(1).

Questionnaires and Document Requests (Section 142(1))

Following the initial notice, you’ll receive detailed questionnaires asking for specific documents and explanations. Common requests include: ​

• Complete books of accounts (ledgers, journals, cash books)
• Bank statements for all accounts (savings, current, cash credit, loan accounts)
• Purchase and sales invoices with party-wise details
• Proof of investments claimed under Chapter VI-A deductions
• Details of loans taken or given, with repayment schedules and confirmations
• Property documents for capital gains transactions
• Expense vouchers for significant business expenses
• Reconciliation of capital account and drawings
• Confirmation letters from parties for outstanding balances etc.

How to Respond Effectively

Respond within deadlines—always: The notice will specify a response deadline, typically 15-30 days. Even if you need more time, file an adjournment request before the deadline expires. Timely responses demonstrate seriousness and compliance. Extensions are granted, but repeated delays create negative impressions. ​

Provide authentic, complete documentation: For every question raised, submit:

1. The primary document (invoice, statement, certificate)
2. Supporting cross-references (ledger entries, bank entries)
3. Third-party confirmations where applicable (from banks, vendors, customers)
4. Reconciliation statements showing how figures tie together

Don’t submit just an Excel summary—AOs need to see the trail from source document to books to ITR.

Structure your submissions professionally: Organize documents logically:

• Create an index with page numbers
• Group documents by query number
• Add cover notes explaining each submission
• Cross-reference between documents
• Highlight relevant portions in lengthy documents​

Be comprehensive, not selective: Even if the AO hasn’t specifically asked for a particular document, if it strengthens your case, submit it proactively.

Show inter-year consistency: If the AO questions a particular accounting treatment or claim, demonstrate that you’ve been following the same method consistently across years and it has been accepted previously. If there’s a change, explain the business or legal reason for it. ​

Understand the AO’s perspective: Remember, AOs work under their own audit and review mechanisms. They need to justify their decisions to Principal Commissioners, and their performance is evaluated partly on revenue collection. If your explanations are unclear or inadequately supported, the AO will make protective additions to avoid later questions from superiors. Make it easy for the AO to accept your position by providing complete, unambiguous evidence.

Show-Cause Notice — The Critical Juncture

After examining your responses, if the AO proposes to make additions to your income or disallow deductions, a show-cause notice (or draft assessment order under the faceless scheme) will be issued. This is your last opportunity before the final order.

Why show-cause stage is critical: Most additions are finalized based on the response to the show-cause notice. Your reply here determines whether additions are made or dropped.

Part 3: After Scrutiny — Strategic Rectification and Appeals

Receiving the Assessment Order

Once the AO passes the order under Section 143(3), you’ll receive it on the e-filing portal along with a demand notice under Section 156 if additional tax is payable. You have 30 days from the date of service to pay the demand. ​

Immediate Steps After Receiving the Order

1. Verify the computation thoroughly: Don’t assume the order is correct. Cross-check every figure:

• Income computations
• Additions and disallowances
• Tax calculations
• Interest under Sections 234A/234B/234C
• TDS credits given
• Advance tax and self-assessment tax adjustments​
• Set-off of carry forward losses.

Computational errors are surprisingly common and can be corrected through rectification.

2. File rectification under Section 154 for apparent mistakes: Section 154 allows correction of “mistakes apparent from the record”—errors that are obvious without detailed investigation or interpretation. Examples include: ​

• Arithmetical errors in computation
• Wrong application of tax rates
• TDS credit not given despite being shown in Form 26AS
• Double addition of the same income
• Carry-forward of losses wrongly computed

Time limit for Section 154: Rectification application must be filed within 4 years from the end of the financial year in which the order was passed. The AO must dispose of the application within 6 months. ​

Important note: Section 154 is not for legal disputes or interpretational issues—only for obvious errors. If your issue requires legal argument, file an appeal instead.

Penalty Proceedings — Section 270A

If the AO has added income or disallowed expenses, a separate penalty notice under Section 270A will likely be issued for underreporting or misreporting of income. ​

Penalty rates:

• Underreporting: 50% of tax on underreported income
• Misreporting: 200% of tax on misreported income​

Misreporting includes situations like false entries in books, claiming bogus expenses, suppression of income, or failure to record investments in books. ​

Responding to penalty notices: Always respond to penalty notices with full explanations and evidence. Key defenses include:

• No intention to evade tax—it was a bona fide error or difference of opinion on law
• Full disclosure was made; all material facts were provided
• The addition itself is being challenged in appeal
• Cite immunity provisions under Section 270AA if applicable​

Even if penalty is levied despite your response, you can file an appeal against the penalty order.

Appeal Before CIT(A) — The Primary Legal Remedy

When an assessee disagrees with an assessment order passed under Section 143(3) or 144, the principal statutory remedy is to file an appeal before the Commissioner of Income Tax (Appeals) [CIT(A)] under Section 246A of the Income Tax Act, 1961. Rectification under Section 154 is reserved for apparent mistakes and does not substitute the appellate process, which is meant for substantive disputes involving law or fact. ​

Time Limit and Procedure

The appeal must be filed electronically in Form 35 within 30 days from the date of service of the demand notice under Section 156 or the assessment order.
If delayed, a condonation petition under Section 249(3) may be filed citing valid reasons—CIT(A) has the discretionary power to admit delayed appeals. ​

Appeals are now completely faceless under the National Faceless Appeal Centre (NFAC) framework. Once filed, the appeal is assigned randomly to an Appeal Unit, ensuring anonymity and independent adjudication.

Conditions for Admissibility

Under Section 249(4), the assessee must pay:

• the self-assessment tax as per the return of income; or
• in case no return is filed, advance tax payable for the relevant year.

No statutory pre-deposit (such as 20%) is required for filing an appeal, though the Department generally insists on partial payment for administrative stay of recovery. This can be managed through a separate stay petition under Section 220(6).

A nominal appeal fee is payable based on assessed income (Rs. 250 to Rs. 1,000 as per Rule 45), and soft copies of documents like the assessment order, notice of demand, tax challan, and statement of facts must be uploaded. ​

Practical Insights

• Filing an appeal automatically does not stay recovery, hence separate stay petitions are advisable.
• Appeals are generally resolved within 1–3 years, depending on complexity and workload.
• Decisions at this stage form the foundation for further relief before ITAT or the High Court.
• Every submission before CIT(A) should be precise, evidence-backed, and legally sound, since this is the most crucial opportunity to overturn the AO’s findings.

Stay Petition — Protecting Against Recovery

Once a demand is raised, the department can initiate recovery proceedings—including attachment of bank accounts—if you don’t pay within 30 days. ​

Filing stay petition with the AO (Section 220(6)): Within 30 days of the demand notice, file a stay petition with the AO requesting that you not be treated as an “assessee in default” pending appeal. The stay application should include: ​

• Brief facts of the case and demand raised
• Grounds of appeal filed (attach copy)
• Detailed reasons why the demand is disputed
• Exact demand amount and amount paid (if any)
• Offer of security, if any
• Request that recovery be stayed without payment, or at most, a nominal amount​

If AO rejects stay or grants conditional stay requiring 20% payment: File an appeal against the stay order with the Principal CIT/CIT.

Refund Adjustment and Section 245

Under Section 245, the department can adjust any refund due to you against outstanding demands from any assessment year. However, they must issue a notice under Section 245 before making the adjustment, giving you an opportunity to respond. ​

Important principle: If you’ve been granted a stay of demand (even conditional upon paying 20%), courts have held that the department cannot adjust refunds against the stayed portion of the demand. Only the unstayed amount (e.g., 20% you were required to deposit) can be adjusted. If the department adjusts the full demand against your refund despite the stay, file a writ petition in the High Court challenging the adjustment. ​

Writ Petition Before High Court — Alternative Strategy

For certain types of errors, consider filing a writ petition directly in the High Court instead of an appeal before CIT(A).

When to file writ petition:

• Apparent procedural violations (notice not properly served, no opportunity given, jurisdiction issues)
• Pure questions of law (no factual investigation required)
• Constitutional violations
• Errors that are glaring and not requiring detailed factual examination

Advantages of writ petitions:

• No 20% pre-deposit required​
• No adjustment of future refunds during pendency
• Can obtain interim stay on recovery proceedings
• Faster resolution in some cases
• Can be filed even after CIT(A) appeal if necessary

Disadvantages:

• High Courts are hesitant to entertain writs when an alternative appellate remedy (CIT(A)) exists
• Writ is discretionary—court may refuse to entertain
• Requires strong legal grounds

Tracking and Responding to Recovery Notices

Even after filing appeals, stay petitions, and doing everything correctly, the recovery machinery may continue issuing notices. You may receive:

1. Repeated demand reminders
2. Show-cause notices before attachment
3. Attachment notices for bank accounts

Action required at every stage:

• Monitor both registered email IDs daily
• Respond to every notice immediately, citing:
  • Appeal filed before CIT(A) / High Court (mention appeal number and date)
  • Stay petition filed (mention status)
  • Stay granted (attach copy of stay order)
  • Payment made (attach proof) ​
  • Adjustments made U/s 245
• Update the “Response to Outstanding Demand” section in the e-filing portal, clearly stating that an appeal and stay petition are pending​

Bank account attachment stage: If you receive notice that your bank account will be attached, act immediately:

1. File urgent stay petition if not already filed
2. Make representation to the recovery officer citing pending appeals
3. If stay is rejected and attachment proceeds despite pending appeals, file an urgent writ petition in the High Court challenging the recovery action as being in violation of natural justice

Timeline Summary for Post-Assessment Actions

Key Statutory Provisions Referenced

• Section 143(1): Summary processing of returns
• Section 143(2): Notice for scrutiny assessment
• Section 143(3): Scrutiny assessment order
• Section 144: Best judgment assessment
• Section 144B: Faceless assessment procedure
• Section 153: Time limits for completion of assessment
• Section 154: Rectification of mistakes
• Section 156: Notice of demand
• Section 220(6): Stay of demand
• Section 245: Set-off of refunds against demand
• Section 246A: Appealable orders
• Section 249: Form and time for appeal to CIT(A)
• Section 250: Procedure in appeal
• Section 270A: Penalty for underreporting and misreporting
• Section 270AA: Immunity from penalty

Conclusion: The Art of Navigating Scrutiny

Income tax scrutiny assessments need not be adversarial if approached systematically. The process rewards those who:

• Prepare comprehensively before filing returns—document everything, verify data sources, maintain consistency
• Respond meticulously during proceedings—provide complete evidence, explain logically, meet deadlines
• Defend strategically after assessment—rectify errors promptly, file stay petitions, choose the right appellate forum

Remember, the objective is not confrontation but resolution. Assessing Officers are bound by law and audit controls; make it easy for them to accept your position by providing unambiguous, complete evidence. When disputes arise, know your legal rights and remedies, and exercise them timely and strategically.

Tax compliance is a partnership between the taxpayer and the department—one built on transparency, documentation, and mutual respect for legal processes.