Bombay High Court overturns AI-generated income tax notice, terms process unjust to taxpayer
The Bombay High Court noted that the Income Tax Department had relied on artificial intelligence (AI) to cite three fabricated judicial precedents and issued a tax notice involving ₹22 crore of alleged income. Upon review, the Court observed that no such rulings actually exist and questioned how the department obtained these so-called judicial references. The Bench remarked, “In today’s age of Artificial Intelligence, there is often a tendency to trust system-generated results. However, when exercising quasi-judicial powers, such AI-generated information should never be accepted blindly but must be properly verified before use — otherwise, errors like this are bound to occur.”
Ultimately, invoking its authority under Article 226 of the Constitution, the Bombay High Court quashed the notice, remanded the matter back to the assessing officer, and directed that a fresh notice be issued with clear and specific findings. The Court further instructed that the taxpayer must be given a fair and reasonable opportunity to present their case.
Chartered Accountant (Dr.) Suresh Surana told ET Wealth Online that in this case (Writ Petition (L) No. 24366 of 2025), the taxpayer had challenged an assessment order passed under Section 143(3) read with Section 144B for AY 2023–24. The Assessing Officer (AO) had raised the taxpayer’s income from ₹3.09 crore to ₹27.91 crore, issuing a consequent tax demand under Section 156 and a penalty notice under Section 274 read with Section 271AAC.
The additions were made on two grounds:
(i) Disallowance of purchases worth ₹2.16 crore from Dhanlaxmi Metal Industries on the pretext that the supplier had not replied to a Section 133(6) notice; and
(ii) An addition of ₹22.66 crore for unsecured loans from directors, calculated on a “peak balance” basis.
According to Surana, the taxpayer argued that both additions violated principles of natural justice. Evidence was produced showing that the supplier had indeed responded to the Section 133(6) notice with confirmations, invoices, e-way bills, transport details, and GST filings before the assessment was concluded. As for the unsecured loans, the taxpayer contended that no show-cause notice was issued, no computation basis was shared, and the AO relied on three fictitious judicial rulings.
Surana noted that the Bombay High Court identified major procedural flaws and a serious breach of fairness, including:
— The supplier’s confirmation was on record but ignored, while the assessment order falsely stated otherwise.
— The AO relied on three judicial citations that did not exist, showing lack of due verification despite AI use.
— No explanation or working for the “peak balance” addition was shared, denying the assessee a chance to respond.
Given these lapses, the Court ruled that the assessment order violated due process and quashed the assessment, demand, and penalty notices. It directed the AO to issue a detailed show-cause notice with clear reasoning, provide a personal hearing, and ensure that any cited judicial rulings are real and verified before being used.
Surana added that the High Court rightly exercised its writ jurisdiction under Article 226 since the case involved a complete breakdown of procedural justice, not just minor technical errors.
Mihir Tanna, Associate Director at S.K. Patodia LLP, highlighted that the ruling underscores two key principles — confirmation by third parties and the right to be heard. When a transaction’s authenticity is questioned, confirmations from the counterparty strengthen the taxpayer’s case. Likewise, denying an assessee a chance to present their explanation breaches natural justice.
How Did the Case Originate?
The matter originated when the taxpayer approached the Bombay High Court through a Writ Petition, contesting an Assessment Order issued under Section 143(3) read with Section 144B of the Income Tax Act, 1961, dated March 27, 2025, for Assessment Year 2023–24.
As per the challenged assessment, the Income Tax Department had increased the taxpayer’s total income to ₹27.91 crore, as opposed to ₹3.09 crore originally reported in his Income Tax Return (ITR). Alongside, the Notice of Demand issued under Section 156 was also disputed in the petition.
Upon examining the assessment order, the High Court observed that the tax officer had made two major income additions. The first was a disallowance of purchases worth ₹2.15 crore from a supplier company on the grounds that it had failed to respond to a Notice under Section 133(6). The second addition related to unsecured loans from directors, where a peak balance of ₹22.66 crore was added to the taxpayer’s income.
The Court remarked, “Even the opening balance was taken into account while making this addition, and to justify it, reliance was placed on certain judicial rulings.”
Bombay HC Rules Assessment Order Unjust: Natural Justice Overlooked
The Bombay High Court observed that after carefully examining the documents and hearing both sides, it became evident that the Assessment Order had been issued in clear violation of the principles of natural justice.
Regarding the first income addition, the Court noted that the tax authorities proceeded without considering the supplier’s reply to the Notice issued under Section 133(6). The taxpayer had attached, on page 568 of the petition, a copy of the notice dated March 4, 2025, addressed to the supplier, asking for detailed information to be furnished by March 5, 2025.
The Court further stated: “The concerned supplier submitted a detailed response on March 8, 2025, which can be found at page 571 of the petition. In that reply, the supplier not only confirmed the transaction but also submitted supporting evidence such as invoices, e-way bills, transport receipts, and GST returns. This response, along with the enclosures, spanned nearly 100 pages.”
The High Court emphasized that this reply was available well before the disputed assessment order was finalized.
The bench remarked: “It is clear that this crucial piece of evidence, though present on record, was ignored by the assessing officer. The order even stated that ‘no such reply was filed.’ In the department’s affidavit-in-reply, an apology has now been offered for the oversight.”
Bombay HC Warns Tax Department Against Blind Reliance on AI
The Bombay High Court, while examining the second issue regarding the addition of peak balances on loans from directors, observed that the tax officer had included the opening balance while computing the peak balance. To justify this, the officer relied upon three judicial decisions.
However, the Court pointed out that these cited rulings were entirely fictitious and had no existence. It questioned the tax department on how such references were obtained. The Court remarked: “In this age of Artificial Intelligence (AI), officials tend to depend heavily on the results produced by such systems. Yet, when performing quasi-judicial duties, one must not rely blindly on AI outputs. Each result should be properly verified before being used, or errors like this will occur.”
The Court further noted that the taxpayer had been left completely unaware of how the figures for the additions were determined. No workings, basis, or show-cause notice had been shared with the petitioner before finalizing the addition of peak balances.
The Bombay High Court concluded: “The taxpayer’s grievance in this regard is absolutely justified.”
Bombay High Court’s Final Verdict
The Bombay High Court concluded that, given the specific circumstances of this case, it would be inappropriate to direct the petitioner to pursue alternate legal remedies. The Court held that this was a suitable matter for exercising its powers under Article 226 of the Constitution of India.
Accordingly, the Court set aside and annulled the Assessment Order issued under Section 143(3) read with Section 144B of the Income Tax Act dated March 27, 2025, for AY 2023–24. It also quashed the related Notice of Demand under Section 156 and the Show-Cause Notice for penalty under Section 274 read with Section 271AAC, both dated March 27, 2025.
The matter has been remanded to the Assessing Officer (AO) with clear directions to issue a fresh show-cause notice, explicitly mentioning the basis of any proposed additions or disallowances. The AO must provide the taxpayer with a fair opportunity to respond, adequate time to file a written reply, and a personal hearing before issuing the final assessment. If the department intends to rely on any judicial precedents, such references must be communicated to the petitioner at least seven days in advance. The fresh order should be a well-reasoned speaking order addressing every contention raised by the taxpayer and must be completed by December 31, 2025.
The Court further clarified that it has not expressed any opinion on the merits of the income additions or disallowances made earlier, and all rights and arguments of both parties remain preserved.
Finally, the writ petition was disposed of in these terms, with no order as to costs. The judgment will bear a digitally signed copy from the Private Secretary or Personal Assistant of the Court, and parties may act upon an authenticated digital version transmitted via email or fax.