Stox N Tax

Beware Taxpayers – Rectification of Earlier ITR Processings to Deny Loss Set-off in Belated Returns – New Departmental Approach

1. Introduction

In recent months, the Income-tax Department has adopted a new operational approach wherein earlier-processed Income-tax Returns (ITRs) — especially those in which set-off of brought-forward business losses was allowed despite belated filing — are being reopened under Section 154 of the Income-tax Act, 1961.

Taxpayers are receiving notices proposing rectification of intimation under Section 143(1), with the reason being that the return for the current year was filed after the due date under Section 139(1), thereby making the set-off of such losses ineligible under Section 139(3).

This move has caught many taxpayers and professionals off guard, especially where the original intimation had accepted the claim without dispute.

In this article, we will unpack:

  • The legal framework on loss carry-forward and belated returns
  • The scope and limits of Section 154 rectification
  • The new departmental process and its implications
  • Remedies available to taxpayers
  • Practical guidance for businesses and professionals

2. Legal Framework for Carry-forward of Losses

2.1 Section 72 – Business Losses

Section 72 allows business losses to be carried forward for 8 assessment years and set off against future business income, subject to compliance with Section 139(3).

2.2 Section 139(3) – Mandatory Timely Filing

For business losses (other than loss from house property) to be carried forward, the return must be filed within the due date specified under Section 139(1).

  • Exception: Loss from house property and unabsorbed depreciation under Section 32 can be carried forward even in belated returns.

2.3 Impact of Belated Returns

If a return is filed after the due date under Section 139(1):

  • Business losses (u/s 72), capital losses (u/s 74), and speculation losses cannot be carried forward.
  • Loss from house property and unabsorbed depreciation remain unaffected.

3. Section 154 – Rectification of Mistakes Apparent from Record

3.1 Nature of Rectification

Section 154 permits correction of mistakes apparent from the record, which are:

  • Obvious and patent errors, not requiring long-drawn legal interpretation.
  • Examples: Clerical errors, calculation mistakes, incorrect carry-forward figures in schedules.

3.2 Suo Motu and On Request

Rectification can be initiated:

  • By the Department (suo motu)
  • On application by the taxpayer

3.3 Time Limits

  • Rectification can be made within 4 years from the end of the financial year in which the order sought to be amended was passed.

3.4 Adverse Rectification – Section 154(3)

When rectification increases a liability or reduces a refund, prior notice and opportunity of being heard must be given to the taxpayer.

4. The New Departmental Process

The Department has started systematically scanning past intimations where set-off of brought-forward loss was allowed despite belated return filing.

Key steps observed in this new approach:

  1. Identification of cases via automated data-matching tools.
  2. Generation of notice under Section 154 proposing rectification.
  3. Option given to the taxpayer to accept or reject the proposed rectification.
  4. If rejected, taxpayer may need to submit a reasoned reply.
  5. Department may pass a rectification order after considering the reply.

5. Legal and Practical Issues

5.1 Is this Rectification Valid?

  • Department’s View: Late filing is an eligibility failure; denial of loss set-off is a clear mistake in original intimation.
  • Taxpayer’s View: Whether loss can be set-off in such cases is a legal issue requiring interpretation; therefore, it’s beyond the scope of “mistake apparent from record.”

5.2 Key Case Laws

  • T.S. Balaram, ITO v. Volkart Brothers [(1971) 82 ITR 50 (SC)] – Rectification cannot be made on debatable points of law.
  • CIT v. Hero Cycles Pvt. Ltd. [(1997) 228 ITR 463 (SC)] – Debatable issues cannot be rectified under Section 154.
  • Mepco Industries Ltd. v. CIT [(2009) 319 ITR 208 (SC)] – Section 154 cannot be used to change opinion.

These authorities support the position that if a matter involves interpretation, it should be taken up through reassessment or appellate proceedings, not via rectification.

6. Taxpayer Remedies

6.1 Respond to the Notice

  • Disagree with the proposed variation if you believe the issue is debatable.
  • Support reply with relevant case laws and legal reasoning.

6.2 Appeal to CIT(A)

  • If rectification order is passed, file Form 35 appeal within 30 days.
  • Grounds:
    • Issue is debatable and beyond Section 154.
    • Original intimation rightly allowed the claim.
    • Rectification amounts to review.

6.3 Writ Petition

  • For cases involving systemic misapplication or procedural violations, consider writ remedy before High Court.

7. Practical Guidance for Businesses

  • File returns within Section 139(1) due dates to safeguard loss carry-forward rights.
  • Review past returns to check if any losses were allowed in belated returns — anticipate potential rectification.
  • Keep documentation ready to defend genuine claims.
  • Respond promptly to Section 154 notices to avoid automatic loss disallowance.

8. Conclusion

The Department’s new initiative to rectify earlier ITR processings for belated returns is legally contentious and has significant implications for taxpayers with loss carry-forwards. While the statutory language of Section 139(3) supports timely filing, the use of Section 154 to deny previously allowed losses can be challenged on the ground that it involves interpretation of law and not a patent mistake.

Taxpayers and professionals must adopt a proactive approach: ensuring timely filings, monitoring departmental communications, and being prepared to respond with fact-based and law-backed submissions.

Leave a comment

Timeline of events