A Comprehensive Guide to Income Tax Scrutiny, Reassessment (Section 148), and Corporate Tax Strategy in India

Introduction

In the evolving landscape of India’s taxation system, the days of manual files and friendly neighborhood Assessing Officers are long gone. They have been replaced by a data-driven, algorithm-led regime characterized by Faceless Assessments, strict Transfer Pricing audits, and aggressive Reassessment proceedings under Section 148.

For a domestic company opting for the concessional tax regime under Section 115BAA, receiving a notice under Section 142(1) or Section 148 can trigger significant anxiety. The convergence of scrutiny proceedings, demand notices under Section 156, and the looming threat of a 200% penalty for “misreporting” under Section 270A requires a sophisticated legal defense strategy.

This guide provides a detailed legal analysis of the current scrutiny and reassessment ecosystem, incorporating pivotal Supreme Court judgments like Union of India v. Ashish Agarwal and Checkmate Services P. Ltd. vs CIT.

Part I: The Scrutiny Ecosystem – From Inquiry to Assessment

1. The First Alarm: Notice under Section 142(1)

The journey often begins with Section 142(1) of the Income-tax Act, 1961. Contrary to popular belief, this notice is not an indictment; it is a preliminary inquiry.

What is it? The Assessing Officer (AO) issues this notice to:

Request the filing of a Return of Income (if not already filed).
Call for specific accounts or documents (e.g., ledgers, bank statements).
Request written information on specific points (e.g., justification for high expenses).

The Legal Implication: Non-compliance with Section 142(1) is dangerous. It can lead to a “Best Judgment Assessment” under Section 144, where the AO estimates your income (usually to your detriment) and can also attract prosecution.

Strategic Tip: Responses to 142(1) must be precise. Over-sharing can open new lines of inquiry, while under-sharing can lead to penalties.

2. Faceless Assessment: The “Invisible” Taxman

The erstwhile Section 144B introduced the Faceless Assessment Scheme. While the section has undergone amendments, the core mechanism, now governed by Sections 143(3A) and 143(3B), remains the standard.

How it Works:

No Physical Interface: You will not meet the AO. All submissions are electronic.
Dynamic Jurisdiction: Your case might be assessed by a team in Chennai, reviewed in Delhi, and finalized in Mumbai. This eliminates local bias and corruption.
Team-Based Approach: The Assessment Unit is supported by Verification Units and Technical Units.

Challenges for the Assessee: The lack of oral persuasion means your written submissions must be impeccable. You cannot “explain” a complex transaction across the table. If the written submission is ambiguous, the algorithm or the remote officer may interpret it adversely.

Part II: The Reassessment Regime (Section 147 & 148)

The most litigated area in recent years is Reassessment—where the tax department seeks to reopen completed assessments because they believe income has “escaped assessment.”

1. The “New” Procedure (Finance Act, 2021)

Before issuing a notice under Section 148, the AO must now follow strict due process under Section 148A:

Inquiry (148A(a)): The AO may conduct an inquiry with prior approval.
Show Cause (148A(b)): The AO must provide the assessee with the information prompting the belief that income escaped assessment and give a time (7-30 days) to reply.
Order (148A(d)): After considering the reply, the AO must pass a speaking order deciding whether it is a fit case to issue a Section 148 notice.

2. The Ashish Agarwal Judgment: A Watershed Moment

Case: Union of India v. Ashish Agarwal (2022)

The Controversy: In 2021, the Tax Department issued nearly 90,000 notices under the old law (which was less taxpayer-friendly) after the new law had already come into effect (April 1, 2021). Various High Courts struck these notices down as invalid.

The Supreme Court Ruling: To save the Revenue from a massive loss, the Supreme Court exercised its extraordinary powers under Article 142. It ruled:

The notices issued under the old law were deemed to be Show Cause Notices under Section 148A(b) of the new law.
Implication for You: If your company received a Section 148 notice during that transition period, the Department must have subsequently provided you with the “material/information” relied upon and given you 2 weeks to reply.
Defense Strategy: If the AO jumped straight to a reassessment order without following the Ashish Agarwal directive (providing material and waiting for a reply), the entire proceeding is void and can be challenged in a Writ Petition.

Part III: Corporate Tax Nuances (Section 115BAA & Transfer Pricing)

1. Impact on Section 115BAA (Lower Tax Regime)

Section 115BAA allows domestic companies to pay tax at 22% (plus surcharge/cess) if they forego exemptions (like SEZ benefits, accelerated depreciation).

The Risk during Scrutiny: If the AO finds during reassessment that your company claimed a deduction prohibited under Section 115BAA (e.g., additional depreciation), two things happen:

The specific deduction is disallowed, increasing taxable income.
Existential Threat: If the violation is severe, the AO might argue that the company violated the conditions of Section 115BAA, potentially stripping the company of the 22% rate and taxing the entire income at 30% for that year.

2. International Dealings & Transfer Pricing (Chapter X)

For companies with “International Transactions” (dealing with foreign Associated Enterprises), scrutiny is intense.

The Trap:

Arm’s Length Price (ALP): Transactions must be at fair market value.
Section 92E: You must file an Accountant’s Report (Form 3CEB).

The Penalty Nexus: If you fail to report an international transaction, it is statutorily defined as “Misreporting of Income” under Section 270A(9)(f). This triggers a flat 200% penalty on the tax sought to be evaded.

Saving Grace: Under Section 270A(6)(d), if you maintained all Transfer Pricing documentation (Section 92D) and disclosed the transaction, but the Transfer Pricing Officer (TPO) merely adjusted the price, you can argue against the penalty.

Part IV: The Checkmate Ruling – A Compliance Nightmare

Case: Checkmate Services P. Ltd. vs CIT (2022)

The Issue: Companies often deduct Employee PF/ESI contributions from salaries but deposit them slightly late (after the PF Act due date, but before the Income Tax Return filing date).

The Judgment: The Supreme Court ruled against the taxpayer.

Employee Contribution is deemed “income” of the employer under Section 2(24)(x).
It is only allowed as a deduction if paid by the due date of the relevant statute (e.g., the 15th of the next month for PF).
Section 43B (which allows payment before ITR filing) applies only to the Employer’s contribution, not the Employee’s.

Scrutiny Consequence: If your reassessment covers years where PF/ESI was delayed by even one day, the AO will add this to your income. This is a “high-pitched” addition that is currently very difficult to defend legally.

Part V: Penalties and Immunity (Section 270A vs. 270AA)

Upon the conclusion of scrutiny, the AO issues a Notice of Demand (Section 156). If additions are made, they will initiate penalty proceedings.

The Math of Section 270A

Nature of Default	Penalty Quantum
Under-reporting (e.g., disallowance of expense due to lack of proof)	50% of Tax Payable
Misreporting (e.g., suppression of facts, false entries, failure to report international transactions)	200% of Tax Payable

The Escape Route: Section 270AA

You can apply for Immunity from Penalty and Prosecution if:

You pay the tax and interest specified in the demand notice.
You do not file an appeal against the assessment order.
The addition is not classified as “misreporting.”

Strategy: If the AO classifies an addition as “misreporting,” you cannot apply for immunity. You must appeal. If it is “under-reporting,” verify if the cost of litigation outweighs the 50% penalty. If the case is weak, paying tax and seeking immunity is often the wisest financial decision.

Part VI: IRAC Analysis

(Legal Opinion based on the User’s Scenario)

1. Issue

The company, opting for Section 115BAA, faces Reassessment (Section 148) and Scrutiny. Key issues are the validity of notices, potential removal of 115BAA benefits, Transfer Pricing adjustments, and penalties under Section 270A, specifically in light of the Ashish Agarwal and Checkmate Services judgments.

2. Rule

Section 148A: Mandatory pre-notice inquiry and show-cause procedure (post-April 1, 2021).
Ashish Agarwal Principle: Pre-2021 notices are valid but deemed as show-cause notices; due process of supplying material is mandatory.
Section 115BAA: Benefit conditional on foregoing specified deductions.
Section 270A(9): Misreporting attracts 200% penalty.
Section 36(1)(va) r.w. Checkmate Services: Employee contributions to welfare funds must be paid by statutory due dates, not ITR due dates.

3. Analysis

Validity of Notices: If the company received a Section 148 notice after April 1, 2021, without the Section 148A procedure, it is initially defective. However, per Ashish Agarwal, the Revenue gets a second chance. The company must check: Did the AO supply the “reasons to believe” and “material relied upon” after the SC judgment? Did the company get 2 weeks to reply? If not, the current proceedings are bad in law.
Section 115BAA Status: The scrutiny itself doesn’t cancel 115BAA. However, if the scrutiny reveals the company claimed “Section 10AA” or “Additional Depreciation,” the 22% rate will be denied.
Transfer Pricing: If the company failed to report a transaction with a foreign associated enterprise, Section 270A(9)(f) applies (200% penalty). However, if the transaction was reported but the valuation is disputed, the company can claim the exclusion under Section 270A(6)(d) to avoid the penalty, provided documentation (Section 92D) is robust.
Employee Contributions: Any delayed payment of employee PF/ESI will be added to income. This is virtually indefensible post-Checkmate Services.

4. Conclusion

The company must participate in the faceless proceedings aggressively.

Challenge Jurisdiction: If Ashish Agarwal timelines were breached.
Protect 115BAA: Ensure no prohibited deductions were slipped into the return.
Mitigate Penalty: Argue that any addition is “under-reporting” (bona fide error) rather than “misreporting.” For Transfer Pricing, leverage Section 270A(6)(d).

Part VII: Strategic FAQ

Q1: Can I ignore a Section 148 notice if I believe I have paid all taxes? A: Absolutely not. Ignoring the notice will lead to an ex-parte assessment (Best Judgment) under Section 144, resulting in maximum tax liability and likely prosecution.

Q2: The notice was issued to my old email ID. Is it valid? A: Generally, yes. It is the taxpayer’s duty to update contact details on the portal. However, if you can prove you never accessed the notice and were denied natural justice, you may get relief from the High Court to “reset” the proceedings, but the notice won’t be quashed permanently.

Q3: Can I withdraw from Section 115BAA during scrutiny? A: No. Once the option for Section 115BAA is exercised, it cannot be withdrawn for the same year. If you fail the conditions, the AO will thrust you into the normal tax regime (30%) for that year.

Q4: What is the time limit for the AO to complete the reassessment? A: Under Section 153, the assessment must generally be completed within 12 months from the end of the financial year in which the notice under Section 148 was served.

Q5: The AO is imposing a 200% penalty for a Transfer Pricing adjustment. Is this automatic? A: No. If you have maintained TP documentation (Section 92D) and declared the transaction, the law protects you from the 200% penalty even if an addition is made to your income. You must contest this vehemently.

Part VIII: Actionable Checklist for Finance Heads

Data Hygiene: Immediately log in to the Income Tax Portal and check “Pending Actions.”
Ashish Agarwal Audit: If your case is a reopened one from 2021, verify if the Department sent you the “underlying material.” If not, file a preliminary objection immediately.
PF/ESI Audit: Re-calculate all payment dates for the scrutiny year. If there are delays, prepare cash-flow justifications (though legally weak, they help in penalty mitigation).
TP Documentation: Ensure the Master File and Local File for Transfer Pricing are ready and the Form 3CEB matches the Return of Income exactly.
Digital Trail: Since assessment is faceless, ensure every reply has a digital acknowledgement. Do not rely on verbal assurances from anyone.