Income Tax

Refund Adjustment Under Income-tax Act 2025: Notice Triggers, Response Strategy and Penalties

By CA Nikhil Gupta High Priority Updated June 2026 ITR Season 2026

Reviewed by CA Nikhil Gupta · Last reviewed 26 September 2026

Corrected 26 September 2026: the earlier version described a "Section 245A" that does not exist — refund set-off is Section 438 of the Income-tax Act 2025 (old Section 245). It also cited wrong sections for rectification, appeal, interest, penalty and TDS default (Sections 287, 357, 411, 412 and 398), and presented the 30-day response window as a statutory period (it is CPC practice; Section 438 requires only a written intimation).

You filed your ITR, your Form 26AS confirms TDS, and you're expecting a refund of ₹45,000. Then the e-filing portal shows: "Your refund of ₹45,000 has been adjusted against outstanding demand of ₹38,000 for AY 2020-21. Net refund payable: ₹7,000." This scenario is playing out across thousands of taxpayer accounts in the ITR 2026 season. The Income-tax Act 2025 retains the refund adjustment power under Section 438 — but also retains your right to contest it. This guide walks you through the triggers, the 30-day window, and the step-by-step response strategy.

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Section 438 of the Income-tax Act 2025 — The New Provision

Under the old Income Tax Act, 1961, Section 245 allowed the Assessing Officer (AO) to adjust any refund due to a taxpayer against any outstanding demand. The Income-tax Act 2025 carries this forward under Section 438, which requires a written intimation to the taxpayer before the adjustment. CPC's notice in practice allows a 30-day response window before making the adjustment.

Aspect	Old Act (Section 245)	New Act (Section 438)
Provision name	Section 245 — Set-off of refunds against tax remaining payable	Section 438 — Set off and withholding of refunds in certain cases
Prior notice required	Yes — intimation before adjustment	Yes — written intimation mandatory (Section 438)
Response time for taxpayer	The section requires written intimation but fixes no period; CPC's notice typically allows 30 days	The section requires written intimation but fixes no response period; CPC's notice continues to allow about 30 days
Demands eligible for set-off	Any tax, interest, penalty outstanding	Any tax, interest, penalty, fee outstanding under new Act
Consequence of no response	Deemed consent; adjustment proceeds	Deemed consent; adjustment proceeds
Adjustment limit	Full refund can be adjusted	Full refund can be adjusted; excess demand stays alive

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The 30-Day Clock Is Absolute: Once the Section 438 notice lands in your e-filing inbox, the 30-day countdown begins immediately — regardless of whether you log in or read it. Set up SMS/email alerts on the e-filing portal for all compliance notices under your PAN. Missing this window means automatic adjustment with no further portal remedy.

What Triggers a Refund Adjustment Notice

Not every outstanding demand leads to a Section 438 notice. The AO (or CPC's automated system) checks the following before initiating adjustment:

Confirmed outstanding demand: The demand must be confirmed — not merely raised. If you've filed a rectification or an appeal that is pending, the demand should technically be under dispute.
Refund due in the current year: A refund must be crystallised and payable in the same PAN — refunds from one PAN cannot be adjusted against demand on another entity.
No stay order in force: If CIT(A), ITAT, High Court, or Supreme Court has granted a stay on the demand, the adjustment cannot be made.
No deposits exceeding demand: If you have deposited 20% of the demand as pre-deposit for an appeal, many AOs treat it as reduced demand — though this is not always automated at CPC level.

Common Trigger Scenarios

Trigger	Demand Origin	What Typically Goes Wrong
Old TDS mismatch	AY 2018-19 to AY 2022-23 processing intimations	TDS not reflecting in 26AS; deductor didn't file TDS return correctly
Unverified AIS data	CPC automated processing under Section 143(1)	Interest income or dividend income added by AIS but not reported in ITR
Revised return not processed	Original ITR processed with errors before revised ITR	Both demands live simultaneously; CPC adjusts against older demand
Unreported capital gains	STT/SFT data in AIS shows capital gains not declared	Short-term gain on mutual fund sale via broker not included in ITR
Old penalty not paid	Penalty under Section 271(1)(c) or old sections	Penalty from concluded scrutiny assessment years old, forgotten by taxpayer

Step-by-Step Response Strategy — The 30-Day Window

How to Respond to a Section 438 Notice

Log into e-filing portal immediately. Go to incometax.gov.in → e-Proceedings → Outstanding Demand. Note the exact demand details: assessment year, section under which demand raised, and the amount.

Verify the demand's origin. Cross-check the demand year's ITR acknowledgment, Form 26AS for that year, and any previous rectification filings. If the demand arose from a mismatch that has since been corrected (e.g., deductor filed revised TDS return), gather that evidence.

Respond via the portal. Under e-Proceedings → Response to Outstanding Demand, submit your response as: (a) "Demand is correct and paid" — with challan details, or (b) "Demand is incorrect" — upload supporting documents like corrected 26AS, TDS certificate, order copy, or stay order.

If a stay order is in force, upload the stay order copy and the appeal reference number (ARN). Click "Demand is under appeal — stay granted" and attach both documents. This should halt the adjustment process within 3–5 working days.

Take a screenshot with timestamp of your response submission confirmation. This is your proof of timely response. Download the acknowledgment PDF from the portal immediately.

If adjustment has already occurred (you received less refund than expected), file a grievance under the e-Nivaran module on the portal — or directly call the CPC Bengaluru helpdesk at 1800-103-0025. The grievance must be filed within 30 days of refund credit.

Case Study: Rajesh's ₹55,000 Refund Swallowed by a 6-Year-Old TDS Demand

IT Consultant, Pune — AY 2026-27 Filing vs AY 2020-21 Demand

Rajesh, a senior IT consultant, filed his AY 2026-27 ITR in July 2026 expecting a ₹55,000 refund (excess TDS deducted by his employer). In August 2026, he received a Section 438 intimation: refund to be adjusted against ₹42,000 outstanding demand for AY 2020-21 (a processing intimation under old Section 143(1) that had flagged his savings bank interest).

Rajesh checked his AY 2020-21 record. He had declared the interest income in his ITR — but his bank had filed its SFT report late, and CPC had added the interest again from AIS, creating a ₹42,000 duplicate demand. He had never noticed the demand notification on the portal.

He logged into e-Proceedings and found the original AY 2020-21 intimation with the demand
He obtained a letter from his bank confirming the SFT correction filed in January 2023
He responded within 15 days with the bank letter and ITR extract showing the interest already declared
CPC reviewed and dropped the demand within 3 weeks; full ₹55,000 refund credited

Expected Refund

₹55,000

Wrongful Demand

₹42,000 (AY 2020-21)

Response Filed

Day 15 of 30-day window

Outcome

Full refund recovered

When the Adjustment Has Already Happened — Recovery Path

If you missed the notice and the refund was already adjusted, your options depend on whether the underlying demand is correct:

If the Demand Is Correct (But You Disagree With Quantum)

File a rectification application under Section 287 (Income-tax Act 2025; old Section 154) for any arithmetic or factual errors in the original assessment order.
File an appeal under Section 357 (new Act) before the Commissioner of Income-tax (Appeals) within 30 days of the order.
Pay 20% of the confirmed disputed demand as pre-deposit if you wish to stay the remaining demand while appeal is pending.

If the Demand Is Completely Wrong (Data Error / Duplicate)

File a Grievance on the e-filing portal under "Refund / Demand" category with documentary evidence.
For demands arising from old 143(1) intimations based on AIS data errors, approach the deductor/SFT filer for a correction certificate.
If CPC is unresponsive, escalate to your jurisdictional AO via a written representation, citing the incorrect data and requesting rectification or withdrawal of the demand under Section 287 of the Income-tax Act 2025.

🚨

Do NOT Ignore Old Outstanding Demands: Before filing your AY 2026-27 ITR, go to incometax.gov.in → e-File → Response to Outstanding Demand and clear any old unaddressed demands. If you have filed appeals, upload the appeal filing proof against each demand. Proactive clearance before ITR filing prevents the refund adjustment surprise entirely.

Penalties and Interest on Unaddressed Demands

Beyond refund adjustments, unresolved demands carry continuing costs under the Income-tax Act 2025:

Consequence	Applicable Section (New Act)	Rate / Impact
Simple interest on unpaid demand	Section 220(2) → Section 411 of the new Act	1% per month from demand date until payment
Penalty for failure to pay demand	Section 221 → Section 412 of the new Act	Up to 100% of tax in arrears; AO discretion
Recovery proceedings	Section 226 → Sections 413 to 422 of the new Act (recovery)	Attachment of bank accounts, property; can be initiated after 30 days of demand
TDS default interest on short deduction	Section 201(1A) → Section 398 of the new Act	1% per month (short deduction); 1.5% per month (non-remittance)

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Pre-Filing Demand Audit — Do This Every Year: Log into the e-filing portal 2–3 weeks before filing your ITR. Check three sections: (1) Response to Outstanding Demand, (2) View Rectification Status, and (3) Grievances. Clear or respond to every open item. This takes 20 minutes and prevents months of refund delays.

The AIS Mismatch — Root Cause of Most 2026 Adjustments

A significant portion of adjustment notices in the 2026 ITR season stem from Annual Information Statement (AIS) data discrepancies. The AIS aggregates data from multiple sources — banks, mutual funds, brokers, property registrars, and foreign remittance banks. When the AIS data differs from your ITR declaration, CPC raises a demand under the processing intimation.

Common AIS vs ITR Mismatches Causing Demands

Savings account interest: Multiple banks report interest; taxpayer declares net but misses one account
Dividend income: Dividend from old physical folio shares not in demat — not auto-populated in ITR portal pre-fill
Mutual fund redemptions: Switch transactions (Growth to IDCW) reported as "sale" in AIS but no gain since same folio
Employer stock options: ESOP perquisite reported twice — by employer in 26AS and by depository in AIS
NRI property sale: Property registrar reports full sale value; taxpayer correctly claims indexed cost — AIS shows gross proceeds as "income"

Refund Season 2026 — Pre-Filing Checklist

Log in to e-filing portal and check "Response to Outstanding Demand" for all assessment years
Download AIS and TIS from portal; reconcile with your actual income records
File AIS feedback for any incorrect data (option: "Income is not pertaining to me" or "Duplicate entry")
Verify Form 26AS for all TDS credits; cross-check with employer Form 16 and bank TDS certificates
For any demand under appeal, upload appeal order / stay order in e-Proceedings section
For demands already paid, upload challan details in "Demand Response" against each open demand
If deductor has filed a correction TDS return, obtain revised Form 16A before filing ITR
Screenshot every response submission with portal-generated acknowledgment number

🧮 Tax Calculator 📋 TDS Calculator ⚖️ Old vs New Regime

Frequently Asked Questions

No. Section 438 set-off is PAN-specific. A refund due on your individual PAN cannot be adjusted against a demand on your proprietorship firm's PAN (same PAN, different entity type), partnership firm, HUF, or company — even if you are a partner or director. However, if you and your sole proprietorship share the same PAN (which they do), then all income and demand on that PAN are consolidated.

Yes — there is no time limit on which assessment year's demand can be adjusted against the current year's refund. Demands from AY 2010-11 onwards (or earlier, if still outstanding) are eligible. The critical condition is that the demand must be "confirmed" and not stayed. This is why pre-filing demand clearance is essential every year.

Yes. If you successfully appeal and the demand is reduced or deleted, the excess tax paid (including the amount that was "adjusted" from your refund) becomes refundable with interest under Section 244A of the Income-tax Act 2025. The interest rate is 6% per annum from the date of payment of the demand (or adjustment date) to the date of refund. This is a meaningful protection — but you must actually file the appeal to claim it.

The Income-tax Act 2025 treats service of notice through the e-filing portal as valid service — regardless of whether you read the email. Notices are deemed served once uploaded to your portal account. You are responsible for keeping your contact details and profile updated on the e-filing portal. If your registered email is wrong, update it immediately under "Profile → My Profile → Contact Details." Claiming non-receipt due to outdated contact info has not been accepted by courts as a ground to quash the adjustment.

Sources: Income-tax Act 2025 (Sections 287, 357, 411, 412, 437 and 438) — Ministry of Finance notification; incometaxindia.gov.in e-Proceedings module; CBDT Circular on refund adjustment procedures; CPC Bengaluru processing guidelines 2026.

Disclaimer: This article is for educational and informational purposes only. It does not constitute legal or tax advice. Tax positions depend on individual facts. Consult a qualified Chartered Accountant or tax professional for your specific situation. Finin2min is not liable for any action taken solely on the basis of this content.

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