Tax dept used AI to issue income tax notice;
Bombay High Court quashes notice, calls process unfair to taxpayer
Nov 4, 2025
Synopsis
The Bombay High Court has cancelled a tax notice because the Income Tax Department used Artificial Intelligence to draft the notice citing three non-existing judgements. The court found the department relied on non-existent judicial rulings. This process was deemed unfair to the taxpayer. The court ordered a fresh notice and a chance for the taxpayer to be heard.
The Bombay High Court has observed that the income tax department has relied on AI (artificial intelligence) to reference three non-existent judicial rulings and issued a tax notice for Rs 22 crore income of a taxpayer.
The court noted that there are no such rulings that the income tax department is trying to use for this tax notice. The Bombay High Court questioned how the tax department came across these supposed judicial judgements.
Bombay High Court said: “In this era of Artificial Intelligence (‘AI’), one tends to place much reliance on the results thrown open by the system. However, when one is exercising quasi judicial functions, it goes without saying that such results [which are thrown open by AI] are not to be blindly relied upon, but the same should be duly cross verified before using them. Otherwise mistakes like the present one creep in.”
In the end, the Bombay High Court exercised its authority under Article 226 of the Constitution of India, and quashed the notice and remanded the matter back to the tax officer and directed him to issue a fresh tax notice and this time, requiring him to clearly specify the findings. The Bombay High Court also said that the taxpayer should be given a reasonable opportunity to be heard.
Chartered Accountant (Dr.) Suresh Surana, said to ET Wealth Online: In the given case (Writ petition (l) no. 24366 of 2025), the taxpayer filed a writ petition before the Bombay High Court challenging an assessment order passed under Section 143(3) read with Section 144B for AY 2023-24. The Assessing Officer (AO) had enhanced the taxpayers' income from Rs 3.09 crore to Rs 27.91 crore and issued a consequential tax demand notice under Section 156 and a show cause notice for penalty under Section 274 read with Section 271AAC.
The additions were made on two points:
(i) disallowance of purchases worth Rs. 2.16 crore from Dhanlaxmi Metal Industries on the ground that the supplier did not respond to a Section 133(6) notice, and
(ii) an addition of Rs. 22.66 crore towards unsecured loans from directors, determined on a “peak balance” basis.
According to Surana, the taxpayer contended that both the income additions violated the principles of natural justice. The taxpayer produced evidence that the supplier had, in fact, responded to the Section 133(6) notice with confirmations, invoices, e-way bills, transport receipts, and GST returns, all before the assessment was finalized. Regarding the unsecured loans, the taxpayer argued that no show-cause notice was issued, the basis of computation was never shared, and the AO relied on three non-existent judicial decisions while making the addition.
Surana says that the Bombay High Court's division bench found clear procedural lapses and gross violation of natural justice as follows:
The Court noted that the supplier’s detailed reply confirming transactions was on record but was ignored. The assessment order incorrectly stated that “no such reply was filed,” and the Department later admitted the oversight.
The AO had cited three judicial precedents that, upon verification, did not exist. The Court remarked that in the “era of Artificial Intelligence,” authorities may rely on system-generated results, but quasi-judicial officers must verify the authenticity of such references before relying upon them.
No working or computation basis was disclosed to the assessee for the alleged “peak balance” addition, and no show-cause notice was issued, denying the assessee an opportunity to rebut.
Surana says that given these cumulative defects, the Bombay High Court held that the assessment suffered from a complete breach of procedural fairness. Accordingly, the Bombay High Court quashed the assessment order, demand notice, and penalty show-cause notice, and remanded the matter to the AO with directions to:
issue a fresh, reasoned show-cause notice clearly explaining the proposed additions;
grant the assessee a personal hearing and adequate opportunity to respond; and
ensure that any judicial decisions relied upon are communicated and verified before use.
Surana says: "Thus, the Court concluded that this was a fit case for exercise of writ jurisdiction under Article 226, considering the breach of principle of natural of justice. as the defects went to the root of due process rather than mere technical irregularities."
Mihir Tanna, associate director, S.K Patodia LLP, says that in the given case, importance is given to two aspects, Party confirmation and opportunity of being heard.
For the first aspect, in the assessment proceedings, when the genuineness and reasonableness of a particular transaction is under doubt, notice is issued to the opposite party. If facts pertaining to a transaction submitted by the taxpayer are also confirmed by opposite party; genuineness and reasonableness of a transaction is proved.
For the second aspect, in the assessment proceedings, taxpayers are provided with the opportunity of being heard before concluding on any issue, so that taxpayers can also provide their own argument. If the other party (taxpayer) is not heard, it will not be natural justice.
How did this case start?
The case began when the taxpayer filed a Writ Petition in Bombay High Court challenging the Assessment Order under Section 143(3) read with Section 144B of the Income Tax Act, 1961, dated March 27, 2025, for AY2023-24.
According to the impugned (challenged) Assessment Order, the tax department had determined the taxpayer’s total income at Rs 27.91 crore instead of Rs 3.09 crore reported by him in his ITR. Other than this, the Notice of Demand issued under Section 156 has also been impugned.
The Bombay High Court noted that after reviewing the assessment order prepared by the tax officer, they discovered two income additions. The first addition involved disallowing purchases amounting to Rs 2 crore (2,15,89,932) from one company, primarily because that company failed to respond to the Notice under Section 133(6). The second addition pertained to unsecured loans from directors, where a peak balance of Rs 22 crore (22,66,06,740) was added.
Bombay High Court said: “While making this addition, even the opening balance was considered and to support the same, reliance was placed on certain judgments.”
Bombay High Court: Assessment order is passed in breach of principles of natural justice
The Bombay High Court said that after perusing the papers and the submissions of the parties, they find that the Assessment Order is, indeed, passed in breach of the principles of natural justice.
The Bombay High Court said that on the first addition, it is apparent that the addition was made without considering the reply to the Notice under Section 133(6). On page 568, the taxpayer has annexed the copy of the Notice dated March 4, 2025 issued to the taxpayer’s supplier under Section 133(6), wherein he was asked to furnish various details by March 5, 2025.”
The Bombay High Court said: “The said supplier had duly filed his reply on 8th March 2025 which is available at page 571 of the Petition. In this reply, not only did the supplier confirm the transaction but also provided various documents in support thereof like invoices, e-way bills, transport receipt, GST returns etc. The reply with the supporting documents itself ran into 100 pages.”
The Bombay High Court said that such a reply was filed much before the impugned order was passed.
Bombay High Court said: “Thus, it is apparent that such a crucial piece of evidence, though available, was not considered by Respondent No. 1 (tax department) and in fact, it was stated in the Assessment Order that no such reply has been filed. Now, in the Reply Affidavit, an apology is tendered for not considering the reply filed by the supplier.”
Bombay High Court: Using AI blindly
The Bombay High Court said that on the second issue of addition of peak balances in respect of loans from directors, it can be seen that while calculating peak balance, Respondent No. 1 (tax department) has considered the opening balance, and for which purpose, he has relied upon three decisions.
Bombay High Court said: “The judicial decisions relied upon are completely non-existent. In other words, there are no such decisions at all which are sought to be relied upon by Respondent No. 1. It is for Respondent No. 1 (tax department) to show from where such decisions were fetched. In this era of Artificial Intelligence (‘AI’), one tends to place much reliance on the results thrown open by the system. However, when one is exercising quasi judicial functions, it goes without saying that such results [which are thrown open by AI] are not to be blindly relied upon, but the same should be duly cross verified before using them. Otherwise mistakes like the present one creep in.”
The Bombay High Court said that it is one of the grievances of the taxpayer that they are clueless as to how the figures are arrived at as no basis or working was ever shown to the Petitioner, nor was any Show-Cause Notice issued before making the addition of peak balance.
Bombay High Court said: “Even this grievance of the Petitioner is justified.”
Bombay High Court judgement
The Bombay High Court said:
Thus, in the peculiar facts of the present case, the Petitioner should not be relegated to avail the alternate remedy. We find that this is a fit case to interfere under Article 226 of the Constitution of India.
In view of the foregoing discussion, we hereby quash and set aside the Assessment Order passed under Section 143(3) read with Section 144B of the Act dated 27th March 2025, for A.Y.-2023-24, the Notice of Demand under Section 156 of the Act dated 27th March 2025 as well as the consequential Show Cause Notice for levy of penalty issued under Section 274 read with Section 271AAC of the Act dated 27th March 2025.
We remand the matter back to the file of the Assessing Officer. He shall issue a fresh Show-Cause Notice to the Petitioner bringing out clearly the proposed addition and disallowance, grant reasonable opportunity of being heard to the Petitioner including sufficient time to file a reply to the notice. Before passing the Assessment Order, a personal hearing shall be granted to the Petitioner. If any decisions are relied upon, then the Petitioner will be put to adequate notice of not less than 7 days, to counter such judgments. The Assessment Order passed shall be a speaking order and shall deal with all the submissions of the Petitioner. The Assessment Order shall be passed on or before 31st December 2025.
We hasten to add that we have not made any observations or findings on the merits of the additions made in the Assessment Order. All rights and contentions of the parties are kept open in that regard.
The Writ Petition is disposed of in the aforesaid terms. However, there shall be no order as to costs. This order will be digitally signed by the Private Secretary/ Personal Assistant of this Court. All concerned will act on production by fax or email of a digitally signed copy of this order.
[The Economic Times]
