How to Respond to an Income Tax Demand Notice

What Is a Section 156 Demand Notice?

A demand notice under Section 156 of the Income Tax Act, 1961, is a formal communication from the Income Tax Department requiring payment of a specific amount — which may include unpaid tax, interest, penalty, or fee. Unlike an intimation under Section 143(1), which is generated automatically by the Central Processing Centre (CPC) in Bangalore, a Section 156 demand notice is typically issued as a consequence of an assessment order, reassessment order, penalty order, or rectification order passed by the Assessing Officer (AO).

For foreign companies operating in India through wholly owned subsidiaries, branch offices, or liaison offices, demand notices are a common occurrence — particularly when the AO makes adjustments to transfer pricing, disallows DTAA benefit claims, or identifies mismatches between the filed income tax return and the information in Form 168 (formerly Form 26AS) or the Annual Information Statement (AIS).

A note on section numbers: the Income-tax Act, 1961 continues to govern tax years that began before 1 April 2026 — which covers most demand notices now in circulation — and this guide uses the 1961-Act numbering throughout. For tax year 2026-27 onwards, the Income-tax Act, 2025 applies; the corresponding provisions are section 289 (notice of demand, replacing section 156), section 287 (rectification, replacing section 154), sections 411 and 412 (recovery and penalty, replacing sections 220 and 221), and section 358 (form of appeal, replacing section 249).

This guide covers the end-to-end process for responding to a demand notice, including differentiation between situations where the demand is correct, partially correct, or entirely incorrect — verified against the current e-Filing portal procedures for 2025-2026.

Common Triggers for Demand Notices Against Foreign Companies

Understanding why the demand was raised is the first step to formulating an effective response. For foreign companies, the most frequent triggers include:

Transfer Pricing Adjustments

Transfer pricing adjustments remain the single largest source of tax demands against foreign companies in India. When the Transfer Pricing Officer (TPO) determines that intercompany transactions — management fees, royalties, cost allocations, or intercompany sales — were not conducted at arm's length, the resulting adjustment is added to the company's taxable income, generating a substantial demand.

A transfer pricing report in Form 48 (formerly Form 3CEB) is mandatory for any international transaction with an associated enterprise, regardless of value; the INR 1 crore figure is only the Rule 10D threshold for maintaining detailed transfer pricing documentation. The TPO can make adjustments if the company's benchmarking analysis does not withstand scrutiny.

Disallowance of DTAA Benefits

The IT Department frequently disallows treaty benefits when the foreign company fails to provide a valid Tax Residency Certificate (TRC) — issued by the company’s own country of residence, not by the Indian Income Tax Department — or the Form 41 (formerly Form 10F) declaration filed on the Indian e-filing portal alongside it. The requirement for a TRC is strictly enforced — an expired or improperly formatted TRC results in automatic disallowance of the treaty rate and application of the higher domestic withholding rate.

TDS Credit Mismatches

Mismatches between TDS claimed in the income tax return and TDS reflected in Form 168 are a frequent trigger. This often occurs when Indian clients deduct withholding tax under Section 195 but file their TDS returns late or with incorrect PAN details, causing the credit to not appear in the foreign company's Form 168.

AIS/TIS Data Discrepancies

The IT Department's Annual Information Statement (AIS) and Taxpayer Information Summary (TIS) now capture an expanded range of financial transactions — high-value purchases, share transactions, foreign remittances, and interest income. If the income reported in the ITR does not match the AIS/TIS data, the CPC or AO may raise a demand for the differential amount plus interest.

Penalty for Under-Reporting or Misreporting

Under Section 439 of the Income-tax Act, 2025 (section 270A of the Income-tax Act, 1961), penalties for under-reporting income range from 50% of tax on under-reported income, while misreporting of income attracts a penalty of 200% of tax. The penalty order is accompanied by a Section 156 demand notice.

Step 1: Verify the Demand Notice

Before taking any action, verify the authenticity and accuracy of the notice.

Verify Authenticity on the e-Filing Portal

1. Log in to the e-Filing portal at incometax.gov.in
2. Navigate to Pending Actions > Response to Outstanding Demand
3. Check if the demand appears with the matching Assessment Year, DIN (Document Identification Number), and amount
4. Cross-reference the DIN with the notice received — every genuine notice issued after 2019 carries a unique, computer-generated DIN

Warning: Fraudulent demand notices circulate via email and WhatsApp. The IT Department has issued multiple advisories cautioning taxpayers to verify notices only through the official portal. Authentic communications originate exclusively from @incometax.gov.in domains.

Analyse the Underlying Order

The demand notice is always a consequence of an underlying order — assessment order (Section 143(3)), reassessment order (Section 147), penalty order (Section 270A/271), or rectification order (Section 154). Download and study the underlying order from the e-Filing portal to understand:

• What specific additions or disallowances were made
• The computation of tax, interest, and penalty that led to the demand amount
• Whether the order cites factual errors, legal interpretations, or procedural non-compliance

Step 2: Evaluate Your Response Options

After analysing the demand and underlying order, you have four primary response options:

Option A: Agree with the Demand (Pay in Full)

If the demand is correct — for example, a genuine computation error in your return or a TDS credit mismatch that you can verify — the simplest course is to pay the demand within 30 days. This avoids interest under Section 220(2) (1% per month on unpaid demand) and prevents the company from being treated as an assessee-in-default.

To pay: Log in to the e-Filing portal, go to Pending Actions > Response to Outstanding Demand, select Demand is correct, and proceed to payment through the Challan 280 mechanism.

Option B: Disagree with the Demand (Fully or Partially)

If the demand is incorrect or inflated, you can disagree. On the e-Filing portal, select Disagree with the demand (Either in full or Part) and choose from the available reasons:

• Demand already paid (in full or part): Provide the challan details and BSR code
• Demand already reduced by rectification/appeal: Provide the rectification or appellate order number
• Demand is not correct: Provide specific reasons why the demand computation is erroneous
• Rectification/revised return filed at CPC: Provide the acknowledgement number of the rectification request
• Appeal filed: Provide the appeal reference number

Critical warning: If you select "Demand is correct," you cannot subsequently disagree. Review the demand thoroughly before submitting your response.

Option C: File Rectification Under Section 154

If the demand arises from a mistake apparent from the record — such as a TDS credit not being allowed despite appearing in Form 168, a computation error by the CPC, or an incorrect application of tax rates — you can file a rectification request under Section 154.

To file: Go to Services > Rectification > New Request on the e-Filing portal. Select the relevant Assessment Year, the order type, and specify the corrections needed. Upload supporting documents (Form 168 reconciliation, correct computation, etc.).

Time limit: A rectification request must be filed within four years from the end of the financial year in which the original order was passed.

Important: Filing a rectification does not automatically stay the demand. If the demand remains outstanding for more than 30 days, interest continues to accrue under Section 220(2).

Option D: File Appeal to CIT(A) / JC(A)

If the demand results from a substantive disagreement — for example, the AO has made transfer pricing adjustments you contest, disallowed DTAA benefits you believe are valid, or applied an incorrect legal interpretation — you must file a formal appeal.

The first appellate authority is the Commissioner of Income Tax (Appeals) [CIT(A)] or the Joint Commissioner (Appeals) [JC(A)]. File the appeal using Form 35 on the e-Filing portal within 30 days of receiving the demand order.

Appeal fees:

Step 3: Apply for Stay of Demand

Filing an appeal does not automatically stay the demand. To prevent the IT Department from initiating recovery proceedings (including attachment of bank accounts and assets), you must separately apply for a stay of demand.

Stay Application Under Section 220(6)

Under Section 220(6), the Assessing Officer has discretion to treat the taxpayer as not being in default for the disputed amount while the appeal is pending. To apply:

1. Submit a written application to the jurisdictional AO requesting stay of the outstanding demand
2. State that you have filed an appeal with the CIT(A)/JC(A) and provide the appeal reference number
3. Present a prima facie case demonstrating why the demand is likely to be reduced or deleted on appeal
4. Offer to pay any undisputed portion of the demand (this strengthens your stay application)

CBDT guidelines on stay: The Central Board of Direct Taxes (CBDT) has issued Office Memoranda (most recently in 2016 and updated subsequently) directing AOs to grant stay of demand if:

• The assessee deposits 20% of the disputed demand (this is a guideline, not a statutory requirement — in certain cases involving high prima facie merit, a lower deposit may be accepted)
• The assessee has filed the appeal within the prescribed time
• The assessee undertakes to cooperate in the early disposal of the appeal

The AO must dispose of the stay application within 15 days of receipt. If the AO rejects the stay or imposes unreasonable conditions, the assessee can approach the CIT(A), the Principal Commissioner, or the High Court under its writ jurisdiction.

Recovery Proceedings If Stay Is Not Obtained

If the demand remains unpaid beyond 30 days and no stay is granted, the Tax Recovery Officer (TRO) can initiate recovery through:

• Attachment of bank accounts: The TRO issues a garnishee order to the company's bank, freezing the account and directing the bank to pay the demand amount to the IT Department
• Attachment of movable/immovable property: The TRO can attach and sell the company's assets
• Arrest and detention of the assessee: In extreme cases, directors can face arrest (though this is rarely invoked for corporate entities)

For foreign companies, bank account attachment is the most common and disruptive recovery action. It can freeze all operations and prevent the company from meeting payroll, vendor payments, and statutory obligations.

Interest and Penalty Implications

Understanding the financial consequences of different response strategies is essential for decision-making.

Interest Under Section 220(2)

If the demand is not paid within 30 days, simple interest at 1% per month (or part of a month) accrues on the unpaid amount from the date of the demand notice until the date of payment. This interest applies even if the assessee has filed an appeal, unless a stay of demand has been granted.

Penalty Under Section 221

If the assessee is deemed to be in default (demand unpaid for 30+ days without stay), the AO may impose a penalty up to the amount of tax in arrears. However, no penalty is leviable if the assessee proves that the default was for good and sufficient reason.

Waiver of Interest Under Section 220(2A)

In cases of genuine hardship, the Principal Chief Commissioner, Chief Commissioner, Principal Commissioner or Commissioner can reduce or waive interest charged under Section 220(2). Three conditions must be satisfied:

• Payment would cause genuine hardship to the assessee
• The default was due to circumstances beyond the assessee's control
• The assessee has cooperated in assessment and recovery proceedings

Special Considerations for Foreign Companies

Authorised Representative for e-Proceedings

Foreign companies that do not have personnel in India to respond to notices should appoint an authorised representative — a Chartered Accountant, Advocate, or Company Secretary — through a registered Power of Attorney. The representative can access the company's e-Filing account and respond to demands through e-Proceedings.

Transfer Pricing Demands and DRP

For demands arising from transfer pricing adjustments, foreign companies have an alternative to the CIT(A) appeal route. Under Section 275 of the Income-tax Act, 2025 (section 144C of the Income-tax Act, 1961), the company can file objections with the Dispute Resolution Panel (DRP) within 30 days of the draft assessment order. The DRP must issue directions within 9 months, and the AO must pass the final order within 1 month of the DRP's directions. This route is often faster than the CIT(A) appeal for transfer pricing disputes.

Advance Pricing Agreements

If your company repeatedly faces transfer pricing adjustments, consider applying for an Advance Pricing Agreement (APA) with the CBDT. APAs provide certainty on transfer pricing methodology for up to 5 years (with rollback for 4 preceding years), eliminating the risk of future demands on covered transactions.

Permanent Establishment Disputes

Demand notices arising from PE determination — where the IT Department argues the foreign company has a taxable presence in India — involve complex treaty interpretation. These cases should be handled by experienced international tax counsel and may warrant invoking the Mutual Agreement Procedure (MAP) under the relevant DTAA.

Step-by-Step Online Response Process

Here is the exact process for responding to an outstanding demand on the e-Filing portal as of 2025-2026:

1. Log in to incometax.gov.in with PAN and password
2. Navigate to Pending Actions > Response to Outstanding Demand
3. The portal displays all outstanding demands with Assessment Year, Section, DIN, and Amount
4. Click on the specific demand you wish to respond to
5. Select your response: Demand is correct OR Disagree with the demand (Either in full or Part)
6. If disagreeing, click Add reason and select applicable reasons (demand already paid, rectification filed, appeal filed, demand not correct)
7. Enter the details for each reason — challan numbers, appeal reference, or a written explanation
8. Upload supporting documents in PDF format (maximum 50 MB total)
9. If partially agreeing, you will be prompted to pay the agreed portion through Pay Now
10. Review all details carefully — you cannot edit after submission
11. Click Submit and then Confirm
12. Note the Transaction ID for your records — a confirmation email is sent to your registered email

Key Takeaways

• Respond within 30 days: Every demand notice carries a 30-day response window. Failing to respond triggers interest at 1% per month under Section 220(2), potential penalties under Section 221, and recovery proceedings including bank account attachment
• Verify before responding: Check the demand on the e-Filing portal, study the underlying order, and reconcile with your records before selecting "Demand is correct" — this choice is irrevocable
• File rectification for computational errors: If the demand arises from a TDS credit mismatch, computation error, or incorrect data processing, file a Section 154 rectification. This is faster than an appeal and can resolve simple errors within weeks
• File appeal for substantive disputes: Transfer pricing adjustments, DTAA disallowances, and PE determinations require a formal appeal to CIT(A). File within 30 days and simultaneously apply for stay of demand under Section 220(6)
• Pay 20% for stay of demand: CBDT guidelines recommend depositing 20% of the disputed demand when seeking a stay. This prevents recovery proceedings while your appeal is heard and demonstrates good faith to the authorities
• Engage a tax professional for high-value demands: For demands exceeding INR 10 lakh or involving cross-border issues, professional representation is essential. Beacon Filing's tax advisory services provide end-to-end support for demand notice responses, rectification applications, and appeal representation