Supreme Court Modifies High Court Order: Direct Tax Demand Barred, but Software Mandate Relaxed

1. The Core Conflict: The “Employer Default” Problem

This case addresses a common grievance: an employer deducts tax (TDS) from an employee’s salary but fails to deposit it into the Government treasury.

The Problem: When the employee files their return, the TDS does not appear in Form 26AS or AIS. The Centralized Processing Centre (CPC) automatically denies credit for the tax and raises a tax demand against the employee.
The High Court’s Stand: The High Court ruled in favor of the employee, citing Section 205. This section creates a bar against direct demand on the assessee once the tax has been deducted at source.

2. Legal Basis: Section 205 and CBDT Instructions

The High Court relied on established legal safeguards to protect the “Deductee” (the employee) from the failures of the “Deductor” (the employer):

Section 205: Explicitly states that where tax is deductible at source, the assessee shall not be called upon to pay the tax themselves to the extent to which tax has been deducted.
Instruction No. 275 (2015): The CBDT had previously directed its officers not to resort to coercive recovery against taxpayers where the deductor had defaulted.
The High Court’s Radical Direction: To solve this permanently, the High Court ordered the CBDT to recode/modify its processing software so the system would automatically stop raising demands in mismatch cases.

3. The Supreme Court’s Intervention

The Revenue (Income Tax Department) appealed to the Supreme Court, specifically contesting the direction to modify the software.

I. Relief for the Individual Assessee (Maintained)

The Supreme Court did not disturb the relief given to the individual employee. The rule remains: If your tax was deducted, the Revenue cannot collect it from you again, even if your employer stole the money. The Revenue must instead go after the employer.

II. Relief for the Department (Software Mandate Set Aside)

The Supreme Court set aside the High Court’s instruction to modify the software.

The Logic: The Court held that such sweeping administrative directions (changing the logic of the national tax processing system) were unnecessary for deciding the merits of the individual case.
The Finding: While the law protects the assessee, the software can continue to function as is, provided that when a taxpayer challenges a demand, the manual/legal override based on Section 205 is applied.

Key Takeaways for Salaried Taxpayers

Section 205 is your Shield: If you receive a demand notice for TDS not deposited by your employer, your response should cite Section 205 and Instruction No. 275.
Evidence is Crucial: To claim the benefit, you must prove the deduction happened. Your Salary Slips and Form 16 are the primary evidence of deduction.
Corrective Action: Don’t ignore the notice. Use the “Response to Outstanding Demand” portal to disagree with the demand, selecting the reason as “Demand paid by way of TDS.”

SUPREME COURT OF INDIA

Income-tax Assessing Officer, Baroda

Shobhan Shantilal Doshi^*

Rajesh Bindal and Vijay Bishnoi, JJ.

CIVIL APPEAL NO.197 OF 2026^†

JANUARY 12, 2026

Raghavendra P Shankar, A.S.G., Ms. Madhulika Upadhyay, AOR, Karan Lahiri, Bhuvan Kapoor, Udit Dedhiya and Shashank Bajpai, Advs. for the Petitioner.

ORDER

1. Delay condoned.

2. Leave granted.

3. The only grievance raised by the appellants in the present appeal is regarding the directions given by the High Court in paragraph Nos.10 and 11 of the impugned order. While granting relief to the respondent on merits, direction has been issued to the Central Board of Direct Taxes to make changes in the software so that no demand is raised in future in similar cases.

3.1 Challenge has not been made to the relief granted to the respondent on merits. Hence, we do not propose to issue notice to the respondent as the order, we propose to pass, will not affect the relief granted to the respondent.

4. Learned Additional Solicitor General appearing for the appellants submitted that unless the Assessing Officer comes to know about the facts of the case regarding deduction of Tax Deducted at Source (TDS) by the person paying the amount to the assessee, the liability cannot be waived of. It is only in case any TDS has been deducted from the payments made to an assessee that he gets credit, despite the fact that the amount may not have been paid to the Department by the person who deducted the TDS. For that, certain facts will always be required to be verified. Any change in the software will not even point out the cases to the Assessing Officer where there may be a wrong claim made regarding deduction of tax. There can be other different factual situations, which may require manual examination after issuance of show cause notice to the assessee. Hence, change in the software may result in ignoring demands, which may be genuine. Technology are only meant for assistance and data processing, and not for adjudication of cases.

5. As the aforesaid directions issued have nothing to do with the case on merits and will not affect the respondent-assessee, in our opinion, the present appeal can be disposed of with the observation that the direction issued by the High Court in paragraph Nos. 10 and 11 of the impugned order for changes to be made in the software are set aside.

6. With the aforesaid clarification in the impugned order passed by the High Court, the present appeal is disposed of.