The Chennai Bench of the Income Tax Appellate Tribunal (ITAT) has held that employees’ contributions towards Provident Fund (PF) and Employees’ State Insurance (ESI) could not have been disallowed by way of a prima facie adjustment under Section 143(1)(a) of the Income Tax Act when the issue was debatable and contentious on the date of processing the return.
The bench of Aby T. Varkey (Judicial Member) and S.R. Raghunatha (Accountant Member) observed that the subsequent settlement of the controversy by the Supreme Court in Checkmate Services (P.) Ltd. v. CIT does not change the character of the issue as it existed when the intimation was originally issued. The order was pronounced on August 13, 2026.
The Tribunal was considering two appeals relating to Assessment Years 2018-19 and 2020-21 against orders of the Commissioner of Income Tax (Appeals), National Faceless Appeal Centre (NFAC). For AY 2018-19, the dispute principally concerned a disallowance of Rs. 7,05,594 under Section 36(1)(va) relating to employees’ PF/ESI contributions and an additional Rs. 26,42,435 disallowance under Section 14A read with Rule 8D.
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The appellant/assessee had filed its return for AY 2018-19 declaring gross total income of Rs. 26.44 crore. While processing the return under Section 143(1), the Central Processing Centre disallowed Rs. 7.05 lakh towards employees’ PF/ESI contributions. The case was subsequently selected for scrutiny, and while completing the assessment under Section 143(3), the Assessing Officer adopted the income already determined in the Section 143(1) intimation and additionally made the Section 14A disallowance.
The CIT(A) upheld the PF/ESI disallowance by relying upon the Supreme Court’s ruling in Checkmate Services, under which employees’ contributions towards PF/ESI are deductible only when deposited within the due dates prescribed under the respective welfare legislations. The assessee carried the matter to the Tribunal.
Before the ITAT, the assessee argued that the real controversy was not merely whether the PF/ESI contribution was ultimately deductible, but whether such a disallowance could legally have been made through the limited adjustment mechanism provided under Section 143(1)(a).
It was contended that Section 143(1)(a) permits only prima facie adjustments based on matters apparent from the return and cannot be employed for deciding issues that are debatable or require adjudication. At the relevant time, there were divergent judicial views on whether employees’ PF/ESI contributions deposited after the due dates under the welfare statutes but before the income-tax return filing deadline could be deducted.
Crucially, the Tribunal noted that the Section 143(1) intimation was issued on November 12, 2019. At that time, the jurisdictional Madras High Court in CIT v. Industrial Security & Intelligence India Pvt. Ltd. had taken the view that no disallowance was warranted where employees’ PF/ESI contributions were deposited before the due date for filing the income-tax return under Section 139(1). Various Tribunal benches had also followed that position. Consequently, the legal position prevailing on the date of the intimation was not free from doubt or debate.
The ITAT referred to the Supreme Court’s decision in Kvaverner John Brown Engg. (India) Pvt. Ltd. v. ACIT, where it was held that prima facie adjustment under Section 143(1)(a) was impermissible when conflicting judicial decisions existed on the interpretation of a provision. It also referred to ACIT v. Rajesh Jhaveri Stock Brokers Pvt. Ltd. regarding the limited jurisdiction available at the Section 143(1) processing stage.
Subsequent Supreme Court Judgment Does Not Change Nature of Issue on Earlier Date
One of the central observations in the ruling concerned the effect of the Supreme Court’s subsequent decision in Checkmate Services.
The Supreme Court eventually settled the PF/ESI controversy in 2022 by holding that employees’ contributions are deductible only when deposited within the due date prescribed under the relevant welfare legislation. However, the ITAT held that this subsequent declaration of law did not alter the fact that the issue was debatable when the Section 143(1) intimation was issued in November 2019.
The Tribunal specifically observed that “the subsequent declaration of law by the Hon’ble Supreme Court does not alter the character of the issue as a debatable issue on the date on which the intimation u/s.143(1) was issued.”
The Bench also drew support from the Chhattisgarh High Court’s decisions in Raj Kumar Bothra v. DCIT and Harsiddhi Infra Developers Private Limited v. ACIT. The High Court had held in similar circumstances that Section 143(1)(a), being summary in nature, could not be used to make an adjustment concerning a highly debatable PF/ESI issue that was then pending consideration before the Supreme Court.
Scrutiny Assessment Did Not Cure Original Defect
Another important question was whether the subsequent scrutiny assessment under Section 143(3) validated the original PF/ESI disallowance.
The Tribunal found from the assessment order that the AO had merely adopted the income determined in the Section 143(1) intimation. There was no independent examination or adjudication of the Rs. 7,05,594 PF/ESI disallowance during scrutiny.
The Bench therefore rejected the proposition that the later Section 143(3) order could cure the defect in the original adjustment. It noted that the scrutiny assessment contained no independent discussion or finding concerning Section 36(1)(va); the AO had simply adopted the income determined through the earlier intimation.
Accordingly, the Tribunal held that the Rs. 7,05,594 disallowance originally made through Section 143(1)(a) could not be sustained because the allowability of employees’ PF/ESI contributions was a debatable and contentious issue at the relevant time. It directed the AO to delete the disallowance.
Separate Appeal Against Section 143(1) Intimation Not Mandatory in These Circumstances
The ITAT also dealt with an important procedural issue: whether an assessee could challenge an adjustment originating from a Section 143(1) intimation while appealing against the subsequent Section 143(3) assessment, even though no separate appeal had been filed against the intimation.
The Tribunal answered the question in favour of the assessee. Since the AO had taken the total income determined under Section 143(1) as the starting point for the scrutiny assessment, the earlier disallowance continued to form part of the ultimate assessed income and corresponding tax liability.
Referring to judicial precedents, the Bench stressed that the statutory right of appeal should be construed liberally and that procedural or technical objections should not defeat an assessee’s substantive right to challenge an order resulting in tax liability. It consequently held that the challenge could not be rejected merely because a separate appeal had not been filed against the earlier Section 143(1) intimation.
The Tribunal clarified that while the intimation gets subsumed into the subsequent assessment order, this does not take away the right to challenge the validity of the intimation. It further held that the assessee could challenge both the jurisdictional validity of the Section 143(1) adjustment and the merits of the addition in the appeal against the main assessment order.
Section 14A: Only Investments Yielding Exempt Income to Be Considered
The ITAT also granted relief on the Section 14A issue.
For AY 2018-19, the assessee had earned exempt dividend income of approximately Rs. 6.32 crore and had already made a suo motu disallowance of Rs. 14.22 lakh under Section 14A. The AO nevertheless made an additional disallowance of Rs. 26.42 lakh under Section 14A read with Rule 8D.
The assessee argued that while applying Rule 8D(2)(iii), only investments that had actually yielded exempt income during the relevant previous year should be considered rather than the entire investment portfolio.
Accepting the contention, the Tribunal held that only investments which actually yielded exempt income during the relevant year should enter the Rule 8D computation. On that basis, the revised disallowance worked out to Rs. 11,37,552, which was lower than the Rs. 14.22 lakh already voluntarily disallowed by the assessee. Thus, no additional disallowance was warranted.
The Tribunal consequently held that the additional Section 14A disallowance could not be sustained. It also observed that the disallowance could not be made while computing book profits under Section 115JB, noting that it did not form part of the inclusions or exclusions contained in the explanation to that provision. The appeal for AY 2018-19 was accordingly allowed.
Similar Section 14A Relief for AY 2020-21
For AY 2020-21, the AO had made an additional Rs. 19,21,870 disallowance under Section 14A, while the assessee had already suo motu disallowed Rs. 28.55 lakh. The assessee had earned exempt dividend income of approximately Rs. 11.91 crore during the year.
Applying the same principle adopted for AY 2018-19, the Tribunal held that only investments yielding exempt income during the relevant previous year should be considered. The revised Rule 8D computation came to Rs. 18,20,602, which was lower than the Rs. 28.55 lakh already disallowed by the assessee.
The ITAT therefore held that no further disallowance was warranted and directed the AO to delete the additional Section 14A disallowance.
Section 80G Claim Sent Back for Verification
The remaining dispute for AY 2020-21 concerned deduction under Section 80G for contributions of Rs. 10,000 to the Armed Forces Fund and Rs. 2,60,800 to the Central Reserve Police Force (CRPF) Fund.
The Tribunal observed that the claim required verification of the factual details and genuineness of the payments based on the supporting donation receipts. In the interest of justice, it restored the issue to the jurisdictional AO for the limited purpose of verifying the payment receipts.
Consequently, the appeal for AY 2020-21 was partly allowed for statistical purposes, while the AY 2018-19 appeal was allowed.
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