• Dated 25^th November, 2025

Judicial Caution on AI-Generated Errors in Tax Assessments/Tax Adjudication

Brief Facts:

The case concerns an assessment order passed by the The National Faceless Assessment Centre (NFAC) in which additions under Section 68 of income tax act were made using peak-credit calculations. During judicial review, the Bombay High Court noted that the NFAC had relied upon three judicial precedents that did not exist. The Court also found that the NFAC had ignored crucial factual material such as the supplier's detailed response under Section 133(6) income tax act.

Recognising that these fabricated citations were similar to AI-generated hallucinations, the Court expressed serious concern regarding unverified reliance on AI tools in quasi-judicial tax proceedings. The Court, however, clarified that it was not examining the merits of the additions and kept the parties' rights open.

Assessee's Contention:

The assessee argued that the assessment order suffered from grave procedural and factual defects, including:
Reliance on non-existent case laws, which demonstrated lack of verification and non-application of mind.

Ignoring material evidence furnished by the supplier, including responses under Section 133(6) income tax act.

Violations of natural justice due to opaque reasoning and failure to consider key facts.

These failures, according to the assessee, resulted in an arbitrary and unsustainable assessment.

Department's Contention:

The NFAC relied on system-assisted assessment processes and judicial precedents (which were later found to be fictitious). The department's stance was that the additions were made based on the information available to the Assessing Officer and system-generated support.

The department did not initially dispute the existence of the cited case laws, but the Court required the department to explain the source of those fabricated judicial precedents - hinting at the use of AI-based search/research tools.

Decision Held by Hon'ble HC:

The Bombay High Court set aside the assessment order, holding that:

Reliance on non-existent judicial precedents amounts to a serious breach of natural justice.

Use of AI-generated or AI-assisted results cannot replace human judicial reasoning, and officers must independently verify every legal authority cited.

Both failure to consider relevant factual evidence and reliance on AI-induced errors are fatal to the legality of a quasi-judicial order.

As India moves towards system-driven and faceless assessments, human oversight must increase, not diminish.

The Court refrained from commenting on the merits of the additions and kept all contentions open.

BTA's Remarks

This judgment is one of India's earliest judicial warnings on the risks of unverified AI usage in tax administration. It establishes an important principle that AI can assist, but not replace, human judgment in tax adjudication. Any assessment relying on AI outputs—especially fabricated case law, templated reasoning, unexplained conclusions—may be struck down for violating natural justice.

(Case Reference: KMG Wires Pvt. Ltd. v. NFAC, before Bombay High Court, 6 October 2025 in Writ Petition 24366 OF 2025.)

Author: Saket Shaw