Introduction:

In a significant and cautionary ruling on the intersection of Artificial Intelligence (AI) and judicial procedure, the Bombay High Court quashed an income tax assessment order after discovering that the Assessing Officer (AO) had relied on non-existent, AI-generated case laws to support the additions made to the petitioner’s income. The case, titled KMG Wires Private Limited v. The National Faceless Assessment Centre (WRIT PETITION (L) NO. 24366 OF 2025), was heard by Justices B.P. Colabawalla and Amit S. Jamsandekar. The petitioner/assessee, KMG Wires Private Limited, challenged the assessment order for the Assessment Year 2023-24, where the Respondent No. 1/Assessing Officer, representing the National Faceless Assessment Centre (with Mr. Akhileshwar Sharma representing the department), had drastically assessed the assessee’s total income at Rs. 27.91 Crores, a substantial increase from the Rs. 3.09 Crores returned by the assessee. The court’s decision not only set aside the impugned order but also issued a crucial mandate that tax authorities must cross-verify AI-generated results before employing them in quasi-judicial functions.

Arguments on behalf of the Petitioner/Assessee (KMG Wires Private Limited):

The petitioner, represented by Mr. Dharan V. Gandhi along with Aanchal Vyas, raised fundamental challenges to both the procedural fairness and the factual basis of the assessment order.

• Reliance on Non-Existent Case Laws: The most compelling argument was the discovery that the assessment order relied on judicial decisions that were “completely non-existent.” The assessee argued that the AO had clearly relied on AI-generated results without proper verification, leading to a legally flawed and unsustainable order.
• Factual Error Regarding Purchase Addition: The assessee contested a primary addition of Rs. 2,15,89,932/- related to purchases from Dhanlaxmi Metal Industries. The AO had made this addition on the incorrect premise that the vendor had failed to reply to the notice under Section 133(6) of the Income Tax Act, 1961. The petitioner submitted evidence showing this was “factually incorrect.” The said party had not only replied and confirmed the transactions but had also provided “voluminous details/evidence” in support of the dealings. Thus, the addition was made “in ignorance” and without considering the evidence on record.
• Lack of Procedural Fairness (Show Cause Notice): The petitioner argued that their grievance was justified because they were “clueless” as to the working or basis upon which the additions were calculated, particularly the addition of the “peak balance.” The assessee contended that no basis or working was ever shown to them, nor was a Show Cause Notice issued before making this addition, constituting a clear breach of natural justice and fair procedure under the Faceless Assessment Scheme.

Arguments on behalf of the Respondent/Department (National Faceless Assessment Centre):

• The Income Tax Department, represented by Mr. Akhileshwar Sharma, sought to defend the substance of the assessment while admitting to a procedural flaw.
• Acknowledgement of AI Error: The department submitted that the reference to some judgments in the Assessment Order that “could not be found” was an “error.” They effectively conceded the use of unverified AI-generated content.
• Rectification of Error: They informed the bench that this error had subsequently been “rectified by the JAO” (Joint Assessing Officer) by passing a rectification order, suggesting that the procedural defect had been cured.
• Merits of the Addition: Crucially, the department maintained that the addition, despite the admitted error in referencing case laws, was “correctly made” on its merits. They implied that the substance of the tax demand remained valid, even if the supporting legal references were flawed.

Court’s Judgement and Rationale:

The Bombay High Court’s judgment centered on the procedural and legal integrity required of a quasi-judicial authority, especially in the context of modern technology.

1. Denouncing Blind Reliance on AI:

The court delivered a firm warning about the use of AI in quasi-judicial functions. Justices B.P. Colabawalla and Amit S. Jamsandekar highlighted the inherent risks of unchecked reliance on technology:

“The Court stated that in the era of Artificial Intelligence, the tax authorities cannot blindly rely on such AI-generated results. AI-generated case laws must be cross-verified before using them in quasi-judicial functions.”

The bench explicitly noted that while the “era of Artificial Intelligence (‘AI’), one tends to place much reliance on the results thrown open by the system,” officers exercising quasi-judicial functions must not “blindly rely upon” such results, but must ensure they are “duly cross-verified before using them.” The court concluded that failure to do so, as in the present instance where the relied-upon decisions were “completely non-existent,” allows such “mistakes” to creep into judicial process. The bench also demanded the Assessing Officer to “show from where such decisions were fetched.”

2. Upholding Procedural Fairness:

The court agreed with the assessee that the lack of disclosure regarding the working of the additions and the failure to issue a proper Show Cause Notice violated the principles of natural justice. The bench held that the assessee’s grievance that they were “clueless as to how the figures are arrived at” and that “no basis or working was ever shown to the assessee, nor was any Show Cause Notice issued before making the addition of peak balance” was “justified.” This violation alone was sufficient grounds to quash the order.

3. Quashing and Setting Aside the Assessment:

Given the gravity of the procedural flaws, particularly the reliance on fictitious legal precedents and the failure to consider the assessee’s reply regarding the purchase addition, the Court quashed and set aside the entire assessment chain. This included:

The Assessment Order passed under Section 143(3) read with Section 144B of the Act.

The Notice of Demand under Section 156 of the Act.

The consequential Show Cause Notice for levy of penalty issued under Section 274 read with Section 271AAC of the Income Tax Act.

4. Remand and Directions:

Instead of concluding the matter, the bench remanded the matter back to the Assessing Officer for a fresh assessment, ensuring the proper procedure is followed this time. The AO was directed to issue a fresh Show Cause Notice to the assessee.

Furthermore, in a directive aimed at preventing future AI-related mishaps and ensuring transparency, the court added a specific procedural safeguard:

“If any decisions are relied upon, then the Petitioner will be put to adequate notice of not less than 7 days, to counter such judgments.”

This final instruction ensures the assessee is given a fair opportunity to review and contest any legal precedents used by the tax authority, effectively mandating judicial verification and full disclosure.