India’s first year of ‘faceless’ tax assessments runs into legal issues

By Suranjali Tandon, National Institute of Public Finance and Policy, New Delhi, India

Several court decisions issued in June and July highlight implementation issues with India’s new “faceless” – i.e., digital – tax assessment scheme, which was intended to be a more taxpayer friendly assessment regime. The litigation and taxpayer experiences with the new scheme suggest some areas for improvement.

Digitalisation of tax functions

The Indian tax administration, like tax administrations around the world, has been digitising its operations in a bid to keep up with the digital transformation of the economy. UK’s HMRC announced its ‘Making Tax Digital Initiative,’ which seeks to make return filing digital, in a phased manner, while remaining cognizant of the taxpayer’s needs to interact better with the tax department. Similarly, the Australian Tax Office in 2013 began the ‘Digital by Default’ program to update the workings and systems to allow digital interface between the tax administration and taxpayer.

India has kept pace with such developments and slowly adopted some of the international best practices. Digitalisation can help administration of tax in different ways. It can improve information gathering, risk analytics and audits, as well as speed up assessment and facilitate better communication. India has adopted changes to implement each of these improvements.

A vast set of information is collected by the tax authorities in India through the mandatory quoting tax ID, Personal Account Number (PAN) and the expanded scope of tax deduction at source for specified incomes. This has not only allowed the Revenue authorities to carry out detailed 360-degree profiling and better risk assessment but also allowed the taxpayer to receive a snapshot of their tax deductions and asset declarations prior to filing returns.

In addition, selection of cases for scrutiny has been digitised. There are two main means of selecting a case for audit – manually and through Computer Aided Scrutiny Selection (CASS). These are mandated for certain transactions and optional in other cases. Manual selection would be based on indicators such as tax deducted to refund ratio or huge capital addition on the books of accounts.

Transition to faceless assessments

CASS was first introduced in 2004 in 60 cities and by 2016 included broad based selection filters. Furthermore, to reduce departmental interface with assessees while providing taxpayers with the ease of compliance assessment through emails, CASS was extended to all scrutiny cases in 2016 after a previous pilot in seven cities. However, assessees can opt-out of this for paper communication.

With its success, the next step for the Revenue was to reduce the interactions between the assessing officers and the taxpayer. In addition to the benefit of convenience, this change was introduced based primarily on grounds of corruption. It was suggested that assessing officers no longer would be able to exploit their position as a result of the absence of, or minimal, personal interface.

To accomplish this, the assessment processes were split between review and verification units, while being centralised at the national e-assessment centre (NeAC), which oversees all communications with taxpayers. Once a return is selected for scrutiny, it will be randomly assigned to a regional e-assessment centre (ReAC) outside the jurisdiction of the assessee. The assessee is expected to provide all required information just as in the earlier system, however through the NeAC. Further, verification, technical and review units of a different ReAC will now carry out the other functions of the AO, i.e., to verify information from other sources, examine the details of the case and assess a draft order respectively.

Based on all the information, the regional assessment unit will issue a draft order and communicate this to the NeAC. The latter will evaluate the draft order based on risk management strategy specified by the Board. NeAC will then have the option to issue a final order – a show cause notice giving the assessees a chance to explain their case or send the order for review to any review unit in another ReAC. Therefore, the new process of assessment distributes the workload of the AO among various ReACs.

Problems with faceless assessments

The intent of the faceless assessment measure was to create a taxpayer friendly system, based on the principle of natural justice, where the taxpayer receives a fair and just tax system, as promised by the taxpayer’s charter. However, the exceptional circumstances imposed by Covid-19 have exacerbated concerns of whether taxpayers have received adequate opportunity to present their case. 

Article 226 of the Constitution of India allows the High Court to issue writs where principles of natural justice are breached or a procedure required for decision has not been adopted. It has come to light that many taxpayers have adopted this recourse for both these reasons.

For example, in Sanjay Aggarwal vs National Faceless Assessment Centre, the taxpayer was not offered an opportunity of personal hearing, even though they may request it. The use of the word “may” in Section 144B(7)(ii) of the Income Tax Act cannot absolve the Revenue from granting such request.

During the imposition of Covid-19 taxpayers were not given enough time to respond. In Naresh Kumar Goyal V. National Faceless Assessment Centre & Ors, the assessee was given 48 hours to respond. In the case of Naina Lal Kidwai Versus National Faceless Assessment Centre Delhi (Earlier National E-Assessment Centre Delhi) & Anr, the assessee and their family were afflicted by Covid-19 and for that reason missed the last date for opting for a hearing. The AO passed the order, even though the date for passing assessment order had been extended.

In another case, Anju Jalaj Batra Vs National E-Assessment Centre Additional Joint Deputy Assistant Commissioner Of Income Tax Officer, the officer issued an assessment order without a mandatory draft assessment order or a show cause notice.

It is clear that there are current procedural anomalies with implementation of the faceless assessment scheme, which could potentially end up burdening the courts and officers further. It is necessary that due consideration is given to the rights of the taxpayer so that the aspired goal of less litigation and speedy assessments are not undermined by orders passed in haste.

In fact, the OECD recommends that tax departments that are now digitalised consider putting in place dedicated web pages, media strategies, hotlines (possibly with call-back facilities), changes to mobile applications, the updating of virtual assistants, etc., to communicate with taxpayers especially during Covid-19.

It may serve the Revenue well to set up better digital infrastructure, such as an app or dedicated hotline to resolve glitches. This does not take away the fact that digital literacy is not sufficient in India to support smooth transition to technology driven functions. Therefore, the tax system, like in other countries must remain considerate to those not comfortable with such interfaces.

Scope for improvement

As a result of the change, another shift in the administration has been the deployment of manpower. Officers manning the assessment system have been reduced from 6,584 to 4,224 officers; and subordinate staff was nearly halved from 33,750 to 17,193. Other than the issues of redeployment of staff and retraining, it is important to note that the while case selection is made better through the use of technology, the assessing officers spend more time on finalising orders which are less prone to errors.

The Comptroller Auditor General (CAG) – India’s apex audit body – found that in assessments during 2014-15 the error rate in a sample of completed assessments was 7.4 percent. To add to this, the success rate of the tax department is estimated to be dismal (27% at the Tribunal, Supreme Court and 13% in High Court) even though the petition rate is in excess of 80%. In fact, in cases such as transfer pricing, 39% of the cases are on grounds similar to previous years.

While digital is the way forward, it perhaps is time to redeploy staff to boost the quality of assessments.

—Suranjali Tandon is assistant professor at National Institute of Public Finance and Policy, New Delhi, India. She leads the Institute’s work on international taxation.