Income tax is a major source of revenue for the Government of India, governed mainly by the Income-tax Act, 1961. It applies to individuals, Hindu Undivided Families (HUFs), firms, companies, and other entities, taxing income earned in a financial year.
Although the Act clearly sets out rules for assessment, collection, and enforcement, practical challenges arise due to complex transactions, ambiguous statutory language, evolving business practices, and disputes between taxpayers and tax authorities.
Over decades, Indian courts have played a vital role in interpreting provisions, resolving disputes, and setting legal precedents. This article explains the top legal issues in Indian income tax law, backed by landmark case laws and practical tips for taxpayers.
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Legal Issues Related to Income Tax
Is This Really My Income? The Definition Dispute I See Most Often
Section 2(24) defines income, but it’s not a complete list. There was a client who received a large one-time compensation from a broken business contract, the Assessing Officer insisted it was taxable income, we argued it was a capital receipt.
The case was won, but only after we cited Cadell Weaving Mill Co., where the Supreme Court said capital receipts aren’t taxable unless specifically included.
Action Tip: If you get money that’s unusual, lottery, damages, or refund, don’t assume it’s taxable. Get a legal opinion before filing.
Am I a Resident for Tax? How One Extra Day Changed a Client’s Status
Residential status under Sections 5 and 6 can turn an NRI’s life upside down. There was a client taxed on global income just because his travel schedule meant he stayed in India one day beyond the limit.
Azadi Bachao Andolan rely on the Tax Residency Certificate and avoided double taxation.
Action Tip: Keep exact travel logs and plan trips with tax residency rules in mind, one day can cost lakhs.
Wrong Head of Income, Wrong Tax – A Common Mistake in Business Returns
In one case, a property developer’s rent was taxed as business income. We argued under East India Housing that it should be “Income from House Property” reducing tax liability.
The department often fights misclassification because it can deny deductions.
Action Tip: Classification affects both rate and deductions. Always check under which head your income fits best.
Why Was My Deduction Denied? The Documentation Battle
Many disputes are about proving eligibility for Sections 10, 80C–80U benefits. A start-up client whose Section 80-IB claim was denied because the AO insisted incentives like duty drawback didn’t qualify, just like Liberty India. We lost that round but structured his claims differently in future years.
Action Tip: Incentives are tricky, keep documentation and be prepared for a strict reading of the law.
Transfer Pricing – Proving the Price is Right
In multinational cases, transfer pricing can make or break a company’s tax liability. In one matter, the benchmarking report we prepared became the client’s shield in a multi-crore adjustment attempt.
Cases like Sony India show that benchmarking is not just paperwork, it’s your defence.
Action Tip: Maintain detailed transfer pricing documentation. It’s your first line of defence.
Capital Gains – When the Cost Can’t Be Calculated
We once argued a case where shares allotted decades ago had no recorded purchase cost. Using B.C. Srinivasa Setty, we proved capital gains couldn’t be computed, and therefore not taxed.
Action Tip: Preserve old purchase records; where costs aren’t available, case law may work in your favour.
Tax Saving or Tax Evasion? – Walking the Thin Line
A corporate client’s aggressive tax structure was challenged as a sham. We used Azadi Bachao Andolan to show it was genuine planning, not evasion. But in McDowell, the Supreme Court had slammed colourable devices, so knowing where the line lies is crucial.
Action Tip: Always have a commercial reason for tax structures beyond just tax saving.
Penalty Notices – Don’t Panic, Respond Smartly
A client once panicked after getting a penalty notice for concealment. In court, we relied on Reliance Petroproducts to show it was just a wrong claim, not concealment, penalty dropped.
Action Tip: Penalty notices can be challenged. Always reply with facts, not fear.
Reopening Assessments – How to Fight Back
An old client’s assessment was reopened after five years, without new evidence. We cited Kelvinator of India, no reassessment without tangible material, and won.
Action Tip: Always ask for and examine the “reasons recorded” before fighting reassessment.
Double Taxation – Paying Twice is Not Inevitable
NRIs claim foreign tax credits using DTAA provisions, preventing double taxation. One client saved over ₹30 lakhs by using Section 90 relief.
Action Tip: If taxed in two countries, explore DTAA benefits before paying.
Search and Seizure – Know Your Rights
In a search case, the AO tried adding income unrelated to seized documents. Kabul Chawla helped us get those additions deleted.
Action Tip: Only material found in search can be used for completed assessments, know this to protect yourself.
When the Law Itself is Unfair – Constitutional Challenges
Rare, but there are provisions that are struck down, like in A. Sanyasi Rao, where presumptive tax rules were discriminatory.
Action Tip: Constitutional challenges need solid legal backing, take specialised advice.
Conclusion
In tax disputes, knowing the law is half the battle; knowing how to use it is the other half.
Every case fought reinforces that preparation, documentation, and timely action are the keys to winning, whether it’s a ₹10,000 penalty or a ₹100 crore transfer pricing adjustment.
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FAQs
1. How can I challenge an invalid notice under Section 148 (reassessment)?
You can request the “reasons recorded” from the Assessing Officer, file objections citing case laws like Kelvinator of India, and seek quashing of the notice if no tangible new material exists.
2. Is it possible to settle a tax dispute without going to court?
Yes, through the Income Tax Department’s dispute resolution mechanisms such as the Dispute Resolution Panel (DRP) for transfer pricing, the Advance Ruling Authority, or the Vivad Se Vishwas settlement scheme.
3. Can income tax authorities seize my bank accounts during a dispute?
Yes, under certain conditions during search and seizure operations, but you can challenge the seizure if it is arbitrary or without valid grounds.
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