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Weekends usually bring a little respite from the otherwise hectic working schedules. But, when one’s mobile and email inbox starts pinging messages and email alerts from the income tax department, in such otherwise relaxing weekend, then it definitely becomes a bit of a concern and a spoiler.

In the weekend gone by, many people have received messages and emails from the I-T department, intimating them about some artificial intelligence (AI) identified mismatches in their interest and dividend incomes declared in their I-T returns for financial years 2021-22 and 2022-23, vis-à-vis, those reported in annual information system (AIS) by the banks and companies.

In order to reconcile the mismatch, an on-screen functionality has been made available in the Compliance portal of the I-T department’s e-filing website for taxpayers to provide their response. It has been clarified that such messages and emails are not notices. The on-screen functionality is self-contained and will allow the taxpayers to reconcile the mismatch on the portal itself by furnishing their response.  No document is required to be furnished. This is a pro-active step taken by the I-T department to reach out to the taxpayers and provide them an opportunity to respond to the communication in a structured manner.

But at the same time, the taxpayers who are unable to explain the mismatch have also been prompted to consider the option of furnishing an Updated Income Tax Return if eligible, to make good any under reporting of income. In order to declare any skipped interest or dividend income, an updated return can be filed within two years from the end of the relevant assessment year by paying additional taxes. If an updated return is filed within 12 months from the end of the relevant assessment year, additional income tax would be 25 percent of the aggregate of tax and interest payable therein. However, the additional income tax would increase to 50 percent if an updated return is filed after 12 months, from the end of the relevant assessment year.

The I-T department has also released an updated ‘User Guide for Submitting Response to Notices and Letters Received under e-Verification Scheme, 2021’ to assist taxpayers with this process.

The I-T department on 26th February has provided a much-needed respite by clarifying that in case the taxpayer has disclosed the interest income in the I-T return under the line item ‘Others’ in the Schedule OS, it need not respond to the mismatch pertaining to the interest income. The said mismatch shall be resolved on its own and will be reflected in the portal as ‘Completed’.

But, apart from this reason, the alleged mismatch in the interest income may also arise from other similar practical reasons, wherein there is no under reporting of interest income as such, and there is a genuine and lawful explanation for such mismatch.

Many taxpayers engaged in business, make fixed deposits, which are intrinsic to such business. For instance, a fixed deposit may need to be made as performance guarantee, in order to obtain a business tender. Similarly, the fixed deposit may need to be made for obtaining a letter of credit for procuring goods. The incidental interest income on such fixed deposits is usually accounted for as business income and is adjusted against the business expenses, and is not shown under the head ‘income from other sources’.

There are many favourable legal precedents allowing for such treatment of interest income as business income and not as income from other sources. Some of these judgements are cited below:

1. CIT v. Karnal Co-operative Sugar Mills Ltd. [2001] 118Taxman489 (SC) and

2. CIT v. Bokaro Steel Ltd. [1999] 236 ITR 315 (SC)

3. 4 CIT v. Shahi Export House [2010] 195 taxman 163 (Delhi HC)

4. CIT v. Shahi Export House [2010] 195 taxman 163 (Delhi HC)

5. Dy. CIT v. G.H. Crop. Science (P.) Ltd. [IT Appeal Nos. 56 and 84 (Asr.) of 2020, dated 23-2-2023] (Amritsar ITAT)

6. DCIT vs. G. G. Continental Traders (P.) Ltd. [2023] 151 taxmann.com 384 (Amritsar - Trib.)

However, the I-T department usually challenges such treatment in the notice for regular assessment. In such full-fledged assessment proceedings, the taxpayer gets an adequate opportunity to furnish its lawful explanation to treat the interest income as business income, based on the documentary evidences and binding legal precedents.

But, in the present e-verification window, there is no scope for the taxpayers to furnish such detailed explanation and uploading any supporting evidences. The limited possible word count explanation given by the taxpayer, is most likely to be ignored by the AI tool of the department.

Another practical reason for such mismatch is the method of accounting being followed by the taxpayers. The non corporate taxpayers can opt for the cash basis of accounting and reporting their interest and dividend income. As such the interest and dividend income will be shown by such taxpayers in their I-T returns, only in the year of actual receipt and not in the year of their accrual.

However, the respective banks and companies usually deduct TDS and report such interest and dividend pay-outs on accrual basis only. So, this different methodology of cash and accrual basis of accounting and reporting, respectively by the recipient taxpayers and the payer banks and companies, is also one of the commonly recurring reasons for the AI generated red-flag, but with no possible lawful redressal in the e-verification window.

So, in such cases, inspite of there being no lawful reason to construe the interest or dividend income as under-reported income, the mismatch will continue to persist, and which may in future become the basis for reopening the entire case of such taxpayer by the assessing authority.    

Thus, there is an urgent need for the I-T department to recognise and accommodate the above commonly applicable practical reasons for the interest and dividend income mismatch also, just like their clarification on 26th February. Then only this redressal initiative of the I-T department will become a full tasty pie and not just remain a half-baked cookie.

[This Article has also been published in Taxmann with the Citation [2024] 160 taxmann.com 2 (Article).