Section 205: Protection Against Double Taxation When Employer Defaults on TDS
The Core Issue
Can the Income Tax Department demand tax directly from an employee if their employer has deducted the tax from their salary but failed to deposit it with the Government?
Facts of the Case (A.Y. 2020-21 & 2021-22)
The Mismatch: The assessee’s employer deducted TDS for two years but didn’t remit it. When the assessee filed their ITR, the Centralized Processing Centre (CPC) system found a mismatch between the claimed credit and Form 26AS, automatically raising a tax demand under Section 143(1).
Statutory Shield: The assessee invoked Section 205, which acts as a “bar against direct demand” on the taxpayer to the extent tax has already been deducted at source.
Administrative Support: The assessee also relied on Instruction No. 275 (01.06.2015) and an Office Memorandum (11.03.2016), which explicitly direct tax officers not to enforce such demands.
The Decision & Supreme Court Intervention (2026)
High Court Ruling
The High Court quashed the demand, holding that the Revenue cannot penalize the employee for the employer’s default. Crucially, the High Court also issued systemic directions to the CBDT to modify the income-tax software so that such demands are not automatically generated in the future.
Supreme Court Clarification (Shobhan Shantilal Doshi [2026])
The Revenue challenged the High Court’s order in the Supreme Court, but only regarding the software modification directions.
Relief Intact: The Supreme Court did not interfere with the relief granted to the individual assessee. The bar on direct recovery remains absolute.
Software Directions Set Aside: In its ruling dated January 12, 2026, the Supreme Court set aside the High Court’s direction to change the software. The Court reasoned that technology cannot substitute the Assessing Officer’s (AO) manual verification. Automated changes might accidentally ignore genuine demands or incorrect claims.
Final Outcome: The Special Leave Petition (SLP) in the current case was dismissed because the law was already settled: the assessee is protected, but the Department is not forced to rewrite its code.
Key Takeaways for Taxpayers
Burden of Proof: If you face a demand due to an employer’s default, you must provide Form 16, payslips, and bank statements showing the net salary credit. Once proven, the demand must be stayed or deleted.
Section 205 is Your Shield: The law treats the deductor (employer) as the agent of the Government. Once they deduct the tax, your liability is discharged, and the Government must chase the “agent” (under Section 201), not you.
Systemic Reality: Since the Supreme Court has set aside the requirement for automated software fixes, these mismatches will likely continue to appear. Taxpayers should be prepared to file a rectification request (u/s 154) or a response to the demand notice citing these precedents.
Would you like me to draft a sample response you can use to reply to a demand notice in cases of TDS mismatch?