Section 144C IT Act | Draft Assessment Order Must Exclude Demand Notice & Penalty Proceedings: ITAT Mumbai

The Income Tax Appellate Tribunal, Mumbai, has delivered a significant ruling affirming that the issuance of a demand notice and initiation of penalty proceedings alongside a draft assessment order under Section 144C of the Income Tax Act renders the entire assessment void. This judgment reinforces the mandatory nature of procedural compliance in transfer pricing assessments and invalidates any attempt to circumvent statutory safeguards.

Background & Facts

The Dispute

The appellant, Marriott International Inc., a non-resident corporate entity incorporated in the United States and tax-resident there, operates a centralized marketing fund for Marriott-branded hotels in India. For Assessment Years (AY) 2013-14 and 2014-15, it filed income tax returns under Section 139(1), declaring NIL income and claiming refund of Tax Deducted at Source (TDS). The Assessing Officer (AO) selected its cases for scrutiny, identifying substantial receipts from India: in AY 2013-14, Rs. 6.54 crore as International Service Marketing Fee and Rs. 6.16 crore as reimbursement of expenses; in AY 2014-15, Rs. 7.83 crore and Rs. 6.52 crore respectively. The AO concluded these receipts constituted royalty under the Income Tax Act and the India-USA Double Taxation Avoidance Agreement (DTAA), and proposed to tax them accordingly.

Key Facts

• The AO prepared draft assessment orders on 09.03.2016 (for AY 2013-14) and 29.12.2016 (for AY 2014-15), labeled as "draft assessment orders."
• Alongside these draft orders, the AO issued notices of demand under Section 156 of the Act, computing tax liability after adjusting prepaid TDS against the proposed tax.
• The computation sheets attached to the demand notices showed net tax payable, not merely proposed adjustments.
• The AO also issued notices under Section 271(1)(c) read with Section 274 for initiation of penalty proceedings for alleged concealment of income.
• The appellant did not file objections before the Dispute Resolution Panel (DRP), and the AO passed final assessment orders under Section 143(3) read with Section 144C(3).
• The appellant challenged the assessment orders before the Commissioner of Income Tax (Appeals), and subsequently before the ITAT.

Procedural History

• 09.03.2016: Draft assessment order issued for AY 2013-14, accompanied by notice of demand and penalty notice.
• 29.12.2016: Draft assessment order issued for AY 2014-15, accompanied by notice of demand and penalty notice.
• 2017-2018: Appeals filed before CIT(A); both dismissed.
• 2021: Appeals filed before ITAT (ITA No. 1622 & 1623/Mum/2021).
• 22.05.2023: Appellant filed additional grounds under Rule 11 of the ITAT Rules, challenging the validity of the draft assessment orders.
• 08.06.2026: ITAT pronounced judgment allowing the additional ground.

The Parties' Positions

For the Appellant

The appellant contended that the AO had effectively passed final assessment orders by computing tax liability, adjusting prepaid TDS, issuing demand notices, and initiating penalty proceedings - all while labeling the order as "draft." It argued that these actions conferred finality on the assessment at the draft stage, thereby bypassing the mandatory procedure under Section 144C. It relied on its own prior victories before the ITAT in AYs 2006-07 to 2009-10 and on decisions from the Karnataka High Court (Cisco Systems Services BV), the Madras High Court (Vijay Television), and the Gujarat High Court (Purshottam Das), all holding that such conduct nullifies the assessment.

For the Respondent

The Departmental Representative (DR) argued that the AO had merely labeled the order as "draft" and that the issuance of demand notices and penalty notices were procedural formalities, not indicative of finality. It relied on Section 292B of the Act, contending that any procedural irregularity could be cured, and that the appellant’s participation in subsequent proceedings estopped it from challenging the validity of the order.

Relief Sought

The appellant sought quashing of the assessment orders for AYs 2013-14 and 2014-15 on the ground that they were passed in violation of Section 144C(1), and consequently, without jurisdiction.

The Legal Issue

The central question was whether the issuance of a notice of demand under Section 156 and initiation of penalty proceedings under Section 271(1)(c) alongside a draft assessment order under Section 144C(1) constitutes a violation of mandatory statutory procedure, rendering the final assessment order void ab initio.

Arguments Presented

For the Appellant

The appellant argued that Section 144C(1) mandates a strict sequence: first, a draft assessment order must be issued; second, the assessee must be given an opportunity to file objections before the DRP; third, only after the DRP’s directions (or if no objections are filed) may the AO pass a final assessment order. The issuance of a demand notice under Section 156, which requires the tax liability to be determined, and the initiation of penalty proceedings, which presuppose a final determination of tax, are acts that can only follow a final assessment. The AO’s actions in computing tax, adjusting TDS, and issuing demand notices at the draft stage amounted to a de facto final assessment. The appellant cited Cisco Systems Services BV, Vijay Television, and Purshottam Das to show that courts and tribunals have consistently held such conduct to be fatal to the assessment’s validity. It further relied on Dipak Babaria to argue that statutory mandates must be strictly followed, and on CIT v. V.M.R.P. Firm to rebut the estoppel argument.

For the Respondent

The DR contended that the use of the word "draft" in the order and demand notice indicated compliance with Section 144C(1). It argued that the demand notice was merely a "proposed" notice and that the entries in the Demand and Collection Register and ITD portal confirmed the non-final nature of the order. It relied on Price Waterhouse Co. to suggest that similar conduct had been upheld in the past and argued that the appellant’s participation in subsequent proceedings estopped it from challenging the order under the doctrine of approbate and reprobate.

The Court's Analysis

The Tribunal conducted a meticulous review of Section 144C of the Income Tax Act, particularly sub-sections (1), (3), and (13). It emphasized that the non-obstante clause in Section 144C(1) overrides all other provisions, making the procedure mandatory and not merely directory. The Tribunal noted that the AO’s draft order contained explicit directions to compute tax liability, adjust prepaid taxes, issue demand notices, and initiate penalty proceedings - all of which are functions reserved for a final assessment order.

"While framing draft assessment order, there is no question of computing the tax liability and issuing demand notice or initiating proceedings for imposition of penalty under section 271(1)(c) of the Act when the assessment has not become final."

The Tribunal rejected the DR’s reliance on Section 292B, citing JCB India Ltd. and Turner International Pvt. Ltd., which held that Section 292B cannot cure a jurisdictional defect. The Tribunal observed that the issue was not a mere procedural irregularity but a failure to follow a statutory mandate that confers substantive rights on the assessee - the right to challenge proposed additions before the DRP.

The Tribunal also dismissed the estoppel argument, relying on CIT v. V.M.R.P. Firm, which held that equity has no place in tax matters and that statutory non-compliance cannot be cured by the assessee’s participation. It further noted that the issuance of a demand notice under Section 156 is not a mere formality but an integral part of the assessment process, as affirmed by the Supreme Court in Kalyan Kumar Ray and the Gujarat High Court in Purshottam Das.

The Tribunal found the AO’s conduct in AYs 2013-14 and 2014-15 to be identical to the facts in its own prior decision in Marriott International Inc. v. DCIT (ITA No. 3232 & 3235/Mum/2018), where the draft assessment orders were quashed for the same reasons. It concluded that the AO had bypassed the entire DRP mechanism, thereby acting without jurisdiction.

The Verdict

The appellant succeeded. The ITAT allowed Additional Ground No. 6 and quashed the draft assessment orders dated 09.03.2016 and 29.12.2016 for Assessment Years 2013-14 and 2014-15, holding them to be wholly without jurisdiction. The Tribunal held that the issuance of demand notices and initiation of penalty proceedings at the draft stage rendered the entire assessment void. The other grounds raised by the appellant were rendered academic and kept open. The order was pronounced on 08.06.2026.

What This Means For Similar Cases

Draft Assessment Orders Must Remain Non-Final

• Practitioners must ensure that draft assessment orders under Section 144C(1) contain no computation of tax liability, no adjustment of TDS against proposed tax, and no reference to demand notices or penalty initiation.
• Any document labeled as "draft" that includes tax computation or demand details is vulnerable to being quashed.

Section 292B Cannot Cure Jurisdictional Defects

• The Revenue’s reliance on Section 292B to save assessments with procedural flaws is now legally untenable.
• Courts and tribunals have consistently held that failure to follow mandatory procedures under Section 144C is an incurable illegality, not a mere irregularity.

DRP Process Is Not Optional

• The DRP mechanism under Section 144C is a substantive right, not a procedural formality.

• Taxpayers must be given a clear opportunity to object before the DRP; any attempt to bypass this by issuing final assessment actions prematurely will result in nullification of the entire assessment.

• Practitioners representing taxpayers should immediately challenge any assessment order where the draft order is accompanied by a demand notice or penalty notice.

• Revenue officials must be trained to issue draft orders strictly as proposed variations only, without any finality-indicating actions.

• In transfer pricing cases, this judgment reinforces the need for strict adherence to the statutory sequence: draft order → DRP objections → DRP directions → final order.

• This precedent applies equally to all eligible assessees under Section 144C, including multinational corporations with transfer pricing arrangements in India.