How to make tax return scrutiny less stressful

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In 2022-23, a landmark shift occurred in Indiaian taxation : For the first time, income-tax revenues from individual taxpayers surpassed those from corporations. This breakthrough may be attributed to the successful implementation of the Integrated Taxpayer Data Management System (ITDMS) which aggregates extensive data on various high-value transactions, including cash dealings, jewellery sale and purchase, car purchases, foreign travel, investments in bonds and shares, and earnings such as interest, dividends, and capital gains. This data is sourced from a multitude of entities, including banks, post offices, regional transport offices, depositories, stock exchanges, etc.

Combined with the integration of Tax Deducted at Source (TDS)/Tax Collected at Source (TCS) data, ITDMS offers a 360-degree view of a taxpayer’s financial activities. It has broadened the tax base and improved compliance. Taxpayers, too, have reaped benefits. The tax department now accepts the bulk of tax returns and processes refunds swiftly. 

The department has also introduced the National Faceless Assessment Centre (NaFAC), which has transformed how tax scrutiny is conducted. Taxpayers subjected to detailed assessments can submit all required information online. NaFAC aims to complete assessments within 12-15 months. Taxpayers who do not agree with the assessment orders passed by NaFAC can file appeals online through the National Faceless Appeal Centre (NFAC). 

However, issues remain. Tax department officials, serving as initial judicial authorities, often tend to favour the department in their rulings. Additionally, the NFAC operates without a mandated deadline for resolving appeals submitted by taxpayers. Taxpayers must also pay 20 per cent of the disputed demand before they can file an appeal with NFAC.

In theory, these advancements should make life easier for taxpayers. In practice, the pressure of high tax collection targets, overbearing and antiquated attitudes of income-tax officials, and a lack of accountability has led to far greater harassment of individuals whose returns are selected for scrutiny.

Tax officials pass high-pitched income-tax assessment orders (additional income at least equal to the returned income) and get taxpayers to cough up 20 per cent of the amount before appeal. While the department often loses these appeals, in the near term the tax officials manage to achieve their collection targets. Assuming that only 2 per cent of returns undergo scrutiny, approximately 14 lakh taxpayers are affected annually.

Taxpayers disputing NFAC’s decisions can appeal to the Income Tax Appellate Tribunal, where they can expect justice at the hands of independent judicial officials.

Taxpayers face harassment on several counts. NaFAC officials demand information they already have, including copies of tax returns filed online with the department. After an initial round of queries where the taxpayer submits voluminous information, the tax department remains silent for months. The taxpayer assumes the department has accepted their submissions and expects a favourable order. The tax officials wake up near the deadline and ask for more voluminous information, giving only five-six days to submit the information, citing the looming deadline. If the information is submitted even a minute late, the information is disregarded. 

Taxpayers who have any doubts about their appeals choose to settle with the tax department by using the Vivaad se Vishwas tak scheme. 

The department is sure to eventually lose most of the pending appeals and will have to refund the 20 per cent amount paid. The NFAC, hence, delays decisions. In many cases, appeals have been pending for more than five years. Grievances filed (including on the PMO portal) are routinely sidestepped by NFAC. 

NaFAC and NFAC can lead to India acquiring a reputation for a just tax administration system, provided the following reforms are implemented: excluding disputed tax collections from revenue targets; holding officials accountable for requesting unnecessary information; ensuring timely responses to taxpayer submissions; and mandatory time-bound decisions from NFAC.

Truth be told, the Indian government has successfully implemented several large-scale, tech-driven initiatives like Aadhaar, UPI, Account Aggregator, and ONDC. NaFAC and NFAC have the potential to join this list and contribute to a fair and just tax administration provided the above-mentioned recommendations are implemented.  

The writer heads Fee-Only Investment Advisors LLP, a Sebi-registered investment advisor

X: @harshroongta

Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of or the Business Standard newspaper

Mandatory disclosure by SEBI

(A slightly different version of this column first appeared in the Business Standard on January 29, 2024)

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