How the budget can cut tax appeals, ease financial burden on small taxpayers

Amid expectations the upcoming budget will address the issue, experts suggest steps such as reintroducing the faceless regime with personal hearings to handle complex cases, ramping up staffing, alternative dispute resolution mechanisms and mandating a one-year deadline to dispose of appeals.

As per the Central Action Plan data, about 550,000 appeals were pending for disposal as of 31 March 2024 at the level of the Commissioner of Income Tax (Appeals) CIT(A), the first level of challenging tax demands. That’s an increase of 64% since FY19, when 335,000 appeals awaited disposal at the end of the year, according to data from EY India.

The numbers are especially of concern because faceless assessment at the CIT(A) level rolled out in 2020 was meant to quicken the process by eliminating the human interface, but the number of pending appeals has only increased since then (see graphics). Year after year, the number of new appeals lodged surpassed the number of appeals disposed of, adding to the backlog.

The main reasons are limited staff and technological limitations, stakeholders said. According to Ajay R. Vaswani, founder of Aras & Company, chartered accountants, it takes over a year to receive the notice for the first hearing in many cases.

“Despite the introduction of the faceless assessment scheme aimed at expediting the process, the backlog and procedural inefficiencies have resulted in significant delays,” Vaswani said. “This delay can be attributed to the high volume of cases and limited capacity of the appellate authorities to handle them promptly.”

Tech challenges

Even before an appeal, the faceless assessment process is saddled with challenges that result in increased appeals.

“The positive of faceless assessment is that it has made compliance easier for taxpayers as they can respond online. However, the issue is that in about half the cases, the taxpayer is not conversant with technology, so either the notices don’t get a response as the taxpayer doesn’t check emails or can login into the IT portal or are unsatisfactorily drafted,” a faceless assessing officer (FAO) told Mint on condition of anonymity. “On not getting a response, the tax officer has no option but to pass an order, which then goes into appeal.”

Secondly, complex cases assigned to officers who may not have the expertise in such matters end up in appeals.

“For instance, AOs in Bihar are adept at handling cases of small scrutiny assessments of low-income taxpayers. But such officers are assigned complex matters involving high-value variations in bigger companies that are based in metro cities. In addition, there is scope to better assess such cases in person, which is quite difficult in a document filed online,” the FAO said.

Hardships for small taxpayers

Delays in disposing of appeals is the primary pain point for small taxpayers. The prolonged processes cause financial distress to them in several ways.

The outstanding tax is to be paid within 30 days of the demand being raised. After that, the income tax department can recover the outstanding tax by deducting it from any refunds due to the assessee in subsequent years or by attaching their assets. The department can do this even when the matter is under appeal unless the taxpayer gets a stay on the demand.

However, there is an added challenge – the taxpayer must deposit 20% of the outstanding demand to get a stay on the remaining 80% tax due. This can be burdensome for those with high order demands. If the assessee wins the case, the deposit is refunded with 6% annual interest. Moreover, depositing 20% of the outstanding demand doesn’t guarantee a stay.

“We are seeing cases where an assessee is unable to obtain a stay of demand even when she has already paid 20% of the tax demand,” said Rakesh Nangia, managing partner at Nangia & Co. “The CBDT’s (Central Board of Direct Taxes) own guidelines prescribe that stay of demand should be granted in such cases where 20% has already been paid. Since the matter is not formally stayed, the tax demand appears as outstanding on the portal, allowing the department to automatically adjust the refund in future years against such outstanding demands. This adjustment causes undue burden on liquidity of an otherwise eligible taxpayer.”

That’s not all. Chartered accountant Prakash Hegde said there have been cases where the Centralised Processing Centre (CPC) has adjusted the refund against outstanding tax even when there is a stay order after the matter has been pending in appeal for several years.

“It happens mechanically, and the assessee can dispute it in court. But it’s an added difficulty, both financially and administratively, when they are already fighting against the tax demand raised in the first place,” Hegde said.

Prolonged litigation also means that 12% annual interest on the outstanding demand gets added during the pendency of the appeal.

Hegde said many taxpayers opt for settlement under the Vivad Se Vishwas scheme just to free themselves from prolonged litigation. The Vivad Se Vishwas scheme allows taxpayers to settle pending cases by paying the tax on the disputed income, with a waiver on interest and penalties, if any.

“Even in cases where the tax demand was undue, the taxpayer paid it just because they wanted the peace of mind after being stuck in litigation for four-five years and get rid of the mounting interest and continued uncertainty,” Hegde said.

Addressing the challenges

With expectations that the budget on 1 February will address the backlog of appeals, Mint spoke to tax professionals to understand how shortcomings in the current faceless regime can be fixed to make it more efficient. A common suggestion was that physical hearings for complex cases and those involving demands due to technical errors are needed.

“Although a faceless regime at the first appellate level is a welcome move, the cases involving complex issues with high stakes do not get early closure,” said Dharmesh Shah, an income tax lawyer. “Complex matters need detailed understanding of facts and evidence, which is difficult in the faceless regime. Hence, such matters should be allowed for personal and physical hearings.”

A chief commissioner of income tax told Mint that disposing of appeals involving complicated issues was faster before the faceless regime.

“The faceless regime has definitely been favourable for taxpayers as it has brought down corruption. However, for complicated matters, it doesn’t work as relief is not granted at any stage and the litigation goes on for many years. This is because the facts of each case can be understood better in person when heard directly from the assessee, as opposed to reading a file online,” the chief commissioner said on condition of anonymity. “The government should consider giving assessees a choice between faceless and in-person appeals.”

The FAO cited earlier stressed the need for a mix of in-person and faceless appeals till technology adoption widens.

“The option to choose should be given to taxpayers as they, ultimately, suffer,” the FAO said.

For small taxpayers, an offline grievance redressal system can be set up consisting of a senior tax officer and an official from another department or a citizen forum who doesn’t have pro-revenue bias, said Hegde.

“Such units can be set up in each town or region that gives small taxpayers the option to explain their case in person. This can be a more effective and faster way to dispose of petty issues for which taxpayers have to appeal,” he said.

For already pending disputes, especially at the CIT(A) level, ramping up staffing is needed, said Shalini Mathur, senior director at EY India.

“The impact of appointing junior commissioner (appeals) for small-value disputes will be known in a couple of years. Meanwhile, the government can look at deploying increased manpower for a limited time period to clear the existing backlog. Moreover, CIT(A) should be directed that orders with high tax demand should be given precedence so that at least the amount stuck in litigation can be unlocked,” she said.

The total tax amount under dispute was ₹31.4 lakh crore at the end of FY24.

Vaswani agreed and said enhancing the capacity of appellate bodies through increased staffing, better technology, and streamlined processes can help reduce delays.

“Additionally, promoting alternative dispute resolution mechanisms like mediation or settlement commissions can expedite resolutions,” he said.

Sticking to the deadline

Mayank Mohanka, founder of TaxAaram India and a partner at S.M. Mohanka & Associates, said the current one-year timeline advised to commissioners to dispose of appeals under Section 250 (6A) should be changed into a mandatory deadline.

“The word ‘may’ used in the section should be amended to ‘shall’ in the upcoming budget to make it a compulsory requirement to reduce the backlog of appeals,” he said.

He added that despite being online, filing a Form 35 appeal requires multiple technical details that makes it necessary for assesses to hire a professional even if the disputed income is small.

“The form should be simplified so that the taxpayer can file the appeal themselves. Many times, they end up paying more in professional fees than the tax demand raised,” Mohanka said.

Lastly, the conditions imposed on taxpayers need to be addressed to alleviate their financial burden, said Vaswani.

“Introducing a cap on the interest or allowing for a temporary suspension of accrual during the appeal process could provide relief. Also, lowering the 20% deposit for a stay or deferring adjustment of outstanding tax with refunds until the final resolution of the case would ensure fairness to the taxpayer,” he said.