IT Notices On The Rise: Most Common Red Flags That Get Taxpayers Scrutinised

Dozens of senior executives earning over Rs 50 lakh annually have recently received income tax notices after the Income Tax Department flagged alleged discrepancies in their returns. Earlier, thousands of taxpayers were also placed under scrutiny for underreporting income and mismatches in filings.

So, why are income tax notices on the rise, and what are the most common red flags that trigger scrutiny?

Incorrect Income Tax Return Filing

One of the most common reasons for receiving an income tax notice is selecting the incorrect tax return form. For individuals, there are four applicable forms - ITR 1, ITR 2, ITR 3, and ITR 4.

“Many filers with first-time income from capital gains or Futures and Options (F&O) trading mistakenly use ITR 1 or ITR 4, instead of ITR 2 or ITR 3. This misfiling can lead to non-disclosure of such income, resulting in defective return notices for selecting the wrong form,” says Neeraj Agarwala, Partner, Nangia & Co LLP.

AIS Mismatches

Individuals generally receive tax notices when the income disclosed in their tax returns does not align with the information captured in the Annual Information Statement (AIS), including omissions such as capital gains, dividend income, interest earnings, or business-related benefits / perquisites.

Mismatch of Information

Scrutiny may also be attracted to overstated or incorrect deductions. “For instance, inconsistencies in HRA claims compared to the landlord’s reported income or fictitious donations to charitable institutions / political parties - as the department increasingly cross-verifies such claims through multiple reporting channels,” says Sumeet Hemkar, Partner, Deloitte India.

Agarwala adds that this issue is particularly common in cases involving House Rent Allowance (HRA) exemptions. Taxpayers often claim HRA benefits, but the corresponding rental income is either not reported under the landlord’s PAN or is reported inaccurately. “Such discrepancies are quickly flagged by the Income Tax Department’s systems, frequently resulting in notices being issued to taxpayers for clarification and reconciliation,” he says.

Credit Card Payments

When credit card payments in AIS appear disproportionate to the income declared, the tax department will invoke section 69C of the ITA, which deals with unexplained expenditure. Under this provision, any expenditure for which the taxpayer offers no satisfactory explanation regarding the source of funds may be treated as income and taxed at the applicable slab rate of the taxpayer.

“To defend against additions, the taxpayer must maintain a clear and complete audit trail linking each credit card payment to the source of funds used,” suggests Agarwala.

Non-Taxable Gifts

Gifts received from specified relatives are exempt from income tax, and there is currently no provision in the income tax forms to declare these non-taxable gifts. Nevertheless, some individuals have received demand notices for non-payment of taxes on such gifts, highlighting a gap in the reporting process.

Non-Reporting of Foreign Income

Another common trigger for sending tax notices is the non-reporting or inaccurate reporting of foreign income and overseas assets, an area now subject to stricter international disclosure requirements.

Inaccurate Reporting Of High-Value Transactions

“Tax notices can also arise from incomplete or inaccurate reporting of high-value transactions such as substantial cash deposits or property transfers, as well as from discrepancies between declared income and actual financial activity reflected in bank, investment, or digital records,” says Hemkar.

What To Do?

Tax experts advise taxpayers to ensure complete and correct disclosure of income, expenses, and assets to avoid any adverse implications.

“On receiving such notices, taxpayers should promptly review all income sources and assets. If discrepancies exist, file a revised or updated return after paying appropriate tax and interest or disclose the correct information as and when called for by the authorities (in case the time to file the revised or updated return has lapsed),” suggests Hemkar.

For errors in the AIS, taxpayers should contact the relevant parties to update the incorrect details. In cases of detailed scrutiny, try to respond quickly with supporting documents to establish the genuineness of the transactions.